Rules for 501(c)3 Corporations

by Elizabeth Rayne
Many charities pursue 501(c)(3) status.

Many charities pursue 501(c)(3) status.

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Many charities pursue 501(c)(3) status because it allows organizations to avoid certain taxes and accept tax-deductible donations. The Internal Revenue Service grants 501(c)(3) status to charitable organizations that meet the requirements set forth in the Internal Revenue Code. While charities are first organized under state law, the IRC restricts the activities and profit distributions of 501(c)(3) organizations, also known as exempt organizations.

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Examples of 501(c)(3) Organizations

The IRS grants 501(c)(3) status to charitable organizations, which includes those that provide relief to the poor, work to eliminate prejudice and discrimination, defend civil rights and similar work. Additionally, nonprofits that are organized for religious, scientific, literary or educational purposes may also pursue 501(c)(3) status. The IRS also recognizes nonprofits that test for public safety, prevent cruelty to children or animals, and foster amateur sports competitions.


501(c)(3) corporations must incorporate under the state law where they are established. In filing the original articles of incorporation, nonprofits that intend to pursue 501(c)(3) status must include certain provisions. The articles must limit the organization's activities to its charitable purpose. Further, the articles must state that if the organization dissolves, its assets will be distributed to another nonprofit organization or to the government. The articles should also provide that the organization will not substantially participate in political activity, and that profits will not be distributed to individual members or officers beyond reasonable compensation for work completed.

Reasonable Compensation

The IRS restricts how an exempt organization may distribute its profits. Directors and members of the nonprofit may not receive a profit from the organization, as shareholders of a for-profit corporation receive dividends. Instead, individuals may only receive reasonable wages for work performed. To determine reasonable wages, the IRS looks at the amount that would ordinarily be paid for similar services by a similar organization. If an individual receives more than reasonable compensation from an exempt organization, the IRS could require the individual to pay excise tax, and the nonprofit may lose its exempt status.


The IRS does not allow lobbying, or attempts to influence legislation, to constitute a substantial part of the overall activities of an exempt organization. To determine whether or not a 501(c)(3) organization has devoted too much time to lobbying, the IRS will look at the amount of time and money the nonprofit has allocated to the activity. One test used by the IRS is the "substantial part test," which provides that organizations that spend too much time on lobbying will lose their exempt status, and all the income will be subject to tax. Lobbying tax may also be imposed against organization managers. An exempt organization may elect to be treated under the expenditure test, which allows exempt organizations to devote a percentage of its expenditures to lobbying activities without affecting its exempt status. The percentage rages from 5 to 20 percent, depending on the size of the nonprofit organization's budget.