What Are 501(c)(3) Prohibited Activities?

An organization with 501(c)(3) status is granted federal tax exemption because it operates for religious, charitable, scientific, or educational purposes. This allows the entity to dedicate its resources to serving the public good. This exemption is contingent upon the organization’s adherence to a specific set of rules that keep its activities aligned with its public-serving mission. To maintain this status, a 501(c)(3) must avoid prohibited activities, as violations can carry substantial penalties.

Private Inurement and Private Benefit

A core principle of 501(c)(3) status is that none of the organization’s net earnings may inure to the benefit of any private shareholder or individual. This rule against “private inurement” specifically targets insiders—individuals who have a significant, influential relationship with the organization, such as directors, officers, and key employees. Any transaction that results in an unfair benefit to these individuals is forbidden, as even a minimal instance of inurement can jeopardize the organization’s tax-exempt status.

Common examples of private inurement include paying unreasonable compensation, making low-interest loans to an officer, or purchasing assets from a board member for more than fair market value. To guard against this, organizations establish procedures, such as compensation studies and conflict-of-interest policies, to ensure all transactions with insiders are conducted at arm’s length and are fair to the organization.

Distinct from inurement is the broader concept of “private benefit,” which extends to any individual or entity, not just insiders. A 501(c)(3) cannot be operated for the substantial private benefit of any person. However, a private benefit may be permissible if it is “incidental” to the larger public benefit being served.

For a private benefit to be incidental, it must be a necessary byproduct of an activity that accomplishes an exempt purpose and be insubstantial when measured against the overall public good. For instance, a conservation organization that cleans a polluted river provides an incidental private benefit to the owners of riverfront property. This is secondary to the primary public benefit of a healthier ecosystem.

Political Campaign Intervention

Under the Internal Revenue Code, 501(c)(3) organizations are prohibited from directly or indirectly participating in, or intervening in, any political campaign on behalf of or in opposition to any candidate for elective public office. This prohibition is absolute; even a single violation can provide grounds for the IRS to revoke an organization’s tax-exempt status. The rule applies to all federal, state, and local election campaigns.

“Intervention” is defined broadly and includes more than just making financial contributions or public endorsements. It encompasses actions such as distributing partisan campaign literature, making public statements for or against a candidate, or allowing a candidate to use organizational assets without equal opportunity for all candidates. Statements by an organization’s leader in an official publication can also be considered intervention.

Organizations are permitted to conduct certain non-partisan activities to encourage broad participation in the electoral process. These activities, such as conducting voter registration drives or publishing voter education guides, must be carried out in a completely neutral and unbiased manner. A voter guide cannot rate candidates or show a preference, and a registration drive must not be targeted to favor one candidate or party.

Influencing Legislation

While political campaign activity is forbidden, attempting to influence legislation, known as lobbying, is permitted for 501(c)(3) public charities, but it is subject to strict limitations. The Internal Revenue Code provides two standards for measuring lobbying: the “substantial part test” and the “expenditure test.” Every public charity is automatically subject to the substantial part test unless it chooses the alternative.

The Substantial Part Test

The default standard states that no “substantial part” of an organization’s activities may be attempting to influence legislation. The challenge with this test is its vagueness, as the IRS has not precisely defined what constitutes “substantial.” The determination is based on all facts and circumstances, including financial expenditures and the time spent by staff and volunteers.

The Expenditure Test

As an alternative, an eligible public charity can file IRS Form 5768 to be governed by the expenditure test under Section 501(h). This election provides a clear, dollar-based framework for lobbying limits. The limits are calculated as a percentage of the organization’s exempt purpose expenditures on a sliding scale, with a maximum annual lobbying expenditure of $1 million.

Under the 501(h) rules, lobbying is categorized into two types. “Direct lobbying” refers to communications with a legislator or government official that express a view on specific legislation. “Grassroots lobbying” involves communications with the public that express a view on specific legislation and include a call to action. The expenditure test sets a separate, lower limit for grassroots lobbying, which is 25% of the overall lobbying limit.

Operating for Non-Exempt Purposes

A 501(c)(3) organization must be organized and operated exclusively for its stated exempt purposes, such as charitable or educational missions. While “exclusively” is not interpreted literally, any non-exempt activities must be an insubstantial part of the organization’s overall operations. This is evaluated through the “primary purpose test,” which examines if the primary activities advance the exempt mission.

If an activity unrelated to the exempt purpose becomes a substantial part of the organization’s functions, it can jeopardize its tax-exempt status. The most common example is an Unrelated Business Income (UBI) generating enterprise. UBI is income from a trade or business that is regularly carried on and not substantially related to the organization’s exempt purpose.

For instance, a museum operating a gift shop that sells items related to its exhibits is conducting a related business activity. However, if that same museum were to operate a commercial office building for profit, that activity would be considered an unrelated business. The income from this unrelated business is subject to the Unrelated Business Income Tax (UBIT).

The issue for maintaining tax-exempt status is the scale of UBI relative to the organization’s exempt activities. There is no specific percentage of revenue that the IRS defines as “substantial.” If the IRS concludes the unrelated business has become the primary purpose of the organization, it may revoke its 501(c)(3) status.

Consequences of Prohibited Activities

Engaging in prohibited activities can lead to consequences from the IRS that threaten an organization’s financial stability and legal status. The penalties vary depending on the violation’s nature and severity. For certain infractions, the IRS can impose financial penalties known as excise taxes, which serve as intermediate sanctions short of revocation.

Excise taxes are often applied in cases of excess benefit transactions under the private inurement rules. When an organization provides an excessive economic benefit to an insider, the IRS can levy a tax on the individual who received the benefit and the organization manager who knowingly approved it. Excise taxes can also be imposed on a 501(c)(3) that exceeds its lobbying spending limits under the expenditure test.

For severe or repeated violations, particularly political campaign intervention, the IRS can revoke an organization’s 501(c)(3) tax-exempt status. Revocation is the most severe sanction, as the organization is no longer exempt from federal income tax and contributions are no longer tax-deductible for donors. This loss of deductibility can hinder an organization’s ability to fundraise and continue its operations.