Many nonprofit organizations are created for the purposes of providing some benefit to the public. Depending on the specific civic purpose of the organization and its anticipated level of involvement in politics, it may be eligible for a federal income tax exemption under subchapter 501(c)(3) or 501(c)(4) of the Internal Revenue Code. Knowing the eligibly requirements and costs and benefits to each classification will help you determine the best way to register your nonprofit.
Overview of Exempt Nonprofits
Nonprofits are business that are created for a purpose other than generating profit. An organization is not precluded from raising revenue, but the funds must be used to support the purpose of the nonprofit and not paid out to directors, members, or staff beyond reasonable compensation. Although this definition is expansive, many nonprofits choose to be subject to more limited rules created by the Internal Revenue Service. Adherence these guidelines can make the nonprofit eligible for a federal tax exemption, meaning that it does not need to pay income taxes. Further, depending on the laws of the state in which it is formed, certain sales, property, and state income tax exemptions may be pursued once the federal exemption is obtained.
Types of Organizations
According to IRS rules, public charities, private foundations and organizations that promote a religious, scientific, charitable, or literary purpose may pursue a tax exempt classification known as 501(c)(3) status. Examples of these organizations include churches, youth summer camps, and museums. By contrast, civil leagues and local associations that further a social welfare objective but do not quite rise to the level of a charitable organization may pursue 501(c)(4) status. Examples of these organizations are the Lions Club and homeowners' associations.
One fundamental difference between 501(c)(3) and 501(c)(4) organizations, is in their ability to freely conduct political or lobbying efforts. These activities include attempts to help pass or repeal legislation, as well as outreach to gain public support or opposition to legislation. 501(c)(3) nonprofits are limited to conducting only "insubstantial" lobbying efforts, determined by the size of the organization. Typically, insubstantial means that you would allocate less than 10 percent of the nonprofits total operating budget. If the nonprofit is found to have engaged in substantial lobbying efforts, it will lose its exempt status. Further, these organizations are prohibited from supporting or endorsing any candidate for public office. By contrast, 501(c)(4) organizations may engage in unlimited lobbying and promotion of candidates, provided that these efforts dovetail with the purpose of the organization.
501(c)(3) and 501(c)(4) nonprofits also differ when it comes to deductions available to individuals and businesses that donate to the organization. Donations to a 501(c)(3) are entirely deductible as a charitable contribution on the donor's tax return. In contrast, donations made to a 501(c)(4) are generally not deductible. This benefit to 501(c)(3) nonprofits can provide a greater incentive to donors, who otherwise might not contribute. However, depending on the nature of the donor's business, certain contributions to a 501(c)(4) may be considered deductible as business expense. Determining when this deduction applies can be complicated, and donors should be advised to contact an accountant before taking the deduction.
- Digital Media Law Project: Nonprofit Organization
- Hurwit & Associates: Lobbying & 501(c)(4) Primer
- Thompson & Thompson: FAQ's: 501(c)(3) Status
- Internal Revenue Service: Political Campaign and Lobbying Activities of IRC 501(c)(4), (c)(5), and (c)(6) Organizations
- Internal Revenue Service: Donations to Section 501(c)(4) Organizations
Wayne Thomas earned his J.D. from Penn State University and has been practicing law since 2008. He has experience writing about environmental topics, music and health, as well as legal issues. Since 2011, Thomas has also served as a contributing editor for the "Vermont Environmental Monitor."