Corporate social responsibility is more than just a buzzword. Many consumers make purchase decisions based at least in part on whether the companies they work with are socially responsible. Whether you own a business and are considering making a contribution or you’re contemplating starting a nonprofit of your own, it’s important to know your options for obtaining a tax-exempt status.
Although there are actually 27 types of nonprofits under the United States tax code, two of the most common options for tax-exempt status are 501(c)(3) and 501(c)(4) organizations. To make an informed decision, it’s critical for you to understand the difference between a 501(c)(3) and a 501(c)(4).
TL;DR (Too Long; Didn't Read)
The main differences between a 501(c)(3) and a 501(c)(4) are the level of political activity in which each organization can engage and whether donations are tax deductible.
What Is a 501(c)(3) Nonprofit?
When you think of a nonprofit organization, you’re probably thinking of a 501(c)(3). Habitat for Humanity and the American Red Cross are two examples of large, well-known 501(c)(3) organizations. These organizations are also referred to as charitable organizations.
A 501(c)(3) must serve a specific purpose as specified by the IRS tax code. It can be charitable, religious, scientific, literary, educational, one that fosters amateur sports competitions or one that prevents cruelty to children or animals. The organization also needs to be appropriately incorporated. It can be a corporation, an unincorporated association or a trust. Sole proprietorships, partnerships and individuals can’t qualify as a 501(c)(3).
What qualifies for 501(c)(3) status? Qualifying organizations can include churches, mosques, schools, charitable hospitals, nursing homes, alumni organizations and parent-teacher associations. They are further categorized as either a public charity or as a private foundation, and they must meet specific requirements. The requirements include operating only for exempt purposes, not operating for the benefit of any private interest or individual and minimizing political and lobbying activities.
A 501(c)(3) can only engage in general voter education that is directly related to its purpose. When this type of nonprofit engages in voter education, it must represent all points of view. A 501(c)(3) can engage in limited lobbying as long as it follows the nonpartisanship rules. It can spend up to 20 percent of its operating budget on lobbying. This is what sets apart a 501(c)(3) vs. a 501(c)(4).
What Are the Advantages of a 501(c)(3) Nonprofit?
The main advantage of a 501(c)(3) is being exempt from most federal, state and local taxes. It also provides some protection from lawsuits and can receive grants from the government as well as from private foundations.
The advantage that separates a 501(c)(3) from a 501(c)(4) is the ability to provide a tax deduction to its donors. An individual or business can deduct cash contributions, in-kind contributions such as property or equipment and mileage and other travel expenses. The specifics for deducting these contributions vary depending on how the business is organized.
What Is a 501(c)(4) Nonprofit?
A 501(c)(4) is sometimes referred to as a social welfare organization. Like a 501(c)(3), they must be operated on a nonprofit basis and must not benefit any specific individual. Homeowners' associations and volunteer fire departments may operate as a 501(c)(4). A 501(c)(4) is exempt from most federal, state and local taxes. If it engages in political activity, though, it may be taxed on either the organization’s net investment income or the amount it spends on political activity, whichever is lower.
With a 501(c)(4), political activity is allowed with some restrictions. A 501(c)(4) can’t give money directly to candidates, and it must relate to the nonprofit’s purpose. It also can’t technically be the only reason the organization exists. A 501(c)(4) can also engage in lobbying to further its purpose.
501(c)(4) organizations have become much more common since the Supreme Court's "Citizens United" decision in 2010. The "Citizens United" decision is what allowed groups with 501(c)(4) status to engage in political activities, and since the decision, the number of applications has more than doubled, according to The Washington Post.
What Are the Advantages of a 501(c)(4) Nonprofit?
Although contributions to a 501(c)(4) are not tax deductible, businesses may be able to write off their contributions as business expenses. Another advantage of a 501(c)(4) is its ability to engage in political and lobbying activity. They can spend up to 50 percent of their budget on politics, and their donors can remain anonymous.
If you donate to other political organizations, such as a Super PAC, your donation must be disclosed. A donation to a 501(c)(4) does not have to be disclosed, which appeals to individuals and businesses who do not want their political affiliations to be revealed.
What Is the Difference Between a 501(c)(3) and a 501(c)(4)?
There are two primary differences between a 501(c)(3) and a 501(c)(4). In a 501(c)(3), political activity is restricted and must be nonpartisan. It must relate to the purpose of the organization, and it can’t comprise more than 20 percent of the organization’s budget.
With a 501(c)(4), political activity and lobbying are much less restricted. They can lobby for specific candidates who further the goals of their organization as long as they don’t give money directly to that candidate. They can spend up to 50 percent of their budget on lobbying and other political activities.
The other difference is in the ability to deduct contributions from taxes. Those who donate money to a 501(c)(3) can deduct their contributions on their taxes. Donations to a 501(c)(4) are not tax deductible, although a business may be able to write the deductions off as a business expense.
