Q&A: Are 501c3 Organizations Tax-Exempt?

  • By: Adam Wire
  • December 20, 2023
Are 501c3 Organizations Tax Exempt
Reading Time: 4 minutes

The Internal Revenue Service (IRS) defines federal tax regulations through the Internal Revenue Code (IRC). Nonprofit operations are listed as 501c3 organizations

After gaining 501c3 status, these organizations enjoy certain benefits, such as exemption from federal income tax, eligibility to receive tax-deductible charitable contributions, and access to various grants and funding opportunities. However, they’re also subject to certain rules and regulations.

Read on to learn how 501c3 organizations become tax-exempt entities, and discover how board management software streamlines operations for nonprofit organizations.

What is a 501c3?

A 501(c)(3) is a type of nonprofit organization that is granted federal tax exemption status and is eligible to receive grants from the government, as well as private sources, to advance its agenda. Many states also offer tax-exempt or otherwise favorable statuses to these organizations and donors can deduct their contributions from their taxable income. 

There are three main categories of 501c3 organizations: charitable organizations, private foundations, and churches/religious organizations. Public charities must receive at least one-third of their funding from public donations in addition to grants from government sources. Private nonprofits get the majority of their funds from individual donors or small organizations. 

These institutions can be of any size, but the biggest examples of 501c3 organizations include the American Red Cross, World Wildlife Fund, and Habitat for Humanity International. 

The IRS recognizes 30 types of nonprofit organizations, and a 501c3 can also qualify for registration as a 501c4. However, there are crucial differences between these models. 

The goal of a 501(c)(4) organization is to promote social welfare among the general public. A 501c4 provides more freedom and fewer restrictions. And while both nonprofits are exempt from paying federal taxes, donor contributions to a 501c4 are not tax-exempt. 

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How to Qualify for 501c3 Status

501c3 organizations must strictly follow IRS guidelines. 501c3 violations can lead to the removal of an organization’s status. 

Follow these steps when forming a 501c3 organization: 

Operate Exclusively for Exempt Purposes

For an organization to qualify for 501c3 status, the enterprise must fit the IRS’ definition of a charity, which may include the following descriptors:

  • Initiatives created to help poor, underprivileged, and overlooked communities 
  • Activities to promote the advancement of science, education, or religion
  • Advocating for and defending civil/human rights 
  • Advocating against animal cruelty
  • Campaigning to prevent and criticize discriminatory practices
  • Constructing or renovating public buildings, monuments, or works

Prohibit Inurement of Net Earnings

Any money raised by or donated to a 501c3 organization can’t be used for private inurement. In other words, no members (anyone on the board of directors, executives, presidents, treasurers, financial officers, and family members) of the organization can misappropriate nonprofit funds for personal interests. 

Examples of private inurement include using charity money to book a vacation or allowing board members to receive certain goods and services from outside parties. All earnings must be used exclusively for the charity’s causes, otherwise you risk facing heavy fines and losing your tax-exempt status. 

Limit Political and Lobbying Activities

501c3 organizations are forbidden from vocally or financially supporting political campaigns for or against any candidate for public office in local, state, and federal elections. 

This is not to say that 501c3 organizations must entirely remove themselves from the political sphere. They can lobby and engage in other political activities as long as they benefit the general public in a non-partisan manner. Civic education and voter registration drives are allowed. 

No Private Benefit

As an extension of the private inurement rule, 501c3 organizations are also barred from offering members an inflated salary. Members can only earn “reasonable compensation” in relation to the fair market. The IRS determines this by evaluating all possible items of compensation, which can include: 

  • A person’s salary, bonuses, severance payments, and deferred and non-cash compensation
  • Payments for liability insurance premiums or tax reimbursements by the organization
  • All other compensatory benefits, whether or not included in gross income for income tax purposes
  • Taxable and nontaxable fringe benefits
  • Foregone interest on loans

An organization can declare that an economic benefit acts as compensation when the benefit is paid with:

  • A signed written contract
  • An original Form W-2, Form 1099, or Form 990 that reports the benefit as compensation
  • An original Form 1040 from a disqualified person that reports the benefit as income

This rule serves as a reminder that 501c3 organizations must maintain a solid set of records to comply with IRS regulations. 501c3s must undergo annual reporting using Form 990 with the IRS. Any member of the public can also access the financial records of nonprofits. 

Are 501c3 Organizations Tax-Exempt?

Yes, all 501c3 organizations are granted tax-exemption status. But to maintain compliance, the operation must closely follow IRS guidelines. The nonprofit organization must be consistent in its charitable ambitions. Members cannot use donated funds for personal matters or make more money than what the market would dictate for a similar role.

Getting Started With OnBoard

Running a nonprofit effectively requires a high level of communication and collaboration from all members of the board. OnBoard’s cloud-based management software makes it easy to record important information and track tasks, so meeting attendees can focus on exceptional governance, rather than dealing with manual processes. 

OnBoard’s top-rated software comes equipped with the following features:

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About The Author

Adam Wire
Adam Wire
Adam Wire is a Content Marketing Manager at OnBoard who joined the company in 2021. A Ball State University graduate, Adam worked in various content marketing roles at Angi, USA Football, and Adult & Child Health following a 12-year career in newspapers. His favorite part of the job is problem-solving and helping teammates achieve their goals. He lives in Indianapolis with his wife and two dogs. He’s an avid sports fan and foodie who also enjoys lawn and yard work and running.