What Is a 501(c)(3) Organization?

Section 501(c)(3) is a portion of the U.S. Internal Revenue Code (IRC) and a specific tax category for nonprofit organizations. Organizations that meet Section 501(c)(3) requirements are exempt from federal income tax. While the Internal Revenue Service (IRS) recognizes more than 30 types of nonprofit organizations, only those that qualify for 501(c)(3) status can say that donations to them are tax deductible.1

Most of the organizations that may be eligible for 501(c)(3) designation fall into one of three categories: charitable organizations, churches and religious organizations, and private foundations.2 The rules outlined in Section 501(c)(3) are regulated by the U.S. Treasury through the IRS.

KEY TAKEAWAYS

• Section 501(c)(3) is a portion of the U.S. Internal Revenue Code (IRC) and a specific tax category for nonprofit organizations.
• Organizations that meet the requirements of Section 501(c)(3) are exempt from federal income tax.
• While the IRS recognizes more than 30 types of nonprofit organizations, only organizations that qualify for 501(c)(3) status can say that donations to them are tax deductible.
• 501(c)(3) organizations must pay their employees fair market value wages.
• To receive its favorable tax treatment, the nonprofit organization must not deviate from its purpose or mission.

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What Is a 501(C) Organization?

How a 501(c)(3) Organization Works

To be considered a charitable organization by the IRS, a group must operate exclusively for one of these purposes: charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, or preventing cruelty to children or animals.3

Furthermore, the IRS defines “charitable” activities as “relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.”3

Requirements of a 501(c)(3) Organization

To be tax exempt under Section 501(c)(3), an organization must not be serving any private interests, including the interests of the creator, the creator’s family, shareholders of the organization, other designated individuals, or other persons controlled by private interests. None of the net earnings of the organization can be used to benefit any private shareholder or individual; all earnings must be used solely for the advancement of its charitable cause.4

A 501(c)(3) organization is also forbidden from using its activities to influence legislation in a substantial way, including participating in any campaign activities to support or deny any particular political candidate. It is typically not permitted to engage in lobbying (except in instances when its expenditures are below a certain amount).56

People employed by the organization must be paid “reasonable compensation,” which is based on the fair market value that the job function requires.7

Once an organization is categorized as a 501(c)(3), the designation remains as long as the organization exists unless it is revoked by the IRS.8

To remain tax exempt under Section 501(c)(3), an organization is also required to remain true to its founding purpose. If an organization has previously reported to the IRS that its mission is to help less privileged individuals gain access to a college education, it must maintain this purpose. If it decides to engage in another calling—for example, sending relief to displaced families in poverty-stricken countries—the 501(c)(3) organization has to first notify the IRS of its change of operations to prevent the loss of its tax-exempt status.