Non Profit 501(c)(3) Status: Everything You Need to Know About Forming and Running a Non-Profit

By Rafael Maga?a

If you've been dreaming of helping others with a charity, forming a non-profit 501(c)(3) is the first step. Whether you want to help pets find a new home, help teach kids about art, books or sports or even serve the homeless and hungry in your community, becoming an official 501(c)(3) can help you reach your goals. 501(c)(3) organizations receive specific perks from the government, notably in the form of tax benefits (and deductions for donors) so they face stringent requirements and scrutiny. The process of forming a 501(c)(3) is similar to starting any other business, with a few additional steps and layers.

What is a 501(c )(3) Organization?

A 501(c)(3) is a business or organization that meets all of the guidelines laid out by the Internal Revenue Service as a charitable organization. 501(c)(3) organizations vary widely in their purposes, the people, populations or even animals they serve and the endeavors they fund, but all must be approved by and comply with the IRS guidelines for non-profits.

While the word "charitable" is often used to describe a 501(c)(3) organization, it is used broadly; entities can be religious, truly charitable, scientific, literary, safety based, sports-based or educational. The ability to comply with all regulations and requirements is the most important factor when it comes to 501(c)(3) status. A 501(c)(3) organization can be a public charity, a private foundation or a private operating foundation; all are regulated by the IRS and US Department of Treasury. 

The actual individuals who benefit from your charity and efforts may vary, but all 501(c)(3) organizations need to follow the same guidelines and have to comply with the same rules.

What Makes a 501(c)(3) Unique?

The way that 501(c)(3) organizations handle donations and their tax burdens set them apart from other corporations and entities. Under 26 U.S.C. 170, donors can make charitable contributions and receive a tax deduction when they give to a 501(c)(3) organization. This means that a person making a contribution to your newly formed 501(c)(3) may deduct a portion of the amount given on their own tax returns at the end of the year.

There are other unique provisions for 501(c)(3) organizations; most states follow the Federal government and allow donations to these organizations to be tax deductible. The US post office also offers bulk postage discounts for qualifying non-profits.

Types of 501(c)(3) Organizations

501(c)(3) organizations fall into a few specific categories, no matter who they ultimately benefit, including:

Public charities: A public charity receives the bulk of its income from government grants or from the general public. To stay a public charity, an organization needs to obtain at least a third of its income from the public. That support can come from individuals, companies, and even other charities. Donations made to public charities are tax deductible; this benefit can also help drive donations to the charity. A public charity is often a large, recognizable local brand, and could be a church, an animal welfare organization, an organization dedicated to education or a benevolence society.

Private Foundations: A private foundation often does not have active programs; revenue generated may come from a single source or from only a few sources. These non-profits often support the work of public charities, but they do not have to. Donations to private foundations are also deductible for individual givers. A private foundation can be a family concern, one run by a specific business or an organization created by several organizations working together.

Private Operating Foundations: Rarer than their public and private counterparts, the private operating foundation works with active programming like a public charity, but is governed like a private foundation. This hybrid style is rare but can be adopted by a variety of organizations or initiatives.

Some common types of 501(c)(3) organizations include:

• Churches and religious organizations
• Food banks
• Homeless shelters and organizations
• Animal shelters, rescues and aid societies
• Medical or veterinary organizations offering free care or care at greatly reduced costs
• Art, music, literature and other related organizations
• Aid societies designed to benefit children, women, teens or specific populations
• Literacy, tax help, and other aid organizations
• Emergency assistance organizations
• Schools and education facilities
• Nursing home and assisted living facilities
• Alumni and sports clubs
• Parents organizations at schools
• Education initiatives that target specific medical issues or complaints, from Autism Awareness to Diabetes education

How Can I Tell if My Organization Qualifies as a 501(c)(3)? 

A careful review of the IRS guidelines for 501(c)(3) organizations can help you determine if your organization qualifies. Applying to the IRS will provide you with a definitive answer; if your business idea meets the qualifications outlined by the IRS and complies with all guidelines, then you should qualify. Your attorney can help you determine if you are on the right track and let you know what else if anything you need to do to qualify.

501(c)(3) and Taxation

It is a common misconception - many people think that a non-profit is automatically tax-free and that this form of organization can ignore tax rules. While there are exemptions and breaks, you still have to complete tax returns and pay applicable taxes as outlined by law.

Taxation and 501(c)(3)

As a 501(c)(3) nonprofit organization, you can use IRS Form 1023 to become tax exempt. Your attorney can help you complete and submit the proper paperwork when you create your organization.

Tax-exempt does not mean tax-free; as a tax-exempt organization, your 501(c)(3) will not have to pay corporate federal income tax on your income, provided that income is related directly to your mission. If you have unrelated business income, that may still be taxable.

