If you’re an aspiring nonprofit founder, you might be wondering: What exactly is a 501c3 Nonprofit Organization? Nonprofit tax designations can be super confusing (and there are a lot of them), so in this blog post, I’m going to break the 501c3 Nonprofit status down for you!
Nonprofits and IRS Tax Designations
Before we jump into the finer details of 501c3 organizations, let’s talk about how nonprofits in the United States are given their tax designations.
Basically, when you decide to start a nonprofit, you’ll (unfortunately 🙁) need to navigate the complex world of IRS tax codes. Nonprofits are categorized into different tax designations based on their chosen mission and purpose, and the most common designation is 501c3. In fact, most nonprofits you’ve heard of or are familiar with will have a 501c3 status, which is the most popular one for public charities. Getting this tax designation is a necessary step toward becoming a full-fledged nonprofit and being able to accept tax deductible donations.
Just how many IRS Tax Designations exist?
You might be wondering, “How many nonprofit tax designations are out there?” Um, a lot. And each has its own unique set of rules and requirements.
These designations are represented by different sections of the IRS tax code, such as 501(c)(4), 501(c)(6), and more. There’s a designation for social clubs, sororities, chambers of commerce, and even cemetery companies!
What it means to be a 501c3 Nonprofit Organization
In short: When your organization is recognized as a 501c3 nonprofit, it means you’re eligible for tax-exempt status. This status comes with a range of benefits, including:
- Exemption from federal income tax
- Access to grants and donations
- Some amount of credibility in the eyes of your nonprofit’s donors and supporters!
If you’re wondering how being a 501c3 Nonprofit is different from being one of the other 501c tax designations, it comes down to a few things:
- Tax Deductible Donations: One of the most significant advantages of being a 501c3 organization is that your donors can typically claim tax deductions for their contributions. In theory, this incentive encourages more people to support your cause.
- Eligibility for Grants: Many foundations and government agencies provide grants exclusively to 501c3 organizations. Having this status opens doors to funding opportunities that might not be available to other types of nonprofits.
- Mission-Focused: To qualify for 501c3 status, your organization must have a charitable, religious, educational, scientific, literary, or other approved purpose. This means your primary focus should be on serving the community and advancing a mission, rather than generating profits (or being a social club, sorority or fraternity, or other type of 501c organization).
Is the 501c3 Nonprofit Organization the right fit for you?
Now that you understand the perks that come with being a 501c3 Nonprofit Organization, it’s really important to consider whether it’s the right fit for your organization and what you aim to accomplish. I talk to a lot of founders who assume 501c3 status is the way to go without understanding all the options. Here are some factors to think through as you’re deciding:
Your Mission: To even qualify to be a 501c3 Nonprofit Organization with the IRS, your organization must have a mission statement that aligns with this designation. Is your organization’s primary goal to serve a charitable, religious, educational, or similar purpose? If so, 501c3 might be a good match.
Fundraising Plans: I always recommend founders draft a nonprofit business plan before even filing their tax paperwork, so you can understand how you’ll generate the funds to cover the costs of the organization before you get too far in. If you plan to rely heavily on donations and grants to fund your activities, 501c3 provides significant advantages. (Note there can also be disadvantages to relying heavily on these revenue sources — keep reading.)
Compliance Commitment: Keep in mind that 501c3 organizations must adhere to strict IRS regulations and reporting requirements. You need to be ready to keep every receipt, submit financial reports on how the nonprofit is spending money, and more.
Long-Term Goals: Consider your organization’s long-term vision. Will a 501c3 status align with your goals and help you achieve your mission more effectively?
Downsides of the 501c3 Nonprofit status
Obtaining 501c3 status for your nonprofit organization can come with a lot of benefits, but it’s also essential to be aware of the potential downsides, including:
Limited Political and Lobbying Activities: 501c3 organizations are restricted in their ability to engage in political activities and lobbying. So, with this designation you won’t be allowed to endorse (or oppose) political candidates. Also, there are strict limits on the percentage of your nonprofit’s resources that can be used for lobbying efforts.
Ongoing Compliance: Maintaining 501c3 status requires staying on top of IRS regulations. This includes annual reporting, record-keeping, and financial transparency. If you fail to submit paperwork and records in a timely manner, it can result in the loss of tax-exempt status.
