Nonprofits Explained: 501(c)(3) and 401(c)(3) Designations

There are several classifications for nonprofit organizations, and it can be difficult to understand their distinctions. From 501(c)(1)s to 501(c)(29)s, there are quite a few to keep up with. One of the most common classifications, however, is the 501(c)(3), or a 401(c)(3). Although the two terms may be interchangeable, the most common (and legal) name for this type of nonprofit is a 501(c)(3). Let’s dive into the details of this type of organization and the benefits of a 501(c)(3) classification.

501(c)(3) Basics

The US Internal Revenue Code (IRC) outlines Section 501(c)(3) in regard to the tax exemption status of nonprofit organizations. Most commonly, this refers to public charities, private operating foundations, and private foundations. This section is regulated and implemented by the United States Department of Treasury, specifically the Internal Revenue Service (IRS). No reference to a 401(c)(3) is made within the IRC, although individuals may use this name in reference to code 501(c)(3).

There are over 30 total types of nonprofits recognized by the IRS. However, only those with the 501(c)(3) designation may claim donations to their organization as tax deductible. The majority of these organizations are charitable organizations, churches and other religious organizations, and private foundations.

Eligibility for a 501(c)(3)

There are a few requirements an organization must meet in order to qualify for a 501(c)(3) designation. This designation may include:

–       Corporations

–       Trusts

–       Community chests

–       LLCs1

–       Unincorporated associations

These groups must be considered to be “charitable” organizations (which comes with its own set of acceptance criteria). The group’s purpose of operation must exclusively remain:

–       Charitable

–       Scientific

–       Literary

–       Educational

–       Religious

–       For testing for public safety

–       For fostering national/international amateur sports competition

–       For preventing animal or child cruelty

–       For lessening the burdens of government

–       Fighting juvenile delinquency

–       For lessening neighborhood tensions

–       Constructing or continuing maintenance of public buildings/monuments/other works

–       Fighting community deterioration

–       Eliminating prejudice and discrimination

–       Defending human and civil rights

3 Types of Eligible Organizations

There are 3 key groups of organizations to keep in mind when evaluating 501(c)(3) eligibility. They can be broken down into private foundations, private operating foundations, and public charities.

Private Foundations

Private foundations typically do not have active programs nor are they required to maintain public support. Their revenue can be generated from a single donor, family, or a smaller number of individuals. They may be called “non-operating” foundations as they usually provide support for public charities, such as through grants, which can be tax deductible.

Example: family foundations

Private Operating Foundations

This type of organization is the least common of the 3. Unlike private foundations, as the name suggests, they operate active programs. They hold similarities to public charities in this regard; however, they often have more attributes similar to a foundation. This is why many consider them to be hybrids of the 2 other types of organizations. Their donations may be deducted up to 60% of the donor’s income. Most of their received donations must be used for the continuance of their programs.

 Examples: Museums and zoos

Public Charities

Public charities are the most recognizable form of 501(c)(3) organizations. They are well known for their active programs and receive a majority of their funding from either the government or general public. Unlike the other 2 types of organizations, public charities must receive at least a third of their donated revenue from public support (individuals, companies and other public charities) in order to maintain their status as a public charity. Similar to private operating foundations, donations to this form of organization are also deductible up to 60% of the donor’s income.

Example: Churches

Examining the Pros and Cons

The designation of a 501(c)(3) comes with its own set of advantages and disadvantages. Some of the pros include being exempt from federal taxes, having tax-deductible contributions, and eligibility for government and/or private grants

On the other hand, however, there are a few cons that you should keep in mind. The organization technically belongs to the public once it receives this type of designation. It must operate under strict parameters in order to keep its designation and receive exemptions. All financial information is readily accessible to the public.

Becoming a 501(c)(3)

To understand if this type of designation is right for your organization, you should reach out for a nonprofit consultation. Otherwise, you can begin reviewing the process on the IRS website. Individuals must fill out and submit Form 1023, or Form 1023-EZ, to apply for this designation.

The filing costs with the state are typically around $100, while the IRS filing fee is about $600. If the organization is expected to yield less than $50,000 in annual earnings, the filing fee is reduced to about $275. The processing timeline varies per applicant, but the average wait for a Letter of Determination is anywhere from 3 to 6 months. The longest waits are a year or more.

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