If you're planning to form a nonprofit organization, it's important to understand that not all 501(c) groups are created equal. There are dozens of options, but some are more common than others.
501(c) exemptions tend to be a bit misunderstood; too often, you'll hear people wondering how political groups, or organizations like the National Football League, are given tax-exempt status. The problem is that, when most people think about a tax-exempt organization, they are picturing corporations that have filed for 501(c)(3) status.
What is a 501(c) organization?
When it comes to your organization soliciting and receiving monetary donations, it's important to remember that the IRS gets a cut of the proceeds. In many instances, the IRS sees donations as taxable income unless they meet certain criteria. For instance, the donations must have been made to an eligible 501(c) charitable organization.
A 501(c) organization is one of 29 different kinds of nonprofit organizations that have been exempted from taxation. Under the law, such organizations are "organized for the exclusive purpose of holding title to property, collecting income therefrom, and turning over the entire amount thereof, less expenses, to an organization which itself is exempt."
Organizations that may fall under this regulation include any "community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes." Others that would be considered a 501(c) are organizations that foster national or international amateur sports, and organizations that prevent cruelty to children or animals.
According to federal regulations, none of the earnings from the organizations can go to a single person, nor should the collected funds be used for political and legislative lobbying activities.
For individual donors, any contributions made to a 501(c) can be tax deductible if the respective federal income tax return is itemized.
What is the difference between 501(c) and 501(c)(3)?
As it stands, a 501(c) is any organization that falls within one of the 29 kinds of nonprofit organizations that have been exempted from federal income tax. Each kind of 501(c) nonprofit addresses a different need or use. Only two can solicit tax-free donations.
The 501(c)(3) has long been considered the most common type of 501(c) nonprofit organization. According to the IRS, 501(c)(3) entities typically have charitable, educational, or religious missions and don't turn a profit. Additionally, they create a nonpolitical public good; thus, any donations are tax deductible.
What are the different types of 501(c) organizations?
There are 29 kinds of 501(c) organizations. While the 501(c)(3) classification might be the best-known, here are some other options that may better fit your needs.
501(c)(4): Civic Leagues, Social Welfare Organizations, and Local Associations of Employees
A 501(c)(4) exemption is the most popular type after the 501(c)(3). Groups that qualify for a 501(c)(4) exemption are supposed to promote social welfare, so organizations like volunteer fire stations and Rotary Clubs are the entities that normally seek a 501(c)(4) exemption.
They get a bad reputation, however, because they are technically allowed to lobby for the furtherance of whatever social mission they embody. As not everyone agrees on what benefits society, some 501(c)(4) organizations are seen as a political problem. Don't write this exemption off, though: A lot of c4 groups do good work.
Some donations to a 501(c)(4) are tax deductible, and others are not. Normally, a c4 has to disclose that information whenever it solicits donations.
501(c)(5): Labor, Agricultural and Horticultural Organizations
Labor and agricultural unions typically seek a 501(c)(5) exemption. There aren't many active unions registered with the IRS, but famous labor organizations like Unite Here, United Auto Workers, and the Teamsters all have 501(c)(5) exemptions.
Though some people disagree with giving organized labor groups tax-exempt status, as they are occasionally believed to have political agendas, the reasoning behind the decision is that these groups spend member dues to better the lives of the laborers and farmers they represent. Donations, or dues paid, are also typically deductible, but as a business or trade expense rather than a charitable contribution.
501(c)(6): Business Leagues, Chambers of Commerce, Real Estate Boards, etc.
501(c)(6) is another slightly controversial tax-exempt status, since the organizations that would qualify for it represent businesses that do turn a profit. A 501(c)(6)-qualified group is typically an association or league of business owners who have united for a common purpose, like furthering the interests of their members within the local community, or giving business owners a united voice to effect change.
The NFL, which has been under fire for its tax-exempt status, is a 501(c)(6). As with c5 organizations, though, any dues paid or donations given to a c6 do not qualify as tax-deductible, charitable contributions.
501(c)(7): Social and Recreational Clubs
There are only a few hundred 501(c)(7) groups registered with the IRS. To qualify, the entity has to be created solely for recreation or other social purposes, so you'll often see country clubs with a 501(c)(7) status. Though these entities do collect dues, any money coming in has to be used in the best interest of the club's members. Since no profit is generated, there is nothing to tax.
501(c)(8): Fraternal Beneficiary Societies and Associations
Like c7s, 501(c)(8)-qualified groups are sustained by member fees and donations. Interestingly, the only fraternal societies that qualify for c8 deductions are those that operate with a lodge or chapter system. They also need to prove they offer a system of support, like discounted insurance or death benefits, for their members and their members' immediate families. Fraternal societies that use a lodge system and don't offer these benefits can still qualify for tax-exempt status, but they have to apply for a 501(c)(10) exemption and devote their earnings to charitable causes.
The one uniting factor for all tax-exempt, 501(c)-qualified entities is the fact that the IRS will keep a close eye on their finances. If you are considering forming a nonprofit entity, it's a good idea to talk your options over with an attorney or another expert. Though a 501(c)(3) exemption is the most popular, it may not be right for your nonprofit. Choosing the right 501(c) designation for your mission will make compliance much easier, alleviating the worry of losing your tax-exempt status. [Read related article: A Nonprofit's Guide to Accounting]
Requirements and how to file as a 501(c)(3) organization
If you're considering starting a 501(c)(3) nonprofit organization, you need to follow some key steps before seeking the designation. Tax law is very specific about what goes into each kind of nonprofit organization, so it's important to do everything correctly.
1. Devise a plan.
When coming up with your nonprofit organization, you need a clear understanding of the kinds of activity it will conduct. As long as it traffics solely in one of the following categories, you will be fine:
- Religious needs
- Scientific study
- Educational services
- Public safety testing
- Charitable contributions
- Calling for the end of child or animal abuse
- The creation and continued support of a national or international amateur sports competition
2. Establish your corporation.
Once you know what your nonprofit will do, you must formally create a corporation at the state level. The process varies from state to state, so check with your state's department of taxation before moving forward. After filing at the state level, you file applications for an employer identification number (EIN) and to be a 501(c)(3) organization.
3. Maintain your tax-exempt status.
Again, a 501(c)(3) is limited in what it can do. If you want your nonprofit to retain its 501(c)(3) status, you have to follow federal and state guidelines. Failure to follow the rules laid out by the IRS can result in the loss of your organization's tax-exempt status.
Andrew Martins contributed to the research and writing in this article.