401c3 Nonprofit Organization – Does It Exist?

I’ve seen in many forums people asking about a 401c3 nonprofit organization. Is this an actual organization? Is there such a thing as a 401c3 nonprofit organization?

A 401c3 organization is a misnomer. Many people confuse it with the IRS-qualified 501c3 organizations that are tax exempt.

To qualify as a 501c3, you should form a trust, a corporation, or an association under the state laws where you live. After doing that, apply for tax-exempt status. So the name of this nonprofit tax category is 501c3, not 401c3.

A 501c3 organization can be an unincorporated association, trust, corporation, or other types of organizations excluded from paying Federal income tax under section 501(c)(3) of the United States Code. Furthermore, the United States recognizes 29 kinds of 501(c) nonprofit organizations.

Read on to learn more about a 501c3 nonprofit organization and how it is not a 401c3 organization.

401c3 Nonprofit Organizations – Does It Exist?

401c3

You can’t create a nonprofit 401c3 organization because there is no such thing under the federal law and IRS regulations of the United States. This particular tax classification does not exist in the records of the U.S. government.

It is usually the misnaming of the 501(c) (3) classification given to tax-exempt organizations. Many people make the mistake of putting a ‘4’ instead of a ‘5’ when writing this term on their IRS tax form, leading to the misconception that there is such a classification.

Should your group or association qualify for this tax-exempt category, it will be classified as a 501(c) (3) nonprofit organization. Thus, all donations that your group gets will be tax-deductible. This privilege is granted to your group to encourage other people to give to your cause.

Indeed, there are many things you should learn and do to get this tax-exempt status. The details are available in IRS Publications 557. Please take note that not all nonprofit associations qualify for tax-exempt status.

In applying for tax-exempt status, you need to fill up the IRS form 1023 or 1023-EZ. Moreover, the IRS also requires you to pay a non-refundable application fee. I will give you several essential things that relate to this. You can treat this article as a primer.

What then is the meaning of the ‘401’ IRS designation? This number refers to owner-employees and self-employed individuals. That means the individual or the organization is in it for the money.

In contrast, under section 3 of the IRS rules, a 501(c) (3) organization can be exempted from paying its taxes if it is primarily used for the following reasons:

  • Religious,
  • Charitable,
  • Educational,
  • Literary,
  • Scientific activities,
  • In encouraging amateur sports competitions,
  • Preventing cruelty to children,
  • Preventing cruelty to animals, and
  • Testing for public safety.

401c3 vs. 501c3 – Is There a Difference? 

The main difference between 401c3 vs. 501c3 is that the latter exists, and the former does not exist. Section 401 (c) (3) defines the term ‘owner-employee.’

This person owns at least 10% of the company or an unincorporated business. Also, they are engaged in activities that have nothing to do with tax-exempt or nonprofit organizations.

In other words, there are no nonprofit 401c3 organizations in existence. But there is a Section 401 (c) (3) that describes whether an owner can include themselves in their company’s retirement plan.

Indeed, the IRS Classifications in the United States have 401 (c) and the 501(c). The big difference is that the 401 (c) refers to ‘self-employed individuals and owner-employees, while the 501(c) refers to not-for-profit groups and organizations.

The Real Score About 401c3 Nonprofit Organizations

To understand what 401c means, you need to know the following information from the Internal Revenue Code Section 401 (c).

This section discusses qualified pension, profit-sharing, and stock bonus plans. It also defines the rules relating to self-employed individuals and owner-employees. Self-employed individuals are treated as employees.

Employee

In general, an ‘employee’ is an individual who is self-employed for any taxable year. It is anyone who has earned income for such a taxable year.

Owner-Employee

The word owner-employee refers to an employee who owns the entire interest in an unincorporated business or trade. If the company is a partnership, it refers to the employee who owns more than 10 percent of either the profits interest or the capital interest.

Profit

The distinguishing word in these definitions of terms is the word ‘profit.’ In 401 (c) classification, profit is the main reason why the company exists, whereas, in 501 (c) categories, profit is not the motive by which the group or association is doing its activities.

The real score is that there are no 401 (c) nonprofit organizations. But there are many kinds of nonprofit organizations in the 501 (c) category. They include 501 (c) (3) public charities, 501 (c) (4) political action groups, 501 (c) (6) membership organizations, and so forth.

Therefore, of all these 501 (c)s, only 501 (c) (3) organizations can accept donations from donors in the form of tax deductions.

What Then Is a 501c3 Nonprofit Organization? [501 (c) (3)]

nonprofit 401c3

A company that does any of the following has the privilege of tax exemption:

  • Religious
  • Charitable
  • Scientific
  • Educational
  • Literary
  • Testing for public safety
  • Preventing cruelty to children and animals
  • Fostering amateur sports competitions

You must also be able to explain how you are serving the public good. Show the IRS that you have organized your group for a specific nonprofit purpose that they have approved.

Here are some of the specific objectives that the IRS has cited. You can use one of them as your goal so that your application will be approved faster:

  • Advancement of religion
  • Relief of the poor, the distressed, or the underprivileged
  • Lessening of neighborhood tensions
  • Advancement of education or science
  • Elimination of prejudice and discrimination
  • Combating community deterioration and juvenile delinquency
  • Lessening the burdens of government
  • Defense of civil and human rights secured by law
  • Erection or maintenance of public buildings, monuments, or works

Some organizations that have qualified for the 501 (c) (3) category include charitable hospitals, churches, parent/teacher associations, the Red Cross, nursing homes, the Salvation Army, and certain schools.

