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Tax differences between nonprofit types

 

Tax differences between nonprofit types

A brief overview of religious organizations, charities, foundations, and other not-for-profits according to the IRS Tax Code.

Brandon Lafving
by Brandon Lafving, IRS contributor (@TechDragoon)

Nonprofits are organizations designed to forward ideas, beliefs, and initiatives as opposed to one individual, or a group of individuals. This is in stark contrast to corporations or many business entities, which transfer a percentage of profits to shareholders or private ownership.

In exchange for waiving the need to pay taxes, organizing around a cause does not sound too shabby, does it?

Section 501(c) of the IRS Tax Code outlines the requirements for non-profits, regulating how they interact with the IRS. Each subsection guides a non-profit type.

  • Subsection 501(c)(1) governs the behavior of entities set up by Acts of Congress, so you probably will not need to worry about this.
  • 501(c)(2) sets up holding corporations for exempt organizations.
  • 501(c)(3) serves as reference for charitable organizations, including religious, educational, and medical organizations. Most nonprofits fall under this category, and we will come back to this later.
  • Section 501(c)(4) is for organizations benefitting social welfare.
  • Section 501(c)(5) organizations are set up for horticultural or agricultural purposes.
  • Section 501(c)(6) sets up the guidelines for business leagues, which forward the interests of an industry. These can provide resources for firms within the industry or influence consumer behavior.

Choosing what type of not-for-profit you are is important – not only as a requirement for tax-exempt status, but also as a defining factor of your organization.

To qualify for tax-exempt status, charitable organizations are required to specify whether they are a public charity or a private foundation. The main difference between these two lay in the source of funds, as private foundations typically receive most or all funds from a single source, such as a donor or corporation. Public charities can be churches, hospitals or other qualified medical research centers.

These organizations regularly fundraise/receive income from activities in the pursuit of their exempt purpose. That is, a church receives its income from contributions from its members. A hospital receives compensation for giving aid to the wounded and sick. But all revenues are re-injected back into the organization’s purpose, as opposed to being sent off to shareholders or ownership, as is the case for a private corporation.

Charitable organizations cannot attempt to sway legislation or politics in a biased way. Spreading awareness of political issues or causes is typically fine, but leadership should read about non-partisan political action before conducting a campaign. 501(c)(3) charities can also lobby in Congress but only with a small percentage of their revenues.

If you qualify as a grassroots organization, you do not need to apply for tax-exempt status. Read my article, “Automatic Recognition of Tax-Exempt Status for Grassroots Organizations” for more information.