Forming a 501(c)(3) Nonprofit: Tax Benefits You Should Know 

Forming a 501(c)(3) nonprofit opens doors for organizations dedicated to charitable, educational, or religious goals to enhance their impact through significant tax benefits. With this designation, nonprofits can access a variety of advantages designed to strengthen their financial resources, helping them allocate more funding toward the causes they serve. 

Understanding these benefits is important for anyone considering forming a 501(c)(3) nonprofit corporation, as they can help improve your organization’s financial stability and growth potential. This blog explores the tax advantages available to 501(c)(3) nonprofits and how they can support your organization’s long-term goals.

Understanding Federal Exemption

A 501(c)(3) designation grants nonprofits exemption from federal income taxes, meaning the organization can redirect funds that would have gone toward taxes back into its programs and initiatives. This tax-exempt status applies to income directly related to the organization’s

mission, allowing more financial resources to be devoted to charitable, educational, or religious activities rather than tax liabilities. 

This benefit is especially significant for nonprofit organizations, as it supports your ability to grow and enhance services. Say your nonprofit is dedicated to providing after-school educational programs for underserved youth. 501(c)(3) status exempts your organization from paying federal income taxes on the donations and grants it receives, as well as any program fees collected that directly support its mission. 

Instead of allocating these funds toward tax payments, you can use those resources to expand organizational reach—hiring more educators, developing new curricula, and offering additional resources to students. That’s the power of tax-exempt status. 

Understanding State Tax Benefits 

In addition to federal tax exemptions, 501(c)(3) nonprofits may qualify for a range of state tax benefits, including exemptions from sales tax, property tax, and, in some states, income tax. These exemptions vary by state but can significantly reduce operational costs, allowing organizations to dedicate even more resources to their mission. For instance, many states offer sales tax exemptions on purchases directly related to a nonprofit’s activities, while property tax exemptions may apply to facilities used exclusively for nonprofit purposes. 

Each state has different requirements and procedures for tax exemptions. Some states may require separate applications for state and tax credits and exemptions, while others may automatically grant these benefits upon approval of your federal tax-exempt status. Additionally, understanding state taxes and their implications can help your charitable organization make informed decisions about financial transactions. 

Consulting a lawyer is often beneficial when navigating these state-level exemptions, as they can guide your nonprofit organization through the necessary steps to secure applicable tax benefits while ensuring adherence to relevant legal requirements. 

Donation Deductibility 

As mentioned earlier, giving individuals and businesses the ability to make tax-deductible contributions to your organization is one of the major advantages of forming a 501(c)(3) nonprofit. This deductibility not only incentivizes donations but also allows donors to reduce their

taxable income by contributing to a cause they support. As a result, nonprofits with 501(c)(3) status often see increased donor interest and larger contributions, as supporters are more inclined to give when they can benefit from a tax deduction. 

For donors, the prospect of reducing their tax bill through charitable giving creates a compelling incentive to help your nonprofit. When potential donors know their contributions are tax-deductible, they can be more inclined to give, especially more significant amounts. This status can also help foster long-term donor relationships, as individuals and businesses who pay income tax themselves are more likely to support organizations that provide them with financial benefits through tax deductions. 

Access to Grants and Public Funding 

Another significant benefit of forming a 501(c)(3) nonprofit is opening access to various grants and public funding sources only available to tax-exempt organizations. Many government agencies, foundations, and private organizations restrict their grants to entities with 501(c)(3) status, making this designation absolutely essential for nonprofits seeking substantial funding sources. 

The ability to secure grant funding can have a substantial impact on the sustainability of your organization. Many foundations and government agencies prioritize funding for nonprofits that operate under this tax-exempt status. By forming a 501(c)(3), you open doors to funding opportunities to help you expand your programs and reach more people and communities in need. 

For example, a 501(c)(3) nonprofit focused on providing mental health resources to underserved communities can apply for federal grants through agencies like the Substance Abuse and Mental Health Services Administration (SAMHSA), as well as state-level and private foundation grants geared toward mental health and community wellness. 

This access to targeted grant funding can enable the organization to secure substantial financial support to expand its services, such as hiring licensed therapists, developing community workshops, and providing free counseling sessions. With each grant secured, the organization can broaden its reach, enhance its services, and sustain its efforts over the long term. 

Less Competition and a Larger Network 

Additionally, 501(c)(3) nonprofits often benefit from lower competition when applying for grants. Many grantors focus exclusively on funding tax-exempt organizations, creating a unique landscape where your nonprofit can thrive. As a tax-exempt organization, you can tap into a network of foundations and organizations supporting causes aligned with your mission. 

Being part of this network can provide additional resources, connections, and opportunities to enhance your organization’s reach and impact. For instance, the benefit for the mental health advocacy group described above is opportunities to establish connections with other like-minded agencies, increasing the likelihood of collaboration and joint funding efforts, which amplifies its impact on the communities it serves. 

