A nonprofit is an organization that does not distribute profit among individual people, such as owners or shareholders. Instead, the income of the organization is used to further the organization’s commitment to public service. There are many kinds of nonprofits - some are exempt from paying taxes, some are not.
A 501(c)(3) nonprofit is a nonprofit organization that the Internal Revenue Service (IRS) recognizes as tax-exempt (excused from paying federal income tax) because it is organized or operated primarily for religious, charitable, scientific, educational, or similar purposes. However, the organization may participate in minor, non-exempt activities as long as they do not make up a substantial part of its activities.
501(c)(3) nonprofits are sometimes called “charitable organizations.” To keep their tax exempt status, charitable organizations must follow certain conditions, including:
- no one in the organization can take the organization’s earnings for themselves;
- no substantial portion of the organization’s activities may be attempts to influence legislation or lobby; and
- the organization cannot take part in political campaigns.
If you already run or plan to start a nonprofit organization, chances are good that you have considered filing to become tax-exempt. This article focuses on one requirement, the "charitable organization" requirement. Be aware that there are many other factors that go into the IRS’s determination of whether an organization will be awarded tax-exempt status.
Read the law: 26 U.S. Code § 501(c)(3)
What makes an organization charitable? It is easy to call an organization a “charity” or to describe its mission as “charitable.” Whether an organization is recognized as charitable under the law is a different story. Generally, an organization that is operated exclusively for public benefit (or for the public interest) is considered charitable.
Federal law provides a useful list of charitable purposes:
- relief of the poor, the distressed, or the underprivileged;
- advancement of religion;
- advancement of education or science;
- erecting or maintaining public buildings, monuments, or works;
- lessening the burdens of government;
- lessening neighborhood tensions;
- eliminating prejudice and discrimination;
- defending human and civil rights secured by law; or
- combating community deterioration and juvenile delinquency.
Read the regulation: 26 Code of Federal Regulations § 1.501(c)(3)-1
However, this list is not as straightforward as it may seem at first glance. If your organization is directly involved in one or more of these purposes, it may qualify for federal income tax-exemption under 501(c)(3). If your organization’s purpose is not listed above, this does not mean that your organization does not qualify for 501(c)(3) status. It is possible that your organization falls into one or more of the above categories, but you do not even realize it. Think of the big picture and ask yourself…
What public benefit does my organization provide?
For example, a community-run farmers market may not appear charitable initially, but it may actually accomplish many of the IRS’s charitable purposes. Sometimes, farmer’s markets are organized by a group of farmers looking to make a profit for themselves. Other times, members of the community organize farmer’s markets not for-profit but to:
- encourage healthy food choices for cheap prices;
- educate the community about healthy lifestyles; and
- foster community relations in a positive and fun environment.
The three purposes listed above look a lot like three of the tax-exempt purposes the IRS lists on its website. When filling out a Form 1023, try to connect your organization's activities or “mission” with the IRS’s core concepts. If we take the above farmer's market example, this is what it might look like:
- encourage healthy food choices for cheap prices = relief of the poor (if, of course, situated to serve the poor community)
- educate the community about healthy lifestyles = advancement of education
- foster community relations in a positive and fun environment = lessening neighborhood tensions
NOTE: This is just an example of how a farmer’s market may be considered a charitable organization. There are many farmer’s markets that have not been granted tax-exempt status. Every farmer’s market differs, just as every organization differs. Each situation is unique. For example, farmer’s markets are sometimes considered “business leagues” or 501(c)(6) organizations rather than 501(c)(3) organizations.
Consider your organization's charitable purpose. Use the core concepts above to review your organization’s purpose, mission statement, and goals. Your organization may have many exempt purposes or just one.