Back to editorials page
501(c)(3) Charitable Tax Exempt Status for
I. A "Charitable"
A. The term "charitable" is used in its generally
accepted legal sense and is not limited by the separate enumeration of tax-exempt
purposes. The term includes relief of the poor and distressed or of the underprivileged;
advancement of religion; advancement of education or science; erection or maintenance of
public buildings, monuments, or works; lessening of the burdens of Government; and
promotion of social welfare by organizations designed to accomplish any of the above
purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and
discrimination; (iii) to defend human and civil rights; or (iv) to combat community
deterioration and juvenile delinquency. Regs. §1.501(c)(3)-1.
1. Focus of organizations purpose must be to benefit
the community or society as a whole, not just the organizations members and their
families or other select individuals. Enumerated purposes under §501(c)(3) include:
religious, charitable, scientific, testing for public safety, literary, or educational
purposes, or to foster national or international amateur sports competition (but only if
no part of its activities involve the provision of athletic facilities or equipment), or
for the prevention of cruelty to children or animals.
2. Organizational tests. An organization is organized
exclusively for one or more exempt purposes only if its articles of organization:
a. Limit the organization to one or more exempt purposes;
b. Do not expressly empower the organization to engage,
except to an insubstantial extent, in activities which in themselves are not in
furtherance of one or more exempt purposes; and
c. Provide that the organizations assets, upon
dissolution, would be distributed for exempt purposes to another §501(c)(3) organization,
or to the federal, state or local government for a public purpose.
3. Operational tests.
a. An organization will be regarded as operated exclusively
for one or more exempt purposes only if it engages primarily in activities which
accomplish one or more §501(c)(3) purposes. An organization will not be so regarded if
more than an insubstantial part of its activities is not in furtherance of an exempt
b. The primary activity of organization cannot be to
"carry on a business with the general public in a manner similar to organizations
which are operated for profit." However, profit-making business may be carried out as
an incidental part of the organizations activities.
c. An organization is not operated exclusively for one or
more exempt purposes if its net earnings inure in whole or in part to the benefit of
private shareholders or individuals.
d. Neither can the organization be operated primarily as
"a social club for the benefit, pleasure, or recreation of its members."
However, social functions for the benefit of members may be carried out if incidental to
the organizations primary purposes.
B. Private Foundation Classification.
1. All §501(c)(3) organizations are also classified by the
IRS as to private foundation status under §509(a).
a. An organization is either a private foundation or it is
a public charity. The presumption, unless an organization can show otherwise, favors a
finding of private foundation status.
b. Private foundations are subject to a number of special
excise taxes on passive income, undistributed income, impermissible expenditures, etc.
which generally make private foundation status undesirable.
2. The chief difference between a public charity and a
private foundation is the source of financial support. A private foundation derives its
financial support from a small number of private sources, while a public charity is
primarily supported by the public. There are four ways an organization can demonstrate
that it is not a private foundation:
a. Traditional charity status. Certain organizations are
presumed to be a public charity, including: churches; schools, certain hospitals and
medical research organizations; collegiate support organizations; governmental units; and
organizations deriving at least 33% of their support from public contributions and
b. Service provider organizations. Organizations receiving
more than one-third of their support from contributions and revenues from related business
enterprises (exclusive of revenues from certain major donors).
c. Support organizations. An organization which is operated
to benefit, perform the functions, or carry out the purposes of another public charity
which is controlled by the public charity.
d. An organization organized and operated exclusively for
testing for public safety.
C. Public Foundation Status.
1. General Definition. A public foundation is a
"donative" public charity which should be qualified as an IRC 509(a)(1) and
170(b)(1)(A)(vi) charity and not as a 509(a)(2) "service provider" charity.
a. To qualify as a "charitable" entity, the
public foundation must meet the organizational and operational tests described above.
b. A public foundation is not a private foundation. A
private foundation derives its financial support from a small number of private sources,
while a public foundation is primarily supported by the public.
2. A Publicly Supported "Donative" Charity. A
public foundation must meet the one-third public support requirements for a
"donative" [i.e., a 509(a)(1) organization] charity, or otherwise be able to
demonstrate facts and circumstances in support of its donative status.
a. A public foundation qualifies as a "donative"
publicly-supported charity if it attracts, receives, and depends on financial support from
members of the general public on a regular, recurring basis.
b. A "donative" charity is distinguished from a
"service provider" charity [a 509(a)(2) organization] which receives its primary
support from membership fees and receipts from admission, sales of merchandise,
performance of services, etc. in a business related to its exempt purposes.
c. A public foundation is not required to engage in
periodic community-wide fund raising campaigns.
3. The governing body of a public foundation must:
a. have the power to modify any restriction on the
distributions of funds where it is inconsistent with the charitable needs of the
b. commit itself to the exercise of its powers in the best
interests of the public foundation; and
c. commit itself to seeing that funds are invested pursuant
to accepted standards of fiduciary conduct. [Reg. 1.170A-9(e)(11)(v)].
II. Governmental Activities.
A. Lobbying Activities.
1. A §501(c)(3) organization may not devote a substantial
part of its activities for lobbying purposes.
a. Lobbying means carrying on propaganda or otherwise
attempting to influence legislation.
b. Lobbying also includes urging individuals to contact
their legislators to propose, support, or oppose legislation.
2. If substantial lobbying activities exist, tax exempt
status is forfeited. Lobbying activities may be found to be substantial in the ten to
twenty percent (10-20%) range of total nonprofit activities.
