What Is the Difference Between 501(c) and 501(c)3?

Unlike for-profit small businesses, 501(c)(3) nonprofit organizations are exempt from paying federal income tax. The Internal Revenue Service (IRS) treats each nonprofit organization differently. Donors can claim a tax deduction for what they give to a 501(c)(3) organization. Some other 501(c) organizations do not get this benefit.

This article explains the difference between IRS designations of these charitable organizations.

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How Does a Small Business Become Exempt?

Organizing as a nonprofit corporation with your state does not automatically grant an entrepreneur's startup tax-exempt status. To be a nonprofit entity, you must meet state criteria when you file your articles of incorporation with the secretary of state.

Your local Small Business Administration Development Center (SBDC) has local resources to help you with your nonprofit application process. The IRS also has an online workshop and tax exemption application guide.

IRS Nonprofit Application Process

The nonprofit's board of directors must apply to the IRS for the nonprofit business to become tax-exempt. The IRS will not grant nonprofit organizations nonprofit status simply because they operate for a charitable purpose. Each organization must apply to the IRS and have an exempt purpose under the Internal Revenue Code.

If the IRS grants an organization nonprofit status under Section 501(c) of the U.S. Tax Code, it is not required to pay tax on income related to its nonprofit purposes. The organization is in the searchable database the IRS maintains on its website.

What Is a 501(c) Organization?

A 501(c) organization is a nonprofit recognized by the IRS.

Under this code, there are 29 different exempt entities. Here are some 501(c) examples:

• 501(c)(1) are corporations formed by Congress, like a federal credit union
• 501(c)(4) are civic leagues and social welfare organizations
• 501(c)(6) are real estate boards, chambers of commerce, and business leagues
• 501(c)(13) are cemetery companies
• 501(c)(24) are veterans organizations
• 501(c)(29) are for qualified nonprofit health insurance issuers

Not all 501(c) organizations can claim tax-exempt status, which means their donors cannot claim a tax deduction for donations. The IRS keeps a list of the types of tax-exempt organizations. Donors may only claim a tax deduction for charitable contributions to some types of nonprofits.

Entities organized under 501(c) can generate income from their operations. But, if their fundraising efforts bring in substantially more than they spend each year, the IRS may revoke their tax-exempt status. The organization must file an unrelated business income tax filing if it brings in over $1,000 from unrelated small business activities.

As a result, most 501(c) organizations try to spend most of their income on operations.

What Is a 501(c)(3) Organization?

The most well-known and common 501(c) organization is 501(c)(3). The IRS allows donors to deduct charitable contributions given to it.

Organizations that have received the 501(c)(3) designation from the IRS are usually either public charities or private foundations established for the following purposes:

• Charitable
• Educational
• Improvement of child welfare
• National or international sports competitions
• Public safety
• Religious
• Scientific or literary
• Prevention of animal cruelty
• Public safety

The directors and officers of a 501(c)(3) nonprofit may get paid for their work, but the profits earned through its activities can't provide them with a direct financial benefit. Because the organization is not-for-profit, the directors and officers can't engage in any activities involving conflicts of interest with the 501(c)(3).

Finally, a 501(c)(3) organization can't pursue lobbying or other legislative activities as its primary activity.

Need Help With Your 501(c) or 501(c)3 Organization?

If you are forming or operating a nonprofit and need help determining whether you can make it a 501(c)3 organization or another type of 501(c) entity, a local attorney can help. An experienced lawyer can help you structure your nonprofit to benefit the organization and its donors.