Understanding Nonprofit Organizations and 501(c)(3) Status
When people hear or say "nonprofit organization," they often assume it automatically means a 501(c)(3) entity—an organization recognized by the IRS as tax-exempt under Section 501(c)(3) of the Internal Revenue Code. While all 501(c)(3)s are nonprofits, not all nonprofits are 501(c)(3)s. Nonprofit status does not automatically grant 501(c)(3) designation.
Here’s what you need to know.
What Is a Nonprofit Organization?
A nonprofit organization is a legal entity established to pursue a specific mission or purpose other than generating profit for its owners or shareholders. Nonprofits generally focus on charitable, religious, educational, scientific, or cultural goals, but the term encompasses a wide variety of organizations.
Key features of nonprofits include:
Nonprofit Purpose: Revenue is used to further the organization’s mission rather than distribute profits.
Legal Structure: In the U.S., nonprofits are incorporated under state law.
Being a nonprofit is a state-level designation. This alone does not provide federal tax exemption or the ability to receive tax-deductible donations.
What Is 501(c)(3) Status?
501(c)(3) refers to a specific category of tax-exempt status granted by the Internal Revenue Service (IRS). Organizations with this designation benefit from:
Federal Tax Exemption: They are not required to pay federal income taxes on most types of income.
Tax-Deductible Donations: Donors can deduct contributions on their federal tax returns within the guidelines of U.S. law.
To achieve and maintain 501(c)(3) status, a nonprofit organization must:
Be organized exclusively for charitable, educational, religious, scientific, or literary purposes (among others);
Apply to the IRS using Form 1023 or 1023-EZ; and
Meet ongoing compliance requirements, such as filing annual Form 990s.
Not All Nonprofits Are 501(c)(3)s
The 501(c) section of the tax code recognizes 29 different types of nonprofit organizations, including:
501(c)(4): Social welfare organizations, such as civic leagues and advocacy groups
501(c)(6): Business leagues, chambers of commerce, or trade associations
501(c)(7): Social and recreational clubs
These organizations are nonprofits under state law, but their tax-exempt purposes differ, and they are not eligible to receive tax-deductible donations like 501(c)(3)s.
Why Nonprofits Are Not Automatically 501(c)(3)s
Nonprofit status under state law does not confer federal tax-exempt status.
Separate Applications: Organizations must file separately for state incorporation and federal tax exemption.
Eligibility Requirements: Not all nonprofits meet the strict requirements for 501(c)(3) status, such as the restrictions on political campaigning or lobbying.
Intentional Designation: Some nonprofits deliberately choose a different tax-exempt status to better align with their mission or operations.
Common Misconceptions
Myth: All nonprofits are 501(c)(3)s.
Reality: Nonprofits can take many forms, including 501(c)(4), (c)(6), etc..
Myth: Incorporating as a nonprofit automatically grants tax-exempt status.
Reality: Incorporation is only the first step; applying for IRS recognition as a 501(c)(3) designated entity is a separate process.
Myth: All tax-exempt organizations can accept tax-deductible donations.
Reality: Only 501(c)(3) nonprofit organizations have this benefit.
Bottom Line
Nonprofit organizations are diverse, and their classification has important legal and operational implications. While 501(c)(3) is a common and well-known designation, it is just one type of nonprofit recognized under federal law. Understanding the distinctions can help you navigate the nonprofit world more effectively, whether you're starting an organization, donating, or engaging with nonprofits.
Questions? Schedule a consultation with Ariella Law.
The information on this website is for informational purposes only, and does not constitute legal advice.