What Is a 501c3? Understanding Nonprofit Tax Status in the US

A 501c3, or 501(c) 3, is a tax category in the United States Internal Revenue Code (IRC) for non-profit organizations. The Internal Revenue Service (IRS) designates non-profit organizations that apply and qualify for 501c3 as charitable organizations, making them exempt from federal income tax. What sets 501c3 organizations apart from other non-profits is that their donations are tax-deductible.

The majority of 501c3 organizations are public charities, private foundations, and private operating foundations, but non-profit corporations, trusts, and limited liability companies (LLCs) may also qualify for 501c3 status.

They are three types of non-profit organizations that meet the IRS’s exemption requirements for 501c3:

1. 1. Private foundation. Private foundations are also known as non-operating foundations because they don’t have active programs and typically support public charities through grants. All 501c3 are initially considered private foundations unless they meet the IRS requirements for a public charity. Fundraising through public support is unnecessary; revenue can come from a small group of donors and even single individuals or families. Donations are tax-deductible (up to 30 percent of an individual donor’s income), and its board of directors can be governed by related or connected individuals, such as families.
2. 2. Private operating foundation. A private operating foundation is the least common form of 501c3 organization and is a hybrid of public and private foundations. Most of a private operating foundation’s earnings must go to programs, and the donation metrics are similar to that of a public charity.
3. 3. Public charity. Public charities, the most commonly known type of 501c3 organizations, include religious organizations, animal welfare organizations, and educational programs. For a public charity to qualify for tax exemption, it must generate most of its fundraising revenue from donations from the general public or government programs. Donations to public charities can be tax-deductible (up to 60 percent of the individual donor’s income), while corporate donations are limited to 10 percent. A public charity’s board of directors must be composed of independent, unrelated individuals to avoid conflict of interest rules that would cause the IRS to reject their application.

There are several advantages for obtaining 501c3 classification, including:

• Discounted post office rates. Qualifying organizations may also be eligible for special bulk rate mailing discounts from the U.S. Post Office.
• Eligible for grants. Organizations that qualify for 501c3 classification are also eligible for federal, state, and local grants. A 501c3 status is frequently required for most grant applications. Learn about writing grant proposals in our complete guide.
• Tax exemption and deduction. 501c3 organizations are exempt from federal income tax. They are also exempt from state income taxes, sales and property tax, and federal unemployment taxes in many cases.

The IRS strictly regulates qualifications for 501c3 status, and organizations must meet many requirements for an organization to qualify, including:

1. 1. Charitable activities must meet specific criteria. According to the IRS, a “charitable activity” that qualifies for 501c3 status includes offering relief to marginalized communities, advancing religion, education, or science, defending human and civil rights, public building maintenance, easing neighborhood tensions, or combating discrimination and juvenile delinquency. If the 501c3 must shutter, the remaining assets after debts must go to a charitable organization or support philanthropic activities.
2. 2. Employee payments must meet specific requirements. Employees must be paid at the fair market value of the job and should not receive a bonus, commission, or other forms of compensation. Additionally, the organization must withhold federal income tax from employee paychecks unless they make less than $100 annually.
3. 3. Focuses on a specific purpose. To qualify as a tax-exempt organization, the non-profit must operate exclusively for one of the following purposes: religious, charitable, scientific testing for public safety; literary; educational; the fostering of national or international amateur sports competitions; and the prevention of cruelty to animals and children.
4. 4. Consistent founding mission. Every nonprofit organization has a founding mission, and they must not add or change their focus to qualify for 501c3 status. For example, if a child welfare agency decides to address neighborhood tensions or add additional charities to its mission, it must first inform the IRS or risk losing its tax-exempt status.
5. 5. The organization must serve public interests. A non-profit organization can’t serve any private interest, including that of the founders, their families, or private shareholders. Also, the organization can only receive limited income from unrelated business operations, like sales or merchandise. The company’s charitable activities or net earnings cannot go to a member of its board of directors or private individuals.
6. 6. Restricted political involvement. Non-profit organizations must also keep political activities, including any lobbying activities and participation in political campaigns, to a minimum. Campaign activity that either endorses or opposes a political candidate for public office is wholly prohibited.

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