February 2, 2023
There are many different types of nonprofit classifications available to organizations, each with their own rules about eligibility and activities. Most are already familiar with 501(3) public charities, but recent large donations by company owners to 501(c)(4) organizations have put these entities in the spotlight. The donations that garnered the attention last year were (1) the transfer of roughly 98% of Patagonia’s stock to the Holdfast Collective and, (2) the donation (prior to sale) of Tripp Lite to the Marble Freedom Trust. Both Holdfast Collective and Marble Freedom Trust are classified as 501(c)(4) organizations.
Deciding on the Right Structure for your Nonprofit
So, what can a 501(c)(4) do that a 501(c)(3) can’t, and why form a 501(c)(4)? There are estate and gift tax implications that go beyond the scope of this article, but we will highlight some of the key differences between 501(c)(3) public charities and 501(c)(4) organizations.
The Purpose of a 501(c)(3) vs. a 501(c)(4)
First, let’s briefly define what constitutes a 501(c)(3) and a 501(c)(4) organization. A 501(c)(3) organization is generally defined as one organized for religious, charitable, educational, scientific, or educational purposes. This can encompass a wide range of entities, including schools, food banks, research institutions and environmental organizations. Defining a 501(c)(4) organization is a little trickier. Internal Revenue Code section 501(c)(4) describes such organizations as those not organized for profit but organized exclusively for the promotion of social welfare. The regulations under 501(c)(4) provide that an organization is operated for the promotion of social welfare if it is primarily engaged in promoting the common good and general wellbeing of the people of the community. While this can be a somewhat amorphous definition, this includes organizations like the American Civil Liberties Union (ACLU), National Organization for Women (NOW), Sierra Club, and civic leagues like the Lions Club. It is important to note that there may be considerable overlap in permissible activities conducted by a 501(c)(3) and a 501(c)(4) organization that would be considered in furtherance of each’s respective exempt mission. In other words, the same activity (e.g., educational) may be both within a 501(c)(3)’s and 501(c)(4)’s exempt mission.
Charitable Contribution Deduction
The first and most obvious difference between a 501(c)(3) and 501(c)(4) is that contributions to a 501(c)(3) organization are generally eligible for a charitable income tax deduction, whereas donations to a 501(c)(4) organization are not. In the situations discussed above, the owners did not get a charitable income tax deduction, however the owners were presumably able to avoid a large income tax on the capital gain resulting from the sale of the stock by donating it to the 501(c)(4) instead. As noted, there may be estate and other income tax considerations that make forgoing an income tax deduction worthwhile. There may also be non-tax considerations for choosing a 501(c)(4) organization as the donee.
Publicly Supported vs. One Donor
Generally, a 501(c)(3) public charity must meet a public support test, most typically under IRC 509(a)(1) or 509(a)(2). This requires the organization to attract support (e.g., contributions or program service revenue) from a from a wide range of donors/payees. A 501(c)(4) organization does not have to meet the public support test and can be funded entirely by one individual or entity.
Lobbying and Political
One of the most significant operational differences between 501(c)(3) public charities and 501(c)(4) organizations is in the lobbying and political activity area. 501(c)(4) organizations do not have a lobbying limit and can devote all their activities to lobbying in furtherance of its exempt purposes.
501(c)(3)s may lobby but the lobbying activity must be an insubstantial part of their activities. This can be measured on an activity basis, or the organization may elect under 501(h) to have the lobbying limit based on a sliding scale depending on the organization’s expenditures. If measured on the activity (rather than expenditures) there are no clear guidelines for “how much is too much” lobbying. If the lobbying activity is less than 5%, the organization’s lobbying level should be acceptable. Lobbying more than the 501(h) election amounts, or in excess of the activity amount, could result in the revocation of exempt status. Exceeding the 501(h) limits in a given year (for grassroots or direct lobbying) will result in an 25% excise tax.
In the political activity area, the difference between 501(c)(3)s and 501(c)(4)s is even more stark. Engaging in political activity by a 501(c)(3) organization will result in a loss of tax-exempt status and/or an excise tax. There are some election-related activities (e.g., conducting voter registration drives, and distributing voter guides) that a 501(c)(3) organization may conduct, but these are limited and must be done in a non-partisan manner.
501(c)(4)s may engage in political activity so long as the political activity is not their primary activity. Once again, how that is measured is a bit unclear. To complicate matters further, there has been an appropriations bill rider that prevents the IRS from drafting guidance on the permissible levels of political activity by section 501(c)(4) groups. Current thinking is that if political activity is not more than 49% of the organization’s overall activity, a 501(c)(4) should not be in violation of the political activity limit. A 501(c)(4) may pay a tax on the lesser of amount of the political expenditures or investment income.
An additional distinction between 501(c)(3) public charities and 501(c)(4) organizations is the requirement to disclose donors to the IRS. 501(c)(3) organizations must attach a list of donors that meet certain dollar thresholds on Schedule B of Form 990. For privacy, personal donor information may be redacted from the organization’s public disclosure copy of Form 990. 501(c)(4) organizations do not have to provide personal donor information to the IRS, though they must keep records of this information.
A final distinction is the process each must go through to obtain tax-exempt status from the IRS. A 501(c)(3) public charity must file Form 1023 or Form 1023-EZ to be recognized by the IRS as tax-exempt. A 501(c)(4) organization may “self-declare”, i.e., it may be a 501(c)(4) organization by being organized and operated as such. A 501(c)(4) organization must file a Form 8976, Notice of Intent to Operate Under Section 501(c)(4), electronically within 60 days of its formation to notify the IRS of its intent to operate as a 501(c)(4).
Your Nonprofit’s Designation
It is important to understand the differences between nonprofit classifications when deciding between forming a 501(c)(3) or 501(c)(4) organization. The distinction between underlying exempt purpose, restrictions on lobbying and political activities, and anticipated donor composition should be considered, among other non-tax considerations.
For general tax information, tools, and resources for tax-exempt organizations, visit the IRS Charities and Nonprofits page. When considering establishing a new nonprofit organization, contact your nonprofit tax advisor to determine which structure will work best for your needs.
Partner and Director, Nonprofit Tax Services
Senior Manager, Nonprofit Tax Services