501(c)(3) organization

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A 501(c)(3) or 501c3 organization is the most common type of the 29 types of 501(c) nonprofit organization in the United States. Most charitable non-profits in the United States that Americans commonly know of, and often make donations to, are 501(c)(3) organizations, ranging from charitable foundations to universities and churches. These organizations must be approved by the Internal Revenue Service to be tax-exempt under the terms of section 501(c)(3) of the Internal Revenue Code.

501(c)(3) tax-exemptions apply to entities that are organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or for testing for public safety, or to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals. 501(c)(3) exemption applies also for any non-incorporated community chest, fund, cooperating association or foundation that is organized and operated exclusively for those purposes.[1][2] There are also supporting organizations—often referred to in shorthand form as "Friends of" organizations.[3][4][5][6][7]

26 U.S.C. § 170, provides a deduction, for federal income tax purposes, for some donors who make charitable contributions to most types of 501(c)(3) organizations, among others. Regulations specify which such deductions must be verifiable to be allowed (e.g., receipts for donations over $250). Due to the tax deductions associated with donations, loss of 501(c)(3) status can be highly challenging to a charity's continued operation, as many foundations and corporate matching programs do not grant funds to a charity without such status, and individual donors often do not donate to such a charity due to the unavailability of the deduction.

Types[edit]

The two exempt classifications of 501(c)(3) organizations are as follows:[8]

  • A public charity, identified by the Internal Revenue Service (IRS) as "not a private foundation", normally receives a substantial part of its income, directly or indirectly, from the general public or from the government. The public support must be fairly broad, not limited to a few individuals or families. Public charities are defined in the Internal Revenue Code under sections 509(a)(1) through 509(a)(4).
  • A private foundation, sometimes called a non-operating foundation, receives most of its income from investments and endowments. This income is used to make grants to other organizations, rather than being disbursed directly for charitable activities. Private foundations are defined in the Internal Revenue Code under section 509(a) as 501(c)(3) organizations, which do not qualify as public charities.

Churches must meet specific requirements in order to obtain and maintain tax exempt status; these are outlined in IRS Publication 1828: Tax guide for churches and religious organizations.[9] This guide outlines activities allowed and not allowed by churches under the 501(c)(3) designation. A private, nonprofit organization, GuideStar, also provides information on 501(c)(3) organizations.[10]

Obtaining status[edit]

The basic requirement of obtaining tax-exempt status is that the organization is specifically limited in powers to purposes that the IRS classifies as tax-exempt purposes. Unlike for-profit corporations that benefit from broad and general purposes, non-profit organizations need to be limited in powers to function with tax-exempt status, but a non-profit corporation is by default not limited in powers until it specifically limits itself in the articles of incorporation and/or nonprofit corporate bylaws. This limiting of the powers is crucial to obtaining tax exempt status with the IRS and then on the state level.[11] Organizations acquire 501(c)(3) tax exemption by filing IRS Form 1023.[12] As of 2006 the form must be accompanied by a $850 filing fee if the yearly gross receipts for the organization are expected to average $10,000 or more.[13][14] If yearly gross receipts are expected to average less than $10,000, the filing fee is reduced to $400.[13][14] There are some classes of organizations that automatically are treated as tax exempt under 501(c)(3), without the need to file Form 1023:

  • Churches, their integrated auxiliaries, and conventions or associations of churches[15]
  • Organizations that are not private foundations and that have gross receipts that normally are not more than $5,000[16]

The IRS also expects to release a software tool called Cyber Assistant, which assists with preparation of the application for tax exemption, but as of late 2011 the release date is unclear.[17]

There is an alternative way for an organization to obtain status if an organization has applied for a determination and either there is an actual controversy regarding a determination or the Internal Revenue Service has failed to make a determination. In these cases, the United States Tax Court, the United States District Court for the District of Columbia, and the United States Court of Federal Claims have concurrent jurisdiction to issue a declaratory judgment of the organization's qualification if the organization has exhausted administrative remedies with the Internal Revenue Service.[18][19]

Prior to October 9, 1969, nonprofit organizations could declare themselves to be tax-exempt under Section 501(c)(3) without first obtaining Internal Revenue Service recognition by filing Form 1023 and receiving a determination letter.[20] A nonprofit organization that did so prior to that date could still be subject to challenge of its status by the Internal Revenue Service.[20]