Avoiding Unrelated Business Income Tax (UBIT) 

Under the Internal Revenue Code, Unrelated Business Income Tax (UBIT) applies to income generated from activities not substantially related to your organization’s tax-exempt purpose. If your nonprofit generates income through activities that don’t directly support your charitable mission—such as operating a gift shop, providing services to the general public, or conducting fundraising events not directly tied to your charitable activities—you may be subject to UBIT. 

The key to avoiding UBIT is understanding the nature of your nonprofit’s activities. Activities regularly carried out and generating income could be classified as unrelated business income. However, revenue from activities substantially related to your nonprofit’s purpose, such as fundraising events directly supporting your cause, typically doesn’t incur UBIT. 

For example, suppose your nonprofit animal rescue organization sells branded merchandise, such as T-shirts and mugs, to raise funds for shelter maintenance. These branded items directly support your organization’s mission and might not be subject to UBIT. 

However, if you decide to expand the merchandise you sell to include other items, like generic sports gear or decor, that income could be considered unrelated business income and thus subject to UBIT. In that case, you may be required to pay taxes on that income, which can diminish your resources for mission-related activities and negatively impact your nonprofit’s ability to fulfill its charitable mission. 

Strategic Planning to Mitigate UBIT 

To stay compliant with UBIT regulations and properly report unrelated business income, it’s advisable to consult a nonprofit lawyer or tax professional with experience in nonprofit tax law. They can guide you in understanding how UBIT may affect your organization and help you navigate the complexities of the Internal Revenue Code. Here are a few approaches a nonprofit lawyer can help your organization with to minimize its unrelated business income: 

• Align Activities with Your Mission: Ensure that your nonprofit’s primary activities directly support your charitable goals. For example, if your nonprofit is focused on education, activities related to providing educational services or resources to the community are more likely to align with your exempt purpose. 
• Separate Unrelated Activities: If your organization generates income through activities that could be classified as unrelated, consider structuring these activities as individual entities or departments within your nonprofit. This separation can help clarify which activities are tax-exempt and which are subject to UBIT.
• Limit Frequency of Unrelated Activities: The Internal Revenue Service (IRS) looks at how frequently your organization conducts an unrelated activity. If it’s considered a sporadic occurrence rather than a regular operation, it may not trigger UBIT. 

Legacy Giving and Estate Tax Benefits 

Legacy giving is a strategic way for 501(c)(3) nonprofits to build long-term sustainability, and create financial stability that empowers the organization to plan ahead, grow, and adapt to future needs while remaining dedicated to its mission. Your organization can receive legacy gifts or bequests that are exempt from estate taxes, offering a valuable incentive for donors interested in leaving a lasting impact. 

When individuals include a nonprofit in their estate planning, the value of these gifts can be transferred tax-free, allowing the entire contribution to support the organization’s mission without estate tax deductions. Establishing endowments or planned giving programs can further encourage legacy giving by providing structured options for donors who wish to make a lasting commitment. 

Many individuals prefer to leave charitable contributions in their wills, and by facilitating this process, you can build a stable source of funding for charitable organizations into the future. These programs allow donors to support your organization’s work far into the future, and the funds generated from endowments can provide a steady income stream over time. 

How Chisholm Law Can Help Your 501(c)(3) Maximize Tax Benefits 

Chisholm Law Firm can empower your 501(c)(3) to take full advantage of the tax benefits available to your organization. Our firm is focused on helping nonprofits navigate the complexities of tax-exempt regulations, ensuring your org is structured to maximize tax savings and maintain compliance with IRS and state requirements. 

We can help you complete IRS Form 1023 to apply for 501(c)(3) status, making sure the information about your organization’s mission, planned activities, and governance structure meet requirements – increasing the chances of approval the first time. 

Our team can also help you navigate the state tax benefits your organization may be entitled to as a registered nonprofit, get and stay compliant with IRS regulations, and even regain your tax-exempt status if it is revoked. We are here to support your organization’s financial health and mission. 

Claim Your Full Tax Benefits with Chisholm Law 

Forming a 501(c)(3) nonprofit brings substantial tax benefits – from federal and state tax exemptions to the ability to offer tax-deductible donations and access exclusive grants. Each of these advantages can play an important role in strengthening your organization’s financial foundation, enabling you to direct more resources toward your mission and long-term goals. 

Understanding and leveraging these tax benefits is essential for maximizing the financial health and sustainability of your nonprofit. Chisholm Law is here to guide you through each step, ensuring your organization is structured to take full advantage of its tax-exempt status. Set up a free consultation with our team today to receive guidance on forming your 501(c)(3) and optimizing the tax benefits available to your organization. 

*Past results do not determine future outcomes