Understanding 501(c)(3) Organizations: A Beginner's Guide

Internal Revenue Code Section 501(c)(3) allows certain organizations to operate as tax-exempt. Use this guide to learn if and how your program can benefit from this status.

When you donate money or goods to your local food bank, women’s shelter, or environmental group, they might tell you that your donation is tax-deductible. This perk is one of the benefits enjoyed by nonprofits with 501(c)(3) status.

They’re able to offer that incentive to encourage the public to support their cause, and they also benefit from discounts on items such as postage, publicity, and other services.

If you’re looking to start a nonprofit, you’ll need to know about the different types of 501(c)(3) organizations and the steps for establishing your organization as one.

Overview: What is a 501(c)(3)?

The term “501(c)(3)” refers to a section in the Internal Revenue Code that describes organizations operated exclusively for one or more of the following reasons:

• Religious
• Charitable
• Scientific
• Testing for public safety
• Literary
• Educational
• Fostering national or international amateur sports competition
• Prevention of cruelty to children or animals

The organization must be established as a corporation, unincorporated association, or trust, and no individuals or private shareholders can profit from its earnings.

Organizations that meet these standards can apply for 501(c)(3) nonprofit status through the Internal Revenue Service (IRS). Receiving this status means the organization is exempt from paying federal corporate income tax. Depending on the state in which a nonprofit is incorporated, the status might also exempt it from paying property taxes.

Since 501(c)(3) organizations are granted this privilege in exchange for the good works they plan to provide the public, nonprofit administration requires a high level of transparency and accountability for how the organization uses its funds. The IRS’s nonprofit database is where members of the public can view the federal tax status and filings of any tax-exempt organization.

The IRS gathers and makes public information on the operations of any organization with tax-exempt status. Image source: Author

4 types of 501(c)(3) organizations

Within the 501(c)(3) status, there are four main types of organizations that can qualify. Each comes with its own special considerations.

Public charity

Charitable organizations are what people most often associate with the 501(c)(3) status. Notable public charities include organizations such as the American Red Cross, the World Wildlife Fund, and UNICEF. Your local food bank, homeless shelter, and bird rehabilitation center all likely fall under this type as well.

Public charities get their funding from a variety of sources, including individual donors, for-profit companies, foundations, and government entities. It’s important for public charities to conduct fund accounting to be able to track and report on all of these different revenue streams.

Churches and religious organizations

Churches and religious organizations, for the most part, fall under the same category as public charities. However, there are some particular rules that limit how the IRS can audit a church and particular annual filing requirements that are worth extra attention.

Private foundation

Private foundations often take up an important cause, but they don’t actually run their own programs to address that cause. They will provide grants to other nonprofits or organizations working in that issue area instead. Their funding commonly comes from a small group, a family, or even just one individual. However, they can still accept tax-deductible donations from individuals under their 501(c)(3) status.

An example of a private foundation could be a situation where a family’s son dies of a rare disease. To honor his death, the family establishes a private foundation named after him that grants money to research organizations working to find a cure for that disease.

Private operating foundation

A private operating foundation is like a hybrid of a private foundation and a public charity. They both grant funding to other organizations working within their mission area and also implement their own programs to make progress on their cause.

The Bill & Melinda Gates Foundation is an example of a private operating foundation because it awards grants to other organizations and conducts a significant amount of its own programming.

How to start a 501(c)(3) organization

If you want your cause and organization to be able to benefit from being a 501(c)(3), there are several steps you’ll need to take to form your nonprofit and file for that status with the IRS.

1. Do market research

Part of creating a small business plan involves market research. You need to know what your consumers want, what’s currently available to them, and where there are gaps between the two. You want to have an idea of who your competitors will be and how you’ll differentiate yourself from them. Just because a nonprofit isn’t seeking to fill its investors’ pockets with money doesn’t mean it shouldn’t do similar market research.

The Urban Center’s National Center for Charitable Statistics reports that there are around 1.54 million nonprofits registered in the U.S. You’ll need to know how to make your mission stand out from the crowd. You should also consider whether you’d be able to make a bigger impact by partnering your resources with an existing nonprofit rather than stretching available funding thin by adding another nonprofit to the mix.

