An exempt project’s tax-exempt purpose should be crystal clear. We love getting calls from potential clients with exciting ideas. However, surprisingly often, we are in a position which we do not enjoy of letting the caller know that as exciting as their idea is, it does not qualify for tax-exemption.
Tax-exempt Purposes that Qualify for 501(c)
There are 29 different exemptions under Code Section 501, the most popular of which is Section 501(c)(3). If a nonprofit corporation plans to qualify for tax-exemption under Section 501(c)(3), the articles of incorporation must limit its activities to a permissible tax-exempt purpose. Tax exempt purposes under 501(c)(3) include:
- testing for public safety,
- to foster national or international amateur sports competition, or
- promote the arts, or for the prevention of cruelty to children or animals.
Purposes that qualify under some of the other sections of 501(c) include:
- 501(c)(4) – Civic Leagues, Social Welfare Organizations, and Local Associations of Employees
- 501(c)(5) -Labor, Agricultural, and Horticultural Organizations
- 501(c)(6) – Business Leagues, Chambers of Commerce, Real Estate Boards, Etc.
- 501(c)(7) – Social and Recreation Clubs
Sources of Law Interpreting 501(c)
The concept of a 501(c)(3) purpose is derived from the English common law of charitable trusts and has been codified in law and interpreted through Treasury Regulations, cases, and rulings. This means that within each of these categories there is a body of legal precedent interpreting the nuances of what each term means. For example, the Treasury Regulations define the term charitable to include the following:
- relief of the poor and distressed or of the underprivileged,
- advancement of religion,
- advancement of education or science,
- erection or maintenance of public buildings, monuments, or works,
- lessening of the burdens of Government,
- promotion of social welfare by organizations designed to accomplish any of the above purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and discrimination; (iii) to defend human and civil rights secured by law; or (iv) to combat community deterioration and juvenile delinquency.
Similarly, the other seven potential rationales for 501(c)(3) status each have specific meaning under the law that can cause problems for the unsuspecting applicant. If a proposed activity is novel, it makes sense to do some research to ensure that it will qualify under one or more of the eight tax-exempt purposes ennumerated in Code Section 501(c)(3).
Examples of Proposals that Do Not Qualify for 501(c)(3)
Some common examples of laudable endeavors that will not qualify for 501(c)(3) include fundraising for a fallen officer or a specific individual’s medical care, raising money to invest in start-up technology companies, or running a business that will turn over all of its profits to 501(c)(3) organizations.
In addition to stating a tax-exempt purpose, to qualify for tax-exempt status, the organization must benefit a sufficiently large and indefinite charitable class. This is why the fund for a specific fallen officer or patient does not qualify for tax-exempt status. The rule of thumb is that charity ends where certainty begins.
Another example is an organization that engages in more than a substantial amount of lobbying or any campaign activity. While such organizaitons will not qualify for tax-exempt status under Code Section 501(c)(3), they may qualify under another section of 501(c) such as 501(c)(4).
Further, in analyzing whether an organization has a tax-exempt purpose, one must analyze the inherent qualities of the activities being conducted, not what is done with the proceeds.
Therefore, a car washing business that is opened up with the express purpose of donating 100% of its profits to charitable causes is not tax-exempt because its inherent activities are not charitable, educational, religious, etc. This type of arrangement is known as a feeder organization.
Organizations that are not operated exclusively for tax-exempt purposes will not qualify for exemption. Any non-exempt activity should be incidental to the exempt activitiies the organizaiton will be engaged in.
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Entity selection and tax classification are the two most important early considerations when starting a nonprofit. Its a good idea to talk your concept through with an expert before investing significant time or money in building the organization to ensure you are builiding it on a strong legal foundation.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.