Nonprofits, Charities, 501c3 … these labels are just a matter of semantics, right? Not really. Knowing the distinctions and ramifications are critically important – not just for the organizations, but for the individuals donating and supporting these entities. Legal definitions are precise – corporate and tax law assigns specific meanings to the words nonprofit, charity and 501(c)3 nonprofit (an "exempt organization.") If you are forming a nonprofit or vetting a group for donation purposes – these definitions matter.
A “nonprofit” is an organized whose goal is something other than making people rich. To qualify as a nonprofit all profits – whether from donations, membership fees or business activities – are prohibited from inuring to shareholders, donors or founders. A nonprofit can pay employees, but all other monies must benefit the population served.
Charities are the best-known nonprofits. These organizations are devoted to improving the quality of life for their member community in some way. Foundations, medical charities, animal rights groups, food banks, homeless shelters, and free clinics are all common examples of charities.
Some nonprofits are not charitable in nature, homeowners associations, many youth sports clubs, certain social groups, veterans groups, religious organizations and even country clubs qualify as nonprofits because they serve their members' interests rather than one person's interest.
Becoming a nonprofit is a matter of state law and nonprofit corporations are registered at the state level. Tax exemption at the federal level is a separate matter and seeking exemption requires the organization to address the question of 501(c) status.
So while all charities are nonprofit organizations, not all nonprofit organizations are charities. Further, not all charities are 501(c)3 "exempt groups." 501(c)3 organizations are exempt from Federal Income tax on monies raised from donations, and donors can write off contributions to these organizations on their taxes.
There is a lengthy vetting process that must be completed for the IRS to determine an organization qualifies. If the IRS finds the organization to be dedicated to an "exempt purpose," a determination letter will be issued. Exempt purposes can be charitable, religious, educational, scientific, literary or preventing cruelty to children or animals.
Per the IRS, charitable purposes include helping the poor and underprivileged; advancing religion, education or science; building or maintaining monuments and public works; lessening the burdens of government; fighting prejudice and discrimination; defending human rights; and fighting juvenile delinquency.
Whatever your purpose, forming a nonprofit doesn't automatically exempt the organization. The organization must have to prove they qualify for one of the 501(c) classes. To become a 501(c)3 exempt charitable group, the organization will have to file Form 1023 (or 1023-EZ) with the IRS together with the following documentation:
The organizations employer identification number (EIN)
The articles of incorporation or other organizing documents
A full description of all organizational activities, so the IRS can decide if you meet the 501(c)3 standard
Full Financial information
An incomplete application, questionable or insufficient information will result in your status being denied. The description of your activities must go into detail: standards, procedures and methods for carrying out your mission, expected sources of funding and what you expect to spend money on. Financial information will need to show salaries, board member information, expenses, overhead and be provided in detail.
This process takes time, on average organizations will not receive a decision on their status for nine (9) months to a year. During that time all activities will need to be fully documented for the organization to take advantage of the tax election retroactively. Additionally, a donor will not be able to claim a tax deduction until the decision is rendered.
The process is complex and has ramifications for the entity and for donors. If you are considering starting a nonprofit or charitable organization, qualified legal advice and input from a knowledgeable accountant are critical. Positioning yourself as 501(c)3 without the proper designation can be detrimental to the health of the organization and to your potential donors. Take the time to research and educate yourself and ensure you are protected, and protecting your population served.