The Difference Between a Nonprofit Corporation & a 501(c)(3)

A nonprofit corporation is a state entity that does not automatically come with a federal tax exemption. A nonprofit corporation that has been given 501c3 status by the Internal Revenue Service is not only tax exempt, but it also allows donors to write off donations. Not every nonprofit organization needs to apply for federal tax-exempt status.

The first step in becoming a nonprofit organization begins with a state registration as a nonprofit corporation. The entity can make a profit, but all of its profits must be put back into the corporation; no members may take profits from the organization. Individuals can be paid a salary, wages or contract fees, but they may not take profits the entity earns.

Each state has its own requirements for nonprofit corporation status, and you can find the rules for your state by visiting the website of your Secretary of State. The process is usually simple, requiring paperwork you can file online and a small fee, often less than $100. State nonprofit incorporation does not come with federal tax-exempt status, but the organization can apply for and receive some tax relief at the state level, such as sales or income tax. Some state nonprofit organizations never apply for federal tax-exempt status.

An organization might want to become a state nonprofit corporation to avoid paying certain state taxes, never opting to become a federal tax-exempt organization. Once a nonprofit has incorporated, it can file for federal tax-exempt status with the Internal Revenue Service, or within its state. The IRS will review the application and determine what type of organization the entity is. The 28 different classifications include such categories as charity, trade, research, civic and religious associations.

A 501c3 is considered a charity, and the IRS allows donors to take a tax deduction for contributions of goods, cash and other assets. A 501c6 organization is a business entity that doesn’t necessarily seek to promote the public good but rather the interests of a select group of business people. Donations to 501c6 organizations are not tax deductible, which is why many trade associations set up 501c3 foundations. These related foundations solicit funds for scholarships, research or education.

Either type of organization can make a profit from its operations, but if the entity consistently makes a significant annual profit, the IRS might remove its tax-exempt status. For this reason, tax-exempt organizations try to operate at or near a break-even basis. If you join a trade association, your membership dues might not be tax deductible unless you itemize your business expenses and declare your dues as an expense, not a donation.

Federal, tax-exempt organizations file an annual financial return to the IRS called a Form 990, which is available to the public each year. This document lists the organization’s board of directors, key employees, income, expenses, assets, mission and major activities. You can download a free copy of many tax-exempt organizations’ Form 990 at websites such as GuideStar.org and FoundationCenter.org.