Navigating 501(c)(3) and 501(c)(6) with Ease: A Step-by-Step Guide
Written By:
Bill Ray, CPA
Are you thinking about forming a new association? After you complete some basic elements, including crafting bylaws and applying to become a nonprofit entity in your state, one important step you will need to take is filing for tax-exempt status with the Internal Revenue Service (IRS). Associations generally fall into one of two tax-exempt classifications: 501(c)(3) or 501(c)(6). Which one should you apply for? And what is the process?
In this blog post, an updated look at one of our most viewed blog topics from 2015, we’ll break down the process into four steps and provide tips for success.
1 Understand the Terminology
First, let’s understand the terminology correctly. “Tax-exempt” refers to the organization’s federal income tax status as governed by the Internal Revenue Code. This is different from ”nonprofit,” which represents the organization’s incorporation or organizational status, as governed by applicable state law.
A nonprofit organization is not automatically tax exempt. Applying for federal tax-exempt status is a critical step in the formation process since a nonprofit is still subject to federal income taxes until obtaining a tax-exempt determination letter from the IRS.
2 Determine the Right Category
The next step is choosing the correct category. The purpose for which your organization was formed (as described in your bylaws, articles of incorporation or other state filing) will dictate which tax-exempt status is the right fit. IRS Publication 557 provides additional details about the requirements for each status. The most common categories among associations include:
- 501(c)(3) – In simplest terms, 501(c)(3) organizations are organized to serve the public (and are commonly referred to as “public charities”). More specifically, they are formed exclusively for one or more of the following purposes: religious, charitable, scientific, testing for public safety, literary, or educational purposes.
- 501(c)(6) – On the other hand, 501(c)(6) organizations are formed to serve their members and may be summarized as trade associations or business leagues. They exist primarily to benefit members who share a common business interest or a broader segment of the public.
The chart below also summarizes some key differences between the two types.
| 501(c)(3) | 501(c)(6) | |
| Purpose of activity: | Operated exclusively for charitable, educational, religious, literary, or scientific purposes. | Operating to promote the common interests of businesses, industries, and members. |
| Types of Organizations: | Includes membership associations if the purpose is to advance the profession with respect to “educational” activities. | Includes membership organizations advancing a common business interest. |
| Lobbying Activities: | Activities are significantly restricted. Organizations can advocate for causes but cannot influence legislation or support a candidate. An organization may lose its tax-exempt status if the IRS determines that it has engaged in “substantial” lobbying activities. | Can participate in lobbying if it is related to the organization’s purpose. The portion of membership dues that fund lobbying activities is non-deductible to the member and must be disclosed on the annual dues notice. |
| Political Activities: | Cannot participate in political campaigns or electioneering. | Can actively take part in political and election campaign activities. |
| Donations / Gifts of Property: | Donations and gifts of property are tax-deductible as “charitable contributions” on the donor’s federal tax return. Any portion for which goods or services were exchanged is excluded. | Dues and other payments may be deducted as a business expense to the extent they are “ordinary and necessary,” but are not charitable donations for tax purposes. |
| Application: | Federal Form 1023 | Federal Form 1024 |
| Annual IRS Filing Requirements: | Must file form 990-N, 990-EZ, or 990 annually. | Must file form 990-N, 990-EZ, or 990 annually. |
| State & Local Taxes: | May be eligible to receive other state and local tax exemptions (such as sales tax). Eligibility for these exemptions is governed by state law. | Generally. not eligible to receive other state and local exemptions (such as sales tax). |
| Donor Disclosure Requirements: | Must disclose major donors (generally $5,000 or more) to the IRS via Schedule B. For public charities, this form is not subject to public inspection. | Is not required to disclose major donors to the IRS or to the public. However, the organization must still maintain appropriate donor records. |
3 Submit Your Application
To apply for recognition of tax exemption with the IRS, an organization would file federal Form 1023 for 501(c)(3) status or Form 1024 for 501(c)(6) status. Application fees are between $275 and $600 currently, but you can find the latest fees and instructions on the pages we’ve linked. Before you apply, consider reviewing some of the resources and videos from the IRS to ensure you are proceeding correctly.
When your application is approved, the IRS will issue an affirmation letter, which is the official confirmation of tax-exempt status. This is useful for additional elements of your process, since banks, insurance companies, and other organizations will frequently require your organization to offer proof of tax exemption.
4 Maintain Your Status in Good Standing
Once your tax-exempt status is granted, you will be required to file IRS Form 990-N, 990-EZ or 990 annually to maintain your status. Form 990-T may also be required if your organization receives more than $1,000 of unrelated business income. Failure to file the correct returns for three consecutive years will result in the automatic revocation of your tax-exempt status.
Be sure to retain a copy of the IRS affirmation letter on file and easily accessible. You will need to contact the IRS to replace a lost tax-exempt status letter or if your organization has a change to its name or address.
A final tip: the IRS offers an abundance of useful information and resources aimed at nonprofit organizations through its Stay Exempt website. These resources can keep your association leadership in-the-know and help ensure no issues with retaining good standing with the IRS.
Degrees and Credentials:
Bachelor of Arts in Accounting from Lycoming College, Certified Public Accountant (CPA)
Association Management Professional Since:
2022
What inspires you about your work?
I am passionate about supporting mission focused clients. By managing the finance and accounting needs of our clients, they can focus their time and effort on the mission and vision of their organizations.
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Are you thinking about forming a new association? After you complete some basic elements, including crafting bylaws and applying to become a nonprofit entity in…