In Part 1, I explained what “501(c)(3),” “501(c)(4),” and “501(c)(7)” mean. In this part, I’ll give the same explanation I give to clients who ask me which status is best for them when they’re trying to start a not-for-profit.
Pros of 501(c)(3) Status
- Easily recognizable by the public. Most people have heard of “501(c)(3),” even if they don’t really know what it means
- People who give donations to your organization can take a tax deduction for making a charitable donation
- Can be useful if you’re applying for corporate or foundation grants — many corporations and foundations will only give grants to a 501(c)(3)
Cons of 501(c)(3) Status
- Start-up costs. If your not-for-profit will have annual revenue of more than $10,000/year, you have to file a Form 1023 to get your tax-exempt status. Form 1023 is a monster of a form. You can fill out the form itself, but it will be a large time commitment. Seeking professional help will result in fees that will often be measured in the thousands of dollars.
- Form 1023-EZ is a streamlined, online application for tax-exempt status. While it’s “simpler” to file than the full-blown 1023, it’s still a time commitment on your part to get it filled out.
- The IRS charges a “user fee” for filing for tax-exempt status. Currently the fee is $400 for organizations with less than $10,000/year of anticipated revenue, and $850 for organizations that anticipate revenue of more than $10,000/year.
- You have to have a legitimate charitable purpose for your organization, and you have to prove that purpose in your application.
- It can take many, many months for the IRS to rule on your application
Pros of 501(c)(4) or 501(c)(7) status
- The form you fill out (Form 1024) is less imposing that Form 1023
- You’re still tax-exempt
- Donations aren’t deductible by donors, but you can structure things so that a business could take a donation for giving money to your organization (for example, by giving advertising in exchange for the donation)
Cons of 501(c)(4) or 501(c)(7) Status
- The filing fees with the IRS are there, and they’re the same as for filing as a 501(c)(3) — $400 or $850, depending on revenue
- Donors can’t take a deduction for a charitable contribution if they give money to your organization (as mentioned above, there may be ways around this when dealing with businesses)
- It will be hard, and perhaps impossible, to get funding from foundations
So How Do You Choose?
Most of the organizations I help with this are very small clubs. They know they have compliance responsibilities, but they’re not exactly sure what those responsibilities are.
Most of them initially gravitate toward 501(c)(3) because that’s all that they’ve heard of. Most of them actually choose 501(c)(4) or (c)(7) status in the end, because they have the characteristics of a club, rather than a charity organized for educational purposes. Also, most of these small organizations are 100% volunteer-run and just need to cover very basic costs. They’re not out soliciting for large donations.
In another case, a client decided to skip applying for tax-exempt status altogether and just file corporate tax returns and pay corporate income tax because they felt that it was simpler to do that than go through the application process.
So the answer to this question is: it’s a discussion that your group needs to have, and you should involve a tax professional and an attorney in the discussion as well.
“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.”