Nonprofits VS. 501(c)(3) : What They Are and How They're Different
Here’s something many people don’t know: All 501(c)(3) organizations are nonprofits, but not all nonprofits are 501(c)(3) organizations.
We all tend to use the terms interchangeably to describe community focused organizations and charities, but there are important differences between the two that you should know about if you are thinking about creating a non-profit organization. If you don't understand the difference, you could form a non-profit, but still be on the hook for taxes for the organization.
So, What is a nonprofit?
A non-profit organization is a group organized for reasons other than making a profit and where the income the group generates as profit cannot be given to the founders, directors, and members. Instead the profit is kept in the organization. Non-profits can hire and pay employees, but these people must be reasonably compensated.
One way to think about it is in comparison to a typical business, like an LLC or a corporation. At the end of the year, after the books have been updated, if there is a profit, these business forms can pay that money to the owners of the businesses and it’s completely okay to do so. However, with non-profits, that’s not the case. Profits stay in the company.
Nonprofits are created under state law, so the specific rules that govern what nonprofits can do, are found in the state’s business code.
Now because nonprofits are formed for benefitting the community, they usually earn money through donations. This is where the 501(c)(3) status confusion comes into play.
Non-profits can still be taxed by the federal government for the money they make unless they receive a tax exemption. Additionally, the donors to a non-profit will not be able to claim exemptions on the money they donate.
How 501(c)(3) status impacts a nonprofit
501(c)(3) is one category of the tax exemption available to organizations. It receives it’s name from the section of the tax code it falls under (Very creative). In other words, being a 501(c)(3) organization means that you are a nonprofit that the IRS has recognized and confirmed as fitting their criteria for tax exemption.
As taxpayers when we give to charities that have the 501(c)(3) designation, we can write the tax donation off.
In order to get this tax-exemption, most organizations need to submit an application to the IRS. The most common organization that does not have to go through this process, is the church.
An organization can file for 501(c)(3) status using Form 1023 (with a filing fee of $850) or Form 1023-EZ (with a filing fee of $275).
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