Rules for 501(c)3 Corporations

by John Landers

Individuals seeking to set up or run nonprofit organizations must follow the rules for 501(c)3 corporations to protect their tax-exempt status; "501(c) 3" refers to the Internal Revenue Service code governing the operation of nonprofits. The services these organizations provide include assisting with natural calamities, providing housing assistance to homeless people, protecting human rights and working to improve neighborhoods. The IRS code defines 27 types of organizations, including: business associations; fraternal organizations; social and recreation clubs; religious organizations; holding companies for pensions; and mutual insurance companies. An estimated 1.9 million 501(c)3 corporations are registered in the United States, according to 2008 statistics. This figure does not include religious establishments.

Significance

Tax-exempt organizations exist in nearly every state; they are actively engaged in a wide variety of purposes. Most nonprofits choose the corporate structure because it protects the directors, officers and members from incurring personal liability for debts and other obligations of the organization. In addition, the majority of government and private grants are given to nonprofit corporations. Because corporations must follow the laws for procedural conduct in the state of establishment, incorporating eliminates the need for nonprofits to formulate most organizational procedures.

Compensation

One of the primary rules for 501(c)3 corporations disallows the distribution of profits or dividends to its officers, directors or members. The law permits officers and staff to earn a fair and reasonable salary. Nonprofits that allot more than $50,000 to compensate staff for salaries and expenses must reveal that information to the IRS. Some states also have a similar requirement. Directors can receive payment for the costs they incur and the time spent at meetings. Nonprofits must protect their tax-exempt status with strong oversight by the directors to steer away from self-dealing or personal financial gain from business transactions.

Defined Purpose

The rules for 501(c)3 corporations mandate that only the functions listed under the IRS code can be undertaken, including scientific, charitable and religious endeavors. Organizations are required to declare a clearly defined purpose; their objective cannot be to the benefit a particular individual or small faction. It is advantageous for 501(c)3 corporations to clearly state their purpose in the bylaws. They also should document the procedures and internal safeguards in place to protect against the appearance of personal enrichment, the questionable use of assets and excessive compensation to members or directors.

Lobbying Restrictions

Lobbying for legislation is not permitted by nonprofit corporations. Lobbying is typically defined as contacting legislators or working to sway public attitude on political or legislative concerns. Nonprofit organizations can implement two tests to determine if their actions constitute undue influence of public opinion: the substantial-part test and the expenditures test. The substantial-part test states that 15 percent or less of an organization's spending can be used for lobbying purposes. The expenditures test, which uses a complicated formula to calculate the percentage of spending that can be used for lobbying efforts, requires detailed records.

Record Keeping

Records of nonprofits can be subject to intense public scrutiny. Detailed studies of the financial dealings of nonprofits are common. The salaries, tax returns, expenditures, sources of revenue, and day-to-day dealings can be investigated and analyze. Nonprofits must adhere to the rules for 501(c)3 corporations for record-keeping, especially when recording and classifying financial transactions. As of 2009, nonprofits that took in more than $25,000 of income were required to submit an annual statement to the Internal Revenue Service. They also may be responsible for paying taxes on trade or commercial business transactions unrelated to the "defined purpose" that exceed $1,000. As with for-profit companies, 501(c)3 corporations are subject to employment taxes.

About the Author

John Landers has a bachelor's degree in business administration. He worked several years as a senior manager in the housing industry before pursuing his passion to become a writer. He has researched and written articles on a wide variety of interesting subjects for an array of clients. He loves penning pieces on subjects related to business, health, law and technology.

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