There are three key components for an organization to be exempt from federal income tax under section 501(c)(3) of the IRC. A not-for-profit (i.e., nonprofit) organization must be organized and operated exclusively for one or more exempt purposes.
Organized — A 501(c)(3) organization must be organized as a corporation, trust, or unincorporated association. An organization’s organizing documents (articles of incorporation, trust documents, articles of association) must: limit its purposes to those described in section 501(c)(3) of the IRC; not expressly permit activities that do not further its exempt purpose(s), i.e., unrelated activities; and permanently dedicate its assets to exempt purposes.
Operated — Because a substantial portion of an organization’s activities must further its exempt purpose(s), certain other activities are prohibited or restricted including, but not limited to, the following activities. A 501(c)(3) organization:
must absolutely refrain from participating in the political campaigns of candidates for local, state,or federal office;
must restrict its lobbying activities to an insubstantial part of its total activities;
must ensure that its earnings do not inure to the benefit of any private shareholder or individual;
must not operate for the benefit of private interests such as those of its founder, the founder’s family, its shareholders or persons controlled by such interests;
must not operate for the primary purpose of conducting a trade or business that is not related to its exempt purpose, such as a school’s operation of a factory; and
may not have purposes or activities that are illegal or violate fundamental public policy.
Exempt purpose — To be tax exempt, an organization must have one or more exempt purposes, stated in its organizing document. Section501(c)(3) of the IRC lists the following exempt purposes: charitable, educational, religious, scientific, literary, fostering national or international sports competition, preventing cruelty to children or animals, and testing for public safety.
The most common types of 501(c)(3) organizations are charitable, educational, and religious.
Charitable organizations conduct activities that promote:
relief of the poor, the distressed, or the underprivileged
advancement of religion
advancement of education or science
erection or maintenance of 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
combating community deterioration and juvenile delinquency
Educational organizations include:
schools such as a primary or secondary school, a college, or a professional or trade school
organizations that conduct public discussion groups, forums, panels, lectures, or similar programs
organizations that present a course of instruction by means of correspondence or through the use of television or radio
museums, zoos, planetariums, symphony orchestras, or similar organizations
nonprofit day-care centers
youth sports organizations
The term church includes synagogues, temples, mosques, and similar types of organizations. Although the IRC excludes these organizations from the requirement to file an application for exemption, many churches voluntarily file applications for exemption. Such recognition by the IRS assures church leaders, members, and contributors that the church is tax exempt under section 501(c)(3) of the IRC and qualifies for related tax benefits. Other religious organizations that do not carry out the functions of a church, such as mission organizations, speakers’ organizations, nondenominational ministries, ecumenical organizations, or faith-based social agencies, may qualify for exemption. These organizations must apply for exemption from the IRS. See Publication 1828, Tax Guide for Churches and Religious Organizations, for more details.
Public Charities and Private Foundations
Every organization that qualifies for tax-exempt status under section 501(c)(3) of the IRC is further classified as either a public charity or a private foundation. Under section 508(b) of the IRC, every organization is automatically classified as a private foundation unless it meets one of the exceptions listed in sections 508(c) or 509(a).
For some organizations, the primary distinction between a classification as a public charity or a private foundation is the organization’s source of financial support. Generally, a public charity has a broad base of support while a private foundation has very limited sources of support. This classification is important because different tax rules apply to the operations of each. Deductibility of contributions to a private foundation is more limited than deductibility of contributions to a public charity. See Publication 526, Charitable Contributions, for more information on deductibility of contributions.
In addition, private foundations are subject to excise taxes that are not imposed on public charities. For more information about the special tax rules that apply to private foundations, see Publication 4221-PF, Compliance Guide for 501(c)(3) Private Foundations and the Life Cycle of a Private Foundation website on www.irs.gov/eo.
Organizations statutorily classified as public charities under section 509(a) of the IRC are:
organizations that provide medical or hospital care (including the provision of medical education and in certain cases, medical research);
organizations that receive a substantial part of their support in the form of contributions from publicly supported organizations, governmental units, and/or from the general public;
organizations that normally receive not more than one-third of their support from gross investment income and more than one-third of their support from contributions, membership fees and gross receipts from activities related to their exempt functions; and
organizations that support other public charities.
If the organization requests public charity classification based on receiving support from the public, it must continue to seek significant and diversified public support in later years. Beginning with the organization’s sixth year of existence and for all succeeding years, the organization must demonstrate in its annual return that it receives the required amount of public support. If the organization does not meet the public support requirement, it could be reclassified as a private foundation.
In addition, to avoid unexpectedly losing its public charity classification, the organization should keep careful track of its public support information throughout the year, so that it will have the information it needs to complete Schedule A, Form 990 or 990-EZ. Unless the organization is committed to raising funds from the public, it may be more appropriate to consider an alternate statutorily based public charity classification. See Publication 557, Tax-Exempt Status for Your Organization, for assistance with determining how your organization would be classified.