Nonprofit vs Tax-Exempt: Are They the Same?

Are you looking to start a nonprofit to help your community? Is that the same as being tax-exempt? There is a common misconception that they are the same – in fact they are two related but different things. Usually when someone wants to start a “charity” what they really want to do is be a tax-exempt organization. But in order to be tax-exempt under the IRS rules, you must first be a nonprofit organization. To become a nonprofit entity, you must register at the state level. However, this does not provide you charitable status at either the state or federal level. Eligibility for 501(c)(3) status requires that an organization be organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competitions, or for the prevention of cruelty to animals or children. Certain organizations do not need to apply with form 1023 but may if they want a declaration that they are tax exempt. It is important to remember that filing a nonprofit application at the state level will not guarantee you will qualify as a 501 (c)(3) tax-exempt entity; nonprofit and tax-exempt are not the same.

When determining eligibility, the IRS looks at both the organization and the operation of the organization. In order to be organized, an organization must be organized as a corporation, trust, or an unincorporated association. This involves filing documents at the state level.

All eligible organizations are further classified as either public charities or private foundations. Public charities include churches, schools, hospitals, medical research organizations, cooperative hospital service organizations, organizations that receive substantial support from grants, government units, or the general public, and organizations that normally receive more than 1/3 of its support from contributions, membership fees, and gross receipts from activities related to their exempt functions and not more than 1/3 of its support from gross investment income or net unrelated business income. Private foundations are all eligible organizations that do not fall under the public charities definition. However, private foundations can be declared as private operating foundations if that foundation actively conducts exempt programs and meets certain support requirements.

Even after federal registration, 501(c)(3) organizations may be required to register with state governments in order to solicit contributions or obtain state level tax exemption.

Along with form 1023, certain organizations must also fill out the required schedules in form 1023. These schedules provide the IRS with additional information about the specific operations of the organization in order to help determine whether the organization can be tax exempt.

If you are interested in starting a 501(c)(3) and would like assistance, please feel free to contact our office. At Griswold LaSalle, our staff has extensive experience counseling clients on creating 501(c)(3) entities.