But too often, the two terms are used interchangeably, and that misunderstanding can set an organization up for fines, penalties, and late fees.
While a 501(c)(3) organization is usually a type of nonprofit corporation, not all nonprofit corporations qualify as 501(c)(3)s, and the 501(c)(3) can also apply to some other business structures, like trusts.
A nonprofit corporation is a business organized for the benefit of the public. It’s tempting to believe that a nonprofit is not allowed to make a profit, but the nonprofit can earn money through its business activities. The difference between a nonprofit and a standard for-profit corporation is that a nonprofit corporation must take those profits and invest them in their cause.
Each nonprofit corporation gains its authority from the state where it is incorporated. If it wants to operate across the nation, it must apply for a certificate of authority in each state.
While a nonprofit corporation is a state-level designation, the 501(c)(3) status is a federal, nationwide designation awarded by the IRS. If a group has 501(c)(3) status, then it is exempt from federal income tax, which often also means you don’t need to pay state income taxes either. Donations to these groups are also tax-deductible, which can be a big factor in attracting donors.
The IRS grants this tax exemption to specific groups. The status usually goes to charities, but it can also be obtained by certain religious organizations, nonprofit hospitals, and education groups.
A 501(c)(3) can be a nonprofit corporation, but unincorporated associations and trusts can also gain this tax exemption. That said, it’s usually easiest to gain the status as a nonprofit corporation, but it’s important to note that this is not the only way to become a 501(c)(3).
As we mentioned briefly, 501(c)(3)s can also have exemption from state-level taxes, but those depend on the state. For example, many states require you to obtain the IRS’s designation before they’ll grant tax-exempt status themselves, while others have entirely separate processes to apply for this exemption.
Many people misunderstand tax exemption and think that all nonprofit corporations are 501(c)(3)s, but that’s not the case.
To be fair, many nonprofit corporations also apply to have tax-exempt status as a 501(c)(3), which is why the misunderstanding occurs, but not all nonprofit corporations are eligible for the status to begin with.
As a part of the privilege of being tax-exempt, a nonprofit has several obligations and restrictions that aren’t applicable to a standard nonprofit corporation. For one, a tax-exempt nonprofit must file IRS Form 990 each year, which serves as a financial report. In addition, the 501(c)(3) organization is highly visible to the public. Most records are legally accessible to the public, especially to donors. This transparency keeps the organization accountable.
Finally, a 501(c)(3) is limited in the types of political and lobbying activities it can participate in. If your organization wants to participate in a local demonstration or protest, it’s recommended that you consult the IRS’s guide to Political and Lobbying Activities or obtain legal counsel before participating.
If you want to apply for 501(c)(3) tax-exempt status for your organization, you have some options. One route is to handle your own application, and the first step is to obtain a federal tax ID number (also known as an EIN) from the IRS. Then, you’ll need to attach exact copies of your organization’s formation documents to your 501(c)(3) application.
The next step is only applicable if your organization has been around for less than three years. If you’re operating a new organization, you must provide the IRS with a financial statement for the current year, along with projected budgets for the next two years.
This statement also needs to include a detailed overview of your organization’s revenue sources and expenses. If your organization is more than three years old, you can simply include basic financial statements for the last three years.
You will also need to fill out and attach IRS Form 8718 to your 501(c)(3) application, and also include a check or money order to cover the “Exempt Organization Determination” fee. At that point, you’ll be ready to fill out the actual 501(c)(3) application itself, which is known as IRS Form 1023. You can find a few different versions of Form 1023 on the IRS website, where you can also find some tips to help determine which version of the form you should fill out for your organization.
If this all sounds like a lot of work, well, it is. Unfortunately, if your organization has a limited budget to work with, the DIY option may be your only choice, because your other options are quite expensive. One of those options is to hire an attorney to apply for your organization’s 501(c)(3) status, and if you’ve ever had to hire a lawyer before, you already know how incredibly costly this option can be.
Your other choice is hiring a professional business services company to get your tax-exempt status for you, although even this option costs several hundred dollars, because the 501(c)(3) application is so extensive. Still, it’s definitely more affordable than hiring a lawyer, so if you’re interested in this route, you might want to take a look at LegalZoom, as they offer 501(c)(3) application service for $595.
In short, a 501(c)(3) isn’t necessarily a nonprofit corporation, but a nonprofit corporation can apply to be a 501(c)(3). A nonprofit corporation can only become tax exempt if it also applies for tax-exempt status. Now that you’re aware of the difference, you can avoid the potential pitfalls of confusing a 501(c)(3) with a nonprofit corporation.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
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