What Is 501(c)(3) Nonprofit Status?
At Fractured Atlas, we talk a good deal about 501(c)(3) nonprofit status for a few reasons. That’s our own tax designation as an organization, so it’s on our minds. But we don’t just write about it or think about it because it affects us as an organization. We talk about it because it is through our 501(c)(3) status that we are able to support other artists and arts organizations via fiscal sponsorship.
And, for our community arts organizations who are considering incorporating as a nonprofit, the kind of nonprofit that they would most likely become is a 501(c)(3) one.
It’s a term that gets used a lot in the arts and nonprofit worlds, but what does it really mean? We’ll cover the basics of what a 501(c)(3) nonprofit is, who is eligible, plus the benefits and drawbacks of this particular tax status.
We aren’t accountants or tax lawyers, so please be sure to consult with your legal team before making any decisions about your own tax status or the tax status of your organization.
What Does 501(c)(3) Mean?
501(c)(3), most simply, is a specific tax category for nonprofit organizations. Nonprofits that fit into this category are called 501(c)(3)’s because that’s the portion of the U.S. Internal Revenue Code that covers these particular kinds of nonprofits. Not all nonprofits are 501(c)(3)’s, but all 501(c)(3)’s are nonprofits.
Being a 501(c)(3) nonprofit has less to do with whether your work is important, whether you are successful, or anything about what you do. It’s more about how the government taxes you and how you can receive money.
501(c)(3) nonprofits can receive tax-deductible donations. This means that any individual donor (if they itemize their taxes) or institution that donates to one of these nonprofits can deduct the amount that they donated from their final taxable income. Nonprofit entities are also exempt from paying federal income tax.
Who is Eligible for 501(c)(3) Status?
In order to qualify as a 501(c)(3) nonprofit, an organization needs to have an exclusively charitable purpose. The IRS defines these purposes as charitable, religious, scientific, literary, educational, for the fostering of national or international amateur sports, testing for public safety, or the prevention of cruelty to children or animals.
This means that businesses or groups who are primarily trying to sell products aren’t eligible for 501(c)(3) status even if their work is, for example, educational or literary.
501(c)(3) organizations cannot be organized or operated for the benefit of private interests such as investors or shareholders. That means that a 501(c)(3) can’t be a money-making venture.
Different Types of 501(c)(3) Nonprofits
There are a few different kinds of 501(c)(3) nonprofits.
The first kind is a public charity. These tend to be religious institutions or educational institutions that get some kind of government funding. Public charities have active programming to support their missions. They must receive at least one-third of their donated revenue from a broad base of public support, whether that’s individual donations or support from companies or other charities. Public charities must be governed by a body of independent, unrelated people like a Board.
The next kind of 501(c)(3) is a private foundation. These tend not to have active programs and often concentrate on grantmaking rather than their own programming. There are no requirements for public support, so funding for these private foundations can come from a small number of donors, like individuals or families. Unlike public charities, there are no requirements for independent governance. An example of a private foundation is a family foundation.
The least common kind of 501(c)(3) is a private operating foundation. They are similar to public charities in the sense that they are required to have active programming, but similar to private foundations in the way that they have more closed governance. They function a bit like a hybrid between the two.
What Does It Mean to be a Nonprofit?
Aside from the tax implications and paperwork required to be a nonprofit, one of the biggest implications of being a nonprofit is that you cannot profit from it.
Everything that goes in and out of a nonprofit needs to be an even exchange of labor or supplies for a fair market value. You can, of course, buy supplies or materials and pay staff for their time and skill, but after you’ve paid your expenses any money left over has to go back into supporting the mission of the nonprofit. It can’t be redistributed to inventors or even staffers.
You aren’t able to have investors in a nonprofit who put in money hoping to get out more money than they put in or a bigger tax break than the one equivalent to what they donated.
Drawbacks of 501(c)(3) Nonprofit Status
501(c)(3) nonprofit status confers several benefits, but also some drawbacks.
501(c)(3) status requires a great deal of paperwork and oversight. Because nonprofits receive tax breaks and accept tax-deductible donations, they need to keep meticulous public records to show where money is coming in and going out. There is a higher threshold for accountability in nonprofits because whatever it is that you produce is owned by the public and not by you.
Applying for 501(c)(3) nonprofit status can be time-consuming and intensive. It can also take months—sometimes years—to complete.
These administrative responsibilities make nonprofits less nimble than other kinds of organizations. It also means that there are limitations on the kinds of work that you can do. For example, there are limitations on what kinds of political lobbying or advocacy work you can do (this is why we ask fiscal sponsorship applicants about political work). There are other limits on what you can make or sell.
Benefits of 501(c)(3) Nonprofit Status
But, of course, there are plenty of benefits to incorporating as a 501(c)(3).
There are the obvious financial benefits. 501(c)(3) nonprofits don’t pay income tax and are able to receive tax-deductible donations from individuals and organizations. Nonprofits are also eligible for certain funding opportunities.
Donors, both individual and institutional, sometimes prefer to donate to 501(c)(3) nonprofits. They get a tax break but also have some certainty that there will be some oversight over how funds will be used.
And, even though plenty of wonderful, powerful organizations doing great work aren’t nonprofits officially, sometimes the status can confer the air of legitimacy onto an organization.
Sharing the Benefits of Nonprofit Status
There are plenty of upsides to being a 501(c)(3) nonprofit for us at Fractured Atlas. One of the biggest ones is that through fiscal sponsorship, we can extend some of the benefits of our 501(c)(3) status to other artists and arts organizations.
Fiscal sponsorship is a contractual relationship between a 501(c)(3) nonprofit organization and a group or individual whose activities fall within the sponsoring organization’s mission. In other words, people without tax exemption can use some of the benefits of a 501(c)(3)’s status to raise funds and execute projects as long as their work furthers the mission of the nonprofit.
So, we can help individuals and organizations receive those tax-deductible donations and apply for those restricted funding opportunities.
New to the idea of fiscal sponsorship? We lay out what it is and how artists and creatives can use it.
About Nina Berman
Nina Berman is an arts industry worker and ceramicist based in New York City, currently working as Content Specialist at Fractured Atlas. She holds an MA in English from Loyola University Chicago. At Fractured Atlas, she shares tips and strategies for navigating the art world, interviews artists, and writes about creating a more equitable arts ecosystem. Before joining Fractured Atlas, she covered the book publishing industry for an audience of publishers at NetGalley. When she's not writing, she's making ceramics at Centerpoint Ceramics in Brooklyn.