A 501(c)(3) organization is the most common type of tax-exempt entity that falls under Internal Revenue Code 26 U.S.C. § 501(c), the law that provides for the different types of nonprofit organizations. For an organization to become a 501(c)(3) its activities must have the following purposes: charitable, religious, educational, scientific, literary, testing for public safety, fostering amateur sports competition, or preventing cruelty to children or animals. The term charitable generally includes 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.
Other than being tax-exempt (meaning the organization does not pay federal income tax), one of the biggest benefits of becoming a 501(c)(3) organization is that donations to the nonprofit are deductible for the donor. Many donors such as businesses or other nonprofits will only contribute to organizations that have obtained 501(c)(3) status. However, establishing and maintaining a 501(c)(3) organization requires that the nonprofit organization have a board of directors of mostly unrelated individuals, a defined mission, and ongoing compliance with IRS rules and regulations, among other requirements.
The process for obtaining 501(c)(3) status can begin when the nonprofit itself is formed or at a later date, depending on the needs of the organization. Some organizations first choose to take advantage of a larger nonprofit's tax-exempt status through a fiscal agency relationship. For instance, a small new nonprofit could come under the tax-exempt umbrella of a community foundation before seeking its own tax-exempt status. All donations would then be made to the community foundation and funneled to the small nonprofit, usually after a fee has been applied. This gives the new nonprofit the opportunity to begin operating as a charity right away and test out an idea before taking on the larger responsibilities of a 501(c)(3) organization. When an organization is ready to operate independently - whether upon forming or later - it must apply for tax-exempt status. This is done either through a Form 1023 or 1023-EZ application.
The Application for Recognition of Tax Exemption, or Form 1023, is a comprehensive examination of an organization's board, structure, governance, fundraising, programs, and the like. It is not unusual for an application to be quite lengthy. Form 1023-EZ, on the other hand, is more streamlined, less expensive, and done online. This shorter application may be appropriate for some smaller nonprofit organizations. Whether proceeding with the more comprehensive Form 1023 or the streamlined Form 1023-EZ, a nonprofit should seek legal counsel when it is ready to obtain tax-exempt status.
The attorneys at Ward & Oehler work with many different kinds of nonprofit organizations, include start-ups. For more information or to schedule an appointment call (507) 288-5567 or send us an email.
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