A nonprofit's core purpose determines its IRS tax classification as either a 501(c)(3) or 501(c)(4). Title 26, Section 501(c) of the Internal Revenue Code creates these two types of nonprofits, with one designated to focus on charitable purposes and the other on social welfare. Additionally, each must comply with different sets of restrictions on their activities and on the allowable use of funds.
A 501(c)(3) organization must operate exclusively for a charitable purpose. This could be poverty relief or civil rights advocacy. It could be carrying out the work of a scientific journal or educating students. The entity might set out to prevent cruelty to animals or to advance a religious mission. The law also forbids it from engaging in campaign work for or against a political candidate. Some (nonpartisan) educational initiatives—such as sponsorship, debates, or voter registration outreach—are acceptable. "Insubstantial" political advocacy is also acceptable, as defined by the relative portion the organization spends in relation to its whole operating budget.
A 501(c)(4) nonprofit operates according to its social welfare purpose. It can be a local association of employees or an organization devoted to the promotion of public safety, recreation, or some other social welfare mission. If it primarily advances the interests of a private group of citizens rather than the common welfare, it will not qualify for 501(c)(4) tax-exempt status.
The most notable difference between these two types of organizations is that under the (c)(4) provisions, this entity may engage in lobbying for or against laws critical to its members and mission, as long as its political activities do not comprise its primary function. Therefore, a group that wishes to participate more than incidentally in political activities will opt for 501(c)(4) status.
In accordance with the Internal Revenue Code, a group that seeks a 501(c)(3) or 501(c)(4) exemption from federal income taxes must follow the Code's procedures and obtain a determination letter or ruling acknowledging the tax exemption.
The 501(c)(3) organization files an Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code (Form 1023). The 501(c)(4) organization files an Application for Recognition of Exemption under Section 501(c)(4) of the Internal Revenue Code (Form 1024-A).
Both groups must thereafter file annual federal tax forms to keep their tax-exempt status.
Tax Deductions for Donors
Individuals and businesses that donate to either of these types of nonprofits may be wondering if their donation will qualify for a tax break. There is a distinct difference here in that this is true for one and not the other.
Tax breaks are available for donations to a 501(c)(3). This title can be a big incentive to potential donors and this is a key reason to apply for this status. Donors to 501(c)(4) nonprofits generally may not list their contributions as deductible donations on their tax returns. Yet, certain contributions may qualify as business expenses, if part of the necessary conduct of the taxpayer's business.
Best of Both Worlds
Can't decide what your nonprofit should be? Note that a 501(c)(3) organization can form a subsidiary to conduct activities that the parent organization may not carry out. Thus, some 501(c)(3) charities form 501(c)(4) subsidiaries.
If the group decides to do this, the subsidiary must be legitimate. The subsidiary must be a more substantial entity than a "mere arm" of its 501(c)(3) parent.
A nonprofit committed to a charitable purpose may qualify for a Section 501(c)(3) exemption under the Internal Revenue Code. A nonprofit maintained for social welfare purposes may qualify for the exempt status under Section 501(c)(4). There is a degree of overlap between charitable and social welfare missions. Yet, vital differences in the Internal Revenue Code about an organization's purpose and tax deductions for donors inform the organization's decision to hold itself out as either a 501(c)(3) or a 501(c)(4) organization.
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