Just as there are countless variations of for-profit organizations, there are a few — three, to be exact — main categories of nonprofit corporations. Under these three categories fall the more-familiar subcategories:

• The public benefit corporation includes the generally understood charitable organizations and social welfare organizations such as those with a 501(c)(3) or 501(c)(4) classification.

• The mutual benefit corporation, which is not public, might include such groups as homeowner's associations and private foundations.

• The great “other,” which includes fraternal societies, labor organizations, farm bureaus, social clubs, veteran's organizations, cemetery companies, credit unions, and the many other organizations listed under the 501(c) code of the Internal Revenue Service.

The Difference Between a 501(c)(3) and a 501(c)(4) Organization

If you are directly involved in the incorporation process or work on an organization's application for federal nonprofit status, it's important to understand how the two primary types of nonprofits — 501(c)(3)s and 501(c)(4)s — are similar and how they are different.

The Similarities

There are a few basic elements that apply to both types of organizations. Both are exempt from paying federal income tax, must be operated as nonprofits, and are restricted from allowing any individual or shareholder to benefit financially from the work of the organization. In fact, because those particular rules are so similar, any organization that qualifies for 501(c)(3) status also qualifies for 501(c)(4) status.

The Differences

First of all, a 501(c)(4) is defined by the IRS as meeting three criteria:

1. The group must be a civic league or organization not organized for profit but operated exclusively for the promotion of social welfare.

2. The group is a local association of employees, the membership of which is limited to the employees of a designated person or persons in a particular municipality.

3. The net earnings of the group are devoted exclusively to charitable, educational, or recreational purposes.

You'll note some immediate similarities to the requirements for the 501(c)(3) status — in particular that the group is, in fact, operating as a not-for-profit. The big differences involve what types of activities the groups plan to undertake, with particular focus on political activities.

Whereas a 501(c)(3) is not permitted to advocate for a political candidate or ballot initiative, a 501(c)(4) may do so all it wants, as long as the activities fall within its primary purpose. The tradeoff is that contributions to a 501(c)(4) are deductible only if the organization is a government agency or is involved in public service. Otherwise, contributions may not be deducted from the personal income tax of the contributor.

If you meet all the other requirements pertaining to both classifications, are not planning to be directly involved in political campaigns, will not be lobbying to a large degree (further discussed in Chapter 3 under the 20 percent rule), and plan to solicit tax-deductible donations, consider applying for the 501(c)(3) status.

If, on the other hand, you meet all the other requirements pertaining to both classifications but do plan on being actively involved in political campaigns, conduct extensive lobbying, and understand that your contributors will generally not be able to deduct those contributions, then consider the 501(c)(4). Some groups have actually formed two separate tax-exempt organizations — a 501(c)(3) and a 501(c)(4), allowing one part of their organization (the c-3) to fully comply with the lobbying and campaigning restrictions and focus solely on the educational component, while the other (the c-4) conducts political outreach and activities.

The Federal Nonprofit Categories

Each of the categories in the following table has very precise rules governing how funds may be collected, whether contributors may also claim tax deductions for their donations, who may or may not participate in the organization, how money may be spent, and exactly what kinds of reporting are required to maintain their nonprofit status. Some of the classifications are more entertaining than practical for the vast majority of people planning to form a nonprofit corporation and apply for a 501(c)(3). View them solely as a reference point in your planning.

TYPES OF NONPROFIT ORGANIZATIONS

Needless to say, it is unlikely that most organizers planning to form a 501(c)(3) or 501(c)(4) nonprofit will need all the information in this table. However, there may be situations where it may be advantageous to apply for another determination in addition to your primary classification.

As your organization grows to maturity and everyone involved becomes comfortable with the opportunities and the limitations of your tax-exempt status — or if you find your operations are expanding beyond your original mission — seeking other exemptions, or perhaps forming another completely unique organization, may be advisable.