If you want to start a nonprofit charitable organization, choosing the right entity to form will be essential to your success and legal status as a nonprofit. A 501(c)(3), which is the official filing status that makes an organization exempt from taxation, is the most common type of nonprofit, but a 501(c)(6) may also be the right option for you. Choosing between a 501(c)(3) and a 501(c)(6) will depend on the goals of your organization and how you want it to operate. Let’s go over what each type of nonprofit is, along with their similarities and differences.
What Is a 501(c)(3) Organization?
501(c)(3) organizations are also known as “charitable organizations,” and they are intended to serve certain specific social purposes and missions that allow them to be exempt from taxes and qualify for certain tax benefits.
Some types of 501(c)(3) nonprofit organizations include: religious organizations, educational organizations (private schools or scholarship funds), scientific organizations, literary organizations, nonprofits dedicated to public safety, amateur sports or preventing cruelty to animals or children.
If your organization qualifies for 501(c)(3) status, you will qualify for the following tax benefits:
- Exemption from federal income and employment taxes
- Tax-deductible contributions (when people give money to your organization, they can deduct those contributions from their personal taxable income)
- Exemption from paying state employment, income and sales tax
- Exemption from paying federal unemployment tax
- May receive tax-exempt financing
- Money savings on postage with reduced postal rates
501(c)(3) organizations receive generous tax benefits because they are supposed to contribute to some kind of socially beneficial mission beyond the pursuit of profit. Tax-exempt charities are an expression of idealism and hope for the common good that is written into the tax code.
However, there are some limitations on how 501(c)(3) organizations can operate. If you want to be a political organization, lobby the government, fund political campaigns or otherwise participate in politics, the 501(c)(3) might not be the right choice. Depending on your goals and mission, other 501(c) organizations might be a better fit.
What Is a 501(c)(6) Organization?
The 501(c)(6) is another type of nonprofit organization that you can set up according to IRS rules. But this is a different kind of organization that is only allowed to serve a narrower range of purposes compared to a 501(c)(3).
501(c)(6) organizations are also called “business leagues.” With a 501(c)(6) nonprofit, you can set up an “association of persons having a common business interest” in order to advance the interests of that business or industry. 501(c)(6) organizations also have some specific guidelines and limitations for raising money to fund themselves. 501(c)(6) groups are allowed to raise money from the general public, but they are expected to have a “meaningful” amount of membership support, such as membership dues.
Examples of 501(c)(6) organizations might include a local chamber of commerce, a trade association, a real estate board or — interestingly — a professional football league. In fact, the National Football League (NFL) was organized as a 501(c)(6) organization and had tax-exempt 501(c)(6) status until 2015.
Setting up a 501(c)(6) organization is a good strategy if the goals of your nonprofit are specific to the interests of a particular industry or group of businesses. For example, if you wanted to set up a trade organization or industry association or otherwise organize like-minded business owners in your field of business for common purposes.
But many nonprofit founders might have more expansive or elaborate goals and a mission that is not just focused on one business or industry. If you want to run a charitable organization that serves “society” and not just “business interests,” you should probably set up a 501(c)(3).
501(c)(3) and 501(c)(6) Similarities and Differences
Here are a few more ways that 501(c)(3) and 501(c)(6) nonprofits compare and contrast on some major points.
According to the IRS, a 501(c)(3) organization cannot be “organized or operated for the benefit of private interests,” and the organization’s net earnings cannot “inure to the benefit of any private shareholder or individual.” These organizations should serve the public interest, not enrich the owners. This is an anti-corruption rule and a reminder of the overall purpose of setting up a 501(c)(3): charities are supposed to enrich the common good, not make their officers, directors, trustees or employees rich.
For example, according to IRS compliance guidelines, 501(c)(3) organizations are not permitted to allow their income or assets to “accrue to insiders,” such as by paying “unreasonable compensation” or excess benefits to an insider. Basically, nonprofits shouldn’t operate like personal piggy banks for the directors and officers, and they’re not supposed to pay excessively high salaries or bonuses to employees or contractors. Nonprofits are required to pay fair market value for services rendered or property purchased by the organization.
In the same way, 501(c)(6) organizations cannot be operated for the profit of any of their members; if you form a business league, industry association, chamber of commerce or other qualifying 501(c)(6) organization, it cannot “inure to the benefit” of any “private shareholder or individual.”
Just like companies and individuals are required to file annual tax returns, 501(c)(3) and 501(c)(6) organizations are required to file an annual return — Form 990 — even though the organizations are exempt from taxes.
If your organization does not file your Form 990 or files late, you may be required to pay penalties to the IRS. And if you fail to file your Form 990 for three consecutive years, your organization automatically loses its tax-exempt status.
Learn more on the IRS website about which version of Form 990 your organization should file, depending on your organization’s annual receipts and assets.
Both 501(c)(3) and 501(c)(6) nonprofits are required to keep detailed records of its financial information, including income, expenses, credits and the supporting documents for these records. Your organization is also required to keep records on file for as long as necessary to comply with the Internal Revenue Code within the statute of limitations for a return — usually at least three years after the date that the return is due or filed.
Limits on Political Activity
Since 501(c)(3) organizations are tax-exempt, they are not supposed to participate in political campaigns or lobbying activity. This means they cannot participate in or contribute to political campaign funds or make public statements on behalf of candidates for public office. If you want your nonprofit organization to be involved in lobbying or supporting political candidates, you need to set it up as a 501(c)(4) organization instead, but donations to these organizations are not tax-deductible.
501(c)(6) organizations are allowed to participate in some lobbying and other political activities that are related to their mission. However, if your 501(c)(6) organization wants to participate in political activities, you might have to pay a proxy tax on the portion of your organization’s funds that is spent on these activities. You might also have to give advance notice to your organization’s members about how you intend to use their membership dues for political activities.
Tax Treatment of Donations
Donations to 501(c)(3) charitable organizations may be tax deductible for the donor. Donations to 501(c)(6) organizations are slightly different; money given to business leagues is not treated as a charitable donation and cannot be deducted from an individual donor’s tax return. However, some taxpayers might be able to deduct their donations to a 501(c)(6) organization as a business expense, “if ordinary and necessary in the conduct of the taxpayer’s business.”
Consult with a professional tax advisor for more specific guidance on charitable contributions and tax-deductible contributions to any 501(c) organizations.
Are you ready to start a 501(c)(3) or 501(c)(6)? Talk to Incfile today! We offer a variety of premium nonprofit services to help get your nonprofit organization launched, approved and on track for success.