Weighing the Benefits of 501(c)(3) Status
One of the most important but overlooked steps in forming a new 501(c)(3), nonprofit organization is to make a fully informed decision about whether the benefits of 501(c)(3) status are worth pursuing in the light of the many compliance burdens that come with operating a charitable organization. This important choice is difficult to change once an organization is formed, so we included this as Step 1 in our new guide sheet: Steps to Forming a 501(c)(3) Nonprofit Organization.
There is no shortage of good ideas in the world of philanthropy, nonprofit organizations, and social enterprise. People often assume that 501(c)(3) status is the best path for all charitable endeavors, and this is indeed often the case. However, it is worth considering exactly what the benefits of 501(c)(3) status entail.
In general, there are three main benefits of 501(c)(3) status:
The organization’s net revenue (after expenses) is generally not subject to federal income tax (this benefit also applies to other types of non-charitable tax-exempt organizations, such as 501(c)(4) and 501(c)(6) organizations);
Contributions to the organization are eligible for the charitable deduction; and
The organization will generally be eligible for grants from private foundations and governmental entities.
These benefits can provide important strategic and financial opportunities, particularly for organizations that plan to rely heavily on grant funding and charitable contributions from individuals and estates. Additionally, there is no doubt that 501(c)(3) status confers a certain credibility and public trust, and this status can be crucial for establishing the positive reputation that most organizations need to succeed.
However, maintaining 501(c)(3) status entails significant ongoing compliance burdens such as navigating conflict of interest transactions to avoid violating the “excess benefit transaction” rules, satisfying the public support test, complying with ongoing public filing requirements including the Form 990 and charitable solicitation registrations, as well as withstanding the added scrutiny of the public, regulators, and charity watchdog groups, to name a few examples.
Therefore, it is important to make sure the benefits of 501(c)(3) status fit into your vision for the organization before proceeding down this path. For example, if your programs and activities will be relying mainly on fee-for-service or sales revenue (with donations and grants playing a minor role), the benefits of 501(c)(3) status may not justify the burdens.
Planning Tip – Before forming a new nonprofit organization and filing a Form 1023 (or Form 1023-EZ) application for 501(c)(3) status, consider first testing your idea through a fiscal sponsorship relationship with an existing 501(c)(3) organization, a concept we’ve explained in Q&A #71. When structured properly with the right fiscal sponsor organization, fiscal sponsorship can provide a chance for you to find out whether your idea has a good chance of attracting donations and grant funding.
Whichever path you choose, it is important to be as informed as possible on the front-end about why you want to form a nonprofit organization and how 501(c)(3) status will help you achieve your goals. For this reason, exploring the benefits and requirements of 501(c)(3) should be one of the first things you do as you go through the list of Steps to Forming a 501(c)(3) Nonprofit Organization.