Tax-deductible charitable contributions[edit]

An approved 501(c)(3) exemption allows donors to the organization to reduce their own taxable incomes by deducting the amounts of their donations given, and thus to reduce their personal income taxes, and it allows the 501(c)(3) organization to avoid federal income taxes on the difference between revenues (donations, grants, service fees) received vs. expenses (wages, supplies, state and local taxes paid, etc.) in its main operations. In a for-profit business, that difference would represent taxable income and be taxed at federal corporate tax rates of 15 to 39 percent.[21] Organizations with 501(c)(3) status may also be exempt from state and local corporate income taxes, which generally range from 0 to 12 percent.[22]

Testing for public safety is described under section 509(a)(4) of the code, which makes the organization a public charity and not a private foundation,[23] but contributions to 509(a)(4) organizations are not deductible by the donor for federal income, estate, or gift tax purposes.

Before donating to a 501(c)(3) organization, a donor may wish to consult the searchable online IRS list of charitable organizations[24] as well as lists that may be maintained by a state on a portion of its web portal devoted to its "department of justice" or "office of attorney general".

Consumers may file IRS Form 13909 with documentation to complain about inappropriate or fraudulent (i.e., fundraising, political campaigning, lobbying) activities by any 501(c)(3) tax-exempt organization.[25] Think tanks are often incorporated as 501(c)(3) organizations, and such a level of political influencing is usually considered acceptable.

Limitations on political activity[edit]

Section 501(c)(3) organizations are prohibited from supporting political candidates, and are subject to limits on lobbying. They risk loss of tax exempt status if these rules are violated.[26][27] An organization that loses its 501(c)(3) status due to being engaged in political activities cannot then qualify for 501(c)(4) status.[28]

Constitutionality[edit]

Since section 501(c)(3)'s political-activity prohibition was enacted, "commentators and litigants have challenged the provision on numerous constitutional grounds," such as freedom of speech, vagueness, and equal protection and selective prosecution.[29] Historically, Supreme Court decisions, such as Regan v. Taxation with Representation of Washington, suggested that the Court, if it were to squarely examine the political-activity prohibition of § 501(c)(3), would uphold it against a constitutional challenge.[29] However, some have suggested that a successful challenge to the political activities prohibition of Section 501(c)(3) might be more plausible in light of Citizens United v. FEC.[30]

Political campaign activities[edit]

Organizations described in section 501(c)(3) are prohibited from conducting political campaign activities to intervene in elections to public office.[31] The Internal Revenue Service website elaborates on this prohibition:[31]

Under the Internal Revenue Code, all section 501(c)(3) organizations are absolutely prohibited from directly or indirectly participating in, or intervening in, any political campaign on behalf of (or in opposition to) any candidate for elective public office. Contributions to political campaign funds or public statements of position (verbal or written) made on behalf of the organization in favor of or in opposition to any candidate for public office clearly violate the prohibition against political campaign activity. Violating this prohibition may result in denial or revocation of tax-exempt status and the imposition of certain excise taxes.

Certain activities or expenditures may not be prohibited depending on the facts and circumstances. For example, certain voter education activities (including presenting public forums and publishing voter education guides) conducted in a non-partisan manner do not constitute prohibited political campaign activity. In addition, other activities intended to encourage people to participate in the electoral process, such as voter registration and get-out-the-vote drives, would not be prohibited political campaign activity if conducted in a non-partisan manner.

On the other hand, voter education or registration activities with evidence of bias that (a) would favor one candidate over another; (b) oppose a candidate in some manner; or (c) have the effect of favoring a candidate or group of candidates, will constitute prohibited participation or intervention.

