Nonprofit organizations exist in many forms. Some are religious organizations, others are charities. Support groups and other social organizations may also be organized as nonprofits. Regardless of what the company or organization does, the key aspect is that it does not operate to make a profit. Most, if not all, of the organization's income, goes back out to finance its charity work or other key objectives.
What many people do not realize is that forming a nonprofit company isn't enough to earn federal tax exemption. There are specific criteria that a company has to meet to earn its tax exemption, and if its practices change then that exemption can be taken away. Perhaps more importantly, there are several types of exemptions that are issued based on what the company or organization does and how it is structured. While 501(c)(3) nonprofit status is the most familiar exemption status for most people, there are other options that a company can pursue as well. One of these is 501(c)(6), which differs from the more common 501(c)(3) in a few key ways.
What Is a Nonprofit Company?
To understand the differences between 501(c)(3) organizations and 501(c)(6) organizations, it's good to first get an idea of precisely what makes an organization a nonprofit. Saying that it's a company or organization that doesn't set out to make a profit is a little sparse for a concrete definition, especially given that the tax code recognizes 29 distinct types of nonprofits, and the National Taxonomy of Exempt Entities recognizes over 600 subcategories of nonprofits that qualify for 501(c)(3) alone.
All these categories do have one core thing in common, though: The businesses or organizations that fall within these categories exist to advocate and promote a specific cause for the public benefit. This can be a religion (especially one with a strong charitable emphasis), a social cause such as fighting homelessness or providing medical care to those who need it, the promotion of scientific research or any of the thousands of other causes that seek to enrich the public in some way. This is the reason that nonprofit organizations qualify for tax exemption at all; the government feels that the social enrichment and aid that they provide is worth more than the IRS would collect in taxes.
Understanding 501(c)(3) Status
The 501(c)(3) exemption status gets its name from its location in the Internal Revenue Code, which is the third subsection of point C within section 501. This section sets forth rules for tax exemption for select business types which operate as charitable organizations.
According to section 501(c)(3), a tax-exempt business must be one that operates for the purpose of a charitable, religious, educational, scientific or literary action or one that performs testing for public safety. Organizations that foster national or international amateur sports competition or work to prevent cruelty to children or animals may also qualify under the tax code. Qualifying businesses that fall within one of these categories can gain 501(c)(3) tax exemption, which not only keeps the company in question from having to pay federal income tax (and often state and local taxes as well) but also makes donations to the company tax deductible for those who make the donations.
Companies and organizations that are recognized as 501(c)(3) charitable organizations do have some restrictions on them, however. They may not be politically active, meaning that they cannot make political contributions or endorsements. Also, a substantial part of a nonprofit's overall activities must not include lobbying for the passage of laws. They also cannot be operated in such a way that they produce a benefit or profit for private interests. Further, nonprofits cannot pay out to shareholders or other individuals in exchange for donations or investments. Violating any of these rules can result in the loss of 501(c)(3) status.
Comparisons to 501(c)(6) Status
If 501(c)(3) organizations are what most people traditionally think of as "nonprofits," what are 501(c)(6) organizations then? Unlike 501(c)(3) exemptions, 501(c)(6) status is reserved for companies and organizations that qualify as "business leagues" under the definition of the term in the tax code. This includes chambers of commerce, boards of trade, real estate boards and sports teams such as professional football leagues that operate as nonprofit entities (as opposed to teams that operate for profit such as those in the National Football League.) Many of the criteria for 501(c)(6) status are the same as 501(c)(3), especially concerning how the organization cannot operate to create any gain for shareholders or private firms.
One item that is different between the two regards political action. While 501(c)(3) organizations are severely limited in what they can do politically, the IRS is more lenient with 501(c)(6) organizations being political. Because business leagues exist to serve the needs of businesses within an area or of a certain type, the IRS recognizes that lobbying for legal change may be one method of serving those needs. As such, organizations with 501(c)(6) status will not automatically lose their exempt status for engaging in political activity related to lobbying on behalf of the businesses they represent. This is the only political activity that is allowed, however, and the organization may still be required to inform its members of its activities and what percentage of any dues or membership fees went toward this political activity. Certain taxes may be levied on the money spent on lobbying costs if the organization does not inform its members.
There is also one other big difference between 501(c)(3) companies and 501(c)(6) groups. While donations to 501(c)(3) organizations are tax deductible under most circumstances, donations made to 501(c)(6) organizations are not. Many of the funds used in the operation of these organizations come from member fees or other dues, so this is generally not a major concern.
Which Status Is Best for Your Company?
As you can see, there are benefits to both 501(c)(3) status and 501(c)(6) status. A company with 501(c)(3) status enjoys the benefits of tax exemption, and fundraising may be easier since donations are deductible from the taxes of donors as well. Even the value of donated goods can be deducted, as long as a receipt is provided to show the approximate value of the items in case the IRS questions the donations. For public charities and other nonprofit organizations that serve the community they exist in, 501(c)(3) status is the goal to try and reach.
For companies that serve the businesses in their community or that represent an entire class of businesses, however, it doesn't make sense to try for 501(c)(3) status. Instead, 501(c)(6) status provides many of the same benefits while still allowing the company to be politically active on its members' behalf. Donations to the business aren't deductible, but these companies also receive significantly fewer donations than public charities, so this shouldn't be a point that makes or breaks the decision to apply for nonprofit status.
Regardless of the type of nonprofit status your company qualifies for, it's essential that you take the time to learn about the application process because nonprofit status isn't always easy to get. You also need to learn about the reporting requirements of the specific type of nonprofit status you apply for and what rules must be followed to keep the status active. Missing reports or operating outside of the rules can lead the IRS to cancel your company's nonprofit status, and it can take significant work to get it reinstated once it's lost.