A nonprofit organization can be classified as a tax-exempt entity under section 501(c)(3) or 501(c)(4) of the Internal Revenue Code. An organization is classified based primarily upon who supports the organization and who benefits from its work. The section under which the nonprofit qualifies for its exemption also determines any ancillary benefits it may enjoy that go beyond not having to pay federal income taxes.
Nonprofits are classified as either a 501(c)(3) or 501(c)(4) organization based upon how the organization is supported and who benefits from the organization's activities. Both are operated for nonprofit purposes, but a 501(c)(3) is a publicly-supported charity that benefits society at-large, while a 501(c)(4) is a membership-based organization or association that is primarily supported by dues and conducts activities that primarily benefit the members, such as a civic league.
A major difference between 501(c)(3) and 501(c)(4) organizations is the authority to engage in lobbying and other political activity. A 501(c)(4) can endorse or oppose political candidates, donate money, work on campaigns and engage in unlimited lobbying, as long as it relates to its mission. Conversely, a 501(c)(3) is not allowed to engage in political activity. It can only do a limited amount of issue-based lobbying, as long as it notifies the IRS and as long as the lobbying expenditure does not exceed a certain percentage of the nonprofit's budget.
One of the major functional differences between 501(c)(3) and 501(c)(4) organizations is the treatment of donations. Donations to a 501(c)(3) organization are tax-deductible as charitable contributions to the person or entity making the donation. Conversely, contributions made to 501(c)(4) organizations are not tax-deductible. This is because the activities of a 501(c)(4) primarily benefit its members, rather than society as a whole. Contributions to a 501(c)(4) may be tax-deductible as business expenses, however.
Nonprofits prefer classification as section 501(c)(3) organizations when they derive most of their revenue from individual donations and institutional grants that require tax-deductibility as a prerequisite for making the contribution. Organizations that can attract money without the enticement of tax-deductibility and may need the ability to engage in unlimited political activity will prefer classification under 501(c)(4). Examples of groups that prefer 501(c)(4) classification are unions and fraternal organizations.
- NJ.com; The Difference Between 501(c)(3) and 501(c)(4) Organizations; Lawrence Kopp; July 2008
- IRS Publication 557: Tax-Exempt Status for Your Organization
- IRS.gov: Donations to Section 501(c)(4) Organizations
- IRS.gov: Types of Organizations Exempt under Section 501(c)(4)
- Texas C-Bar: The Basics of 501(c)(3), 501(c)(4), and 501(c)(6) Tax-Exempt Status
- Citizen Media Law Project: Application for 501(c)(3) Tax Exemption