Tax-Exempt Status – Section 501(c)(3): The Basics

Non-profits are formed for a variety of reasons.  For some, forming a non-profit is a way of being altruistic and the non-profit is not formed for personal gain, but for charitable purposes.  For others, forming a non-profit is a way for them to express their frustration at the lack of government action to solve a problem that from their perspective, should be solved by the government.  Whether you’re forming a  non-profit for either of these reasons, Section 501(c) of the Internal Revenue Code, applies to the organization’s formation.

Section 501(c) lists more than 20 classes of activities, besides 501(c)(3) activities, that can qualify a non-profit, for tax-exempt status. Some of them include:

501(c)(4): civic leagues, social welfare organizations
501(c)(5): labor, agricultural, or horticultural organizations
501(3)(6): business leagues, chambers of commerce, trade associations
501(c)(7): social clubs
501(c)(8): fraternal beneficiary societies
501(c)(9): voluntary employee beneficiary associations
501(c)(10): domestic fraternal societies and orders that do not provide life, sick, or health benefits
501(c)(11): teacher retirement fund associations
501(c)(12): benevolent life insurance associations and other mutual businesses
501(c)(13): cemeteries and crematoria
501(c)(14): credit unions
501(c)(15): mutual insurance companies
501(c)(16): farmers’ co-ops
501(c)(17): unemployment compensation benefit trusts
501(c)(20): prepaid group legal services organizations
501(c)(25): title holding corporations or trusts

Section 501(c)(3):

The federal regulations implementing the tax-exempt status provided by Section 501(c)(3), (Reg. §1.501(c)(3)-1(d)), states as follows:

(d) Exempt purposes. (1) In general.

(i) An organization may be exempt as an organization described in section 501(c)(3), if it is organized and operated exclusively for one or more of the following purposes:
(a) Religious,
(b) Charitable,
(c) Scientific,
(d) Testing for Public Safety,
(e) Literary,
(f) Educational, or
(g) Prevention of cruelty to children or animals

(ii) An organization is not organized or operated exclusively for one or more of the purposes specified in subdivision (i) of this subparagraph unless it serves a public rather than private interest. Thus, to meet the requirement of this subdivision, it is necessary for an organization to establish that it is not organized or operated for the benefit of private interests such as designated individuals, the creator or his/her family, shareholders of the organization, or person controlled, directly or indirectly, by such private interests …

Designation by the Internal Revenue Service for 501(c)(3) status, should be a major objective for qualified non-profits, to be obtained as quickly as possible after incorporation. With this status, the organization enjoys substantial benefits:
(1) the non-profit will be exempt from federal income taxes other than unrelated business income taxes. Although most nonprofits will not generate large amounts of revenue, 501(c)(3) status will allow them to invest a lot more money in growing the organization. Considering, as of 2012, the federal corporate income tax is 15% on the first $50,000 of taxable income, 25% on the next $25,000, 34% on the next $25,000, 39% on the next $235,000, and 34% on the rest up to $10 million.
(2) individuals donating money to the organization can take a deduction on their own income taxes for their contributions.
(3) many major donors, like United Way, will not contributions to organizations without 501(c)(3) status.

As with everything however, there are disadvantages. A 501(c)(3) cannot participate in partisan politics, on behalf of or in opposition to political candidates; nor lobbying activities. They are also subject to a higher level of accountability than their for-profit counterparts.

The Application Process:
To apply, you must obtain the following forms and booklets from the IRS:
– Form SS-4: Application for Employer Identification Number or complete the application online
– Form 5768: Election by an Eligible Organization to Make Expenditures to Influence Legislation
– Package 1023: Forms and instruction booklets for applying for 501(c)(3) tax-exempt status
– Publication 557: Tax-exempt Status for Your Organization

Organizations that will have gross receipts of less than $5,000 per year, bona fide religious organizations, and certain groups affiliated with a parent organization that already has tax-exempt status, are exempt from having to file the 1023.

Generally, the IRS expects that an application for 501(c)(3) status will be filed within 15 months after the end of the month in which the Articles of Incorporation are filed. If you file on time, when the application is approved, it will be retroactive to the date of the Articles of Incorporation. If you do not file on time, an additional form (see IRS Publication 557), must be filed.

Fees: The application fee is $750. However, new organizations not expecting gross receipts to exceed $10,000 for each of its first 4 years, or existing organizations that have not had $10,000 in gross receipts for the previous 4 years, qualify for the reduced rate of $300.

To help the application process run smoothly, here are a few tips:
– have all of your governing documents: Articles of Incorporation and bylaws, incorporate “charitable purpose” language
– have an organizational conflict of interest policy consistent with the contents of IRS Form 1023
– provide a sensible/logical/not inflated 3-year budget

That’s it. Those are the basics on 501(c)(3)s and the application process. Please feel free to contact me with any clarifying questions or if you need additional information. Hope this was helpful!