501(C)(3) Filings

Starting a 501(c)(3) nonprofit organization takes careful planning to file the necessary paperwork to incorporate the entity and request tax exemption.

Nonprofits that wish to operate as 501(c)(3) organizations, a designation named after Internal Revenue Code Section 501(c)(3), must pay attention to many details to ensure they are created and operate properly. They are accountable to federal agencies, including the IRS, and must follow their state’s regulations. Section 501(c)(3) tax-exempt status applies to federal income tax and federal unemployment tax. States, too, grant tax exemption. The types of exemption and processes for requesting them vary from state to state.

What Is a 501(c)(3) Organization?

The United States Internal Revenue Code’s Section 501(c) identifies the 27 different types of nonprofit organizations. The 501(c)(3) is the most common designation chosen by organizations. Not only does the status exempt an organization from federal taxes, but also it allows it to collect tax-deductible donations from people and businesses and get grants.

Organizations must be considered “charitable” by the IRS to receive a 501(c)(3) classification. According to the IRS, a charitable organization is established for one of the below purposes :

• Charitable
• Religious
• Educational
• Scientific
• Literary
• Testing for Public Safety
• Fostering of national or international amateur sports
• Prevention of cruelty to animals and children

A 501(c)(3) may not be organized or operated for any private interests. All, except for those with the purpose of testing for public safety, may receive tax-deductible contributions.

The two primary types of 501(c)(3) organizations are:

• Public charities
• Private foundations

Public Charities

Public charities serve a public interest, not a private one. If they fail to fulfill their ongoing compliance responsibilities or engage in activities they’re prohibited from, they may lose their tax-exempt status.

Public charities must be supported financially by the general public. They must obtain 33 percent of their funding from small donors, the government, or other public charities.

Some key things to know about operating as a public charity include:

• Public charities may not directly or indirectly participate or intervene in any political campaign.
• A public charity may not allow its income or assets to benefit insiders (i.e., directors, officers, key employees, any persons who have a personal or private interest in the organization’s activities). Any payments to insiders for their work in the organization may not be deemed unreasonable compensation.
• Public charities may not participate in lobbying activities.
• A public charity must have a diversified board of directors (over 50 percent of directors must be unrelated by blood, marriage, or other business ownership).
• Public charities must file an informational return (Form 990 or 990-EZ) with the IRS annually. Those that have $1,000 or more of gross income from taxable income-producing activities from an unrelated business or trade must also file Form 990-T.

Private Foundations

Private foundations usually have a single major funding source (e.g., gifts from one family or business) rather than numerous sources. Most private foundations’ purpose is to raise funds and award grants to support the work of public charities. Within the category of private foundations are private operating foundations, associations that dedicate most (85 percent or more) of their resources to conducting their exempt activities (e.g., administering their programs).

As with public charities, private foundations must refrain from certain activities, or they will jeopardize their tax-exempt status.

Some key things to know about operating as a private foundation include:

• Private foundations are prohibited from allowing more than an insubstantial accrual of private benefits, including non-monetary benefits, to individuals or organizations.
• A private foundation may not allow its income or assets to benefit insiders (i.e., directors, officers, key employees, any persons who have a personal or private interest in the organization’s activities). Any payments to insiders for their work in the organization may not be deemed unreasonable compensation.
• There is an excise tax on the net investment income of most domestic private foundations (to be reported on Form 990-PF).
• If a private foundation violates Internal Revenue Code provisions, it may incur additional taxes and penalties.
• Private foundations are prohibited from directly or indirectly participating or intervening in any political campaign (on behalf of—or in opposition to—candidates for public office).
• Private foundations will incur significant excise tax on expenses related to lobbying activities.

Who Needs a 501c(3) Status?

Although nonprofits do not need 501(c)(3) status to operate, they must apply for 501(c)(3) status if they want to be able to collect tax-deductible donations and be exempt from paying federal income tax and federal unemployment tax.

Realize that filing for 501(c)(3) status alone does not guarantee that a nonprofit will be granted tax-exempt status or retain it.

How to start a 501c(3)?

Some of the steps to become a 501(c)3 organization include:

1. Decide on the type of 501c(3).
2. Decide on the organization’s name.
3. Determine the board of directors.
4. Write bylaws.
5. Designate a registered agent.
6. File nonprofit articles of incorporation (certificate of incorporation) with the state agency and pay the applicable filing fee.
7. Obtain an EIN.
8. Request 501(c)(3) status from the IRS.
9. Request state tax exemption.
10. Understand, and follow through with, ongoing compliance requirements.

Nonprofit founders should get guidance from an attorney and accountant or tax advisor to understand all start-up and ongoing compliance requirements. Every nonprofit is unique in some way!

How to Request Tax Exempt Status

To request federal tax exemption, nonprofits must electronically file IRS Form 1023 (Application for Recognition of Exemption under Section 501(c)(3) of the Internal Revenue Code). While this sounds simple enough, the form is quite long. Other schedules and supporting materials (e.g., organizing documents, bylaws) must accompany the filing.

If eligible according to the IRS requirements, an organization may use Form 1023-EZ, which is a streamlined version of Form 1023.

Nonprofit organizations may also have to submit a state application to obtain state tax exemption status.

How much does it cost to file the 501(c)(3) application? The fee for applying to the IRS is $800 for Form 1023 and $275 for Form 1023-EZ. That’s the fee to the U.S. Government and doesn’t take into account the amount of time nonprofit founders will spend trying to figure out the instructions and fill out the form. States’ fees vary for filing their tax-exempt forms.