What Is 501(c)(3)?
Not All Nonprofits Are 501(c)(3)
Should We Be A 501(c)(3)?
How Do We Get 501(c)(3) Status?
Who Is Eligible Under 501(c)(3)?
Required Articles
How to Apply
Responding to Questions
Notification
Conclusion

Even if you are new to the non-profit world, you will soon hear the term "501(c)(3)." What is it? Do you need it? How do you get it? This Do It Right! Kit will help you understand.

Section 501 of the US Internal Revenue Code defines more than 30 categories of tax exempt organizations, from veterans organizations to labor unions. Different tax rules apply to different categories. If your organization will be seeking grants and donations, you will want to explore the requirements of Section 501(c)(3).

Qualifying under Section 501(c)(3) offers significant benefits:

• Exemption from payment of federal income tax
• Exemption from payment of federal unemployment tax
• Reduced postal rates
• Tax deductions to contributors for their donations

If your organization is a loose, informal group with little money or expenses, incorporation and 501(c)(3) tax exemption may be unnecessary. Many small volunteer service and advocacy groups exist with little or no money. They don't seek grants and their members or contributors don't care if their gifts are tax deductible.

Even if you have some money or wish to seek an occasional grant, you may not need to establish a separate non-profit 501(c)(3) organization. You may partner with an existing 501(c)(3) non-profit that would agree to serve as your "fiscal sponsor," administering financial matters on your behalf. For more information on this option, see CTAC's Do It Right! Kit on Fiscal Sponsors.

Tax exempt status under Section 501(c)(3) also imposes significant responsibilities:

• Limits the organization's purpose and activities
• Limits lobbying activities
• Prohibits political activities
• Prohibits excessive financial benefits to its directors and employees
• Requires tax returns
• Requires many records be open to public scrutiny
• Restricts certain distribution of assets if the organization is dissolved

Carefully weigh the benefits and costs of all your options before you commit the time and money to a 501(c)(3) application.

How Do We Get 501(c)(3) Status?

If you have decided that 501(c)(3) tax exempt status is appropriate for your organization, be prepared for the process. Because this designation confers significant benefits on a non-profit organization, the IRS carefully screens applications to weed out inappropriate, ineligible or ill-prepared applicants.

The process may take a year or more and you may have to respond to IRS requests for additional information, often on a short time deadline.

Who Is Eligible Under 501(c)(3)?

501(c)(3) status is limited to non-profit entities that are organized and operated for one or more of the following purposes:

• Religious
• Educational
• Charitable
• Scientific
• Literary
• Testing for pubic safety
• Fostering national or international sports competitions
• Preventing cruelty to children or animals

IRS Publication 557 explains these categories further. Most community development non-profits will apply under the broad sounding term "charitable", but not every non-profit purpose will qualify under the IRS definition of the term.

Required Articles

To qualify for 501(c)(3) tax exemption, certain provisions must appear in the non-profit's Articles of Incorporation or By-Laws. If you are starting a new organization, you can save time and money by including these provisions in your original filing. If you have an existing non-profit, you will need to obtain copies of your organizational documents on file with the Secretary of State and make amendments as needed.

The following provisions are required:

A statement that profits or funds will not inure (be paid) to any members. Of course the organization can pay its employees appropriate compensation.

Sample: No part of the Corporation's net earnings will inure to the benefit of members, directors, or other private persons except that the Corporation shall pay reasonable compensation to staff for services rendered.

A statement that if the corporation dissolves, its remaining funds will be given to another tax-exempt organization according to the requirements of Section 501(c)(3) of the Internal Revenue Code.

Sample: Upon dissolution of the Corporation, assets shall be distributed for one or more exempt purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code.

Be sure that your statement of purpose, or Mission Statement, is consistent with the IRS regulations for tax-exempt activity. Your Mission Statement should briefly describe your purpose and then add the following:

Sample: The Corporation is formed solely for charitable and educational purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code.

A Statement that the corporation will not lobby extensively or support or oppose candidates for public office.

Sample: No substantial part of the Corporation's activities will consist of carrying on propaganda, or otherwise attempting to influence legislation. The Corporation will not participate in any political campaign on behalf of or in opposition to any candidate for public office.

• IRS Publication 557 - Tax Exempt Status for Your Organization. A great cure for insomnia, but you'll need to read through it carefully to understand and complete Form 1023.

• Form 1023 - Application for Recognition of Exemption under Section 501(c)(3).This is it. Don't let it frighten you.

• Form 8718 - User Fee for Exempt Organization Determination Letter Request. This form determines the amount of your application fee. Current fees range from $300 to $750.

In addition, some organizations may need to file other IRS forms depending on the type and length of their activities. Look through the list of forms and publications for anything that may be relevant to your organization.

Make several copies of the forms to use for working drafts. After reading the instructions and Publication 557, fill in as many of the blanks as you can. If you still have some blanks, read the instructions and Publication 557 again, and then yell for help.

You can seek assistance from an attorney or accountant, but find one with experience with non-profits. You can seek out a local technical assistance provider, such as CTAC. You can also call the IRS Exempt Organization Office at (877) 829-5500.

The financial pages are a common sticking point for applicants. If your organization has been in existence for more than one year, you must provide the current year's data plus up to three previous years of actual revenue and expense information. If your organization is less than one year old, you must provide the current year's data and two years of projected revenue and expense.

Remember, the IRS wants to see if your organization has a broad base of public support. If it doesn't, your organization may be classified as a "Private Foundation" and be subject to different tax rules. Take great care with this section and read the IRS definitions for the various categories.

They also want to see that your dollars are being spent on the charitable activities you described, that funding is broad enough to qualify as public charity and that the organization is not overly influenced by a small number of people. Otherwise, you will be classified as a private foundation.

When you have completed your draft, ask a qualified attorney, accountant or technical assistance provider to review it with you. Incorporate their suggestions if applicable, and prepare the final version of the form.

Sign it, prepare a check for the application fee, gather up the attachments and mail the whole package to the IRS.

It is not uncommon for the IRS to take months to review your application and then play "20 Questions" with you. They may ask for more information or documents, and they will set a deadline for response. DON'T MISS THE DEADLINE.

Carefully prepare your response, collect any requested documents and review it all with your lawyer, accountant or technical assistance provider. Send it to the IRS by the deadline.

Eventually, you will receive notice of the IRS decision. This is called a "Determination Letter," and it is a key document that you will need for every grant application you ever write, so guard it carefully.

If you are a new organization, you will receive a Preliminary Determination. You may function as a 501(c)(3) tax exempt organization for five (5) years, when the IRS will examine your activities and financial information to see if you indeed met the requirements as you projected. If you have, or if you applied with an existing history of activities and financials, you will receive a Final Determination.

Relatively few completed and timely applications are denied, but if you are unsuccessful, contact the IRS and an attorney for assistance with the appeal process.

Conclusion

The 501(c)(3) process is not easy, and it is not appropriate for every organization. Carefully evaluate your options, choose what's right for your organization and prepare for the process.