Guide To 501(c)(3) Tax-Exempt Status
What Is 501c3 Status?
501(c)(3) tax-exempt status is an informal term for organizations that meet the requirements of section 501c3 of the Internal Revenue Code. This is the IRS tax code that defines the federal tax-exempt status of public charities and private foundations.
Qualifying organizations receive the following benefits:
- They don’t pay federal income taxes.
- They pay reduced postal rates.
- They qualify for tax-exempt financing.
- They usually qualify for additional state tax exemptions.
- Their donors’ contributions are tax-deductible, which means big donors might find charities with 501(c)(3) status more attractive than those without it.
For your nonprofit corporation to qualify for federal tax-exempt status, you must convince the IRS that your nonprofit exclusively serves one or more charitable purposes recognized by the federal government, and that you formed your nonprofit to fit the organizational requirements of section 501c3 of the federal tax code.
Fair warning: it isn’t easy.
When you apply for 501(c)(3) tax-exempt status, your nonprofit goes under the IRS microscope. You’ll need to submit the lengthy Application for Recognition of Exemption (Form 1023), likely the most difficult application you’ve ever completed. The IRS will closely examine your nonprofit’s formation document, its statement of purpose, its bylaws, its finances, the relationships between the members of its board of directors, and a host of other details. You’ll need to make sure your nonprofit’s formation document includes specific tax-exempt language required by the IRS. You’ll also need to budget 6-9 months to complete the application process, which might involve answering additional questions from the IRS.
But if you have the patience and the time, and if you want your nonprofit to face fewer financial obstacles, the benefits of 501c3 status will likely outweigh the difficulties. With this possibility in mind, we’ve put together this guide to get you started on the path toward 501(c)(3) federal tax-exempt status.
Qualifying Your Nonprofit for 501(c)(3) Status
501c3 status is for charitable organizations that focus exclusively on one or more of the following tax-exempt purposes:
- Testing for public safety
- Fostering national or international amateur sports competition
- The prevention of cruelty to children or animals
Furthermore, 501(c)(3) nonprofits must organize themselves to promote their exempt purpose. They don’t issue stock or have shareholders. They don’t distribute profits to directors, officers, or other members of their organizations. And even when a 501c3 organization shuts down (or “dissolves”), it must distribute its assets in a way that furthers its tax-exempt purpose. For example, organizations like the Red Cross, churches, mosques, nonprofit animal shelters, and community colleges usually qualify for federal tax-exempt status so long as they exclusively serve one or more of the purposes recognized by the IRS in section 501(c)(3) of the tax code, and so long as they are organized to serve public (not private) interests.
Most 501(c)(3) charitable organizations are nonprofit corporations, unincorporated associations, or trusts, but it is possible, in very rare circumstances, to obtain 501(c)(3) tax-exempt status for a limited liability company (LLC).
Public Charities / Private Foundations
Like public charities, private foundations that qualify for 501(c)(3) status are also charitable organizations, but their organization and main sources of financial support are different.
Basically, public charities (such as the Girl Scouts of America) get more of their support from government entities and public donations, and they typically get at least 1/3 of their financial support from the general public. Public charities, in other words, actively solicit contributions from a diverse range of sources.
Private Foundations (such as the Bill and Melinda Gates Foundation) are usually controlled by a small group of often related people, and they usually draw most of their support from one major source (such as a single corporation or a family).
The IRS treats every applicant for 501(c)(3) status as a private foundation unless the organization specifically seeks recognition as a public charity when filing Form 1023. But of course most applicants likely make this request. Public charities make up the vast majority of nonprofits with 501(c)(3) status.
Steps to Applying for 501(c)(3) Status
1. Form Your Nonprofit
To form your nonprofit, file your formation documents with the secretary of state offices in every state your nonprofit intends to operate. Your formation document, called nonprofit Articles of Incorporation in most states, should include a detailed statement of purpose and dissolution of assets provision that use specific language, provided by the IRS, if you hope to qualify for 501(c)(3) status.
