A 501(c)(3) is a corporation that receives tax-exempt status from the Internal Revenue Service (IRS). To get the 501(c)(3) status, a corporation must file for a Recognition of Exemption. While there are services that will do this for you for an inflated fee, there is only a $600 fee when filing the application directly to the IRS. Here’s what you need to know about the 501(c)(3) application process, including instructions on how to complete the necessary forms.
What Does 501(c)(3) Status Mean?
The 501(c)(3) status means that the corporation is exempt from paying federal taxes on revenues and income generated in the organization. It does not exempt the organization from filing tax returns. You must still file Form 990 with the IRS to account for the income that comes into the organization.
How a 501(c)(3) Nonprofit Works
A 501(c)(3) works like most other C corporations. The main difference is that the financial data of a 501(c)(3) is subject to public review, whereas a private organization is able to maintain its books without this type of potential scrutiny.
It’s important to remember that the nonprofit is fundamentally a corporation, trust, LLC or unincorporated association and must follow the organizational rules of the underlying business entity. For example, with a corporation, you’ll have articles of incorporation with bylaws that dictate how you run your organization. A board of directors is elected to oversee the company’s operations. The nonprofit can hire people and pay them a salary and benefits from revenues generated. Where the scrutiny comes is how much of the incoming revenues is paid toward fulfilling the mission of the organization.
While the IRS says that 501(c)(3) nonprofit organizations can pay employees a “reasonable salary,” it doesn’t give a definitive set of parameters. But if the IRS, in reviewing the annual tax filing, feels that the status is just a tax shelter for a profit organization paying inflated salaries, it could revoke the status.
What Is Required To Maintain Status
The primary thing that an organization needs to do to maintain its 501(c)(3) nonprofit status is to do the annual filing. This is done with Form 990 and any subsequent schedules accompanying the form. IRS Form 990 has four parts to the summary section. The first reviews details about the organization’s mission and volunteer base, the second summarizes revenues, the third summarizes expenses and the fourth summarizes net assets.
Aside from filing the annual tax forms, the organization should avoid engaging in activities that could jeopardize the tax-exempt status. Activities that should be avoided include:
- Participating in political campaigns at any level
- Lobbying as a substantial part of its regular activities
- Operating in a way unrelated to its exempt mission
- Violating public policy with activities
- Not filing a return for three consecutive years
- Not operating for the benefit of public interest
Additionally, a nonprofit is only allowed minimum levels of unrelated business activities. These are activities that generate revenues but aren’t directly related to fundraising efforts, and include things like renting out office space or selling merchandise.
Advantages and Disadvantages of Nonprofit Status
As with anything, there are pros and cons to becoming a 501(c)(3) nonprofit.
The advantages of becoming a nonprofit include:
- Tax advantage. The tax exemption status allows nonprofits to put more money to the fulfillment of their goals.
- Grant eligibility. Many public and private grants won’t consider organizations that aren’t a registered 501(c)(3).
- Formal structure. Being a formal structure keeps founders and volunteers separate from the organization. This helps limit the liabilities of the organization away from founders, board of directors and volunteers unless someone used the organization to shield illegal or irresponsible actions.
The disadvantages of becoming a nonprofit include:
- Administrative work. Nonprofits require detailed records that must be kept along with annual filings to the IRS.
- Shared control. Most states require a 501(c)(3) nonprofit to have several members on the board who are responsible for electing officers who determine organizational policy.
- Public scrutiny. Because a nonprofit is dedicated to the public interest, it is subject to having its records and accounts reviewed by the public upon request. This includes salaries and expenditures.
How To Apply for 501(c)(3) Status
Before applying for 501(c)(3) status, an organization must complete organizational paperwork with the state, whether that is articles of incorporation, a trust or other organizational entity. The organization must then apply for an Employer Identification Number (EIN) with the IRS by completing Form SS-4.
Applications for nonprofit status must be submitted online to the IRS. If an organization is eligible to apply for nonprofit status with Form 1023-EZ, the process can take as little as four weeks. For those who must file Form 1023, the process could take up to six months or longer.
You may be eligible to file Form 1023-EZ if you meet the following requirements:
- Gross income under $50,000 for three prior years
- Estimate gross income under $50,000 for next three years
- Have less than $250,000 in fair market assets
- Formed in the U.S. with a domestic mailing address
- Organized as a corporation, unincorporated association or trust
- Cannot be a successor to a for-profit entity
Required Documentation and Infrastructure
With Form 1023, you’ll need to include other paperwork items. Failure to provide one or more of the items will lead to delays in processing your application or denial of 501(c)(3) status. It’s best to follow the checklist carefully.
The documentation you’ll send to the IRS includes:
- Form 1023 Checklist
- Application (Form 1023 with applicable Schedules A-H)
- Articles of Incorporation or other organizing documents
- Any amendments to organizing documents (in order of changes)
- Organization bylaws
- Other attachments including financial data, printed materials and explanations
- Check for $600 fee made payable to the Department of the Treasury
Be sure that each document has the organization name and EIN on it.
The IRS will send requests for information if it needs it. This will delay processing time, so it’s best to make sure the application is complete when first submitting. Once approved, the IRS sends a determination letter, which should be kept with the organization’s bylaws.
Submitting Your Completed Application
Once you have gathered all of the above documentation, you can create an account to submit your completed Form 1023 online at www.pay.gov and mail the supporting information to:
Internal Revenue Service P.O. Box 12192 Covington, KY 41012-0192
If you’re in a rush you can use express mail or delivery service to send details to this address:
Internal Revenue Service Mail Stop 31A: Team 105 7940 Kentucky Drive Florence, KY 41042