Restrictions on how you generate inccome: This is what I was alluding to above: While 501c3 organizations can engage in some revenue-generating activities (e.g., through fundraisers, merchandise sales, or program-related income), they must primarily rely on donations, grants, and public contributions for financial support. Many find it very challenging to bring in significant donations, which may result in your nonprofit struggling financially.
Public Scrutiny: 501c3 organizations are subject to public scrutiny. Your financial information will be accessible to the public through IRS Form 990 filings. This can be a positive thing – after all, transparency can lead to increased accountability. But some may be concerned with the privacy issues this represents.
Your activities are restricted: Some activities that might be considered “commercial” or “non-charitable” in nature could jeopardize a 501c3 organization’s tax-exempt status if pursued extensively. For example, running a for-profit business as a significant part of your nonprofit’s operations may be problematic.
Additionally, to maintain your 501c3 status, your organization must ensure your activities align with their specific stated tax-exempt purpose. You need to stay focused on the mission you submitted to the IRS when you filed for 501c3 status. If your organization needs to change its mission, you need to file an amendment with the IRS.
All that said…
While there are downsides to 501c3 status, it’s true that many organizations find that the benefits, such as tax exemptions and access to grants, outweigh them. Just consider all the possibilities (including starting a private for-profit company instead of a nonprofit, if that gives you the flexibility you need to achieve your specific mission!). Ultimately, the decision to pursue 501c3 status should align with your organization’s mission and long-term goals.
How to become a 501c3 Nonprofit Organization
To get 501c3 nonprofit status in the United States, you’ll need to submit several documents to the Internal Revenue Service (IRS) (among other steps, which I talk through in the video below):
Last but not least, here’s a rundown the items and paperwork you’ll typically need to submit:
- Form 1023 or Form 1023-EZ: The main application form is either IRS Form 1023 or Form 1023-EZ. Form 1023-EZ is a simplified version available for organizations with gross receipts of $50,000 or less and total assets of $250,000 or less.
- Articles of Incorporation: You must provide a copy of your organization’s articles of incorporation with the your Secretary of State agency. This includes your organization’s name, purpose, and dissolution clause, among other requirements.
- Bylaws: Include a copy of your organization’s bylaws, which outline your internal governance structure and rules.
- Description of Your Nonprofit’s Intended Activities: Describe your organization’s past (if any), present, and planned activities in detail. This should include information about your mission, programs, and how you intend to achieve your ultimate social impact goals.
- Financial Statements: Provide financial statements, including a balance sheet, income statement, and cash flow statement, for at least the past three years – OR for as long as your organization has been in existence – since most new nonprofits don’t have much, if any, financial activity yet. So, if you’re a new organization, include projected financial statements.
- Pay the Registration Fee: The application typically requires a fee, which varies depending on the size and type of your organization. You can find the current fee schedule on the IRS website.
- Conflict of Interest Policy: Some states and the IRS may require you to have a conflict of interest policy in place. Basically, this written policy should outline procedures for handling conflicts of interest among board members and key employees (for example, if a board member works with a business that the nonprofit is considering doing business with).
- List of Board Officers and Directors: You’ll need to recruit a Board of Directors if you haven’t already. Board members are unpaid volunteers who serve as your organization’s officers and directors. If you’re starting off with funding and plan to hire paid staff, then the top employee(s) may also be considered officers. You’ll need to submit their names, addresses, and positions.
- Form 8718 (User Fee for Exempt Organization Determination Letter Request): This form is used to calculate and pay the appropriate user fee for your application.
- Additional Attachments: Depending on your organization’s activities / structure, the IRS may ask for additional attachments. For example, if you engage in any lobbying or political activities, you may need to provide additional information.
Note: The specific requirements / forms may vary depending on the nature and size of your organization.
Some choose to compile and submit this paperwork on their own, but many consult with an attorney or accountant to avoid any errors – which can result in the IRS rejecting your nonprofit application.
Wrap Up: The 501c3 Nonprofit Organization
I can say from experience, the journey of creating a nonprofit is a rewarding one, and it all starts to feel official and real once you obtain your tax-exempt approval letter!
Whether you decide to go for that 501c3 status or explore other options, keep your passion and dedication at the forefront of your mission. It’s all about choosing the right structure to achieve your end goals.
As always, check out our trainings and resources to support your journey!