The IRS describes unrelated business income as income that:

• Is generated by your business
• Is regularly occurring
• Unrelated to your organization's stated purpose
• Income that meets all of these guidelines is considered unrelated by the IRS and is usually subject to taxation.
• Income from fundraising could potentially be taxed; if you are exchanging services or goods for that revenue or the activity happens regularly, that money could be taxable.

Your 501(c)(3) nonprofit may still have to pay sales tax; your home state may require you to submit a separate application for a state sales exemption. Their tests or rules to qualify may be different from the rules used by the Federal government; you'll need to fully research your sales tax rules and obligations when you form your 501(c)(3).

 Your 501(c)(3) income tax exemption is not permanently granted; the IRS may review your status at any time, and in some instances, it could revoke your 501(c)(3) status. If a 501(c)(3) organization uses funds for private purposes, fails to comply with the rules laid out for non-profits or engages in lobbying, then their exemption could be revoked.

How Can I Start a 501(c)(3)?

You would begin by carefully planning out your business, just like you would for a for-profit organization. A clear mission statement and an idea of both who you wish to help and how you want to achieve your goals are essential starting points.

Once you know what you want to do and who you want to benefit, you'll begin by filing Articles of Incorporation with your state. By incorporating, you protect yourself and other founders and officers from liability; even a non-profit can be sued or held responsible for damages or losses.

You'll need to obtain a Federal Tax ID Number (FEIN) and appoint a board of directors and create bylaws and rules for your board.

Once you incorporate, you need to apply for 501(c)(3) status with the Internal Revenue Service. This will formally recognize you as a non-profit. IRS form 1023 can be used to apply for your non-profit status. This document is relatively complex, and at 28 pages long, it can take some time to complete. For the IRS, asking for a substantial amount of information up front allows them to be sure that programs will follow their stated guidelines and income generated will be used to directly benefit those named in the application and charter.

Once you have your 501(c)(3) from the IRS, you also need to complete legal forms and applications with your home state. Most states (40 of them as of 2017) require you to register with the State Attorney General's office to begin accepting donations and soliciting for help from the public.

If your state offers a corporate tax exemption or a sales tax exemption for non--profits, you'll have to apply for them directly; you'll usually need to have your 501(c)(3) status approved by the IRS before you can apply for these state benefits. Your local attorney general office can let you know exactly what you can apply for and what to expect when you run a non-profit in your state.

501(c)(3) Restrictions

501(c)(3) organizations are heavily regulated by the IRS and state governments, with strict rules to follow. Anyone working as an officer, director, or otherwise associated with the charity can profit from the organization in an unfair way. Individuals are not permitted to share in the assets or the distribution of assets if the organization closes.

Political activities like lobbying are also not allowed for 501(c)(3) organizations. As a 501(c)(3), you can't engage in political activities at all. In some cases, you may lobby for specific rules, but these exemptions are granted on a very limited basis in very specific circumstances.

Compliance Issues

501(c)(3) status is initially granted based on your application, but you are required to follow and comply with all IRS regulations and guidelines. Form 990 must be filed with the IRS each year; your state may also have specific guidelines you need to follow as well to fully comply.

Considerations

Before you start a 501(c)(3) program, make sure your non-profit doesn't already exist; there are thousands of charities in each state, and if you are closely competing with another non-profit, neither of you will thrive.

Incorporating is a must; while it seems like people wouldn't sue a charity, they can and do - and they often win. Incorporating allows you to be benevolent and help others without exposing yourself to risk. It also makes it easier for others to serve on your Board since they won't have to take on additional liability to do so.

You may need to register in more than one state. If you plan on soliciting for donations outside of your home state or applying for grants elsewhere, you need to register in these other locations. Separate applications and fees will be required for each state that you hope to receive donations or funding from.

Planning and opening your 501(c)(3) takes time, but most of the work only has to be done once, at the time you create your organization. Taking the time to carefully perform all steps and to fully comply with all IRS guidelines ensures you can fulfill your dreams, and you can fulfill the mission of your organization.

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Copyright February 9, 2020 by Rafael Maga?a. Contact for usage license.

Rafael Maga?a helps organizations grow. Helps leaders accelerate strategy implementation in their organizations. Specializes in donor-centered Philanthropy. Major Gift Officer -Veritus Scholar. Director of Development & Communications at BREATHE California of Los Angeles County. Director of Development at the Emphysema Foundation of America. Enjoys writing about leadership and management in nonprofit organizations. Founder of Latino Professionals and Latina Professionals.  Resides in California.  

Follow Rafael on LinkedIn and on Twitter: @RafaelMagana

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