Benefits of Tax-Exempt Status under IRC Section 501(c)(3)

There are numerous benefits of having Internal Revenue Code Section 501c3 tax-exempt status:

  • Exemption from federal income tax;
  • Tax-deductible contributions;
  • Possible exemption from state income, sales, and employment taxes;
  • Reduced postal rates;
  • Exemption from federal unemployment tax; and
  • Tax-exempt financing.

 What is a 501(c)(3) Tax-Exempt Organization?

A 501(c)(3) tax-exempt organization is a nonprofit corporation, trust, or unincorporated association described in the Internal Revenue Code as exempt from federal income tax. It is for organizations that are engaging in some exempt purpose and mission.

It must be organized and operated for one or more exempt purposes described in Code section 501(c)(3):

  •  Charitable,
  •  Educational,
  •  Religious,
  •  Scientific,
  •  Literary,
  •  Testing for public safety,
  •  Fostering national or internationalamateur sports competition, and/or
  •  Preventing cruelty to children or animals.

What does the IRS word “charitable” mean?

The IRS word charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.

Is 501(c)(3) status automatic for a nonprofit?

No. Having 501(c)(3) status is not automatic. A nonprofit organization must apply for and receive the tax-exemption.

There are several steps to getting IRS 501(c)(3) status, including:

  • forming a board of directors
  • setting up a state nonprofit corporation
  • getting an EIN,
  • preparing bylaws and conflict of interest policies
  • completing IRS Form 1023 or IRS Form 1023 EZ to apply for IRS 501c3 status,
  • applying for state tax exemptions and other permits and licenses,
  • and more.

However, please note that churches are different. Learn about churches and their 501(c)(3) status here.

Are there activities that a 501(c)(3) cannot do?

Yes. There are many types of activities that can jeopardize your 501(c)(3)’s tax-exempt status:

    •  Private benefit/inurement,
    •  Lobbying,
    •  Political activity, and
    •  Excessive unrelated business income(UBI).

501(c)(3) Risk: Private Benefit

Nonprofit organizations with 501(c)(3) status must avoid all activities that will substantially benefit the private interest of any individual or organization.

Inurement: No part of an organization’s net earnings may inure to the benefit of a private shareholder or individual. This means that a 501(c)(3) organization is prohibited from allowing its income or assets to accrue to insiders. The prohibition of inurement is absolute. Any amount will jeopardize the organization’s 501(c)(3) status.

501(c)(3) Risk: Lobbying

Lobbying is an activity designed to influence legislation. If its lobbying activities are substantial, a 501(c)(3) nonprofit may risk losing its tax-exempt status. The IRS uses two tests to determine whether lobbying is substantial: the substantial part test and the expenditure test.

501(c)(3) Risk: Political Campaign Activity

Political campaign activity involves directly or indirectly participating or intervening in any political campaign on behalf of or in opposition to any candidate for elective office. The prohibition of political campaign activity is absolute. Any violation may result in the loss of tax-exempt status and the imposition of excise taxes.

501(c)(3) Risk: Excessive Unrelated Business Income (UBI)

If a nonprofit, tax-exempt organization regularly carries on a trade or business that is not substantially related to its exempt purpose, except that it provides funds to carry out that purpose, the organization is subject to tax on its income from that unrelated trade or business. Learn more about UBI and UBIT here.

What is the Difference Between Nonprofit & Tax-Exempt?

Many people mistakenly believe that all nonprofits automatically have 501(c)(3) tax-exempt status.We have outlined in other posts the difference between nonprofit corporations and tax-exempt organizations:

  • nonprofit status refers to state-law corporate status
  • tax-exempt status refers to state and federal tax exemption under tax regulations.

Many organizations are organized as both a nonprofit corporation and a tax-exempt entity.

A nonprofit organization, whether incorporated or not, can decide whether or not it wants to apply for tax-exempt status from the IRS and the state.

Get assurance that your 501c3 nonprofit is set up the right way, the first time

The Cullinane Law Group provides a quick, straightforward solution to set up new nonprofits with formal 501(c)(3) status. From drafting your governing corporate documents and obtaining federal tax exemption, to counseling on compliance and reporting requirements, we offer complete flat-rate packages to get your organization off the ground.

This article and Cullinane Law are cited in the Marquette Sports Law Review. See Laurel C. Montag, It’s (Not) All Par for the Course: An In-Depth Analysis of the PGA’s Controversial Nonprofit Status, 32 Marq. Sports L. Rev. 569 (2022)