A nonprofit organization organized and operated for charitable purposes may be exempt under Section 501(c)(3) of the Internal Revenue Code while a nonprofit organized and operated to promote the common business interest of its members and not to engage in regular business activities ordinarily carried on for profit may be exempt under Section 501(c)(6) of the Code.
While 501(c)(3) organizations and 501(c)(6) organizations appear to have completely different purposes, there are many organizations that operate to advance both types of purposes. For example, a medical association might look to promote public health policy and provide educational materials and programs for its members and the general public. At the same time, it might provide business tips and host networking events principally for the benefit of its members. If these were the planned activities of a startup, what would be the appropriate tax-exemption classification for this association?
This determination is specific to each organization, but there are several key considerations. The first consideration is whether the organization is contemplated to primarily benefit its members who share a common business interest or a broader segment of the general public. If the former, a 501(c)(6) organization would be the appropriate choice between the two. If there is uncertainty about this issue, other considerations flow out of the following:
Both 501(c)(3) and 501(c)(6) organizations are tax-exempt from federal income taxes on the income raised or earned related to their exempt purposes. Generally, a startup nonprofit (other than a church) must apply for exemption under 501(c)(3) by filing Form 1023 or Form 1023-EZ with the IRS. In contrast, a nonprofit may either (1) apply for formal IRS recognition of exemption under 501(c)(6) by filing Form 1024 or (2) self-declare itself as exempt under 501(c)(6).
The exempt purposes under 501(c)(3) are: religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals. We’ve previously written on what constitutes “charitable” under 501(c)(3) here (starting a nonprofit), here (environmental), here (economic development), and here (arts). Regarding the operational test that every 501(c)(3) organization must pass, the regulations provide:
An organization will be regarded as operated exclusively for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.
The exempt purpose for the 501(c)(6) is to promote the common business of its members. The regulations provide:
A [501(c)(6)] business league is an association of persons having some common business interest, the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. It is an organization of the same general class as a chamber of commerce or board of trade. Thus, its activities should be directed to the improvement of business conditions of one or more lines of business as distinguished from the performance of particular services for individual persons.
It’s important to note that a 501(c)(3) organization is expressly prohibited from engaging in more than an insubstantial amount of activities not in furtherance of its exempt purpose. On the other hand, a 501(c)(6) organization may engage in more than an insubstantial amount of activities not in furtherance of its exempt purpose so long as it is primarily engaged in activities that further its exempt purpose.
Fundraising and the Deductibility of Contributions/Dues
Most 501(c)(3) organizations are eligible to receive deductible charitable contributions. However, the actual provision of the Code that provides for the deductibility of contributions is found in Section 170(c), which includes:
(2) A corporation, trust, or community chest, fund, or foundation—
(A) created or organized in the United States or in any possession thereof, or under the law of the United States, any State, the District of Columbia, or any possession of the United States;
(B) organized and operated exclusively for religious, charitable, scientific, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals;
(C) no part of the net earnings of which inures to the benefit of any private shareholder or individual; and
(D) which is not disqualified for tax exemption under section 501(c)(3) by reason of attempting to influence legislation, and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.
The principal differences between Section 170(c)(2) and 501(c)(3) is the requirement in the former that the entity be created or organized in the United States and the absence in the former of a “testing for public safety” purpose. Accordingly, a taxpayer could not take a charitable contribution deduction for a gift to a foreign 501(c)(3) organization or a domestic 501(c)(3) organization whose exempt purpose is testing for public safety.
It’s also important to note that a contribution to a 501(c)(3) organization also described in 170(c)(2) will not be deductible if earmarked for lobbying.
Payments of dues to 501(c)(6) organizations may be deductible to a member as an ordinary and necessary business expense in the conduct of the member’s business. However, contributions to 501(c)(6) organizations are not deductible as charitable contributions. Moreover, a 501(c)(6) organization must disclose, in any fundraising solicitation, that contributions to the organization are not deductible for federal income tax purposes as charitable contributions. The disclosure must be expressed in a conspicuous and easily recognizable format.
501(c)(3) public charities may engage in lobbying so long as such activities are insubstantial in relation to their overall activities. Despite such restriction, public charities may engage in generous levels of lobbying without it being considered substantial if they make the 501(h) election. 501(c)(3) private foundations are generally not permitted to engage in lobbying but may fund grantees with general support that the grantees decide to use for lobbying. 501(c)(3) organizations often discount their ability to engage in substantial permissible advocacy-related activities, including issue advocacy, get-out-the-vote drives, and voter registration. We believe advocacy is often a critical tool that boards must consider as a potential way to most effectively and efficiently advance their organization’s mission.
501(c)(6) organizations may engage in unlimited lobbying in furtherance of their exempt purposes. See Lobbying Activities – Business Leagues. However, a 501(c)(6) organization that engages in lobbying (and certain political activities) may be required to either:
- notify its members about the percentage of dues that are used for lobbying (and certain political activities) that are consequently nondeductible; or
- pay a proxy tax.
Lobbying for the lobby tax purposes described above is defined differently from lobbying for 501(h)-electing public charities. For example, for lobby tax purposes, lobbying expenditures do not include expenditures for influencing local legislation and do include expenditures for any direct communication with a covered executive branch official in an attempt to influence the official actions or positions of such official.
Both 501(c)(3) and 501(c)(6) organizations must also comply with non-tax-related laws governing lobbying and political activities. These may include complying with registration and periodic reporting requirements.
Political Campaign Intervention
501(c)(3) organizations are prohibited from engaging in any political campaign intervention activities.
501(c)(6) organizations may engage in political campaign intervention activities so long as such activities do not represent their primary activity. Interpreting the limitation with a high risk tolerance, some 501(c)(6) organizations spend 49% of their resources on electioneering.
IRS Revenue Rulings on the Difference
IRS Rev. Rul. 71-504 (city medical association)
IRS Rev. Rul. 71-505 (city bar association)