A 501(c)(3) Organization: What Is It?
A section of the U.S. tax code is 501(c)(3). The Internal Revenue Code (IRC) and a specific tax classification are both applicable to nonprofit organizations. Exemption from paying federal income taxes by complying with Section 501(c)(3) standards. Although there are more than 30 different kinds of nonprofit organizations recognized by the Internal Revenue Service (IRS), only those who are granted 501(c)(3) status are able to claim that donations to them are tax deductible.
The majority of businesses that may qualify for 501(c)(3) designations belong to one of three groups: charity organizations, churches and other places of worship, or private foundations. The US governs the regulations established in Section 501(c)(3). IRS on behalf of the Treasury.
KEY LESSONS
A section of the U.S. tax code is 501(c)(3). The Internal Revenue Code (IRC) and a specific tax classification are both applicable to nonprofit organizations.
501(c)(3)-compliant organizations are exempt from paying federal income taxes.
Although there are more than 30 different kinds of nonprofit organizations recognized by the IRS, only those can claim that donations made to them are tax deductible.
Fair market value salaries must be paid to employees by 501(c)(3) organizations.
The nonprofit organization must adhere to its goal or objective in order to qualify for its favored tax treatment.
A 501(C) Organization: What Is It?
Workings of a 501(c)(3) Organization
The IRS defines a charitable organization as one that operates solely for one of the following purposes: charitable, religious, educational, scientific, literary, testing for the general welfare, promoting amateur sports competition on a national or international scale, or stopping cruelty to children or animals.
“Charitable” activities are further defined by the IRS as activities that provide relief of the underprivileged; advance religion, education, or science. The erecting or maintaining public buildings, monuments, or works; lessening the burdens of government are considered charitable. Reducing neighborhood disputes, prejudice, discrimination and defending the rights secured by law; and combating community decay and juvenile delinquency.”
Standards for 501(c)(3) Organizations
An organization must not be advancing any private interests in order to qualify for Section 501(c)(3) tax exemption, including the interests of the organization’s founder, the creator’s family, stockholders, other named individuals, or any people under the control of private interests. All net earnings of the organization shall be used only for the development of its philanthropic purposes, and no part of the net earnings of the organization shall inure to the advantage of any private shareholder or individual.
A 501(c)(3) organization is likewise prohibited from utilizing its operations to significantly influence legislation, including by taking part in any political candidate support or opposition efforts. Generally speaking, lobbying is not allowed (except when its expenditures are below a certain amount).
The organization is required to pay employees “reasonable compensation,” which is determined by the fair market value needed to perform the job function.
Until the IRS cancels the designation, a group’s 501(c)(3) classification stands for the duration of the group’s existence.
An organization must also continue to fulfill its original mission in order to maintain its Section 501(c)(3) tax exemption. An organization must continue to pursue its stated goal if it previously informed the IRS that it was committed to assisting underprivileged people in obtaining access to higher education. The 501(c)(3) organization must first notify the IRS of its change of operations if it decides to pursue another vocation, such as providing aid to displaced families in impoverished nations, in order to keep its tax-exempt status.
501(c)(3) organization are allowed to collect some unrelated business income; but, the tax-exempt charity is not permitted to receive a sizable amount of income from unrelated business operations. As a nonprofit organization, the firm’s primary focus must therefore be on fulfilling its exempt purpose. The IRS does not specify how much is too much unrelated business income, but Hurwit & Associates, a law firm that specializes in representing nonprofits, estimates the amount at between 15% and 30%. Any unrelated business from sales of goods or income from rental properties could cause the organization could lose its 501(c)(3) status.
While Section 501(c)(3)-compliant organizations are exempt from federal income tax, they are nevertheless obligated to deduct federal income tax from employee paychecks as well as pay Social Security and Medicare taxes. Nonetheless, they are exempt from paying federal unemployment taxes.
Particular Considerations
Public charities and private foundations are two categories into which organizations can be categorized if they satisfy the 501(c)(3) tax category standards. The primary distinction between these two groups is how they are supported financially.
The public good
A nonprofit with a significant amount of its income or revenue coming from the general public or the government is considered a public charity. Public donations must account for at least one-third of the organization’s revenue (including individuals, corporations, and other nonprofit organizations).
An individual may be eligible for tax deductions that lowers their taxable income if they make a donation to a charity that the IRS deems to be a public charity. In general, a person’s ability to deduct donations to tax-exempt public charities is capped at 50% of their adjusted gross income (AGI). Donations to recognized charity organizations, such as 501(c)(3), are not, however, subject to any restrictions (3).
Individual Foundation
A private foundation often belongs to an individual, a family, or a business, and the majority of its funding comes from a select few donors. Public charities are not subject to the same rules and restrictions as private foundations. If a 501(c)(3) organization cannot demonstrate that it satisfies the requirements of the IRS to be categorized as a public charity, it is automatically classified as a private foundation. Contributions to private foundations have fewer tax benefits than gifts to public charities.
