When a group wants to set up a charitable organization, the company formed is generally established as a 501(c)(3) corporation under the guidelines found in section 501(c)(3) of the Internal Revenue Service tax code. This type of corporation provides nonprofit services to the community, state or nation and is responsible for complying with standards for reporting, managing and operation as outlined in section 501(c)(3).
Qualifications
Corporations, limited liability corporations, unincorporated associations, trusts and community chests can apply for a 501(c)(3) determination from the IRS. Most of these organizations, however, are nonprofit corporations. A 501(c)(3) can be operated for a variety of purposes, including charitable, religious, scientific, educational, recreational or public service. All profits from the operation of the company must be reinvested according to the mission of the organization and may not be distributed to board members, owners or officers.
Deductions
Donations to a 501(c)(3) organization are deductible for federal income tax purposes for most donors. Most states also allow these donations to be deductible, and many also exempt nonprofits from sales tax on purchases, property taxes and some local taxes. The post office also offers special nonprofit bulk rates to charities that have an IRS 501(c)(3) determination letter.
Types of 501(c)(3)'s
These organizations fall into three categories: private foundations, public charities and private operating foundations. A public charity receives most of its revenue from the general public, foundations, corporate sponsors or the government. At least a third of its income must come from a broad base of public donors, such as individuals, companies or other charities. A public charity must have a board of directors of unrelated individuals who operate the organization in the public interest. Churches, homeless shelters, clinics, food banks, churches, schools and educational programs are all public charities.
A private foundation does not operate active programs. Its funding may come from a single donor, and its revenue is generally distributed as grants to support the work of public charities. Foundation boards may consist of family members or close associates.
The rarest 501(c)(3) is the private operating foundation. These often have active programs similar to public charities, but they may be structured like a foundation. They are something of a cross between a foundation and a public charity.
Restrictions
Strict rules apply to 501(c)(3) governance and operation. These organizations may engage only in limited lobbying or legislative activity, and charities cannot endorse candidates for public office or aid political campaigns. No director, private individual or officer of the corporation can benefit unfairly from the activities of the organization or from distribution of assets if the nonprofit shuts down. Unlike other corporations, nonprofits cannot change their purpose or become for-profit.
Obtaining 501(c)(3) status
The requirements for incorporating as a nonprofit corporation vary by state. Costs vary and are similar to costs for forming a for-profit organization of similar size. Lawyers often are recruited to serve on nonprofit boards and provide free legal services in the initial stages. Once your organization is incorporated in your state, file an application for your 501(c)(3) determination letter from the IRS. This can take up to a year to obtain.
Maintaining 501(c)(3) status
To maintain your 501(c)(3) status, you must comply with IRS regulations. Most nonprofits file a version of Form 990, the nonprofit annual tax return. You also have to meet your state's reporting requirements. In many states, when a nonprofit reaches a specific annual income level, it must complete an annual audit. Some funding sources may require an audit every one to three years.