Lobbying[edit]

Main article: 501(h) election

In contrast to the prohibition on political campaign interventions by all section 501(c)(3) organizations, public charities (but not private foundations) may conduct a limited amount of lobbying to influence legislation. Although the law states that "No substantial part..." of a public charity's activities can go to lobbying, charities with large budgets may lawfully expend a million dollars (under the "expenditure" test), or more (under the "substantial part" test) per year on lobbying.[32]

The Internal Revenue Service has never defined the term "substantial part" with respect to lobbying.[33]

In order to establish a safe harbor for the "substantial part" test, the United States Congress enacted §501(h), called the Conable election after its author, Representative Barber Conable. The section establishes limits based on operating budget that a charity can use to determine if it meets the substantial test. This changes the prohibition against direct intervention in partisan contests only for lobbying. The organization is now presumed in compliance with the substantiality test if they work within the limits. The Conable election requires a charity to file a declaration with the IRS and file a functional distribution of funds spreadsheet with their Form 990. IRS form 5768 is required to make the Conable election.[34]

Foreign activities[edit]

A 501(c)(3) organization is allowed to conduct some or all of its charitable activities outside the United States.[35][36] A 501(c)(3) organization is allowed to award grants to foreign charitable organizations if the grants are intended for charitable purposes and the grant funds are subject to the 501(c)(3) organization's control.[37] Additional procedures are required of 501(c)(3) organizations that are private foundations.[36][38]

Allowance of tax-deduction by donors[edit]

Donors' contributions to a 501(c)(3) organization are tax-deductible only if the contribution is for the use of the 501(c)(3) organization, and that the 501(c)(3) organization is not merely serving as an agent or conduit of a foreign charitable organization.[37] The 501(c)(3) organization's management should review the grant application from the foreign organization, decide whether to award the grant based on the intended use of the funds, and require continuous oversight based on the use of funds.[37]

If the donor imposes a restriction or earmark that the contribution must be used for foreign activities, then the contribution is deemed to be for the foreign organization rather than the 501(c)(3) organization, and the contribution is not tax-deductible.[37]

The purpose of the grant to the foreign organization cannot include endorsing or opposing political candidates for elected office in any country.[37]

Foreign subsidiaries[edit]

If a 501(c)(3) organization sets up and controls a foreign subsidiary in order to facilitate its charitable work in a foreign country, then donors' contributions to the 501(c)(3) organization are tax-deductible even if they are intended to fund the charitable activities in the foreign country.[37][39]

If a foreign organization sets up a 501(c)(3) organization for the sole purpose of raising funds for the foreign organization, and the 501(c)(3) organization sends substantially all contributions to the foreign organization, then donors' contributions to the 501(c)(3) organization are not tax-deductible to the donors.[37]

References[edit]

