"We're a 501(c)(3)" is one of the most commonly used phrases in the nonprofit world, and one of the least understood. It is not a type of company. It is a section of the Internal Revenue Code that grants federal tax exemption to organizations meeting specific requirements.
Two separate steps
Becoming a tax-exempt nonprofit involves two distinct actions that people frequently confuse. First, you form an entity under state law, usually a nonprofit corporation filed with the Secretary of State. Second, you apply to the IRS for recognition of exemption under Section 501(c)(3).
Incorporating does not make you tax-exempt. Plenty of organizations complete step one, start fundraising, and only later discover that donors' contributions were never deductible because step two never happened.
The three requirements
An exempt purpose. The organization must be organized and operated exclusively for one or more purposes the code recognizes: charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports, or preventing cruelty to children or animals.
No private inurement. Earnings cannot benefit any private shareholder or individual. Paying a fair salary for real work is fine; using the organization to enrich insiders is not.
Limited lobbying, no campaigning. Lobbying must remain an insubstantial part of activities, and 501(c)(3) organizations may not participate in political campaigns for or against candidates at all.
What exemption actually gives you
- Exemption from federal income tax on income related to your exempt purpose
- Donors can generally deduct their contributions
- Eligibility for grants that are only open to recognized exempt organizations
- Access to nonprofit postal rates and, often, state sales and property tax exemptions
What it does not give you
It does not exempt you from payroll taxes on employees. It does not eliminate state registration requirements before you solicit donations. It does not exempt unrelated business income. And it does not remove the annual filing obligation: miss three consecutive years and exemption is revoked automatically.
Public charity or private foundation?
Every 501(c)(3) is classified as one or the other. Public charities draw support from a broad base and face lighter rules; private foundations are typically funded by one source and face stricter ones. Your classification is determined when you apply, so it deserves thought up front.
If you're at the beginning of this process, our 501(c)(3) formation service handles both steps, state filing and IRS application, from start to determination letter.
This article is general information, not legal advice, and reading it does not create an attorney-client relationship. Rules differ by state and change over time. Please speak with a licensed attorney about your own situation.