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Nonprofit Education

501(c) Nonprofits

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Most individuals or groups seeking to found a nonprofit are typically seeking to found a public charity, or a type of 501(c)(3) organization. Most people do not know, however, that not only are there other forms of 501(c)(3) organizations, specifically private foundations and private operating foundations, but there are also 29 other forms of 501(c) nonprofit organizations. A comprehensive list is available in IRS Publication 557, but they run the gamut from 501(c)(1) organizations (corporations organized under an act of Congress such as federal credit unions and national farm loan associations) to 501(c)(29), qualified nonprofit health insurance issuers.

Common 501(c) Nonprofit Types

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Some of the most common types of 501(c) nonprofit organizations that the general public come across include:

  • 501(c)(3) — Organizations formed for Religious, Educational, Charitable, Scientific, Literary purposes, Testing for Public Safety, to Foster National or International Amateur Sports Competition, or Prevention of Cruelty to Children or Animals Organizations.
  • 501(c)(4) — Civic Leagues, Social Welfare Organizations, and Local Associations of Employees
  • 501(c)(5) — Labor, Agricultural, and Horticultural Organizations
  • 501(c)(6) — Business Leagues, Chambers of Commerce, Real Estate Boards
  • 501(c)(7) — Social and Recreational Clubs

Otherwise, many 501(c) nonprofits fulfill some sort of insurance, fiduciary, legal, or economic/beneficiary function for qualified members.  All, at some level, operate for the “public good.”

The Common Denominator

So, in the end, what is the meaning of a 501(c) designation? What this broad swath of organizational types has in common is that they all fall under IRS Code Section 501(c), which exempts them from some federal income taxes. Notice the word some

Nonprofits, like all other employers, must pay their portion of Social Security and other payroll taxes. Additionally, depending upon the organization’s mission and its income streams, it can be taxed on “unrelated business income.” This type of tax obligation can be quite significant in the case, for example, of colleges and universities with significant real estate or intellectual property holdings, depending upon how they structure their holdings and how they treat any income derived from such holdings. Even endowments must be carefully managed in order not to run afoul of IRS regulations on the treatment and payout of endowment income. But these forms of income represent complex topics for major, flagship organizations that the majority of nonprofit founders and managers are not typically concerned with. 

Otherwise, depending upon the state in which a nonprofit is incorporated and operates, the organization can also be exempt from sales tax (or the obligation to collect sales tax) and property taxes. But these are state-based matters that derive secondarily from the organization’s overarching federal, IRS-approved, nonprofit designation.

What 501(c) Nonprofit Designation Doesn’t Mean

There is a great deal of misunderstanding on the part of the general public as to what it means to be a nonprofit. You’ll often hear people opine that a nonprofit “doesn’t” or “shouldn’t” make money.  While it is true that a nonprofit does not distribute “profits” to “business owners or shareholders” (i.e., profits do not inure to any individual or shareholder), it is most certainly the case that successful nonprofits are managed in the same way that any successful business entity is managed — with an eye toward maximizing net income from operations and using investment capital wisely to support “profitable” business activities.  

Managing a nonprofit in this way is essential to its long-term sustainability and service to its community.  It just so happens that in the case of the nonprofit, income must be reinvested back into the organization, and the organization is not liable for paying taxes on income earned through its primary, mission-driven, business activities.

The Devil is in the Details —  501(c) Filing

If you have taken any time to investigate IRS Publication 557, you might imagine that the subject of 501(c) determination is more complex than you may have originally thought.  You would be correct in that assessment, which is why nonprofit founders are wise to engage experts when submitting their 501(c) Filing to the IRS, including a consultant qualified to advise you on legal, filing and tax matters. 

Depending on the nature of your organization’s mission and programming, the exact tax designation you apply for and receive can mean the difference between being set up to succeed, or creating a potentially expensive or embarrassing false step.

The Bottom Line — Compliance

In great part due to exemption from federal income and some state taxes, the nonprofit sector is highly regulated, both on the federal and state levels. While technically not owing income tax, with very few exceptions, 501(c) nonprofit organizations are required to file some form of tax return (either a 990, 990-EZ, 990-N (or e-Postcard), or a 990 PF return). Failure to file an appropriate 990 return for a three-year period of time results in an organization losing its tax-exempt status. 

Beyond ongoing IRS oversight, there are 13 states in which the office of the Attorney General has its own division dedicated to oversight of charitable organizations, and another 14 states that house oversight of the charitable sector within an office of consumer affairs.  Otherwise, the office of the Secretary of State or some form of business or finance regulatory body will oversee the activities of charitable organizations.

Beyond compliance with tax law, nonprofits are subject to fundraising regulations, industry regulations, and all other laws that govern other businesses operating in the same industrial “space.”

In Summation…

We think that you get the picture. The IRS and state governments take nonprofit designation seriously. If you’re looking to grow your 501(c) nonprofit organization and stay in compliance during every stage of your journey, investing in a competent, capable advisor from the outset is a good first step in ensuring your organization gets off on the right foot down a road toward long-term success. Reach out to our team of nonprofit specialists to learn more about how we can help.