3. Sec. 501(c)(3) organizations other than churches, church
auxiliaries, and certain affiliated organizations are permitted to make a special election
a. For electing organizations, lobbying expenses are
limited to between five and twenty percent (5-20%) of their annual budget for exempt
b. A maximum limit on lobbying expenses of $1,500,000
applies, although an additional twenty-five percent (25%) of this amount is allowed for
grass roots expenses.
B. Political Campaigning Activities.
1. A §501(c)(3) organization is absolutely prohibited from
engaging in any political campaigning activities whatsoever, or else it will forfeit its
tax exempt status.
a. Campaign activity includes participation or intervention
in any political campaign on behalf of, or in opposition to, any candidate for public
office. A candidate is any contestant for elective office.
b. Political campaign activities relate to individual
candidates, whereas lobbying activities relate to social issues and laws.
c. Participation in a campaign includes publishing or
distributing statements made either by a candidate or by someone else directed at a
C. Prohibited Political Activities.
1. The endorsement of candidates.
2. Making donations to a candidates campaign.
3. Engaging in fund raising on behalf of a candidate.
4. Distributing statements supporting or opposing a
5. Becoming involved in any other activities that may be
beneficial or detrimental to any candidate.
III. Unrelated business activities
A. Any organization exempt from tax under §501(a) must
nonetheless pay income tax on its unrelated business income. This refers to income derived
from any unrelated trade or business regularly carried on.
1. An "unrelated" trade or business is one which
is not substantially related to fulfilling the organizations exempt purposes, aside
from the need for funds. A trade or business is "related" if the activity is: a)
causally connected to achieving an important exempt purpose of the organization; and b)
the causal connection is "substantial."
2. A "trade or business" includes any activity
carried on for the production of income from the sale of goods or the performance of
services. Key factors in determining whether an activity is a trade or business include:
a. Whether a profit motive is evident.
b. Whether the activity is normally conducted by commercial
enterprises, or is viewed as competitive to commercial businesses.
3. Whether any activity is "regularly carried on"
depends on the frequency and continuity of the activity.
B. Exceptions to UBTI.
1. UBTI does not include income from any trade or business:
a. In which substantially all the work is performed for the
organization without compensation.
b. Which is carried on by a §501(c)(3) charity or a state
college or university primarily for the convenience of its members, students, employees,
c. Carried on by certain local associations of employees.
2. UBTI does not include, for organizations exempt under
§501 and contributions to which are deductible under §170(c)(2) or (3);
a. Income from exchanging or renting membership or donor
lists to or with another similarly exempt organization. But, watch out if the other
organization is not similarly exempt!
b. Activities related to distributing "low cost
articles" incidental to the solicitation of donations.
(1) A "low cost article" is one which costs the
organization no more than $6.70 in 1996 (indexed for inflation).
(2) The low cost articles must be distributed without being
requested or consented to by the donor.
(3) The articles must be accompanied by a solicitation for
donations and a statement that the article may be kept regardless of whether a donation is
3. UBTI generally does not include income from
"passive" sources, such as dividends, interest and royalties, or rental of real
a. However, such income will be taxable if: a) derived from
a controlled organization; or b) derived from debt-financed property.
b. Note: rental of personal property or intangible property
is generally taxable as UBTI. Thus, Payments received by a nonprofit for the use of its
name and logo, together with an exclusive active endorsement of a certain product (such as
long-distance telephone services), are viewed by IRS as rental income, not royalties. This
case involved Disabled American Veterans.
C. Other Considerations Regarding Unrelated Activities.
1. If a nonprofit accepts paid advertising, the advertising
fees may be unrelated business taxable income. The act of selling advertising is not in
itself a tax exempt activity, but is a sale of a business service that is taxed like a
business is taxed.
2. However, advertising can be related to an exempt purpose
a. The organization coordinates the content of the
advertisements with the editorial content of the publication; or
b. Published advertisements reflect new developments in the
fields promoted by the organization as part of its exempt purposes.
3. If unrelated activities become substantial, a nonprofit
organization may lose its tax-exempt status. Although there is no "bright line"
test under federal tax law, an activity generally becomes "substantial"
somewhere between 10% and 20% of gross revenues or gross expenditures.
4. An organizations unrelated business activities are
generally not exempt from state sales taxes and other state taxes.
IV. Reporting Requirements.
A. Form 990. Form 990 is required to be filed by nearly all
exempt organizations. Among other things, Form 990 now requires disclosure of:
1. Unrelated business taxable income;
2. Allocation of revenues and expenses between fundraising,
program activities and administration;
3. Disclosure of excise taxes paid by reason of improper
lobbying or political activities; and
4. Disclosure of excise taxes paid by reason of excess
B. Public Inspection File. [IRC 6104]
1. Application for Exemption (Form 1023 or 1024). The full
application, together with all papers submitted in support and the determination letter
issued by the IRS, must be available for public inspection.
2. Annual Returns (Forms 990). Annual returns must be made
available for public inspection for 3 years after filing with the IRS.
3. When and How. Inspection files must be maintained at the
organizations principal office and at any other regularly maintained office having 3
or more employees.
a. Anyone may request a copy of such documents - and only a
reasonable copying charge (and mailing cost, if applicable) can be collected.
b. Written requests must be complied with in 30 days. In
person requests must be satisfied immediately.
a. IRC 6652. A willful failure to comply with IRC 6104 is
subject to a penalty of $5,000.
b. IRC 6685. Organizations which fail to timely file Form
990 are subject to a penalty of $20/day up to the lesser of $10,000 or 5% of its gross
receipts. For organizations with gross revenues exceeding $1,000,000 annually, the penalty
is $100/day up to the lesser of $50,000 or 5% of its gross receipts.
to editorials page