In the last couple of years, I’ve had the chance to help several small not-for-profits that were trying to get off the ground.
One of the first questions they have is: can we be a 501(c)(3)?
In the end, most of these clients ended up becoming 501(c)(4) or 501(c)(7) organizations.
What Do These Code References Mean?
The general rule for organizations is: all organizations are subject to income tax. But tax law carves out exceptions in Section 501(c). There are 29 different types of organizations described in Section 501(c) that are exempt from income taxes.
For the vast majority of not-for-profits, they’ll be looking at 501(c)(3), 501(c)(4) or 501(c)(7) as their ticket to tax-exempt status.
For further reading, check out this post I wrote in 2015 about the differences between a “not-for-profit” organization and a “tax-exempt” organization. It’s possible for an organization to be organized as a not-for-profit but still be subject to income tax.
This is the most-famous of all tax-exempt organizations. Here’s how the code section reads. The organization must be:
(O)rganized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h) ), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.
Basically this is saying a 501(c)(3) can’t lobby lawmakers or try to influence elections, and no individual or shareholders can benefit from the income of the organization.
This is where it gets tricky — trying to navigate the nuances of these code sections. A 501(c)(4) organization is a “social welfare organization.” How is this different from 501(c)(3)? Well, here are a few examples the IRS gives of what a social welfare organization is:
- A community association (such as a homeowners association)
- An organization that sponsors a community sports league
- Community associations devoted to preserving the community’s traditions, architecture and appearance. Think “downtown preservation” groups. These groups likely have a need to lobby at the local or perhaps state level — something they couldn’t do if they were a 501(c)(3).
A 501(c)(4) can also engage in lobbying and trying to influence legislation.
A 501(c)(7) is a recreational group. Think country clubs and other types of social or recreational clubs.
So with these definitions in place, what’s the best choice for a not-for-profit trying to get off the ground?
I’ll go into the pros and cons of each choice in the next installment.
“This blog post, along with comments that may follow, should not be considered tax advice. Before you make final tax or financial decisions, please secure a professional tax advisor to give you advice about your unique situation. To secure Jason as your accountant, please click on the ‘Services’ link at the top of the page.”