Deciding Between a 501(c)(3) and a 501(c)(4) for Your Organization
If your organization meets all of the other requirements for a nonprofit organization, including not being operated for the interest of any particular individual, then the question of whether to seek 501(c)(3) or 501(c)(4) status depends on your organization’s goals, purpose and level of political activity. If political activity and lobbying is a relatively minor part of your organization’s budget and goals, you may want to pursue a 501(c)(3). If lobbying and political activity are important to you and your organization and you anticipate spending more than 20 percent of your budget on those activities, you should organize as a 501(c)(4) or as another 501(c) status.
How to Qualify as a 501(c)(3) Nonprofit Organization
Each state governs how an organization qualifies for nonprofit status. The first step in qualifying for 501(c)(3) status, then, is learning the laws for qualifying as a nonprofit in your state. In most states, the first step to starting a 501(c)(3) is to choose a business name. As with any business, the name needs to be unique and not in use by any other business or organization.
The next step is to appoint a board of directors. Boards typically have at least three members, but your state may have specific requirements. Your board will need to develop the bylaws for your organization. Bylaws typically include the purpose of your organization, how your board is elected and how the board makes decisions, who the officers are in your organization and the role of each officer. If your organization has members, the bylaws may also include rules and regulations regarding membership.
If you haven’t already, you also need to decide on the appropriate structure for your organization. Nonprofits can be a trust, a corporation or an association. Once you know which structure is best for you, you will need to file your incorporation paperwork. This paperwork varies by state and typically requires paying a filing fee with your state.
After you’re incorporated, you should obtain an employer identification number from the IRS. You may also need to complete an annual registration form with your state. For example, California requires Form CT-1 to be filed each year. There may be other forms required by your state as well.
Once you’ve met your state’s nonprofit requirements, you’re ready to apply for your federal tax exemption. If your organization brings in less than $50,000 per year, you may be able to file a Form 1023-EZ. Otherwise, your organization will need to complete Form 1023.
Form 1023 is extensive. It requires information about your organization’s structure, how officers and other employees are compensated, who will benefit from your organization and your actual or projected revenue. You will also need to thoroughly describe the activities of your organization, including what the activities are, when and where your organization’s activities take place and how your activities are funded.
Once the form is completed, you can file the form with the IRS. The filing fee for Form 1023 is up to $850, depending on the size of your organization, and it can take the IRS at least three months to process the form. Your state may also require you to file a tax exemption form. For example, in California you are required to file Form 3500A with the California Franchise Tax Board.
How to Qualify as a 501(c)(4)
Many of the steps involved in forming a 501(c)(4) are the same as the steps in forming a 501(c)(3). You will need to choose an appropriate name, appoint a board of directors, draft bylaws and decide on a legal structure. You will need to qualify for nonprofit status under the rules of your state.
Once you qualify as a nonprofit, you can work on the 501(c)(4) filing requirements. The primary form you need to complete is Form 8976, which is the Notice of Intent to Operate Under Section 501(c)(4). The form must be completed electronically and costs $50 to file. You will need to provide basic information about your organization, including your business name and address, your EIN, when your organization was organized and your statement or purpose.
You may also opt to complete a Form 1024-A. This form is not required, but many 501(c)(4) organizations complete the form in order to get official recognition as a 501(c)(4), which may entitle you to other benefits, such as a state tax exemption and nonprofit mailing privileges. Form 1024-A requires you to submit a thorough description of your organization’s activities and the names, addresses and titles of all your organization’s officers, directors and trustees. You also need to provide your organization’s financial information and proof of your organization’s structure, such as the articles of incorporation or your trust agreement.
The most time-consuming section is the narrative description of your activities. This should include all your past and present activities and how much time and money was spent on each activity. You can provide brochures, printed copies of your website pages and other documents to illustrate the work your organization does.
The IRS estimates that it will take about 17 hours to complete Form 1024-A, and it will take at least three months for the IRS to process your application. You will also need to file Form 8718, the User Fee for Exempt Organization Determination Letter Request, and the user fee, which is $600 for most organizations.
- Sustainable Brands: New Report Reveals 86% of US Consumers Expect Companies to Act on Social, Environmental Issues
- The Balance Small Business: What Is a 501(c)(3) Tax-Exempt Organization?
- IRS: Tax-Exempt Status for Your Organization
- The Balance Small Business: Can My Business Deduct Charitable Donations?
- IRS: Exemption Requirements – 501(c)(3) Organizations
- Nonprofit Hub: The Differences Between a 501(c)(3), 501(c)(4) and Other Tax Exemptions
- The Washington Post: What is a 501(c)(4), Anyway?
- Nolo: What are Section 501(c)(4) Social Welfare Organizations?
- IRS: Instructions for Form 1023-EZ
- IRS: Form 1023
- IRS: New Fees with Form 8718, User Fee for Exempt Organization Determination Letter Request
- IRS: Social Welfare Organizations
- IRS: Before Applying for Tax Exempt Status
- IRS: Applying for Tax Exempt Status
- IRS: Electronically Submit Your Form 8976, Notice of Intent to Operate Under Section 501(c)(4)
- IRS: Form 1024-A
- IRS: Instructions for Form 1024-A
- USA.gov: Starting a Nonprofit Organization
- CalNonprofits: How to Start a California Nonprofit