Organizations that qualify as a 501c3 nonprofit can enjoy various tax-related benefits. Although there are different types of 501c organizations, ranging from 501c1 to 501c29, 501c3 nonprofits are unique because their donations are tax deductible. Since they are also exempt from federal income tax, 501c3 organizations are the most sought after nonprofit status.
What is a 501c3 Nonprofit Organization?
A 501c3 nonprofit is an organization that is exempt from federal income tax. More specifically, section 501c3 is a part of the U.S. Internal Revenue Code (IRC) and a distinct tax category for nonprofit organizations. This means that 501c3s don’t need to pay any taxes on the money they make.
Although the Internal Revenue Service (IRS) acknowledges over 30 types of nonprofit organizations, only 501c3 qualified organizations can claim tax deductibles on donations. Most organizations that qualify for 501c3 nonprofit status are charitable organizations, private foundations, and churches and religious organizations.
Unlike corporations and limited liability companies (LLCs), nonprofit organizations don’t seek to make a profit. Typically, 501c3s want to make money in order to further a social cause or provide a public benefit. After a nonprofit organization pays off its office expenses, salaries, and so forth, it uses the excess money for the specific cause it supports.
Since 501c3 nonprofits don’t pay taxes, the nonprofit maximizes the amount of money it uses towards its specific social cause. There are 1,919,926 nonprofit organizations in the United States with churches and religious organizations as well as schools and educational institutions leading the pack.
How Does a 501c3 Nonprofit Work?
To qualify as a 501c3 nonprofit by the IRS, an organization must exist exclusively for one or more of the following purposes:
- Testing for public safety
- Fostering national or international amateur sports competition
- Preventing cruelty to children or animals
If the nonprofit doesn’t exist for one of the purposes above, it will not qualify for 501c3 status.
The IRS also describes what “charitable” activities include:
- Providing relief for the poor, distressed, and underprivileged
- Advancing religion
- Advancing science or education
- Erecting or maintaining public buildings, monuments, or works
- Lessening the burden of governments
- Lessening neighborhood tensions
- Eliminating prejudice and discrimination
- Defending human and civil rights secured by law
- Combatting community deterioration
- Addressing juvenile delinquency
A common misconception about nonprofits is that they are only run by volunteers. However, most 501c3s have salaried staff that work for the organization. But nonprofits may use volunteers to perform some of the nonprofit services under the direction of paid staff.
Types of Different 501c3 Nonprofit Organizations
The organizations that qualify under section 501c3 are classified into two categories: public charities and private foundations. The difference between them is how they receive financial assistance.
Public charities receive most of their revenue or income from the government or the general public. To qualify as a public charity, the nonprofit must receive at least one-third of its income from public donations. These include donations from corporations, individuals, and other nonprofit organizations.
Individuals who donate to a public charity qualify for certain tax deductions that will lower their taxable income. Usually, individuals can claim a deduction of up to 60% of their adjusted gross income (AGI). Corporations can claim up to 10% when filing taxes.
Individuals, families, or corporations are usually the ones who hold private foundations. This type of 501c3 nonprofit receives most of its income from a small number of donors. Furthermore, private foundations adhere to stricter rules and obligations than public charities. All 501c3 nonprofits are automatically considered a private foundation unless they can prove to the IRS that they meet the guidelines of a public charity.
What are the 501c3 Nonprofit Requirements?
If you’re considering starting a 501c3 nonprofit organization, it’s important to understand the requirements.There are specific rules and regulations a nonprofit must follow to maintain its status.
The 501c3 nonprofit requirements include:
- It can only be organized and operated for exempt purposes
- It’s forbidden from using its activities to influence legislation in a substantial way
- It cannot be organized and operated for any personal or private interests
- It can make profits, but all profits must go towards charitable purposes
- Staff employed by the nonprofit must be paid “reasonable compensation” based on the fair market value that the job function requires
- It’s required to remain true to its founding purpose
- It must withhold federal income tax from its employee’s paychecks and pay Social Security and Medicare taxes
After an organization is considered a 501c3, the designation remains for as long as the organization exists unless the IRS revokes it. The IRS can revoke the 501c3 designation if the organization fails to follow the nonprofit requirements listed above.
Bylaws of a 501c3 Nonprofit
Similar to regular corporations, 501c3 nonprofit organizations have a set of bylaws and a number of directors and officers. Nonprofit bylaws are the rules that determine how a 501c3 nonprofit will be governed and run. You can view it as a constitution for the nonprofit organization.
It helps clarify the rules and priorities of everyone involved in the nonprofit. The directors of a 501c3 are responsible for overseeing the organization’s operations. The nonprofit’s board of directors is responsible for management level hirings, such as officers and managers.
The officers of a nonprofit, such as the president or secretary, are individuals with responsibilities and the authority to execute based on their job description.
Advantages and Disadvantages of a 501c3 Nonprofit
The primary advantage of a 501c3 nonprofit is that it’s exempt from paying federal income and unemployment taxes. Furthermore, patrons who donate to a 501c3 can claim a tax deduction for their contributions.
501c3 organizations are also eligible to receive government and private grants. However, the organization needs to have a mission that aligns with the purpose of the grant and a need for the funds. Another advantage of 501c3s is that they frequently receive discounts from retailers, food and supplies from other nonprofit organizations when needed, and free press from public service announcements.
On the other hand, once an organization is officially a 501c3 nonprofit, it no longer belongs to the founder. Instead, it becomes a mission-oriented organization that belongs to the public. Since the organization serves the public, it must operate with complete transparency.
Frequently Asked Questions (FAQs) for 501c3 Nonprofit
We understand that you may have additional questions about 501c3 nonprofits. So here is a list of common questions about nonprofit organizations and our answers.
Bottom Line on 501c3 Nonprofit Organizations
501c3 nonprofits are organizations with a distinct mission and cause. The majority of people know them as charities and churches, but private foundations can also be 501c3 nonprofits. As long as they qualify under section 501c3 by the IRS, the organization receives favorable tax treatment and is exempt from federal income and unemployment taxes.