What Are the 26 USC 501(c) Requirements for Nonprofits?

Section 501(c) of the Internal Revenue Code is the federal law that provides an exemption from federal income tax to nonprofit organizations. The purpose of this designation is to remove the tax burden from organizations established to serve a public or mutual benefit, rather than to generate profit. This status applies to a wide array of entities, from public charities and social welfare groups to business leagues and recreational clubs. By not having to pay federal income tax, these groups can invest more of their resources directly into their programs and services.

Categories of Tax-Exempt Organizations

The Internal Revenue Code outlines nearly 30 distinct categories of nonprofit organizations under section 501(c). The most widely recognized is the 501(c)(3) organization, formed for religious, charitable, scientific, literary, or educational purposes. This category also includes organizations dedicated to testing for public safety, fostering certain amateur sports competitions, or preventing cruelty to children or animals. Contributions made to these organizations are generally tax-deductible for the donor under Code section 170.

Another common classification is the 501(c)(4) organization, operated for the promotion of social welfare. These groups, which can include civic leagues and local employee associations, often engage in advocacy and lobbying. While they are tax-exempt, donations to 501(c)(4) organizations are not tax-deductible as charitable contributions.

Business leagues, chambers of commerce, and professional associations often qualify under section 501(c)(6). These organizations work to improve business conditions within one or more lines of business. Their activities are directed at the betterment of their respective industries or professions as a whole, rather than performing particular services for individual members.

For groups organized around leisure and hobbies, section 501(c)(7) provides an exemption for social and recreational clubs. This category includes entities like country clubs and college fraternities, provided they are organized for pleasure and recreation. To qualify, a substantial portion of their activities must be for their members, with strict limits on the amount of income they can receive from non-member sources.

General Requirements for Exemption

To qualify for tax-exempt status, an organization must satisfy the “Organizational Test.” This test scrutinizes the organization’s founding documents, such as its articles of incorporation or trust agreement. These documents must explicitly limit the organization’s purposes to one or more exempt purposes and cannot empower it to engage in activities that do not further those purposes, except to an insubstantial degree.

For a 501(c)(3) organization, the articles must specifically state that its purposes are charitable, educational, or religious. The documents must also include a dissolution clause, ensuring that if the organization ceases to exist, its assets will be distributed for an exempt purpose. This provision prevents the assets from being distributed to private individuals or for-profit entities.

An organization must also meet the “Operational Test,” which focuses on its actual activities. The organization’s activities must primarily further its stated exempt purpose, and it will not qualify if a substantial part of its activities is for a non-exempt purpose. For instance, an organization formed for charitable purposes must actually engage in activities that are charitable in nature.

The operational test also prohibits the organization’s net earnings from benefiting any private shareholder or individual, a concept known as private inurement. This means the organization cannot be a vehicle for distributing profits to insiders, and any benefit to private individuals must be incidental to accomplishing its public purpose.

Information and Documents for the Application

The primary application for organizations seeking 501(c)(3) status is Form 1023. For social welfare organizations applying under 501(c)(4), the correct form is Form 1024-A, and for most other 501(c) types, Form 1024 is used. Before an organization can submit its application, it must obtain an Employer Identification Number (EIN), even if it does not have employees.

A complete application package must include conformed copies of the organization’s legal organizing documents. This means submitting a copy of the filed Articles of Incorporation or a similar founding document, with evidence of being filed with the appropriate state authority. A copy of the organization’s bylaws, if adopted, must also be included.

A detailed narrative describing the organization’s activities is also required. This section requires a thorough explanation of past, present, and planned activities, demonstrating how they align with the exempt purpose. The description should be specific and comprehensive, as it forms the basis for the IRS’s determination of whether the organization meets the operational test.

Financial data is another requirement. Newly formed organizations must provide a projected budget for the next three years, detailing anticipated revenue and expenses. Organizations that have been in existence for some time must provide financial statements for their past years of operation.

The Application Submission Process

The application submission process is entirely electronic through the federal government’s online portal, Pay.gov. Organizations must create an account on the Pay.gov website to begin the submission. At the time of electronic submission, the organization must pay a non-refundable user fee.

The fee amount varies depending on the form being filed; for example, the standard Form 1023 has a user fee of $600, while the streamlined Form 1023-EZ for smaller organizations has a lower fee of $275. This payment is made directly through the Pay.gov platform using a bank account or a credit/debit card.

After the application is successfully submitted, the IRS will send an acknowledgment of receipt. The review process can take several months, and an IRS agent may contact the organization to request additional information or clarification. The final step is the receipt of a determination letter from the IRS.

If the application is approved, this letter formally recognizes the organization’s tax-exempt status under the specified section of 501(c). This letter is a document that the organization will need to keep in its permanent records and provide to donors and grantors as proof of its status.

Maintaining Tax-Exempt Status

Receiving a determination letter is not the final step; organizations must adhere to ongoing compliance rules to maintain their tax-exempt status. A primary responsibility is the annual filing of an informational return with the IRS, usually a version of Form 990. Failure to file for three consecutive years results in the automatic revocation of tax-exempt status.

The different versions of the annual return include Form 990-N for small organizations with gross receipts of $50,000 or less, and Form 990-EZ for organizations with gross receipts under $200,000 and total assets under $500,000. Larger organizations must file the full Form 990, and private foundations file Form 990-PF.

Organizations must also be mindful of Unrelated Business Income Tax (UBIT). If a nonprofit regularly carries on a trade or business that is not substantially related to its exempt purpose, the net income from that activity may be subject to tax. For example, if a museum operates a public parking lot for general use, the income could be considered unrelated business income. An organization with $1,000 or more in gross income from an unrelated business must file Form 990-T and pay the tax.

For 501(c)(3) organizations, there are strict rules limiting lobbying activities and an absolute prohibition on participating in political campaign activities. Most tax-exempt organizations are also required to make certain documents available for public inspection. This includes their approved application for exemption and their annual information returns for the last three years.