501c3 rules are the Internal Revenue Service (IRS) guidelines set forth to regulate the activities of certain nonprofit organizations. 501c3 tax status is awarded to charitable organizations and provides them exemption from federal taxes. There are a wide variety of federal nonprofit tax codes, spanning from (1) to (28). 501c3 is one of the most popular yet restrictive tax codes. Some common examples of organizations that fall into this group include trusts and public foundations, but the most popular type of institution is nonprofit corporations. This type of nonprofit tax code stands apart from its counterparts because of the donation exemptions. Individuals or companies that donate to 501c3 organizations are able to deduct the contribution on their taxes. The majority of state governments also allow tax deductions for donations, making gifts to nonprofit entities under this category appealing to many donors. 501c3 institutions can also benefit from state tax reductions such as sales and property fees. Other outlets, like the post office, also provide discounts for certain types of groups. Organizations with 501c3 statuses span a wide variety of industries and service types. One of the main distinguishers of a public charity, at least according to the IRS, is that it isn’t a private foundation. They’re many other things that they look for to approve companies for tax-exemption, and they place a heavy focus on revenue sources.
The bulk of public nonprofit’s revenue must be provided by public donations or government entities, and one-third of the public donors must be composed of a broad range of backgrounds and classes. The IRS does allow that funds be obtained from individuals as well as companies, and it can also come from other types of charities. Individual donors can write off donations up to amounts that equal half of their yearly income while corporations can only deduct up to 10 percent of their income. There are many similarities between public and private nonprofit organizations, but there are specific differences that the IRS looks for when determining status. While most private organizations are run by families, the rules for a 501c3 charity demand that the majority of the company’s board members are not related.
Private organizations aren’t known for their continuously active programs, which is another stipulation for public entities. While they may not technically be active, many private foundations fund the activities of public groups through the use of grants. However, their donor base is usually much smaller than their counterparts because they don’t face the same variety of restrictions. Donors also don’t receive the same deduction opportunities as the IRS limits the claims to 30 percent of their income. It’s not impossible for private foundations to earn 501c3 status, especially if they’re practices result in a hybrid organization, but they’re the smallest type of institution among (3) tax codes. If they do in fact qualify, their donors are able to reap the same tax deduction benefits.
What Are Restrictions on Activities For Non-Profits?
501c3 organizations face extensive restrictions that are much tougher than other 501c tax code categories. Some of these rules include:
• Individual members or leaders can’t benefit financially from the programs and activities of the organization;
• The assets of a dissolved company much transfer to another 501c3 organization and not to any one person;
• Lobbying should be limited and only use a small percentage of the budget.
The IRS also prevents organizations from making official ties to political campaigns including candidate endorsements.
How Do You Obtain 501(c)(3) Non-Profit Status?
In order to obtain 501c3 status, the company or organization needs to complete and file Form 1023. Small entities or those with limited income can use the 1023-EZ Form if they meet the minimal requirements. The IRS requires companies with early earnings of $10,000 or more to pay an $875 filing fee. Organizations with lower revenues are only charged $400 for the application process, but certain entities, like religious institutions, can avoid the entire process as they aren’t required to apply. It’s easy for a nonprofit organization to maintain its tax exempt status and can be just as easy to lose it. Each year, the IRS revokes the tax-exempt status of more than 100 501(c)(3) organizations. Organizations recognized as exempt from federal income tax under this section of the Internal Revenue Code include private foundations as well as churches, educational institutions, hospitals, and many other types of public charities.
But these organizations can maintain their tax-exempt status if they heed the rules in six areas:
• Private benefit
• Political campaign activity
• Unrelated business income (UBI)
• Annual reporting obligation
• Operation in accord with stated exempt purpose(s)
When Should You File For 501(c)(3) Tax Exempt Status?