Limits of Activities for 501c3 Organizations

All groups need to incorporate to qualify as a 501c3 organization unless they are an unincorporated association or a trust. Loosely organized groups, partnerships, and sole proprietorships, even with charitable objectives, are not qualified to be 501c3 nonprofits.

However, no clear defining terms differentiate nonprofit unincorporated groups from loosely organized groups. The law allows you to operate an unincorporated organization even if you don’t have the proper paperwork.

It is just like two people who agreed to form a business legally together as a partnership even if they did not file the proper paperwork. You don’t need to complete documents such as a charter or other organizational papers as long as the business is not incorporated.

However, this is a risky route to take in many areas in the United States. If there is no legal distinction between an unincorporated organization and its members, creditors could sue each separate individual for their assets instead of the company. 

There are also some limitations on the activities that a 501 (c) (3) organization can engage in. To be able to maintain tax-exempt status, your organization should do the following:

  • Lobbying for legislation for or against any issues that are not a major aspect of your objectives;
  • Engaging in “excess benefit transaction” like allowing the directors of the corporation to use the company’s nonprofit funds for themselves;
  • Using the organization’s staff and facilities to benefit private individuals or allocating the association’s funds to private shareholders;
  • Campaigning for or against political parties and candidates;
  • Paying the exorbitant amount of salaries to the company staff for their work; and
  • If your company violated the rules, the tax-exempt status might be revoked.

Types of 501c3 Nonprofit Organizations

There are two basic types of 501 (c) (3) nonprofits:

Public Charity

According to the IRS, these organizations are not private foundations. Most of the income or funds of these organizations come from the government or the general public. To get enough funds, public charities must have broad support from the public and the government.

Private Foundation

As the word implies, private individuals or companies support the private foundations instead of the general public or the government. Their income or funds come from endowments and investments.

Again, 401c3 nonprofit organization – is there such a thing? 401c3 nonprofit organization does not exist. Some people might have confused it with tax-exempted 501c3 organizations. For your organization to qualify for tax exemption, you have to form trust by following your state laws.

Benefits of a 501 (c) Status

The general public and wealthy private individuals can benefit from their favorite charities or foundations. Some of these benefits are:

  1. Anytime a taxpayer donates to a non-profit organization, they can deduct the amount on their taxable income. To be able to do this, they have to itemize their tax deductions.

This scheme makes it easy for 501 (c) organizations to raise funds. It also encourages the public and private individuals to give to charity.

2. Those who want to raise money for a certain cause can form a 501 (c) (3) organization.

401c3 nonprofit organization

You can do good to many people by using the funds that you will get to improve their lot in life, and you get the satisfaction of helping others. You should follow the rules set by the IRS for such organizations.

Disadvantages of 501c3 Organizations

There are also some disadvantages in forming a 501 (c) organization:

  1. An IRS approval may require you to take a lot of work and documentation;
  2. The non-profit status may not be right for your organization if your group is engaged in ongoing income activities, especially if those activities are not related to nonprofit purposes;
  3. The IRS examines income not related to a company’s nonprofit status. If so, IRS will penalize you with large fines. They might also revoke your nonprofit status; and
  4. Should you discontinue your non-profit operations, you will be required to pay your creditors. You may also be required to give the remaining assets of your organization to another nonprofit group. 

Overall Requirements for 501 (c) (3) Tax-Exempt Status

If you want to form a 501 (c) (3) organization, you should satisfy several requirements to receive tax exemption benefits. That includes being allowed to operate your company exclusively for tax-exempt purposes.

  1. The number one requirement is: your organization must not be operated to benefit any private interest;
  2. The net earnings of your organization should not benefit any private individual or shareholder; and
  3. Your organization can profit, but you should spend any profit that you make for charitable purposes only.

Process of Application

As has already been mentioned, you can apply as an unincorporated organization, or you could incorporate it as a nonprofit organization in your state.

That said, there are two possible applications you can submit to get tax-exempt status. The most commonly used is Form 1023. But you can also use Form 1023-EZ. The latter is an easier and streamlined application for small organizations.

Fill out the eligibility worksheet to see if your organization qualifies for the streamlined process.

Then, file whichever forms apply within 27 months from the date of your incorporation to receive tax exemption status. Your exemption will only take effect from the postmark date of your application if you wait much longer.

There are three types of groups that are not required to file Form 1023, including:

  • Public charities with gross receipts of no more than $5,000 per year.
  • Subsidiary organizations that are exempt under a group exemption
  • Churches

Conclusion: Non-profit 401c3 Organizations

There is no classification such as a “401c3 organization”. It is an inaccurate term for the IRS-qualified 501c3 nonprofit organizations. These 501c3 corporations are tax-exempt.

Moreover, to get tax-exempt status from the IRS, you need to form an association, trust, or corporation under your state’s laws. And then apply for tax-exempt status.

Moreover, to qualify for tax exemption, your group or company must be doing something for the greater good, such as:

  • Advancement of religion
  • Relief of the poor, the distressed, or the underprivileged
  • Lessening of neighborhood tensions
  • Advancement of education or science
  • Elimination of prejudice and discrimination
  • Combating community deterioration and juvenile delinquency
  • Lessening the burdens of government
  • Defense of civil and human rights secured by law
  • Erection or maintenance of public buildings, monuments, or works