2. Get an Employer Identification Number (EIN) from the IRS
Once your nonprofit is registered with the secretary of state, you can apply for a federal employer identification number (a FEIN or EIN) on the IRS website or by phone.
3. Submit Form 1023 or 1023-EZ to the IRS
Form 1023, also known as the Application for Recognition of Exemption, is an 11 page application that highlights your nonprofit’s history, organization, activities, finances, and numerous other details used by the IRS to determine if you qualify for 501(c)(3) tax-exempt status. Some smaller charities, however, might qualify to submit the shorter and less expensive Form 1023-EZ instead.
Crafting Your Purpose and Dissolution Clause
In part three of your Application for Recognition of Exemption, you’ll check a box verifying that your formation document states your exempt purpose, and you’ll identify the statement’s location (by page, article, and paragraph). Then you’ll do the same for your dissolution clause—a statement in your formation document that when your nonprofit dissolves its remaining assets will get used exclusively to promote a 501(c)(3) exempt purpose.
And, yes, the purpose clause and dissolution clause will be two of the most scrutinized parts of your application materials.
Make sure both clauses include the specific language provided by the IRS for nonprofits seeking 501(c)(3) status. Since the IRS’s recommended language is lengthy, we put together a helpful guide that contains that language here: IRS 501(c)(3) Tax-Exempt Language.
But your overall goal is pretty simple. Taken together, the purpose and dissolution clauses need to convince the IRS that your nonprofit is organized for exclusively charitable purposes; that it won’t distribute profits to individuals; and that upon your nonprofit’s dissolution its assets won’t go to an individual. If it turns out that your formation document doesn’t satisfy the IRS’s requirements, you’ll need to amend your nonprofit’s formation document if you still intend to seek 501(c)(3) status.
Completing 501(c)(3) Form 1023
Filing Fee: $600
Deadline: An organization must submit Form 1023 within 27 months of formation to be recognized as tax-exempt for the entire history of its existence. If a qualifying organization submits after the deadline, the IRS will recognize its tax-exempt status from the application’s postmark date.
What follows is a preliminary guide, a basic outline, to completing Form 1023 (the Application for Recognition of Exemption). It should help get you get started, but we recommend getting some professional advice before you finalize and submit Form 1023.
Form 1023 contains the following 11 sections:
Part One: Identification of Applicant
You’ll begin by providing basic information about your nonprofit, such as its name, address, telephone number, EIN, primary contact, website, and email address. If your nonprofit has an authorized representative, you’ll need to attach that representative’s name and the name and address of the representative’s firm. If your nonprofit paid (or promised payment to) anyone for outside organizational, financial, or tax assistance, you’ll need to list that person’s name and firm as well.
Lastly, you’ll need to list your nonprofit’s date of formation, acknowledge if your nonprofit was formed under the laws of a foreign country, and identify if you think your organization qualifies for an exemption from filing the annual Form 990 or Form 990-EZ.
Part Two: Organizational Structure
This section asks you to identify your nonprofit’s organizational structure: either a corporation, an LLC, an unincorporated association, or a trust. If your nonprofit isn’t structured in one of these four ways, it won’t be eligible for tax-exempt status under section 501(c)(3). You’ll also need to attach your nonprofit’s formation document and bylaws.
Part Three: Required Provisions in Your Organizing Document
In this section you’ll affirm that your formation document contains a purpose clause and dissolution clause satisfying the requirements of section 501(c)(3) and using the specific language provided by the IRS. If not, you’ll need to amend your nonprofit’s formation document before submitting Form 1023.
Part Four: Narrative Description of Your Activities
For this section you’ll tell your nonprofit’s story and predict its future. The IRS wants a thorough description of your nonprofit’s past activities, present activities, and planned activities. For each activity, answer the following questions (from the IRS Form 1023 instructions): What is the activity? Who conducts the activity? When is the activity conducted? Where is the activity conducted? How does the activity further your exempt purpose? What percentage of your total time is allocated to the activity? How is the activity funded?
