501(c)s: Comparing Organizational Structures

Date August 6, 2021
Categories

Not all nonprofit organizations are structured the same. We count 27 different types of organizations to choose from to structure and operate as a nonprofit. If you are looking to form a nonprofit or expand your current nonprofit, will you be able to do so under your current structure? Or will you need to look at forming a new entity to best accomplish your intended goals? Let’s explore a few of the most common types of nonprofits.

501(c)(3) organizations

A 501(c)(3) is the most widely used organizational structure, constituting about 75 percent of the nonprofit world. A 501(c) (3) is organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, to foster amateur sports competitions, or for such purposes as preventing cruelty to children or animals. Examples include charitable hospitals, boys’ and girls’ clubs, churches, nonprofit retirement homes or elderly homes, and parent-teacher associations.

To be tax-exempt, the IRS requires a 501(c)(3) to be organized and operated exclusively for exempted purposes. It also requires that none of its earnings may inure to any private individual—that is, the organization’s assets are not held to benefit a person, but for the community at large or for its stated exempt purpose.

Like many of the entities that organize under the 501(c) tax code, a 501(c)(3) is exempt from most federal taxes. However, there are exceptions to the income earned by the organization that could give rise to Unrelated Business Taxable Income (UBTI), income that is not related to its exempt purpose. Each organization must evaluate this on an entity-byentity basis as one entity’s income may be UBTI, and the other’s is not.

Contributions to a 501(c)(3) entity are generally tax-deductible and are not subject to federal gift and estate taxes. The most common form of contribution is cash, but other forms include stocks, bonds, exchange-traded funds (ETFs), clothing and household goods (new and used), food, vehicles, boats, and so on. Depending on its specific charitable purpose, an organization may keep a donated vehicle or boat when it is needed to execute its mission; others must convert the item to cash to support their charitable purposes.

A 501(c)(3) can be organized as a corporation, foundation, or community chest but must follow state regulations pertaining to these types of organizations. The requirement flows from the fact that the entity is started on the state level, and the incorporation document smust contain two distinct paragraphs before requesting the federal election as a nonprofit organization: one stating that the entity is organized and operated exclusively for one of the qualifying exempt purposes; a second stating that if the organization shuts down, or discontinues operations, any remaining assets will be contributed to another 501(c)(3) entity.

After applying at the state level, the nonprofit can apply for exempt status on the federal level using Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. The application is lengthy, 28 pages, and requires significant time to prepare. In addition, answers to the questions on the form will likely result in more than the 28 pages required by the IRS. However, suppose the organization does not expect to collect more than $50,000 in its first three years of operation. In that case, it can file Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. Form 1023-EZ requires answers to only two-and-a-half pages of questions.

A 501(c)(3) must file a tax return annually, a Form 990, Form 990-EZ, or 990-N, depending on the entity. If the entity does not file on time, which is either the original filing date or the extension date, it could incur fines of up to $250,000. If no filing occurs in three years, the IRS could revoke the entity’s tax-exempt status.

Finally, a 501(c)(3) entity is prohibited from engaging in any partisan political activities but may conduct nonpartisan voter engagement activities. Lobbying cannot be a substantial part of the entity’s activities; it’s best to avoid them entirely. If an IRS review reveals such activities and determines a violation, it can revoke the 501(c)(3) tax-exempt status.

501(c)(4) organizations

A 501(c)(4) must be organized as a nonprofit and operated exclusively to promote social welfare, that is, the common good and general welfare of the people in its community. Examples include a Lion’s Club, a civic organization, a neighborhood association, a volunteer fire department, veteran’s organizations, and homeowners and tenants associations.

Unlike a 501(c)(3) entity, a 501(c)(4) may inform the public about controversial subjects and attempt to influence legislation relevant to its programs or activities. It can also participate in political campaigns and elections—if the primary focus is on the community’s social welfare and related to the organization’s purpose. However, the entity must register with the respective state or federal government related to such activities.

In general, contributions to a 501(c)(4) organization are non-deductible unless they are to entities such as a volunteer fire department or a veteran’s organization. Contributions could also be subject to federal gift taxes. As well, like 501(c)(3) entities, some 501(c)(4) income could be subject to taxation as UBTI. A 501(c)(4) can be organized in various ways and does not have the same limitations as a 501(c)(3). The main stipulation is that the organization is not established to create profit and only uses the funds it receives for social welfare or promoting the community’s common good.

For exemption under the Internal Revenue Code, a 501(c)(4) files a Form 1024, Application for Recognition of Exemption under Section 510(a). The form is completely different from Form 1023, and there is no simplified or 1024 EZ-form. It is 20 pages long and requires the filer to answer questions in essay form. It will take substantial time to complete; a completed form will consist of more than the original 20 pages.

Like 501(c)(3) entities, 501(c)(4)s are required to file one of the 990 forms and are subject to the same penalty provisions for not filing on time or not filing for three years as 501(c)(3s. Also, like 501(c)(3)s, 501(c)(4) funds cannot benefit a private individual and must go to fulfill its purpose.

501(c)(6) Organizations

A 501(c)(6) organization is an association of persons with a common business interest that promotes the interest but does not conduct a regular trade or business for profit. Examples include chambers of commerce, economic development corporations, real estate boards, trade boards, and professional football leagues, including the National Football League.

Contributions are not tax-deductible as this entity is not organized for “charitable” purposes like a 501(c)(3) entity. A 501(c)(6) is normally a membership organization, and dues may be deductible as a business expense. The organization must track its lobbying and political activity expenditures and report annually to members the percentage of members’ dues that are non-deductible due to the organization’s lobbying and political activities.

IRS rules for 501(c)(6) entities are less stringent than for 501(c)(3) and 501(c)(4) entities. However, they must file Form 1024s to obtain tax-exempt status.

As with the other forms of 501(c) entities, 501(c) (6)s are subject to UBTI and must file one of the 990 forms. They are also subject to significant penalties for not filing, and no earnings may benefit private individuals and benefit the organization’s common interest as a whole.

These three types of nonprofit entities make up more than 80 percent of U.S. nonprofits. Another 24 entities make up the remaining 20 percent. There are some similarities in filing, penalties, and benefiting the community or common good of the organization. Organizers of nonprofits need to thoroughly review the different types of 501(c) entities and once they choose an organizational structure, follow the guidelines for filing for exemptions at both federal and state levels.

Read the full Summer issue of HBK Nonprofit Solutions quarterly newsletter.

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