501(c)(3) Pros and Cons

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Nonprofit organizations allow individuals to provide valuable resources to the general public. 501(c)(3) status allows nonprofits to provide these resources while benefiting from federal tax exemption. Charitable, educational and religious nonprofit organizations seeking to become a 501(c)(3) must apply with the IRS. Although 501(c)(3) status is beneficial for many nonprofits, there are also some disadvantages. Directors and members of a nonprofit should decide whether applying for 501(c)(3) status is beneficial to their organization.

Tax Benefits

The IRS allows 501(c)(3) nonprofits to receive exemption from federal income taxes. This means eligible organizations do not have to pay taxes on profits at year-end. This is a major advantage for nonprofits because they are able to put more money into their organizations to further their missions. However, the IRS restricts 501(c)(3) organizations from distributing profits to members of the nonprofit. Some states automatically exempt 501(c)(3) organizations from the obligation of paying state income taxes and property taxes. States typically require organizations to show proof of their federal tax-exempt status.

Donor Confidence

Nonprofit organizations benefit from 501(c)(3) status because donors are likely to give to them due to the tax deductions they receive for their contributions. While a tax deduction is some donors' only incentive for giving, nonprofits still benefit from federal tax-exempt status because they receive funds they normally would not acquire. Many 501(c)(3) organizations depend on donations to continue operating, so receiving donations is vital for a nonprofit. Another advantage of having 501(c)(3) status is that organizations can apply for federal grants. Nonprofits are usually required to have federal tax-exempt status to qualify for federal aid.

Bureaucracy

501(c)(3) organizations must carefully follow the rules of the IRS. Profits can only go back into the organization, and nonprofits are expected not to have a large surplus at the end of the fiscal year. Nonprofits that receive grants from the federal government must use the money according to the grant guidelines of the governmental agency. The federal government provides oversight to ensure that nonprofits use money in the way it sees fit. The bureaucratic system is a disadvantage for many 501(c)(3) organizations.

Cost and Paperwork

A disadvantage of a 501(c)(3) is the cost to apply for federal tax-exempt status. The application fees of a nonprofit organization are determined by the budgeted annual gross income. As of the time of publication, the 501(c)(3) application fee is $400 for nonprofit organizations with expected yearly income of less than $10,000. Nonprofits with gross yearly incomes of $10,000 or more must pay an application fee of $850. The application process is tedious. Many nonprofits hire attorneys to help complete the application. This is a major disadvantage for nonprofits with small budgets.

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