You’ll also need to list any other names your nonprofit has used in the course of its operations (if applicable). You can even attach corroborating documents to support your narrative (a printed copy of your website, for example, or brochures and newsletters).
Part Five: Compensation and Other Financial Arrangements
In this lengthy section you’ll provide details about the financial arrangements internal to your nonprofit. For example, you’ll provide information about compensation (or proposed compensation) for your nonprofit’s officers, directors, trustees, highest paid employees, and highest paid contractors, as well as detailed information about their relationships with each other (for example, if an officer and one of the nonprofit’s highest paid employees belong to the same family or share a business relationship outside the nonprofit).
If your nonprofit has already adopted a conflict of interest policy as part of its bylaws, you’ll attach them to Form 1023. If not, you’ll need to answer various questions asking how your nonprofit will prevent conflicts of interest. As complicated as this section may be, it’s very important. Without it, the IRS couldn’t make sure a nonprofit doesn’t really serve to enrich individuals at the expense of its stated exempt purpose.
Part Six: Individuals/Organizations that Receive Benefits
In this section you’ll explain the services your nonprofit provides and to whom you provide them, including individuals, organizations, and members of your nonprofit. You’ll also need to describe any business or family relationships between individuals benefiting from your services and individuals serving as officers, directors, trustees, or highly compensated employees. This is a “yes” or “no” section that also requires attached explanations each time you answer “yes.”
Part Seven: Your History
For this section you’ll identify if your nonprofit is taking over another organization’s activities, if you’re taking over 25% of another organization’s assets, or if you were formed by a formerly for-profit organization changing to nonprofit status. You’ll also identify if you’re submitting Form 1023 more than 27 months after you formed your nonprofit.
Part Eight: Your Specific Activities
This section asks “yes” or “no” questions to find out about your nonprofit’s specific activities. Before answering these questions, you should study section 501(c)(3) of the Internal Revenue Code, as well as the IRS’s instructions for filling out Form 1023, to determine the approved types of activities available to tax-exempt organizations. You’ll answer questions about political activities, gaming activities, fundraising, connections with other organizations (including foreign organizations), and a host of other activities. Your answers could make or break your potential tax-exempt status under section 501(c)(3).
Part Nine: Financial Data
For this section you’ll provide a detailed financial information about your nonprofit, but you’ll provide different information depending on how long your nonprofit has been around.
- If you’ve been operating for five years or more, you’ll provide financial information about your most recent completed tax year and the three immediately preceding years.
- If you’ve operated for more than one but less than five years, you’ll provide information for every completed year of operation, an estimate for the current year, and an estimate for future years adding up to a total of four years.
- If you’ve operated for less than one year, you’ll provide projected estimates for the current year and the next two years for a total of three years.
Part Ten: Public Charity Status
The questions in this section serve to classify your nonprofit as a public charity or private foundation.
Part Eleven: User Fee Information and Signature
In this final section you’ll identify the amount you’re paying for your user fee, which you can pay by personal or certified check, bank check, or cashier’s check. The fee for filing Form 1023 is $600, and you should include the check among the documents attached to the application. An authorized official needs to sign and date the form.
Annual Returns: The 501(c) 990-Series
The IRS requires most tax-exempt charitable nonprofits to file an annual informational return. There are four possible returns for charitable organizations—each belonging to the 501(c)(3) 990-series—and the form you file depends on your nonprofit’s public or private status, its gross receipts for the year, and/or its total assets.
Below you’ll find a list of the different forms to help you determine which annual return you should file each year:
This form is for public charities with annual gross receipts of $200,000 or more and/or total assets of $500,000 or more.
This form is for public charities with annual gross receipts of less than $200,000 and total assets of less than $500,000.
Also called the e-Postcard, this form is for public charities with annual gross receipts of $50,000 or less. (However, organizations that qualify to file Form 990-N may file Form 990 or 990-EZ if they wish.)
This form is only for private foundations (“PF”). Private foundations must file 990-PF each year regardless of its annual gross receipts and total assets.