What 501(c)(3) Status Means for You as a Board Member

This guide explains what 501(c)(3) status is, what it gives your organization, what it asks in return, and looks at your duties as a board member. It assumes your organization is already incorporated and has 501(c)(3) status.

What 501(c)(3) status is, and what it gives you

Section 501(c)(3) is a section of the Internal Revenue Code that exempts certain organizations from federal income tax. The IRS grants 501(c)(3) status to organizations that are organized and operated exclusively for purposes such as charitable, religious, educational, scientific, or literary work.

The status has two main benefits:

• Federal income tax exemption. The organization generally does not pay federal income tax on income related to its mission.
• Tax-deductible contributions. Donors can deduct gifts to the organization on their own tax returns, a major reason donors give.

Many funders, including foundations and government grant programs, will require recognized 501(c)(3) status before they will award money. The exemption is a privilege conditioned on how the organization behaves, not a permanent label.

Federal status, state law: who does what

501(c)(3) is federal, so the same tax rules apply in every state. However, a non-profit is created under state law by filing articles of incorporation with the state, therefore law sets the rules for board duties, meetings, voting, and officers. 

Several ongoing obligations are also set at the state level:

• State tax exemption. Federal exemption does not automatically cover state income, sales, or property tax. Most states require their own application.
• Charitable solicitation registration. Most states require charities to register before asking residents for donations, including online.
• Annual state filings. These often include a report to the Secretary of State and a copy of the Form 990 for the state charity regulator.
• Attorney general oversight. The state attorney general typically has authority over charitable assets and can investigate mismanagement.

Requirements differ by state and change over time, so confirm current rules with your state's regulator or a non-profit attorney.

What the status asks in return

Tax exemption comes with limits on how the organization operates. Five matter most to a board.

1. Serve a public purpose. The organization must operate for charitable or other exempt purposes, not for the benefit of private interests.
2. No private inurement. None of the organization's net earnings may benefit insiders such as directors, officers, or founders. Compensation must be reasonable, and payments above fair value to an insider can trigger penalties.
3. Limited lobbying. A 501(c)(3) may attempt to influence legislation only as an insubstantial part of its activities. 
4. No political campaign activity. A 501(c)(3) may not support or oppose candidates for public office. This is an absolute prohibition, and it applies to the organization's official communications and spending.
5. Tax on unrelated business income. Income from regularly carried-on activities unrelated to the mission may be taxable, even though the organization is exempt.

The IRS can revoke exemption for serious or repeated violations, and some violations lead to excise taxes on the organization or on the individuals involved.

Ongoing obligations

Most 501(c)(3) organizations must file a Form 990 series (annual information) return with the IRS each year. The version depends on the organization's size. Very small organizations may file a simplified electronic notice instead.

An organization that fails to file for three consecutive years loses its tax-exempt status automatically. Reinstating it takes work, so a missed filing is one of the most avoidable ways to lose exemption.

Beyond the 990, the board should make sure the organization:

• Files required state reports and keeps its state registrations current.
• Keeps accurate financial records and board minutes.
• Sends written acknowledgments to donors for qualifying gifts, which the IRS requires for larger contributions.
• Makes its exemption application and recent returns available for public inspection when requested.

The Form 990 is public, so donors, funders, and journalists can read it. Board members should review it before it is filed.

Your role as a board member

The board is ultimately responsible for making sure the organization follows the rules that keep its status. In practice, this comes down to a few habits.

• Know the three fiduciary duties
• Duty of care - making informed decisions. 
• Duty of loyalty - putting the organization ahead of personal interests. 
• Duty of obedience - keeping the organization faithful to its mission and the law.
• Have a conflict of interest policy
  Directors should disclose conflicts each year and step out of decisions where they have one.
• Set executive pay carefully
  Review comparable data, have unconflicted directors approve the decision, and record the reasoning in the minutes.
• Review the Form 990 before filing
  The return describes the organization's governance practices, and the board answers for what it says.
• Document decisions
  Minutes, approvals, and policy adoptions are your evidence that the board did its job if the IRS or the state attorney general ever asks.

A director who acts in good faith and follows these practices is better protected than one who cannot show what the board did.

Common ways status is put at risk

Most problems come from ordinary oversights. Watch for these:

• Missing the Form 990 deadline, especially for three years running.
• Paying an insider more than fair market value, or buying from or renting to one on generous terms.
• Endorsing or contributing to a political candidate, including through social media posts.
• Spending heavily on lobbying without tracking it.
• Letting the organization drift from the mission stated in its founding documents.
• Failing to register for fundraising in states where the organization solicits.
• Keeping no record of board decisions.

Learn more

The IRS's Charities and Non-Profits pages, cover exemption requirements, filing rules, and guidance for board members. For state rules, the National Association of State Charity Officials lists state charity regulators.

Keeping the evidence of good governance in one place makes all the above items easier. A board portal such as BoardCloud can hold your minutes, approvals, and standing documents together, so new directors can find them and the board can show what it decided and when.

This guide is general information, not legal or tax advice. For decisions about your organization's status, consult a non-profit attorney or CPA.