What is a 501(c)(3) Organization?
Not-for-Profit organizations are organizations that do not earn profits for their owners. In most cases, they are tax-exempt. Not-for-Profits are generally categorized under different codes of IRS 501(c). The most common classification code for not-for-profits is 501(c)(3) and it is used for nonprofits.
Not-for-profits can belong to different sectors of an economy and they serve different purposes. For example, a trade organization or labor union is formed to advance the interests of an industry or certain employees. In order for a not-for-profit organization to qualify for 501(c)(3) status, they must be involved with one or more of the following:
- Religion (such as churches)
- Charity (such as the Salvation Army)
- Literacy (such as the Barbara Bush Foundation for Family Literacy)
- Education (such as a university)
- Prevention of cruelty to animals and/or children (such as PETA)
- Fostering amateur sports, either locally or internationally (such as the Special Olympics)
- Public safety (such as Red Cross)
- Scientific activities or operations (such as museums)
Examples of not-for-profit organizations that aren’t a 501(c)(3) organization might be social clubs, where members gather to exchange information related to a specific field, or an organization they can be dedicated to the promotion of certain pursuits, such as running or astronomy. Over the years, the loosening of regulations combined with a rise in philanthropic giving has led to not-for-profits becoming multinational corporations with billion dollar budgets.
To start a not-for-profit, you should need to define a mission for your organization. For example, you might want to start a neighborhood club dedicated to running or other physical activity. Then you will need to find like-minded individuals for your not-for-profit. Once you have these ready, you will need to define the bylaws or rules and processes for your not-for-profit. Subsequently, you must incorporate your organization with the state and request the not-for-profit status from the IRS.
Difference Between Not-for-Profits and For-Profits
Not-for-Profits are not required to show revenues and profits whereas for-profit organizations are explicitly organized to generate them. To that end, the latter’s organization and activities are directed towards that goal. They may or may not be owned by a single person or entity.
On the other hand, not-for-profits may or may not generate revenue. Their organizational structure is directed towards the fulfilment of a specific mission or social purpose and they cannot be owned by a single person. Control in not-for-profit organizations typically rests with a Board of Trustees that oversee the organization’s commitment to its mission.
The two types of organizations also differ with regards to disclosure rules. The tax-exempt status of not-for-profits means that they must disclose financial and operations information to the public so that donors can track use of their funds. For-profits can be private companies or publicly-listed corporations. In the former instance, they are not required to make their financials and other details public.
Examples of for-profit companies are publicly-listed companies, such as Walmart Inc. and Apple Inc. Most universities and hospitals in the United States are organized as not-for-profits.
While they have different organizational setups and legal statuses, not-for-profits and for-profit organizations are also alike in some ways. Both employ modern business practices and organizational structure to achieve their goals. However, all profits earned, whether as revenue or donations, must be invested back into the organization.
Not-for-Profits can acquire for-profits and vice versa. A not-for-profit organization can acquire a startup or make investments into financial products. The guiding rationale, in both cases, will be to advance its mission. For example, a university endowment invests in Treasury bonds and private equity funds to generate returns, that are then plowed back into its facilities or research to further its educational mission. Or a not-for-profit involved in worker rights may acquire a for-profit news organization whose coverage of labor unions aligns with its mission.
Differences between Nonprofits and Not-for-Profits
While they are often referred to interchangeably, nonprofits and not-for-profits are actually different. Some of the main differences between them are:
- All donations made to nonprofits are tax-exempt. But donations made to not-for-profit organizations are free from taxes only if the organization is classified as a 501( c)(3).
- Nonprofits are explicitly formed to serve a public good while not-for-profits can be targeted at a wide variety of objectives, including recreational activities. Further, the activities or nonprofits must be directed towards the public good and they must show measurable progress towards that goal.
- Nonprofits pay employee salaries by earning revenues through various activities while not-for-profits can be run entirely by volunteers. Nonprofits also have volunteers on their staff but they also have formal organizational setup in which professional workers are employed to oversee activities.
History of Not-for-Profits
The origins of not-for-profits go back to the Revenue Act of 1913 that re-established income tax in the United States. It provided exemptions from the tax to four categories of institutions that are relevant to modern society:
- Civic leagues or organizations not organized for profit but operated exclusively for the promotion of social welfare
- Clubs organized and operated exclusively for pleasure, recreation, and other non-profitable purposes whose earnings did not accrue to any private stockholder or member.
- Corporations and community organizations organized and operated exclusively for religious, charitable, scientific, etc., societies. literary, or educational purposes, or for the prevention of cruelty to children or animals whose earnings did not accrue to any private stockholder or member
- Business leagues and chambers of commerce or boards of trade whose earnings did not accrue to any private stockholder or member
The exemptions enabled the mushrooming of not-for-profits dedicated to various causes in a country that was rapidly becoming a major superpower and asserting itself on the world stage. The 1969 Tax Reform Act was the second major development to accelerate the number of not-for-profit organizations in the country.
That act established the 501(c)(3) nonprofit classification that allowed donors to such organizations to claim tax exemption for the donated amount. The number of organizations classified as nonprofits multiplied in its wake. In 1976, not-for-profit organizations were allowed to spend as much as $1 million for political lobbying, allowing them to influence government direction and policy on certain issues. However, the unshackling of campaign finance laws has led to concerns that not-for-profits formed exclusively for the purposes of political lobbying disproportionately influence election results.