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.
Nonprofit cheat sheet: IRS Nonprofits
If you already run or plan to start a nonprofit organization, chances are good that you have considered filing a Form 1023 or a Form 1023 EZ to become tax-exempt. The purpose of this article is to help people who are considering filing for tax-exempt status determine whether their organization qualifies as a “charitable organization” under Section 501(c)(3) of the federal tax code.
What is a 501(c)(3) nonprofit, generally?
A 501(c)(3) nonprofit is a nonprofit organization that the 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 these three: (1) No one in the organization can take the organization’s earnings for themselves; (2) no substantial portion of the organization’s activities may be attempts to influence legislation or lobby; and (3) the organization itself cannot take part in political campaigns.
Read the law: 26 U.S.C. § 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. The law provides a useful list of charitable purposes, but the list is not as straightforward as it may seem at first glance. We’ll refer to the items on the following list as “core concepts”:
- 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.
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?
Here’s an 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, it is helpful for organizations to try to connect their activities or “mission” with the IRS’s core concepts. If we take the above 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
In fact, there is an article dedicated to helping farmer’s markets become tax-exempt by connecting their activities with tax exempt purposes. For more, read Chasing the Coveted (c)(3): The Trials and Tribulations of Form 1023.
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 will be very different/unique. For example, farmer’s markets are sometimes considered “business leagues” or 501(c)(6) organizations rather than 501(c)(3) organizations. This is because a given farmer’s market may not line up with 501(c)(3)’s charitable purpose requirement. Business leagues are organizations organized by people with a common business or economic interest.
Read the law: 26 U.S.C. §501(c)(6).
The IRS may consider a farmer’s market that is organized by farmers to promote their common interest a business league. In our example, however, the farmer’s market is not organized by the farmers to promote their common interest, but instead by the community for the public benefit.
NOTE: There are many other factors that go into the IRS’s determination of whether an organization will be awarded tax-exempt status and there are many other parts of the Form 1023. Being considered a “charitable organization” is just one of the requirements of a Form 1023.
Consider your own organization’s charitable purpose.
You may wish to put your organization’s purpose or mission statement through the test above. Consider what you hope your organization will accomplish. What are your goals? If you are an existing corporation, you may want to refer to the purpose section of the articles of incorporation, or think about your “mission statement.” The core concepts listed above may help you think this through. Your organization may have many exempt purposes or just one.