The world of nonprofits can be a confusing place for anyone not familiar with the terminology.
Between understanding the different types of nonprofits to knowing which paperwork to file with the IRS, running a nonprofit is about a lot more than helping the greater good. Even if you’re new to the nonprofit sector, chances are you’ve heard the phrase 501(c)(3) before.
You might even be vaguely familiar with the basics of charities with 501(c)(3) designation, i.e. tax-exempt status and the types of nonprofits that might qualify. Even so, there’s probably something you’re still unfamiliar with that you’re hoping to learn about.
This article will cover the ins and outs of 501(c)(3) nonprofits and dive deep into everything you need to know about what they are, the benefits they enjoy, and how to become one.
Looking for specific information about 501(c)(3)’s? Click the links below to jump ahead:
What is a 501(c)(3)?
501(c)(3) is more than just a moniker, it’s a legal designation. The 501(c)(3) designation is reserved for nonprofits and charities that qualify under Section 501(c)(3) of the Internal Revenue Code, which is the portion of Federal statutory tax law in the United States used by the IRS.
What what qualifies as a 501(c)(3)?
Being a 501(c)(3) means that your nonprofit organization has been approved by the IRS as a tax-exempt charitable organization. Organizations that qualify for this under 501(c)(3) are organizations that support charitable causes such as animal welfare, religious organizations, education, public safety, and more.
Types of 501(c)(3) charities
In order to qualify as a 501(c)(3), your nonprofit will need to do more than serve the public good.
Because tax-exemption is on the table for 501(c)(3)s, the IRS has strict guidelines for which organizations can claim to be 501(c)(3) charities. In general, all 501(c)(3) organizations fall into one of the following two categories: public charities and private foundations.
1. Public charity
When people think of nonprofits or 501(c)(3)s, they are usually thinking of public charities.
Public charities include organizations such as churches, food banks, animal shelters, educational foundations, and more. They rely heavily on public donations or government grants to fund the work they do.
There are three main requirements a 501(c)(3) must fulfill in order to remain a public charity:
1. At least one–third of its donated revenue must come from public support, aka donations from individuals, companies, or other public charities. By law, they cannot raise more than a third of their income from unrelated commercial activity of investments.
|Example: Even though the Girls Scouts of America raise millions of dollars through annual cookie sales, the money used from those sales are not used to fund their national organization, but rather the local Girl Scout councils that sell them. The Girl Scouts of America as a national group rely on partnerships and donations for the primary source of their funding. This allows them to qualify as a 501(c)(3).|
2. Public charities must be governed by a board of directors. The board must comprise of independent individuals. By law, no more than 50% of the board directors may be related to each other. That includes blood relation, marriage, or even co-ownership of a business. This is to prevent any single group from influencing the direction of a 501(c)(3).
3. 501(c)(3)s must be actively supporting a direct, charitable activity. These initiatives can be anything from religious missions, educational programs, animal welfare projects, and more. The purpose of this requirement is to ensure that only organizations doing active charity work reap the benefits of being a 501(c)(3) public charity.
2. Private foundation
When it comes to classifying 501(c)(3)s, private foundations are tricky.
Not all private foundations qualify as 501(c)(3)s and many designations are decided on a case-by-case basis. Private foundations are often founded by a single founder, family, or business. The purpose of a private foundation is to support other nonprofits through grants and program funding.
In general, they can be more judicious about which nonprofits they support. This makes them very similar to public charities, but there are some key differences:
What makes private foundations different from public charities?
Remember, the 501(c)(3) designation is used by the IRS for tax-recording purposes. A private foundation can still qualify as a nonprofit and do important work in the community without qualifying as a 501(c)(3). If you’re curious whether a private foundation you’re thinking of supporting is a 501(c)(3), you can always check their website. Most private foundations disclose their nonprofit status.
It’s important to note that there are always exceptions to the rule. Some nonprofits may qualify as a 501(c)(3) without being a public charity or private foundation. These are always handled by the IRS on a case-by-case basis.
How to become a 501(c)(3)
Whether you’re an established charity looking to become a 501(c)(3) or you’re looking to create a nonprofit from scratch, you’ll need to understand how to file your taxes as a 501(c)(3). The first step is figuring out whether your organization qualifies for 501(c)(3) status.
In order to qualify as a tax-exempt 501(c)(3) organization, a nonprofit must serve one of the following purposes:
If your organization ticks one of the boxes above, you can start the process of filing for 501(c)(3) status. According to CharityNet USA, the IRS receives about 80,000 applications for nonprofits annually. That means it could take anywhere from a couple of months to a full year before you hear back about your application, so plan ahead!
How to become a 501(c)(3) charity
- Define your organization's purpose
- Determine if you qualify for 501(c)(3) status
- Name your nonprofit
- Write your by-laws
- Form your board of directors
- File your incorporation paperwork
- File Form 1023 for tax-exempt status
- Ensure annual compliance is met
Because 501(c)(3) is a tax designation, there will be a waiting period during which the IRS reviews your organization’s structure, financial records, programs, governance, board of directors, mission, and more. If you don’t have a clear purpose for your organization in mind, there’s a chance you might be rejected. That’s why you need to do the legwork upfront.
Once you get your nonprofit off the ground, you’ll need to have the right tools to manage it! Check out the variety of different nonprofit software options available to you, from fundraising management to donor database software, and more!
What are the pros and cons of being a 501(c)(3)?
Registering your nonprofit as a 501(c)(3) might seem like a no-brainer, but it’s not as simple as it looks. 501(c)(3)s reap exclusive benefits that other nonprofits do not, however, those benefits comes at the cost of tighter restrictions and rules from the IRS.
These are just a high-level overview of the advantages and disadvantages of being a 501(c)(3). As with most things, there is good with the bad. Before you register your nonprofit as a 501(c)(3), you should weigh the benefits before making your final decision.
Still have unanswered questions about 501(c)(3)s?
That’s understandable, there’s a lot of ground to cover! We’ve taken the nine most frequently asked questions about 501(c)(3)’s and created a handy one-sheet that you can download, print, and take with you on the go!
Download our FAQ guide for answers to some of the most common questions about 501(c)(3)s!