how a 501 c 3 organization works
a group must operate exclusively for one of certain purposes to be considered a charitable organization by the irs charitable religious educational scientific literary testing for public safety fostering national or international amateur sports competition or preventing cruelty to children or animals 3the irs further defines charitable activities as relief of the poor the distressed or the underprivileged advancement of religion advancement of education or science erecting or maintaining public buildings monuments or works lessening the burdens of government lessening neighborhood tensions eliminating prejudice and discrimination defending human and civil rights secured by law and combating community deterioration and juvenile delinquency 3requirements of a 501 c 3 organizationan organization must not be serving any private interests to be tax exempt under section 501 c 3 these include the interests of the creator the creator s family shareholders of the organization other designated individuals or other persons controlled by private interests none of the net earnings of the organization can be used to benefit any private shareholder or individual all earnings must be used solely for the advancement of its charitable cause 4a 501 c 3 organization is also forbidden from using its activities to influence legislation in a substantial way including participating in any campaign activities to support or deny any particular political candidate it s typically not permitted to engage in lobbying except in instances when its expenditures are below a certain amount 56people employed by the organization must be paid reasonable compensation which is based on the fair market value that the job function requires 7the 501 c 3 designation remains for as long as the organization exists unless it is revoked by the irs 8an organization is also required to remain true to its founding purpose to stay tax exempt under section 501 c 3 an organization must maintain the purpose that it has previously reported to the irs such as that its mission is to help less privileged individuals gain access to a college education the 501 c 3 organization must first notify the irs of its change of operations if it decides to engage in another calling such as sending relief to displaced families in poverty stricken countries failing to do so would result in the loss of its tax exempt status 9some unrelated business income is allowed for a 501 c 3 organization but the tax exempt charity may not receive substantial income from unrelated business operations the majority of the firm s efforts must go toward its exempt purpose as a nonprofit organization any unrelated business from sales of merchandise or rental properties must be limited or the organization could lose its 501 c 3 status 10the irs doesn t specify exactly how much is too much unrelated business income but the law firm of hurwit associates which specializes in representing nonprofits estimates the amount at somewhere between 15 and 30 11organizations that meet the requirements of section 501 c 3 are exempt from federal income tax but they re required to withhold federal income tax from their employees paychecks as well as withhold and pay social security and medicare taxes 12special considerationsorganizations that meet the 501 c 3 tax category requirements can be classified into two categories public charities and private foundations the primary distinction between these two categories is in how they get their financial support 13a public charity is a nonprofit organization that receives a substantial portion of its income or revenue from the general public or the government at least one third of its income must be received from donations from the general public including individuals corporations and other nonprofit organizations 14individuals who donate to an organization that the irs considers to be a public charity may qualify for certain tax deductions that can help them lower their taxable income the total amount of donations to a tax exempt public charity that an individual can claim is generally limited to 60 of their adjusted gross income agi as of 2024 but there s no limitation on donations to qualified charitable organizations such as a 501 c 3 15a private foundation is typically held by an individual a family or a corporation and it obtains most of its income from a small group of donors private foundations are subject to stricter rules and regulations than public charities all 501 c 3 organizations are automatically classified as private foundations unless they can prove that they meet the irs standards to be considered a public charity 16 the deductibility of contributions to a private foundation is more limited than donations made to a public charity 15most nonprofit organizations are required to file form 1023 or form 1023 ez within 27 months from their date of incorporation to apply for tax exempt status under section 501 c 3 17 the charitable organization must include its articles of incorporation and provide documents that prove that the organization is only operating for exempt purposes 13however not all organizations that qualify for the tax category must submit form 1023 public charities that earn less than 5 000 in revenue per year are exempt from filing this form but they may still choose to file the form even though it s not required so they can ensure that donations made to their organization will be tax deductible for donors 18advantages and disadvantages of a 501 c 3 organizationthe 501 c 3 status offers a myriad of benefits to the designated organizations and the people they serve these organizations are exempt from paying federal income and unemployment taxes and patrons who donate to them are allowed to claim a tax deduction for their contributions these organizations are eligible to receive government and private grants to help with funding and to further their mission the organization must have a mission aligned with the purpose of the grant and a need for it to qualify these organizations also often receive discounts from retailers free advertising by way of public service announcements and food and supplies from other nonprofit organizations designed to help in times of need a 501 c 3 could be the lifelong dream of its founder but it no longer belongs to its founder after it s established as a 501 c 3 it s a mission oriented organization that belongs to the public it must operate within the confines of the law pertaining to 501 c 3 organizations to maintain its favorable tax treatment because the organization serves the public it must operate with full transparency its finances including salaries are available to members of the public and subject to their review 19exempt from federal taxescontributions are tax deductibleeligible for government and private grants