In other words, a nonprofit organization is not required to pay federal income taxes.
More in depth, a 501c3 is a nonprofit corporation considered by the IRS to be either a “public charity” or a “private foundation” under section 501(c)(3) of the Internal Revenue Code. Upon filing the required documents and receiving IRS tax-exempt status, such an organization is tax-exempt, meaning that it is not required to pay taxes on donations made to it, or even on certain forms of income made by the organization.
501c3 organizations are split into two categories: public charities and private foundations. Public charities are much more common – and generally more desirable – so we’ll start with those and address private foundations in a moment.
How hard is it to obtain 501c3 approval? And how long does it take to register as a 501c3 organization?
Normally, obtaining 501c3 approval is a long and involved process beginning with forming a board of directors, filing articles of incorporation with your state, drafting and adopting bylaws, voting in the nonprofit officers, adopting a conflict of interest policy, completing the IRS 501c3 application, including a projection of your financial data for the nonprofit’s first three years, and much more.
However, with the help of Harvard-trained lawyer David G Marmon and his 39+ years of experience and helping more than 3,000+ nonprofits do just that, turning your charitable dreams into a registered 501c3 will be an easy step by step process.
The earlier you start, the better! The IRS processing times for 501c3 applications have been notoriously long, ranging from 6-10 months. And making a mistake as a result of trying to do it yourself can cost you months more in delays as the IRS sorts out the information they need or just denies tax-exempt status to your organization. However, with our new system following a new system with the IRS, we have found that most clients get their tax-exempt status in 2-3 months. It still varies with the IRS backlog, time of year, and how complicated your 501c3 application is.
The good news is, once you receive that 501c3 approval letter from the IRS, your tax-exempt status is retroactive to the date of your filing articles of incorporation in your state, meaning any contributions received after that point are tax-exempt for your organization and tax-deductible for the donors.
***Public charity: Organizations that are exempt under section 501(c)(3) and are not private foundations because they are: churches, schools, hospitals, governmental units, entities that undertake testing for public safety; organizations that have broad financial support from the general public; or organizations that support one or more other organizations that are themselves classified as public charities. Public charity status is a more favorable tax status than private foundation status.
Obtaining 501c3 tax-exempt status is one of the best actions you can take for your charitable organization. Not only will donations to the nonprofit be tax-exempt, but they will also be tax-deductible for the donors, meaning donors will be significantly more motivated to give to your charity.
Moreover, income from business sources related to the organization’s tax-exempt purpose is also tax-exempt. For example, an organization could teach homeless individuals how to paint, and later could sell their paintings to others. The income from selling the paintings would be directly related to the exempt purpose of the organization–rehabilitating homeless individuals through painting workshops–and so would not be taxed income. Note that unrelated business income, such as this organization also running a for-profit art gallery (separate from their selling of the paintings by the homeless individuals), is generally taxed if grossing more than $1,000 annually.
Registered 501c3 organizations are also perceived as more credible by potential donors. Donors, especially those with large donations to make, want to be sure that their money will be used wisely and effectively to support the cause toward which they are donating. Registering as a 501c3 indicates that your charitable work has been approved of by an impartial governmental agency (the Internal Revenue Service), and that you have taken certain required steps such as establishing a board of directors.
In addition, grant-making foundations will usually refuse to make a grant to an organization that is not a registered 501c3. Because these situations frequently involve large sources of funding for nonprofits, it is very beneficial to obtain your 501c3 status early.
Are there any negatives to being a registered 501c3? Tax-exempt organizations do face compliance-related required filings every year, as well as the responsibility to maintain records such as receipts and records of contributions received. Moreover, 501c3 organizations cannot generally engage in political activity, and officers and directors are limited to reasonable salaries.
These considerations, however, amount to basic principles of bookkeeping, and of charitable work. Thus, if your goal is to make a political impact or to make a personal profit, a public charity may not be for you. Otherwise, public charities are the perfect vehicle for turning your charitable dreams into a reality that will be well-respected and well-funded.
Let’s take a look at 501c3 compliance issues.
501c3 compliance is relatively basic, but extremely important. Many organizations, as discussed further below, are only required to file a very simple electronic form. However, even for these organizations, the consequences of failing to file are great: any organization required to file an annual return and failing to do so for three consecutive years will be subject to losing their tax-exempt status entirely. This results in another time-consuming and expensive process to regain 501c3 status.
Annual Exempt Organization filings for 501c3 organizations. All tax-exempt organizations (with the exception of churches and certain church-affiliated organizations) must file an annual return with the IRS. This keeps the IRS informed on the activities and financial status of the nonprofit, and helps them ensure that tax-exempt organizations remain charitable in nature, rather than slowly morphing into tax-exempt for-profit businesses.
Most organizations will use Form 990 or a variant for this purpose. Small organizations, defined by the IRS as “those whose gross receipts are normally $50,000 or less,” are permitted to file a very simple online form. Larger organizations, however, will be required to submit more detailed information.
501c3 organizations with more than $1,000 in unrelated business income will also need to file Form 990-T and pay taxes on this income. Moreover, all organizations with paid employees will need to file the appropriate forms to pay their employee taxes.
Let’s look at private foundations for a moment.
So, what is a 501c3? It’s the perfect way to ensure all your funds and energy are directed into your charity rather than going through the tax and hassle of doing the same work without the 501c3 tax-exempt structure.
501c3 status will give you tax-exempt contributions, make donations tax-deductible, give you credibility and eligibility for grants, and help generate more enthusiasm in donors for the charitable work you’re already doing.
Start fulfilling your dream now, fill out our online form to get the process started.