Demystifying the Various Tax Exemptions: 501(c)(3) vs. 501(c)(4)

What is the difference between a 501(c)(3) and a 501(c)(4)? The answer to the question isn’t all that simple, even for nonprofit board members. Both designations fall under the umbrella of nonprofit organizations, and these classifications are only 2 of the 29 different types of nonprofits that fall under the U.S. IRS tax code.

Something both classifications share in common is that they’re both exempt from federal income taxes.

Depending on which state your nonprofit is domiciled in, they may also be exempt from state or local taxes. Following, we’re providing an overview of each classification to help answer the question of, “What is the difference between a 501(c)(3) and 501(c)(4) organization?” including definitions, requirements, and restrictions.

Understanding the 501(c)(3) Classification

If the term 501(c)(3) sounds familiar, it’s because it’s the most common type of nonprofit in the country. Section 501(c) defines the categories for which types of organizations fall under 501(c)(3).

They include organizations exist for the following purposes:

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

The term charitable is a broad term that includes, “relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency”.

All 501(c)(3) organizations are required to file an IRS Form 990 every year that details the nonprofit’s activities, financial information, and governance practices. Nonprofits also have to describe their accomplishments to justify maintaining their tax-exempt status. Churches and schools may be required to submit additional documents or information.

While nonprofit organizations receive several valuable benefits, they also have to abide by certain restrictions imposed on them by the IRS. They include:

• Directors, officers, and individuals may be paid a salary from their work, but they can’t use nonprofit funds to benefit them in any other way. For example, they’re not allowed to share in the nonprofit’s stock or profits as is typical with for-profit corporations.
• If the nonprofit were to shut down for any reason, no individuals may benefit from the distribution of assets.
• Lobbying and legislative activities are allowable as long as nonprofits keep it on a small scale. Generally, they can spend no more than 10% to 20% of their funds on legislative advocacy.

Now, we’ll take a look at how the 501(c)(4) classification differs from the 501(c)(3) classification.

Understanding the 501(c)(4) Classification

As we dig deeper into the question over, “What is the difference between 501c3 and a 501c4?” let’s first consider the two types of 501(c)(4) organizations which are:

1. Social welfare organizations
2. Local associations of employees

Social welfare organizations include:

• An organization that operates an airport that serves the general public where there are no other airports that are situated on land that’s owned by a local government, and the local government supervises the operation of the airport.
• Community associations that were formed to improve public services, housing, and residential parking.
• Community associations that publish a free community newspaper.
• Community associations that sponsor a community sports league, or holiday programs and meetings.
• Community organizations that contract with a private security service to patrol the community.
• Community associations that are dedicated to preserving the community traditions, architecture, and appearance and representing such interests before authorities in matters related to zoning, traffic, and parking.
• Organizations that encourage industrial development and that make loans to businesses to attract them to the community with the goal of increasing employment.
• Organizations that hold traditional annual festivals of regional customs and traditions.
• Homeowner associations and volunteer fire departments that fit certain exemptions.

The criteria for local associations of employees include:

• They must be local.
• Members are limited to employees of a designated employer within a particular location.
• They’re only allowed to use funds for charitable, educational, or recreational purposes.

501(c)(4) organizations also have regulations for lobbying. Unlike 501(c)(3) organizations, 501(c)(4) organizations are allowed to pursue lobbying activities as long as their efforts relate to the organization’s official purpose. They’re not limited to how much they can spend on legislative efforts, and expenses related to political activities could be taxable. That said, they may be required to disclose how much of their members’ dues apply to lobbying activities, and they may have to pay a proxy tax. Much like their 501(c)(3) counterpart, 501(c)(4) organizations can’t directly or indirectly engage in political campaigns whether they support or oppose a candidate. The organization’s primary purpose has to be something other than political activity.

In 2010, the Supreme Court allowed corporations and labor unions to register as 501(c)(4). Many corporations took advantage of this opportunity because it allowed them to spend any amount of money on political activities without having to disclose the names of donors.

Similarly, to 501(c)(3) organizations, 501(c)(4) organizations cannot give any portion of their profits benefit any member or individual.

Nonprofits that don’t fall into one of these classifications may fall into another classification of the 501(c) code such as:

• 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 recreational clubs
• 501(c)(8) Fraternal beneficiary societies and associations
• 501(c)(9)     Voluntary employees beneficiary associations
• 501(c)(10)   Domestic fraternal societies and associations
• 501(c)(11) Teachers’ retirement fund associations
• 501(c)(12) Benevolent life insurance associations, mutual ditch or irrigation companies, mutual          or cooperative telephone companies, etc.
• 501(c)(13)  Cemetery companies
• 501(c)(14) State-chartered credit unions, mutual reserve funds
• 501(c)(15)  Mutual insurance companies or associations
• 501(c)(16) Cooperative organizations to finance crop operations
• 501(c)(17)  Supplemental unemployment benefit trusts
• 501(c)(18) Employee funded pension trust (created before June 25, 1959)
• 501(c)(19)  Post or organization of past or present members of the armed forces
• 501(c)(21)  Black lung benefit trusts
• 501(c)(22)  Withdrawal liability payment fund
• 501(c)(23)  Veterans’ organization (created before 1880)
• 501(c)(25)  Title holding corporations or trusts with multiple parent corporations
• 501(c)(26)   State-sponsored organization providing health coverage for high-risk individuals
• 501(c)(27)   State-sponsored workers’ compensation reinsurance organization
• 501(c)(28) National railroad retirement investment trust
• 501(c)(29) CO-OP health insurance issuers

Some of these classifications allow tax-deductible donations, and others don’t. If this information hasn’t taken the confusion out of 501(c), a tax attorney can shed some light on the particulars.

Of course, it’s up to your nonprofit’s board to ensure that your organization is registered properly with the IRS and to file your Form 990 in a timely manner. There’s no better place to store your 501(c)(3) documents and meeting minutes than BoardEffect’s board management system. With a secure platform and granular permission, BoardEffect takes the mystery out of which digital tools your board needs to manage your board activities responsibly.