What is a 501(c)(3)?
Applying for 501(c)(3) Tax-Exempt Status is designed to help prospective charities apply for tax exemption under the tax law.
If you're here, this means you've been researching the process of starting a nonprofit and you need more information on what 501(c)(3) status is and why it's so important. The most common misconception with nonprofits is that nonprofit and tax-exempt mean the same thing. Although in everyday communication the two concepts are often used interchangeably, their differences are important to know if you are involved in the nonprofit sector.
You may be thinking to yourself, wow this just sounds like one more thing to add to my list of everything I need to do. Well, not only is this one more thing to add but it could be a very important step of your process, we're here to tell you why and give you a breakdown of that process.
So does my nonprofit qualify for a 501(c)(3) status?
Generally speaking, a nonprofit organization that is organized and operated for purposes of benefiting the general public (for example charitable, educational, literary, religious, or scientific purposes) qualifies for 501(c)(3) status.
Why 501(c)(3) status may be important to my nonprofit?
Receiving tax-exempt 501(c)(3) status from the IRS is one of the most important steps in starting your nonprofit organization. One of the main reasons is because contributions to 501(c)(3) nonprofits are tax-deductible.
Essentially, this will allow your donors to deduct any of the contributions they make to your mission and cause. As a nonprofit, you will not only be able to use this as a marketing tool to grow your organization and bring in larger donations but 501(c)(3) organizations are eligible for federal exemption from payment of corporate income tax. Once you are exempt from this tax, your nonprofit will usually be exempt from similar state and local taxes. For the sustainability of your nonprofit, make sure you get 501(c)(3) status.
Before we dive into the process, you may already be feeling a bit intimidated but I encourage you to do a quick reminder to yourself of how important this will all be once your nonprofit is set up and ready to impact people's lives. You're already on the right track if you're here so let's dive into what you should have already done before starting the 501(c)(3) application process.
☑️ Determine exactly what type of 501(c)(3) nonprofit you're starting
☑️ Clearly understand your 501(c)(3) nonprofit's mission and goals
So you've done all of the above, now what?
1. ☑️ Does your organization have an appropriate legal form?
For the Internal Revenue Service (the IRS) to recognize an organization's exemption, the organization must be organized as a trust, a corporation, or an association. This would have been decided in the step above where you decided what type of 501(c)(3) nonprofit you have. We almost always recommend organizing as a nonprofit corporation as opposed to a trust, association, or other types of legal entity (though there may be certain circumstances in which a different entity may be appropriate).
2. ☑️ File articles of incorporation with your state government
*Are you in Kansas or Missouri? More specifics on filing fees in Kansas or Missouri here!
The key contents of the articles of incorporation document include the name of the organization, registered address, custom corporate purpose statement, and specific language required by the IRS in order to qualify for 501(c)(3) status. This must be submitted to the Secretary of State's Office. You must file articles of incorporation with your state's corporate filing office. It is typically recommended that you incorporate in the state where you will conduct your nonprofit's programs or services.
Incorporating a nonprofit does not automatically make it 501(c)(3) exempt. A key thing to remember is that creating your nonprofit entity at the state level and applying for tax-exempt status at the federal level are two independent steps. Even if you create a nonprofit entity with the state, the IRS (and most state tax agencies) will view the entity as a taxable entity even though it is nonprofit. This means that your nonprofit could be subject to paying income taxes if it does not obtain 501(c)(3) status.
3. ☑️ Receive an EIN and start the IRS Form 1023
The application for an EIN is submitted to the IRS via a Form called SS-4. There is no fee required to obtain an EIN. This is an important step even if you don't have employees quite yet as you must have an EIN in order to open a bank account for your nonprofit.
4. ☑️ Prepare your bylaws, programming, and board in advance
Bylaws contain the rules and procedures for things like holding meetings, electing directors, appointing officers, and taking care of other formalities.
Although it may be tempting to look up templates online, please beware that not all templates have the appropriate language needed in order to obtain 501(c)(3) language. Additionally, bylaws need to be tailored specifically for your state of incorporation, as well as for items like whether your nonprofit is a “membership” organization, how directors should be elected, and other items specific to your organization. For example, a Conflict of Interest Policy will need to be drafted and provided to the IRS when applying for tax-exempt status.
5. ☑️ File Form 1023
To apply for tax-exempt status, also known as 501(c)(3) status, a lengthy application (about 40 pages before supplemental materials are added) needs to be submitted to the IRS. The application contains a variety of organizational, financial, ethical, and legal questions. While you can fill out this application on your own, you may require professional counsel to accurately answer some of the questions. Legal questions often arise from the IRS and you may be sent a letter of inquiry. These inquiries can be about a variety of issues including board governance, intellectual property, real estate, liability concerns, fundraising and charitable contributions, employee relations, and contractual obligations.
Once the IRS has determined your organization meets the criteria for a tax-exempt organization, you will receive a document in the mail called a “determination letter” that confirms your 501(c)(3) status, among other things. Once you receive this document you can confirm to donors the tax-deductible nature of their contributions to your organization and you can start the good work you set out to do.
BONUS TIPS* STATE COMPLIANCE REMINDERS:
While obtaining 501(c)(3) status grants your new nonprofit federal tax exemption, there are two other, critical issues that must be addressed.
- Charitable Solicitations Registration – This is a required registration in 40 states and is usually administered through the Attorney General's office, though not always. Most states require registration prior to soliciting donations.
- State Corporate Tax Exemption – Most states recognize the federal 501(c)(3) status as valid for state corporate tax exemption. California and Texas are big exceptions, requiring their own application process for charity status in their state. Several other states require a separate application, but those are typically simpler registrations.
How long does it take for a 501(c)(3) to be approved?
Typically, IRS 501(c)(3) approval takes between 2 and 12 months, not including any time for follow-up questions. It is possible that filers of Form 1023-EZ may experience a shorter time frame due to the streamlined process of e-filing.
One of the reasons for the long timeline is the period of time it takes for a particular case to be assigned to a review agent. It can also depend on the time of year, the type and classification of the nonprofit, and the complexity of the application itself.
As you can see, even with the most basic breakdown, the process itself can be time-consuming and tedious. It's advisable that you consult with local expertise to ensure that your new nonprofit complies with state and federal laws and requirements. The lengthy process should not discourage you as you are on the right path and obstacles, questions, and refinements are normal within this process.
Do you have more questions or need additional assistance? Mission Counsel would love to help. We are a modern law firm seeking to end the access to justice gap faced by nonprofit organizations and to change the world by helping nonprofits navigate the unending legal and strategic questions they face by providing client-centered legal counsel focused on advancing our clients' missions. Click hereto schedule a free 15-minute Mission Discovery Session with us.