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Helping hand

The section of the Internal Revenue Service code that describes the requirements for nonprofit entities, including public charities and private foundations, is known as 501(c)3. This section explains the benefits of nonprofit status, including most notably the ability to deduct contributions to a charity from an individual’s or business’s federal income tax return. Section 501(c)3 specifies that nonprofits must engage only in certain sorts of activities and can’t steer financial or other benefits to private individuals. Organizations recognized as charitable organizations under this section of the tax code are also restricted from political activities and lobbying.

501(c)3 Benefits

Without a doubt, one of the most special features of 501(c)3 organizations is the tax deductibility of contributions from individuals and businesses. The availability of tax deductions gives nonprofit charities a powerful tool for soliciting donations. And for individuals and businesses, the tax deductibility of charitable contributions gives them a tool for managing their tax burden while also allowing them to support worthy causes.

Charitable donations are also exempt from state income taxes, in most states. In addition, states often exempt 501(c)3 organizations from having to pay sales taxes. Even postal services come at a discount for charitable organizations, which can receive low rates for bulk mailing from the U.S Postal Service.

501(c)3 Limits

Muslim worker for a nonprofit

All the benefits of 501(c)3 status come with a sizable number of strings attached. To begin with, they can only exist for certain purposes. These include charitable, religious, educational and scientific causes. Also included are causes such as literacy, public safety, amateur sports and opposition to abuse of animals and children. Under the tax code, charitable organizations may exert themselves to help the poor and underprivileged. They may advance religion or science, promote education, build and maintain monuments and other public structures. They can be dedicated to combating prejudice and discrimination, defending human rights, elevating communities and discouraging juvenile delinquency.

One thing nonprofits can’t do is provide benefits to individuals or private interests. Specifically, that means no part of the organization’s net income can flow to any director, officer, shareholder, donor or other private individual. The IRS uses a so-called excess benefits test to determine this. The test prohibits a 501(c)3 from supplying indirectly or directly to any donor or shareholder an economic benefit that exceeds the value of the donation or other contribution.

There are special filing requirements for 501(c)3 organizations. At the federal level, this includes a corporate annual report using IRS Form 990. States also require charitable organizations to register and to renew their registrations periodically.

Politics and Lobbying Restrictions

In addition, 501(c)3 charitable organizations are also strictly barred from participating in political campaigns and specifically from endorsing candidates for elective office. Similarly, they are not allowed to oppose any candidate for elective office. That includes making contributions to campaign funds as well as making written or oral public statements for or against candidates. Any violations could result in the 501(c)3 losing tax exempt status and having to pay extra taxes.

Charitable organizations are not completely banned from the political process, however. They can safely engage in voter education, conduct voter registration drives and encourage citizens to vote. These activities have to be nonpartisan and not favor any one candidate or party.

Lobbying is another restricted activity. That includes attempting to influence legislation by Congress, state legislatures, city councils or other governing bodies. Nonprofits can’t use public appeals or direct contacts to legislators or their staffs to propose, support or oppose legislation. In addition to banning attempts to influence legislation, the rules keep 501(c)3 groups from trying to steer resolutions, appointments, public referendums and ballot initiatives.

Nonprofits can, however, petition non-legislative public officials, such as executives, judges and administrators. And there is some leeway on legislative lobbying as well. The IRS specifically says an organization can’t have 501(c)3 status if a “substantial” portion of its activities are devoted to influencing legislation. In practice, that means nonprofits may be able spend up to 20% of their budgets on lobbying activities.

The Bottom Line

Worker at a nonprofitSection 501(c)3 is a portion of the U.S. tax code that exempts qualifying organizations from federal income taxes. Donations to 501(c)3 organizations give individuals and businesses deductions to help them reduce their tax bills. To quality for tax-deductible status, 501(c)3 organizations have to restrict their activities to those deemed to boost the public good. They can’t benefit officers or donors and must also avoid political activities and lobbying.

Tips on Forming a 501(c)3 Organization

  • Consider working with an experienced financial advisor if you are considering setting up a 501(c)3 or contributing to one. Finding the right financial advisor who fits your needs doesn’t have to be hard. SmartAsset’s free tool matches you with financial advisors in your area in five minutes. If you’re ready to be matched with local advisors who will help you achieve your financial goals, get started now.
  • To obtain 501(c)3 status organizations apply to the Internal Revenue Service using Form 1023. The application details the organization’s programs, governance and structure. A shorter version of the form, 1023-EZ, offers a streamlined application for organizations anticipating less than $50,000 in annual receipts.

Photo credit: ©iStock.com/scyther5, ©iStock.com/Kritchanut, ©iStock.com/SDI Productions

Mark Henricks Mark Henricks has reported on personal finance, investing, retirement, entrepreneurship and other topics for more than 30 years. His freelance byline has appeared on CNBC.com and in The Wall Street Journal, The New York Times, The Washington Post, Kiplinger’s Personal Finance and other leading publications. Mark has written books including, “Not Just A Living: The Complete Guide to Creating a Business That Gives You A Life.” His favorite reporting is the kind that helps ordinary people increase their personal wealth and life satisfaction. A graduate of the University of Texas journalism program, he lives in Austin, Texas. In his spare time he enjoys reading, volunteering, performing in an acoustic music duo, whitewater kayaking, wilderness backpacking and competing in triathlons.
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