What's in a Name? Nonprofit vs. Charity
A common source of confusion in both the United States and other countries is the difference between a nonprofit organization and a charitable organization. While these terms are sometimes used interchangeably, they have different meanings under U.S. tax law. Generally, nonprofit status is a concept of state corporate law, and charity status — or what is charitable — is a concept of federal tax law.
What Is Nonprofit: It Depends on the State
Whether an organization is nonprofit is usually determined at the time the organization is formed. By forming a nonprofit organization, the organization's founders agree to operate for a purpose other than making a profit. A nonprofit organization may be created as a corporation, a trust, or an unincorporated association (and in some cases, an LLC or other state-specific form). Any of these entities, even while nonprofit, may or may not qualify as charitable at the federal level. Therefore, in the U.S., charities must first be organized as an entity at the state level before they can apply to be recognized as tax-exempt charities at the federal level.
Here are a few examples of nonprofit organizations that are not charitable (or at least not exclusively charitable).
• Civic leagues (like the Junior League)
• Social welfare organizations (like AARP or local chambers of commerce)
• Homeowners associations
• Labor unions
• Trade associations (like the American Bar Association or the Recording Industry Association of America)
• Social clubs (like fraternities, sororities, and country clubs)
What Is Charitable: a Federal Concept
Charitability is a tricky concept! At the federal level, Treasury regulations define "charitable" to include
Relief of the poor and distressed or of the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening of the burdens of government; and promotion of social welfare by organizations designed to accomplish any of the above purposes, or (i) to lessen neighborhood tensions; (ii) to eliminate prejudice and discrimination; (iii) to defend human and civil rights secured by law; or (iv) to combat community deterioration and juvenile delinquency.
Luckily, there are numerous U.S. court decisions and Internal Revenue Service rulings that have expounded on the meaning of charity within these broad guidelines. At NGOsource, we are also happy to discuss the parameters of charitability with grantmakers and NGOs.
Internal Revenue Code Section 501(c)(3)
Recognition under Internal Revenue Code section 501(c)(3) is typically the most desirable federal classification for a U.S.-based nonprofit organization. The reason is that 501(c)(3) charities are exempt from federal income tax and are able to receive tax-deductible contributions from donors. (THIS RULE IS NOT APPLICABLE FOR EQUIVALENCY DETERMINATIONS.) While other kinds of nonprofit organizations (like the ones mentioned above) may be granted tax exemption, only charitable organizations, described under section 501(c)(3), are eligible to receive tax-deductible donations.
For a nonprofit organization in the U.S. to be recognized as a charity under section 501(c)(3), it must be "organized and operated exclusively for charitable purposes”; it must not be organized or operated for the benefit of private interests; and no part of its net earnings may benefit private parties. In addition, it is restricted in how much political and legislative lobbying activities it may conduct. Thus, recognition as a 501(c)(3) charitable organization entails much more than simply operating on a “not-for-profit” basis.
Other terms often used to describe domestic and international nonprofit organizations include, for example, "non-governmental organization (NGO)," "civil society organization," and "public benefit organization." Many countries have laws that specifically define these terms: Brazil, Kenya, and Uganda are examples of countries with such laws. However, whether any of these organizations is charitable by U.S. legal standards is a separate determination.
This article is for general informational purposes only and does not represent legal advice as to any particular set of facts. Please seek legal counsel as you deem necessary.