To get the most out of your tax-exempt status, you’ll want to file your Form 1023 within 27 months of the date you file your nonprofit articles of incorporation. You should really file as soon as possible. If you file within this time period, your nonprofit’s tax exemption takes effect on the date you filed your articles of incorporation (and all donations received from the point of incorporation onward will be tax deductible). If you file later than this and can’t show “reasonable cause” for your delay (that is, convince the IRS that your tardiness was understandable and excusable), your group’s tax-exempt status will begin as of the postmark date on its IRS Form 1023 application.
Form 1023-EZ: The Streamlined Application
Smaller nonprofits may be eligible to file Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. This is a shorter, simpler application form that you complete online. Form 1023-EZ may only be filed by nonprofits with less than $50,000 in annual receipts and $250,000 in total assets. If you’re in the ballpark, complete the Form 1023-EZ Eligibility Worksheet contained in the Form 1023-EZ Instructions to determine if your nonprofit meets all the requirements for using the shorter streamlined form. If you are eligible to use it, this version of the form is much easier to complete and will take you much less time. The filing fee is also much smaller.
Identification of Applicant
This section tells the IRS about your organization. It asks for basic information like the name of your nonprofit corporation, contact information, and when you filed your articles of incorporation. Your nonprofit must have a federal employer identification number (EIN) prior to applying for 501(c)(3) tax exemption, even if it doesn’t have employees. This can be done quickly and easily. Even if your organization held an EIN prior to incorporation, you must obtain a new one for the nonprofit corporate entity.
Required Provisions in Your Organizing Document
There are certain clauses that you must have in your articles of incorporation in order to get your 501(c)(3) exemption, including:
• a clause stating that your corporation was formed for a recognized 501(c)(3) tax-exempt purpose (charitable, religious, scientific, literary, and/or educational), and
• a clause stating that that any assets of the nonprofit that remain after the entity dissolves will be distributed to another 501(c)(3) tax-exempt nonprofit or to a federal, state, or local government for a public purpose.
Narrative Description of Your Activities
Here you provide a detailed, narrative description of all of your organization’s activities — past, present, and future — in their order of importance (that is, in order of the amount of time and resources devoted to each activity). For each activity, explain in detail:
• the activity itself, how it furthers an exempt purpose of your organization, and the percentage of time your group will devote to it
• when it was begun (or, if it hasn’t yet begun, when it will begin)
• where and by whom it will be conducted, and
• how it will be funded (the financial information or projections you provide later in your application should be consistent with the funding methods or mechanisms you mention here).
Compensation and Financial Arrangements
The purpose of this section is to prevent people from creating and operating a nonprofit for the sole benefit of its founders, insiders, or major contributors. You’ll need to give information about all proposed compensation to, and financial arrangements with:
• initial directors
• initial officers (such as the president, chief executive officer, vice president, secretary, treasurer, chief financial officer, or any other officer in your organization)
• the five top-paid employees who will earn more than $50,000 per year, and
• the five top-paid independent contractors who will earn more than $50,000 per year.
In computing the amount of compensation paid, include employer contributions made to employee benefit plans, 401(k)s, IRAs, expected bonus payments, and the like. You must also answer questions relating to possible conflicts of interest, which is an important part of the application.
All groups wishing to obtain 501(c)(3) exempt status must provide a statement of revenues and expenses and a balance sheet. An organization that has been in existence for five years or more must provide financial data for its most recent five years. Other groups must provide financial data for each year they have been in existence and good faith estimates for future years for a total of three or four years, depending on how long the organization has been in existence. These revised financial data requirements relate to IRS rules that automatically classify all new 501(c)(3) groups as public charities as long as they can show in their Form 1023 that they reasonably expect to receive qualifying public support. If your nonprofit is a public charity, you will want to include all the information necessary to avoid misclassification as a private foundation.
