501(c)(3) explained

What the designation is

Section 501(c)(3) of the Internal Revenue Code exempts certain organizations from federal income tax. It covers organizations organized and operated exclusively for charitable, religious, educational, scientific, or literary purposes, testing for public safety, fostering national or international amateur sports competition, or preventing cruelty to children or animals.

Being a nonprofit corporation under state law and being tax-exempt under federal law are two separate things. You create the corporation with your state. You apply to the IRS for exemption.

What it allows

• Exemption from federal income tax on income related to the mission.
• Donors can generally deduct contributions on their federal returns, within the limits of the tax code.
• Eligibility for most foundation and government grants.
• Access to nonprofit programs from vendors, software companies, and some postal rates.

The limits that come with it

No private benefit. Net earnings may not benefit founders, directors, or other insiders. Reasonable salaries for real work are allowed. Excessive pay and sweetheart deals are not.

No political campaigns. A 501(c)(3) may not support or oppose candidates for public office. This prohibition is absolute.

Limited lobbying. Some lobbying is permitted, but it cannot be a substantial part of the organization's activities.

Assets stay charitable. If the organization dissolves, its assets must go to another exempt purpose, not to the people who ran it.

Public charity or private foundation

Every 501(c)(3) is classified as either a public charity or a private foundation. Public charities receive broad support from the public, government, or other charities. Private foundations are usually funded by one family or company and face stricter rules and an excise tax on investment income. Most organizations that raise money from many donors aim to qualify as public charities.