How to Obtain 501(c)(3) Tax-Exempt Status in 3 Steps

A nonprofit organization provides services to the community without the aim of making a profit. As a result, the Internal Revenue Service (IRS) allows these organizations to apply for federal and state tax exemption. However, to acquire tax exemption, also known as 501(c)(3) status, you must apply for recognition by filing IRS Form 1023. 

Here, we will discuss the three key steps to successfully file a 501(c)(3) application. 

Key Takeaways

• A 501(c)(3) organization does not have to pay income tax, can attract donors with tax-deductible donations, and gains access to grants restricted for 501(c)(3) nonprofits.

• To obtain 501(c)(3) tax-exempt status, you must determine your eligibility, fill out Form 1023 with the IRS, and wait for a determination letter. 

• Maintaining nonprofit status is an ongoing process, as violating legal regulations could result in loss of tax-exempt status. 

What Is a 501(c)(3) Organization? 

The IRS has a set of tax laws called the Internal Revenue Code (IRC) that apply to individual and business income. IRC subsection 501(c) covers the 12 types of organizations exempt from federal taxes. 

Section 501(c)(3) is specifically dedicated to charitable organizations.[1] These organizations are operated for religious, charitable, scientific, educational, or social causes without the aim of making profits. 

Advantages of 501(c)(3) Nonprofit Status

Now that you understand what a nonprofit or 501(c)(3) organization is, let’s discuss some of its benefits. 

Federal Income Tax Exemption

The IR grants a 501(c)(3) organization federal tax exemption, which is the biggest advantage as it results in significant tax savings. In addition, donations are tax-deductible, which encourages more people to donate. 

Personal Liability Protection

In most cases, nonprofit organizations operate as corporations or limited liability companies (LLCs). Typically, this type of business structure guarantees its members or shareholders personal liability. If the nonprofit gets into debt, its personal property is kept separate and can’t be repossessed to cover it.

Donations and Discounts

Many businesses have a philanthropic mindset and prioritize giving back to society. One way they do this is by extending rewards in the form of donations and discounts to nonprofits. As such, nonprofit organizations obtain goods at lower prices, helping reduce operating expenses. 

Moreover, they might receive cash and in-kind donations such as food, clothing, furniture, office space, or pro bono services like legal or accounting assistance.

Grant Eligibility

501(c)(3) nonprofits qualify for public and private government, organization, and individual-funded grants reserved for charitable organizations.[2]

Disadvantages of 501(c)(3) Nonprofit Status 

Although nonprofits have many benefits, they also have some downsides, including: 

No Ownership Claims

Even if you are one of the board members of a nonprofit organization, you can never claim its ownership once it’s tax-exempt. Technically, it belongs to the public. Even when you dissolve the organization, you must reinvest all the profits.

Lack of Freedom to Engage in All Activities

The tax-exempt status for nonprofit organizations doesn’t come freely. These organizations have restrictions on their activities and conduct. They will lose this status if they violate any of the requirements stipulated by federal law.[3]

Scrutiny by the Public

Because nonprofit organizations serve the public, all details, including management structure and financial statements, are public. This extra scrutiny keeps nonprofit organizations accountable, but the pressure to meet high expectations can be challenging. 

How to Obtain 501(c)(3) Status

Before starting the 501(c)(3) application process, you must familiarize yourself with the necessary steps to avoid potential pitfalls. Here are three simplified steps to follow. 

1. Determine Your Eligibility

For the IRS to grant you tax exemption, your company must be a public charity or private foundation that is not for profit. As such, before applying for 501(c)(3) status, it’s crucial to determine your eligibility.

Your company’s mission must operate with a recognized exempt purpose, which includes: 

• Charity

• Religion

• Science

• Education

• Prevention of cruelty to children and animals

• Literary content

• National or international amateur sports

• Public safety

The listed criteria may also include groups centered around arts and culture, human and animal rights activists, environmental conservationists, social clubs, chambers of commerce, civic leagues, and agricultural societies.[4]

Additionally, to qualify for 501(c)(3) status, a nonprofit corporation must:

• Be organized under state law

• Be formed as a corporation, trust, or foundation

• Support a wide-reaching and undesignated group in need

• Limit political activities, such as lobbying and political campaigns

• Derive at least a third of its income from government or public donations

• Not distribute profits to shareholders

Organizations influencing legislation or generating income for individuals do not qualify for tax exemption.

2. File IRS Form 1023

After confirming that your organization is eligible for tax exemption, you must file IRS Form 1023 to receive 501(c)(3) status. 

The IRS has two 501(c)(3) application forms: Form 1023 and Form 1023-EZ. Let’s have a look at both forms.

Form 1023-EZ

Form 1023-EZ is the newer and much-simplified version of the application for recognition of tax exemption. It is designed to shorten the application process by being less detailed and only three pages long. Online filing costs $275, and the IRS takes about four weeks to process. 

However, only some organizations are eligible to complete this form. The IRS provides a 30-question Eligibility Worksheet. The requirements include: 

• Annual gross receipts less than $50,000 for the first three years

• Total assets valued at under $250,000

• No history of tax exemption status being revoked

• No foreign ties, such as foreign primary addresses or foreign origins[5]

Form 1023

Form 1023 is the original version of the tax-exempt status application form. It is 40 pages long and costs $600 to file. The form also has a checklist of items organizations must include in their application:

• Articles of Incorporation Certificate

• Employer Identification Number (EIN)

• Organization bylaws

• List of directors

• Power of Attorney application form, if filing through a lawyer

You must complete the first 12 pages of the form in full, as outlined below. However, the form has eight extra forms marked schedules A-H that organizations complete depending on if they apply to them.

