Title 26, Section 501(c) of the Internal Revenue Code recognizes several different types of nonprofit organizations. Nonprofit corporations, trusts and foundations have several advantages over for-profit organizations, including an exemption from paying federal income taxes. Two classes of 501(c) nonprofits, known as “C3” and “C4” organizations, are similar in some respects. However, they have different eligibility requirements, and the IRS places different restrictions on their activities and donations. When deciding whether to structure your nonprofit as a C3 or a C4, these distinctions should be considered.
To qualify as a nonprofit, an organization must be structured and operated for one of the purposes recognized in Section 501(c). A 501(c)(3) organization must operate exclusively for a charitable purpose. Advocating for improvements in education, defending civil rights and providing assistance to the poor are common charitable purposes. A 501(c)(4) nonprofit must operate exclusively for the promotion of social welfare. Civic associations and volunteer fire departments are common social welfare organizations.
A nonprofit organization seeking exemption from federal income taxes must meet specific IRS requirements. Neither a 501(c)(3) nor a 501(c)(4) can distribute any of its net proceeds to individuals or shareholders. The IRS must officially recognize the organization’s tax-exempt status, either through a determination letter or a ruling. To obtain 501(c)(3) tax-exempt status, an organization must file IRS Form 1023. To apply for 501(c)(4) status, the organization must file IRS Form 1024. To maintain tax-exempt status, all nonprofits operating under these provisions must file annual informational returns with the IRS.
Nonprofits established as C3 entities are often called “charitable” organizations because, in most cases, donors may claim contributions as deductions on their federal income tax returns. In contrast, federal tax law does not allow donations to C4 nonprofits to be deducted on donors' tax returns.
IRS regulations forbid 501(c)(3) nonprofits from engaging in most political activities. Several exceptions exist. For example, a C3 may participate in some nonpartisan political educational activities, such as sponsoring a debate. Unlike C3 organizations, C4 nonprofits may engage in political or legislative activities; however, the organization’s activities cannot be primarily political, and its expenditures on political activities may be subject to federal taxation. Both C3 and C4 nonprofits are prohibited from participating in political activities for or against a particular candidate.
The two major factors in determining whether to seek recognition as a C3 or C4 are your organization’s anticipated mission and the likely importance of tax-deductible donations to your fundraising success. If your organization’s mission will not involve significant legislative lobbying or political campaigning, 501(c)(3) status is likely more desirable; your donor’s contributions will be tax-deductible in most cases, and this fact may attract more donors and larger contributions. In contrast, if your organization’s mission will likely participate more than incidentally in political activities, 501(c)(4) status may be more appropriate. Keep in mind that your donors will not be able to claim their contributions as tax deductions. Consider whether this will impact your organization's fundraising potential.