Practice Tips

PRACTICE TIPS By: Taylor P. Scott

Bradley Arant Boult Cummings LLP

SECTION 501(C)(3) ORGANIZATIONS – ISN’T THAT JUST ANOTHER WAY TO SAY “NON-PROFIT”?

1. What is a Section 501(c)(3) organization?

A Section 501(c)(3) organization, frequently referred to as a charitable organization, is an organization that qualifies for exemption from federal income tax under, you guessed it, section 501(c)(3) of the U.S. Internal Revenue Code, meaning the organization is federally tax-exempt and donors to the charitable organization will receive a tax write-off accordingly. The organization must be organized and operated exclusively for one or more of the following purposes: (i) religious; (ii) charitable; (iii) scientific; (iv) testing for public safety; (v) literary; (vi) educational; (vii) fostering national or international amateur sports competition (so long as none of its activities involve providing athletic facilities or equipment); and (viii) prevention of cruelty to children or animals.

2. Is a Section 501(c)(3) organization the same as a non-profit?

No, although 501(c)(3) and non-profit are terms that are often used interchangeably, they have different meanings. A non-profit entity is an entity that is organized for a nonprofit purpose. However, as briefly explained above, 501(c)(3) means the non-profit entity has been recognized by the Internal Revenue Service (“IRS”) as being tax-exempt by virtue of its charitable programs.

Non-profit organizations are not required to apply for 501(c)(3) status and many non-profits never seek 501(c)(3) status, depending on the respective goals of the non-profit. For example, non-profit organizations that will not be seeking donations often do not need 501(c)(3) status, because of the lack of need to offer tax-exempt donations to donors.

3. My client wants to apply for and earn Section 501(c)(3) status for their charitable organization. What’s the catch?

a. Benefits of classifying as a Section 501(c)(3)? Tax-exemption for the organization and donors of the organization are eligible to receive a tax write-off for said donation. b. Consequences? As noted, Section 501(c)(3) organizations are highly regulated with strict rules that apply to formation, activities, earnings, and governance of the organization.

In addition, Section 501(c)(3) organizations come paired with increased tax preparation and annual expenses, lengthy application process, and compliance requirements at both the state and federal level for annual filing requirements including a corporate annual report, IRS Form 990, and state registration and renewal.

4. How does a company become a Section 501(c)(3) organization?

a. Step One: Form a qualifying organization. Which begs the question, what is a qualifying organization? To qualify, the organization must be organized as a corporation, limited liability company, unincorporated association, or trust. Sole proprietorships, partnerships, individuals, or otherwise loosely associated groups of individuals will not qualify. In order for a corporation or limited liability company to qualify, the entity’s charter or articles of incorporation must contain certain language regarding the entity’s charitable purpose, its earnings, and its dissolution. (See IRS Publication 557, Suggested Language for Corporations and Associations for the necessary language). Examples of qualifying organizations include the following: Chapters of the Red Cross, Boys’ or Girls’ Clubs, nonprofit long-term care facilities, charitable hospitals, and schools.

None of the organization’s net earnings may inure to any private shareholder or individual. Additionally, the organization cannot attempt to influence legislation as a substantial part of its activities or participate in any campaign activity for or against political candidates. b. Step Two: Apply for and obtain an Employer Identification Number via the IRS’s website. c. Step Three: Create an account on Pay.gov. If the entity has never created a Pay.gov account, simply go to the website and click “Create an Account” at the top right of the website. If the entity has used Pay.gov for other forms in the past, there is no need to create a new account to complete and submit the Form 1023.

Sign into your Pay.gov account and type “1023” in the search bar located at the top right of the website. The search results will display the Form 1023. Click “Continue” under Form 1023 to begin completing the form. d. Step Four: Apply for Section 501(c)(3) status by completing and submitting the IRS Form 1023, Application for Recognition of Tax Exemption. The application is a thorough examination of the organization’s structure, past and future anticipated budgets, governance, and programs. The application is broken down into the following sections: - Part I: Identification of Applicant – Provide basic organizational information including the name and mailing address of the organization, Employer Identification Number, contact information, a list of officers, directors, and trustees, and the name and mailing address of the individual executing the application on behalf of the organization. - Part II: Organizational Structure – Provide the organization’s formation details. Part II will also request that the applicant upload a copy of the articles of incorporation or bylaws, as applicable. - Part III: Organization Documentation – Provide a copy of the operating agreement or bylaws, as applicable. - Part IV: Organization’s Activities: Provide a detailed (but less than 5,000 characters) description of the activities of the organization.

Note that the activities must also note the percentage of time spent on each respective activity, and the percentages must total one hundred percent. - Part V: Compensation and Financial Arrangements – Provide three to five years of revenues and expenses, depending on how long the organization has existed. - Part VI: Projected Finances – Provide the number of years the organization has existed, then provide the appropriate number of years of projected or actual financial information. Additionally, the applicant is required to complete a balance sheet within Part IV, which is a snapshot of the assets and liabilities of the organization. - Part VII: Foundation Classification – Provide the organization’s foundation classification. - Part VIII: Effective Date of Exemption – Generally, if you file the

Form 1023 within twenty-seven months of the end of the month in which the organization was legally formed and the IRS approves the application, the effective date of the exemption status is the same date of the organization’s legal date of formation. e. Step Five: Execute the application, submit the user fee, upload any supporting documentation, and submit the Form 1023. Charitable organizations are permitted to accept tax-exempt donations with the appropriate written disclaimer that the organization’s 501(c)(3) status is pending.