In the world of charitable activities, it’s common to hear people using the terms nonprofit organization and 501(c)(3) in reference to all charitable organizations. There’s a good deal of truth in that, but it’s not quite that simple. The federal government recognizes different types of charitable organizations, and there are different rules for each of them, depending on the classification.
We’re providing an overview that includes how to define a 501(c)(3) and what the requirements are, as well as specific restrictions and tax implications boards need to be aware of.
Defining Nonprofits: What Is a 501(c)(3)?
Exactly what is a 501(c)(3) organization? In broad terms, it’s a section of the U.S. Internal Revenue Code (IRC) that corresponds to a distinct category of nonprofit organizations. An organization that has a 501(c)(3) distinction isn’t required to pay federal income taxes.
The federal government also defines public charity as a nonprofit organization that receives a large part of its income or revenue from the general public, the government, or both. There is a requirement that nonprofits receive at least of third of their income from donations given by the general public.
The federal government also gives a tax break to individuals and organizations that make donations to charitable organizations. That’s a great incentive for people and businesses to lower their taxable income while supporting their favorite charities. Typically, individuals can make donations for up to half of their adjusted gross income and still get the tax break.
Understanding Different Types of Section 501(c)(3) Organizations
The IRS lists over 30 types of nonprofit organizations, and not all of them are 501(c)(3). The rules are regulated by IRS as delegated by the U.S. Department of the Treasury.
What type of corporation is a 501(c)(3)? To understand the differences in the types of Section 501(c)(3) organizations, you could think of it in three categories:
- Charitable organizations
- Churches and other religious organizations
- Private foundations
The IRS also looks at where each organization’s primary financial support comes from. That puts private foundations in a little different classification than charitable organizations and churches/religious organizations.
Private foundations are different because they’re usually held by an individual, family, or corporation and they get most of their income from a small group of donors. The rules and regulations for private foundations are a bit stricter than for other types of charities. Donors of private foundations have more limitations on tax deductions than when making other types of donations.
One other thing to note—the IRS automatically assumes nonprofits are private foundations unless they prove otherwise.
What Are the Requirements for Section 501(c)(3)?
The IRS approves charitable organizations according to their purpose. For example, charitable organizations must exist for one of the following purposes:
- Testing for public safety
- Fostering national or international amateur sports competitions
- Preventing cruelty to children or animals
The IRS is also specific about what they consider to be charitable activities. These activities include:
- Providing relief for the poor, distressed, and underprivileged
- Advancing religion
- Advancing science or education
- Erecting or maintaining public buildings, monuments, or works
- Lessening the burden of governments
- Lessening neighborhood tensions
- Eliminating prejudice and discrimination
- Defending human and civil rights secured by law
- Combatting community deterioration
- Addressing juvenile delinquency
The basic rules for these types of organizations prevent nonprofits from serving private interests including the interests of the founder, founder’s family, shareholders, or other people that have controlling interests in the organization. Nonprofits are required to use all donations for the sole purpose of advancing the stated charitable cause.
Do 501(c)(3) Organizations Have Any Restrictions?
Nonprofit organizations also have a few other restrictions. For example, they’re not allowed to influence legislation unduly or directly participate in campaign activities that support or oppose particular political candidates. Nonprofits are allowed to participate in lobbying as long as it’s minimal, and it’s not a primary activity of the nonprofit.
Nonprofits that hire employees must pay them based on the fair market value for their job position. It’s allowable for nonprofits to offer bonuses or other compensation, but it doesn’t have to be a condition for employment.
A nonprofit’s purpose and mission are major factors in nonprofits maintaining their 501(c)(3) status. Nonprofits must stay true to their founding purpose to qualify as tax-exempt. If your mission changes, as it sometimes does, you must notify the IRS of the change and get validation that the tax-exempt status still applies.
Tax Rules for 501(c)(3) Boards to Be Aware Of
Not following all the rules for 501(c)(3) status can cause fines, penalties, and loss of tax-exempt status. It’s important for nonprofit boards to know that not everything is tax-exempt.
These points make for great board education and discussion:
- Nonprofits aren’t allowed to receive a substantial amount of income from unrelated business operations (UBI-unrelated business income).
- Some types of UBI are allowable, but the majority of income must support the 501(c)(3)’s stated purpose.
- Nonprofits are allowed to sell merchandise or rental properties on a limited basis.
- Nonprofit organizations must withhold federal income taxes from employees’ paychecks for employees that make over $100 per calendar year.
- Nonprofits must file IRS Form 1023 or Form 1023 EZ in the first 27 months of their date of incorporation unless they earn less than $5,000 per year (nonprofits may choose to file it so that donors get the tax advantages).
- Nonprofits are also required to file Form 990 every year.
The Value of a Board Management System in Setting Up a 501(c)(3) Organization
Now that you have the answers to, “What is a 501(c)(3) nonprofit organization?” you need the right tools to manage all your board activities. An online board management system provides all the proper tools to ensure that your nonprofit is in compliance with the rules for 501(c)(3) status. BoardEffect offers a secure platform that supports creating online board books, creating and storing meeting minutes, and storing an unlimited number of important files. The platform offers granular permissions that give you total control over who can view various parts of the portal.
In summary, it’s essential for your board to understand the qualifications for tax-exempt status and which IRS tax forms need to be completed every year. Also, it’s important to know and abide by the restrictions and tax implications that could risk your tax-exempt status.