1. Identification of the applicant

2. Organizational structure

3. Required provisions in your organizing document

4. Your activities

5. Compensation and other financial arrangements

6. Financial data

7. Foundation classification for nonprofit status

8. Effective date

9. Annual filing requirement

10. Signature

After completing all sections, you can send an online application and pay the required filing fee on pay.gov.

Organizations must file Form 1023 within 27 months after the end of the month they filed their nonprofit articles of incorporation. This way, if approved, their tax exemption status will apply from the date the organization was formed.

3. Receive Your Determination Letter

Upon sending your tax exemption request, you can check the status of your application by visiting the IRS website. Use your EIN or organization’s name to search for your application status on the exempt organizations search page. 

Typically, the IRS takes approximately two to four weeks to review Form 1023-EZ and three to six months for Form 1023. When the IRS approves your application, you will receive a determination letter to grant you tax-exempt status. 

In case of denial, you will receive an adverse determination letter detailing the reasons for rejection and your right to appeal. The IRS also issues a proposed adverse determination letter to organizations that have not provided sufficient information to justify their application. This letter can be appealed within 30 days of issuance before it takes effect as a denial. 

Maintaining Your 501(c)(3) Tax-Exempt Status

After the IRS validates your 501(c)(3) status, you have to ensure you maintain the status day in and day out. Here are some ways to do it:

Not Participating in Political Campaigns or Lobbying

The IRS requires 501(c)(3) organizations to steer clear of all political endeavors aimed at favoring one candidate or political party over another.[6] This means they should not:

• Endorse candidates

• Make campaign contributions

• Distribute political materials

• Engage in political rallies

Be that as it may, 501(c)(3) organizations can take part in activities such as voter education and voter registration.

Lobbying involves supporting, opposing, or proposing specific policies that align with overall missions. This can involve forming a coalition with like-minded bodies to make sure their voices are heard. 

Tax-exempt organizations have a right to lobby. However, no organization may qualify for 501(c)(3) status if a substantial part of its activities involves lobbying.[7]

Complying With Public Policies

To avoid conflict with the IRS, 501(c)(3) status organizations must comply with all relevant public policies. This includes observing the laws related to employment, fundraising, and any other activities in which the organization engages. Besides avoiding legal issues, staying compliant maintains their credibility and trustworthiness.

Filing Tax Returns

Although 501(c)(3) status organizations are tax-exempt, they have to file tax returns every year. This report should disclose the income the organization has made from donations, fundraisings, and other sources. Usually, you report your income by filling out Form 990-N or Form 990-EZ, depending on the gross income received or the nonprofit organization’s size. 

Separating the Nonprofit Organization’s Finances

None of the income received from the tax-exempt nonprofit organizations should be used for personal needs. Moreover, you should keep accurate financial records showing income sources and expenses. If you use the same bank account for the nonprofit organization and your finances, it’ll be impossible to keep an accurate account.

FAQs

How long does it take to get a 501(c)(3) approval?

501(c)(3) status applications can take about three to four weeks for approval with Form 1023-EZ and about three to six months with Form 1023.

What is the difference between a nonprofit and a 501(c)(3)?

A nonprofit is an organization such as a corporation, trust, or foundation that does not engage in activities to make a profit. A 501(c)(3), on the other hand, is a nonprofit organization that has been approved for federal tax exemption by the IRS.

How do I get a 501(c)(3) status letter?

To get 501(c)(3) status recognition by the IRS, you can apply by using the simplified Form 1023-EZ if you meet the criteria or the long version of Form 1023. 

How long does the 501(c)(3) application process take?

For organizations using the shorter Form 1023-EZ, the application can take anywhere between three to four weeks. Applicants using the longer Form 1023 can take between three to six months to hear from the IRS. 

What are the reporting requirements for 501(c)(3) nonprofit organizations?

501(c)(3) nonprofit organizations have to file IRS Form 990 for their annual information returns. This form should be submitted on the 15th day of the fifth month after their accounting period ends.

What are the eligibility requirements for applying for 501(c)(3) status?

To apply for 501(c)(3) status, an organization must be properly formed as a corporation, trust, or foundation, generate income that does not benefit private individuals, and meet all requirements set forth in the IRC exempt purposes.

What are the necessary steps to apply for 501(c)(3) tax-exempt status?

The necessary steps to apply for 501(c)(3) status are: incorporating your organization as a nonprofit trust, foundation, or corporation, getting an EIN, and filing Form 1023 or Form 1023-EZ with the IRS for tax-exempt status.

What information is required to complete a 501(c)(3) application?

To complete a 501(c)(3) application, you will have to provide information on your organization’s structure, financial data, and specific activities.

Bibliography

1. IRS.gov. “Exemption Requirements - 501(c)(3) Organizations.” Accessed March 7, 2024. 

2. Grants.gov. “Grant Eligibility.” Accessed March 7, 2024. 

3. IRS.gov. “Common Tax Law Restrictions on Activities of Exempt Organizations.” Accessed March 7, 2024. 

4. IRS.gov. “Exempt Organization Types.” Accessed March 7, 2024.

5. IRS.gov. “About Form 1023-EZ.” Accessed March 7, 2024.

6. National Council of Nonprofits. “Political Campaign Activities - Risks to Tax-Exempt Status.” Accessed March 7, 2024.

7. IRS.gov. “Lobbying.” Accessed March 7, 2024.