What is a 501(c)(3) organization — short definition
– A 501(c)(3) organization is a U.S. nonprofit that meets the Internal Revenue Code’s Section 501(c)(3) rules and is exempt from federal income tax. Only organizations with this designation can generally say that donations to them are tax-deductible for donors.
Core purposes that qualify
– To be eligible the group must exist for one or more of these purposes: charitable, religious, educational, scientific, literary, testing for public safety, preventing cruelty to children or animals, or promoting amateur sports competition. The organization must stick to those purposes unless it notifies the IRS of an official mission change.
Key operational rules and limits
– No private benefit: Net earnings cannot be distributed to private individuals (founders, family members, shareholders). All earnings must support the organization’s mission.
– Unrelated business income: Non-mission activities are allowed but must not be “substantial.” The IRS does not set a bright-line percentage; one specialist law firm estimates the practical range might be roughly 15%–30% of total activities (this is an estimate, not an IRS rule).
– Political activity and lobbying: A 501(c)(3) cannot participate in political campaign activity for or against candidates, and lobbying must not be substantial. There are limits on lobbying expenditures.
– Payroll and employment taxes: Even though the organization is tax-exempt, it must withhold federal income tax and pay Social Security/Medicare on behalf of employees. Staff must receive “reasonable compensation” — i.e., pay consistent with the fair market value of the work.
Status, classification, and donor tax treatment
– Once the IRS grants 501(c)(3) status, it generally remains in effect until revoked. Organizations that meet 501(c)(3) rules fall into two main types:
– Public charities: Funded substantially by the general public, government, or other public charities. To be treated as a public charity the organization generally must receive at least one-third of its support from public donations and similar sources.
– Private foundations: Usually funded by one family, individual, or corporation and receive most support from a narrow donor base. Private foundations face tighter limits on donor deductibility.
– Donor deductibility: Donations to qualifying public charities can be deductible by donors up to 60% of their adjusted gross income (AGI) as of 2025. Deductions for gifts to private foundations are generally more limited.
Practical benefits
– Exemption from federal income tax.
– Donors can claim tax deductions (subject to AGI limits).
– Eligibility for government and private grants.
– Access to certain discounts and in-kind assistance from other organizations.
Transparency and public access
– Because they serve the public, 501(c)(3) organizations are generally expected to be transparent. Financial information, including salaries, is available to the public.
How to start a 501(c)(3) — basic steps
1. Incorporate the organization under state law (this creates an official “date of incorporation”).
2. Draft and file articles of incorporation that state a qualifying tax-exempt purpose.
3. Collect documents that show the organization’s mission and operations (these support the IRS application).
4. Prepare and submit IRS Form 1023 or Form 1023‑EZ to request recognition under Section 501(c)(3). File within 27 months of the incorporation date to secure tax-exempt treatment from inception.
– Note: Small public charities with under $5,000 annual revenue are not required to file Form 1023 but may choose to file to ensure donor deductibility.
5. Comply with payroll tax withholding and establish policies to ensure reasonable compensation and limited unrelated business activity.
Short checklist for organizers
– [ ] Incorporate as a nonprofit in your state.
– [ ] Draft articles of incorporation that state a qualifying purpose.
– [ ] Gather mission- and governance-related documents to support the IRS application.
– [ ] Decide whether to file Form 1023 or Form 1023‑EZ and submit it within 27 months of incorporation.
– [ ] Plan operations so unrelated business activity and lobbying remain limited.
– [ ] Set up payroll systems to withhold and pay required employee taxes.
– [ ] Track public support to determine whether the organization will qualify as a public charity or be treated as a private foundation.
Small worked example — donor deduction limit
– Scenario: A donor has adjusted gross income (AGI) of $100,000 in 2025 and makes a cash gift to a qualifying public charity.
– Rule (2025): Cash gifts to public charities are generally deductible up to 60% of AGI.
– Calculation: 60% × $100,000 = $60,000.
– Result: The donor could generally deduct up to $60,000 of cash contributions to public charities in that year (subject to other tax rules and recordkeeping).
Illustrative example — unrelated business income (estimate)
– Suppose a nonprofit has $200,000 total revenue. If one uses the specialist-law-firm estimate that “substantial” unrelated activity might fall between 15% and 30%, that corresponds to $30,000–$60,000 of unrelated business income. If unrelated activities approach or exceed that range, the organization should evaluate risk and consult advisors. (This is an illustrative estimate; the IRS has no definitive percentage.)
Strengths and common challenges (summary)
– Strengths: tax exemption, donor deductibility, grant eligibility, public credibility.
– Challenges: limits on political/lobbying activity, restrictions on private benefit, requirements for transparency, payroll tax obligations, and careful management of unrelated business activity.
Relevant sources (for further reading)
– Internal Revenue Service — Exemption Requirements (Section 501(c)(3) Organizations): https://www.irs.gov/charities-non-profits/charitable-organizations/exemption-requirements-section-501c3-organizations
– IRS Publication 557, Tax-Exempt Status for Your Organization (PDF): https://www.irs.gov/pub/irs-pdf/p557.pdf
– Investopedia — What Is a 501(c)(3) Organization?: https://www.investopedia.com/terms/1/501c3-organizations.asp
– Candid / GrantSpace — What Is a 501(c)(3)?: https://grantspace.org/resources/knowledge-base/what-is-501c3/
Educational disclaimer
This explainer is for educational purposes only and does not constitute legal, tax, or financial advice. For specific guidance on forming or operating a 501(c)(3) — or on donor tax treatment in your circumstances — consult a qualified attorney or tax professional.