Public Charity or Private Foundation
This section relates to your nonprofit’s classification as a public charity or private foundation. Public charities, which include churches, schools, hospitals, and a number of other groups, derive most of their support from the public or receive most of their revenue from activities related to tax-exempt purposes. Most groups want to be classified as a public charity because private foundations are subject to strict operating rules and regulations. Under IRS regulations all new 501(c)(3) groups are automatically classified as public charities for the first five years as long as they demonstrate in their Form 1023 that they reasonably expect to receive qualifying public support. This way new groups applying for 501(c)(3) tax-exempt status need not seek an advance IRS ruling on their public charity status. For the first five years, the group will maintain its public charity status regardless of how much public support it actually receives. After the initial five-year period, the IRS will start to monitor whether the group receives the public support necessary to qualify as a public charity.
You must pay a fee when you submit your Form 1023 application. Check the IRS website for the current user fee.
Certain types of nonprofits must attach an additional schedule to their Form 1023 application. Most of these schedules concern statutory public charities–nonprofits like churches and hospitals that are automatically classified as a public charity no matter how much public support they receive. Each schedule asks for additional information geared to the type of nonprofit. For example, Schedule A for churches asks a series of questions designed to show whether the organization really is a church for tax purposes, such as whether it has a creed or form of worship. These schedules include:
• Schedule A: filed by churches
• Schedule B: filed by schools, colleges, and universities
• Schedule C: filed by hospitals and medical research organizations
• Schedule D: filed by supporting organizations
• Schedule E: filed by nonprofits over 27 months old
• Schedule F: filed by homes for the elderly or handicapped, or low income housing
• Schedule G: filed by successors to other nonprofits.
After You File
After reviewing your application, the IRS will do one of three things:
• grant your federal tax exemption
• request further information, or
• issue a proposed adverse determination (a denial of tax exemption that becomes effective 30 days from the date of issuance).
If you receive a proposed denial of tax-exempt status and you wish to appeal, see a lawyer immediately.
The IRS requires that nonprofit organizations must meet specific requirements before earning 501c3 status. Some of the basic essentials include:
• Avoid any purpose that praises or calls for discrimination;
• Must have obtained an official status as an association, corporation, or trust;
• Provide a reason for their desire to seek tax exemption;
• Three-years of existence before applying;
• Earnings and funds raised by the outlet can’t benefit a sole member;
• Profits must be used for charitable activities;
• Political involvement should be avoided;
• Sole purpose is to meet public needs.
A non-profit attorney handles many of the same issues as a business lawyer, but focuses on the special issues that affect non-profit organizations. An attorney can help your non-profit if you’re just starting up and need guidance on the paperwork that needs to be filed, when you file taxes, or when you need litigation. A non-profit lawyer can help you lay the proper foundation so that your organization can flourish. Your non-profit lawyer can advise you on the right form of entity for your organization, depending on the activities and goals you plan to achieve. For instance, your charitable organization may be able to gain a tax-exempt status if you meet conditions set forth in section 501(c)(3) of the Internal Revenue Code and maintain specific documents. A political organization, private foundation, or religious organization has different legal and tax obligations. With the right lawyer, you can also get advice about the management for your non-profit such as how to form a board of directors, how to appoint officers, and whether you can form an affiliation. A non-profit lawyer can advise you what types of legal forms and documentation you need to maintain your non-profit status, and aid the education of directors, personnel, and other stakeholders so you can run your organization diligently. Depending on what service you need, your lawyer may use different methods of billing. For simple tasks like document drafting or review, a non-profit attorney often charges a flat fee. For longer or more complex matters, your lawyer will likely charge an hourly rate. Rates will vary depending on your industry, the complexity of your case, and where your business is located. Be sure to negotiate a rate up front with your attorney.
Non-Profit Lawyer Free Consultation
When you need legal help with a non-profit company or charity, please call Ascent Law LLC for your free consultation (801) 676-5506. We want to help you.
8833 S. Redwood Road, Suite C
West Jordan, Utah
84088 United States
Telephone: (801) 676-5506