Most nonprofit organizations must submit Form 1023 or Form 1023-EZ within 27 months after the date of formation in order to request Section 501(c)(3) tax-exempt status. The articles of incorporation for the nonprofit organization and documentation demonstrating that it only serves exempt purposes must be included.
Not all organizations that fall within the tax category, meanwhile, are required to submit Form 1023. For instance, public charities are excluded from filing this form if their annual revenue is $5,000 or less. They are not required to file the form, but they may do so if they want to guarantee that donations made to their organization would be tax deductible for contributors.
Benefits and Drawbacks of 501(c)(3) Organizations
The 501(c)(3) designation provides the authorized organizations and the beneficiaries it supports with a wide range of advantages. To begin with, 501(c)(3) organizations are excluded from paying federal income and unemployment taxes, and donors to them are welcome to claim a tax deduction for their gifts.
These organizations are qualified to obtain grants from the public and private sectors to assist with funding and further their missions. The organization’s mission must be compatible with the grant’s objectives, and it must demonstrate a need for the funding. Moreover, 501(c)(3) organizations frequently receive food and supplies from other nonprofit organizations created to help in times of need, discounts from shops, free publicity via public service announcements, and other benefits.
Although becoming a 501(c)(3) may have been the founder’s lifelong ambition, the organization no longer belongs to the creator after that point. Instead, it is a public organization with a clear objective. It must adhere to the 501(c)(3) regulations in order to keep its advantageous tax treatment.
The company must function completely transparently because it provides services to the general population. This means the public has access to and can analyze its finances, including its salaries.2021
Pros
not subject to federal taxes
Donations are deducted from income.
being qualified for both public and private funding
Cons
not the property of those who produced it
limited to particular operations in order to qualify for tax exemptions
Financial data is available to the general public.
A 501(c)(3) Organization Example
One of the first nonprofit organizations in the United States was the American Red Cross, which was founded in 1881 and granted congressional authorization in 1900. Since its founding, the organization has aimed to assist active-duty military personnel and provide aid during natural disasters.
The Red Cross manages the world’s broadest network of volunteers, which is spread over 191 nations. The National Red Cross has three departments that make up this 501(c)(3) organization.
The American Red Cross seek to alleviate human suffering on a global scale by enabling subordinate groups to work inside their country’s borders to offer disaster relief, educational programs, and other related services. During times of peace, the International Federation of Red Cross and Red Crescent Societies offers international humanitarian aid, such as helping refugees. Those impacted by war or other armed conflicts can get humanitarian aid from the International Committee of the Red Cross.
Contributions to the Red Cross may be made by individuals who itemize their tax deductions and claim the donation as a deduction. Up to $600 of a taxpayer’s 501(c)(3) contributions may still be deducted from their taxes in 2021 if they take the standard deduction.
How Can a 501(c)(3) Be Started?
You must specify the kind of organization and its goal or objective in order to create a 501(c)(3). Make sure the name is available before choosing it by conducting a search. Get the name by registering it with your state, if it is available. If not, make sure to reserve the name when you submit the articles of incorporation.
IRS (Form 1023) and state tax exemption for nonprofit organizations applications should be made after filing. Create your organization’s bylaws, which outline the organization’s governance and structure, once everything is finished. The last step is to elect and convene your board of directors.
What Does It Cost to Launch a 501(c)(3) Organization?
Depending on the requirements of the organization, different 501(c)(3)s have different fees to establish them. Some costs, nevertheless, can be roughly estimated. For instance, it normally costs $100 to file the articles of incorporation with the state. The filing fee for IRS Form 1023 is $600. However, Form 1023 EZ can be filed for $275 by companies with expected yearly earnings of under $50,000.
the timeframe for a Letter of 501(c)(3) Determination?
After submitting a request for 501(c)(3) exemption, a determination letter is delivered. The IRS does provide a list of 10 ideas that can speed up the process, but will only declare that “applications are processed as promptly as feasible” and “are handled in the order received by the IRS.”
Anecdotally, according to the website BoardEffect, which provides software “that makes the work of boards of directors easier, more efficient and more effective,” it may take as little as two to four weeks if you can file Form 1023-EZ, but choosing file Form 1023 will probably have to wait anywhere from three to six months to a year, to receive their letter.
Is a 501(c)(3) Required to Be a Corporation?
The IRS states that in order for an organization to be eligible for 501(c)(3) status, it must have been established “as a trust, a company, or an association.”
What Distinguishes a 501(c)(3) From a 501(c)(4)?
An organization classified as 501(c)(3) must be nonprofit created specifically for one of the following purposes: charitable, religious, educational, scientific, literary, testing for public safety, promoting amateur sports competition on a national or international scale, or stopping cruelty to children or animals. While 501(c)(4) organizations, which are also nonprofit and are social welfare groups, are allowed to lobby, most of these organizations are forbidden from doing so.
the conclusion
Organizations with a 501(c)(3) status are nonprofit associations with a clear objective. These include private foundations as well as the churches and charities that the majority of people are familiar with. They obtain advantageous tax treatment, such as avoiding federal income and unemployment taxes, as long as they operate to further their objective.