  1. ^ Exempt Purposes – Internal Revenue Code Section 501(c)(3).
  2. ^ IRS Publication 557 "Tax-Exempt Status For Your Organization", Page 19, (Rev. June 2008), Cat. No 46573C., Retrieved March 9, 2009.
  3. ^ Hopkins, Bruce R. (2011), The Law of Tax-Exempt Organizations (10 ed.), John Wiley and Sons, p. 879, ISBN 978-0-470-60217-1 
  4. ^ Judith S. Ballan, "How To Aid a Foreign Charity Through an 'American Friends of' Organization", in Proceedings of the Twenty-Third New York University Conference on Tax Planning.
  5. ^ "Legal Dimensions of International Grantmaking: How a Private Foundation Can Use "Friends of" Organizations". Usig.org. Retrieved June 7, 2011. 
  6. ^ "Meet the expert: Suzanne M. Reisman, Law Offices of Suzanne M. Reisman". Giving Insights. March 3, 2010. Retrieved June 7, 2011. 
  7. ^ Larkin, Richard F.; DiTommaso, Marie (2011), Wiley Not-for-Profit GAAP 2011: Interpretation and Application of Generally Accepted Accounting Principles, John Wiley and Sons, p. Ch.11, ISBN 978-0-470-55445-6 
  8. ^ IRS, "Life Cycle of a Public Charity/Private Foundation", IRS.gov, Retrieved March 9, 2009.
  9. ^ "Tax guide for churches and religious organizations" (PDF). 26 USC 501(c)(3). Internal Revenue Service. Archived (PDF) from the original on April 29, 2011. Retrieved April 24, 2011. 
  10. ^ "Police: Beware scammers during holiday". The Leader-Herald. December 3, 2016.
  11. ^ "IRS Exemption requirements: 501(c)(3) organizations". Internal Revenue Service. April 15, 2016.
  12. ^ Phillips, Marlissa J. "tax zone: Nonprofit Not Tax Exempt?" The Atlanta Tribune. December 2002. p. 64.
  13. ^ a b IRS "Form 1023" (Rev. 6-2006), p. 12.
  14. ^ a b IRS Exempt Organizations Website Retrieved on September 7, 2009.
  15. ^ 26 U.S.C. § 508(c)(1)(A)
  16. ^ 26 U.S.C. § 508(c)(1)(B)
  17. ^ "Should You Wait For the Cyber 1023?". 501c3book. 
  18. ^ "Internal Revenue Code 7428". Internal Revenue Service. via Legal Information Institute, Cornell University. Retrieved October 2, 2013. 
  19. ^ Journy, Matthew T.; Ziffer, Yosef; Tenenbaum, Jeffrey S. (September 2013). "Tools for Bypassing IRS Delays in EO Applications: Organizations and their representatives missed opportunities to mitigate the consequences of the IRS' delays and requests for inappropriate information" (PDF). Venable LLP. Retrieved October 2, 2013. 
  20. ^ a b "Internal Revenue Manual, Part 4. Examining Process, Chapter 72. Employee Plans Technical Guidelines, Section 13. 403(b) Plans, 4.72.13.8.6 Eligibility – Examination Steps, Paragraph 1(F)". Internal Revenue Service. Retrieved May 15, 2015. 
  21. ^ "Corporate and Individual Tax Data". 
  22. ^ "Corporate tax rates table (global corporate tax rates between 2006 and 2014)". KPMG. 
  23. ^ IRS, Publication 557 "Tax-Exempt Status For Your Organization", p. 43, (Rev. June 2008), Cat. No 46573C.
  24. ^ "IRS Search for Charities". Internal Revenue Service. Archived from the original on April 27, 2011. Retrieved April 24, 2011. 
  25. ^ "Form 13909: Tax-Exempt Organization Complaint (Referral) Form" (PDF). Internal Revenue Service. Archived (PDF) from the original on April 29, 2011. Retrieved April 24, 2011. 
  26. ^ "Lobbying". Internal Revenue Service. April 18, 2013. Retrieved May 14, 2013. 
  27. ^ Elacqua, Amelia. "Eyes wide shut: The ambiguous "political activity" prohibition and its effects on 501(c)(3) organizations". Houston Business and Tax Journal. 2008. p. 119, 141. Referenced February 16, 2012.
  28. ^ Chick, Raymond; Henchey, Amy. "Political Organizations and IRC IRC 501(c)(4)" (PDF). Exempt Organizations-Technical Instruction Program for FY 1995. Internal Revenue Service. 
  29. ^ a b Joseph S. Klapach, Note, Thou Shalt Not Politic: A Principled Approach to Section 501 (C)(3)'s Prohibition of Political Campaign Activity, 84 Cornell L. Rev. 504 (1999).
  30. ^ Hannah Lepow, Speaking Up: The Challenges to Section 501(c)(3)'s Political Activities Prohibition in a Post-Citizens United World, 2014 Colum. Bus. L. Rev. 817.
  31. ^ a b "The Restriction of Political Campaign Intervention by Section 501(c)(3) Tax-Exempt Organizations". Irs.gov. Internal Revenue Service. August 14, 2012. Archived from the original on December 2, 2010. Retrieved September 9, 2012. 
  32. ^ "Political and Lobbying Activities". Irs.gov. January 6, 2009. Archived from the original on May 7, 2009. Retrieved June 3, 2014. 
  33. ^ Berry, Jeffrey M. (November 30, 2003). "The Lobbying Law Is More Charitable Than They Think". The Washington Post. p. B1. 
  34. ^ "Form 5768: Election/Revocation of Election by an Eligible Section 501(c)(3) Organization To Make Expenditures To Influence Legislation (Under Section 501(h) of the Internal Revenue Code)" (PDF). Internal Revenue Service. 
  35. ^ "Rev. Rul. 71–460, 1971–2 C.B. 231". Internal Revenue Service. 1971.
  36. ^ a b "Domestic Organizations with Foreign Operations". Exempt Organization Continuing Professional Education Text. Internal Revenue Service. 1983.
  37. ^ a b c d e f g "Rev. Rul. 63–252, 1963–2 C.B. 101". Internal Revenue Service via Bradford Tax Institute. 1963.
  38. ^ "Memorandum 200504031". Internal Revenue Service. January 28, 2005.
  39. ^ "Public Letter Ruling 201438032". Internal Revenue Service. September 19, 2014.
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