2. Establish your name and mission

If your nonprofit idea is unique, viable, and needed within your community, it’s time to formalize its purpose. Create a name for your nonprofit, including a logo, that will establish the tone for your brand. Be creative but not so much so that potential supporters can’t quickly connect your name to your cause.

In addition to your name, you’ll want a quick one to two sentence mission statement that clearly states the purpose of your nonprofit and what it will do. Your name and mission will be front and center on all future marketing materials.

N Street Village, a 501(c)(3) nonprofit in Washington, D.C., clearly states its mission on its website’s homepage. Image source: Author

3. Create a board of directors

Once you have a name and a mission, now you need organizational support. The next step on your journey to 501(c)(3) status is forming a board of directors. This should be a group of people passionate about your cause and willing to help with nonprofit accounting, incorporation paperwork, and future operations.

Try to recruit board members with particular skill sets that will be valuable during your formation and future operations. For example, it can be helpful to have a legal expert on your board who understands state laws as they pertain to nonprofit operations. You might also want to have an accountant and a marketing specialist.

It’s also best practice to have at least one member with lived experience related to your cause. For example, if you’re opening a cold-weather shelter, consider including a board member who has experienced homelessness.

4. Write your nonprofit bylaws

Nonprofit bylaws are legally required for the incorporation of your nonprofit. They’re a critical piece of your nonprofit business plan since they outline the foundations of how you will operate, make decisions, and resolve conflicts.

Bylaws must be accepted by your board. Any future amendments must be adopted through the board, as well as reported to the IRS through your annual Form 990, which is required for the renewal of your 501(c)(3) status.

5. File for incorporation

At this point, you’re ready to officially incorporate within your state. This process and any related fees will vary, depending on the state where you operate. Overall, it’s likely to involve some mix of submitting your articles of incorporation, filling out various paperwork, paying a filing fee, and waiting for a response. Once you’ve been approved, hold your first board meeting to announce the incorporation.

6. Apply for 501(c)(3) tax-exempt status

Incorporating as a nonprofit in your state doesn’t automatically grant you 501(c)(3) status. To get that, you’ll need to submit a 501(c)(3) application to the IRS.

This paperwork is known as Form 1023 and can be up to 28 pages long. However, if your nonprofit has gross receipts of less than $50,000 and less than $250,000 in assets, you can likely use Form 1023-EZ, which is only three pages. The IRS has an eligibility worksheet and other resources available to determine which methods are right for your nonprofit.

FAQs

• Do the terms nonprofit, 501(c)(3), and tax-exempt mean the same thing?

  These terms are all related but distinct in their meanings, even if people tend to use them interchangeably.

  Nonprofit is the term used to describe the actual incorporated organization that implements services in line with its mission. If it hasn’t had its Form 1023 approved by the IRS, or if it has lapsed on annual reporting requirements, it might not be a 501(c)(3) or tax-exempt at that moment.

  Tax-exempt describes an organization recognized by the IRS under one of the 501(c) designations that waives the requirement of paying federal corporate income tax on specific activities.

  Is a 501(c)(3) tax-exempt? Yes! The 501(c)(3) designation means that a nonprofit has met the requirements under that specific section of the Internal Revenue Code to be considered a tax-exempt charitable nonprofit.

• How long will it take to get approved for 501(c)(3) status?

  Depending on the complexity of your application and how many follow-up questions the IRS has for you, it can take between three to 12 months for a final decision. To speed up the process, make sure to review the IRS’s guidance on the most common reasons for delays in processing applications for tax-exempt status.

• Will it cost money to apply for 501(c)(3) status?

  Yes. The user fee for your application will depend on a few factors, including which form you submit, and it can range from $275 to $600. You can learn more about the IRS’s user fees on its website.

Apply for 501(c)(3) status for tax exemption and other benefits

Understanding the nitty-gritty details of the Internal Revenue Code can feel daunting. However, it’s worth grasping the basics of 501(c)(3) status so your nonprofit can be recognized as a tax-exempt organization by the IRS. This status qualifies your nonprofit for certain grants and benefits, and it also adds a layer of credibility to your operations in the eyes of your donors.