Not-For-Profit, 501(c)3 Tax-Exempt Status: An Overview

What does it mean to be “not-for-profit”?

Becoming a not-for-profit organization is a form of incorporation. Organizations that incorporate as not-for-profits exist for the public good rather than for the financial benefit of an individual (an owner) or stockholders. The law does not prohibit a not-for-profit from making a profit; however, all profits must be funneled back into the management or programming of the organization.

The actual process of incorporation varies from state to state and takes some time because it requires approval from certain state agencies. It is a good idea to receive legal advice when considering any issues of incorporation. If you do not have the benefit of pro bono legal counsel from a friend or colleague, you may want to contact your state’s branch of Volunteer Lawyers for the Arts (a list of VLA branches is available through CLMP).

What does it mean to be “tax-exempt”?

Tax-exempt status does not, as many people believe, automatically follow from incorporating as “not-for-profit.” Not all not-for-profits file for tax-exempt status, and the IRS is not required to grant that status to every organization that applies.

Being tax-exempt is commonly known as having 501(c)3 status because that is the section of the tax code which grants tax exemption to literary and arts organizations. However, the internal revenue code has many classifications for not-for-profits; 501(c)3 is only one of many categories exempt from paying taxes. The rules for organizations exempt under 501(c)3 are more strict than those governing other not-for-profits because organizations that receive this status have the added benefit of being eligible to receive tax deductible contributions.

The primary requirement for receiving 501(c)3 status is that an organization be both organized and operated towards the pursuit of certain educational or charitable objectives that benefit the public as spelled out in section 501(c)3. This requirement of "organized and operated" is examined by looking at whether an organization's articles of incorporation address one or more of the objectives supported by the 501(c)3 code and whether the organization's activities support that purpose. 501(c)3 organizations have the option of being classified as either public charities or private foundations, depending upon their primary sources of financial support. When applying for 501(c)3 status, it is important to understand the differences between the two categories to avoid being classified as a private foundation in error.

What are the advantages of becoming not-for-profit, tax-exempt?

• Individuals and organizations may make tax-deductible contributions directly to your organization;
• Your organization becomes eligible to apply directly for grant support from federal, state and local arts agencies as well as private foundations;
• You will be eligible to use not-for-profit postal rates (which are lower than regular rates).
  

What are the disadvantages?

• You must keep detailed financial records;
• Not-for-profit status requires that your board of directors (the legal custodian of the organization) hold annual meetings and take official minutes;
• You will not be able to deduct business related expenses from your personal taxes;
• The process may cost more effort/time/money than it is worth. A careful evaluation of your organization’s needs and objectives is recommended before undergoing this process. Talk with publishers who are both not-for-profit and those who are for-profit; ask them why they made the choices they did.

If I decide that this is right for my organization, how do I go about obtaining this status?

Not-for-profit incorporation: Write to the Secretary of State in your state capital for specific procedures. The degree of complexity and cost of incorporating varies from state to state.

Tax-exempt status: You must be incorporated as a not-for-profit organization before applying to the IRS for 501(c)3 status. Your application will be made by using IRS Form 1023. It may then take as long as 3-6 months for a ruling on your organization’s application. If you are granted federal tax-exempt status, most (but not all) state and local governments will automatically grant you tax-exempt status, although filing additional forms may be necessary.

Due to the legal complexities of incorporating an organization and the stringent requirements required to receive tax-exempt status, legal counsel is advisable.

Additional resources

Volunteer Lawyers for the Arts (VLA) is an excellent source of information on this topic. The national VLA publishes a directory that lists the various state programs across the country; their general number is 212-319-ARTS. Another good source is the ART LAW LINE (212) 319-2910, which is staffed by law student interns trained to answer arts related legal questions. In addition, the national VLA holds frequent seminars on not-for-profit incorporation, tax exemption and possible alternatives.

Useful publications include

• Pressing Business: An Organizational Manual for Independent Publishers (VLA, 1984);
• Getting Organized: A Not-for-Profit Manual (Lawyers Alliance of New York, 1993);
• How to Form a Nonprofit Corporation (Nolo Press, 1994);
• Managing Nonprofit Organizations in the 21st Century (ORYX Press, 1992);
• What a Difference Understanding Makes: Guides to Nonprofit Management— Classifying 501(c)3 Nonprofits (Accountants for the Public Interest, 1994);
• IRS Publication 557: Tax-Exempt Status for Your Organization.