Sandy Trowbridge, Grants Development Associate - Education
Funders identify who may apply for their grants based on factors such as organization type, operational focus, geographic location, organization size, and mission alignment. Determining whether your organization is eligible to receive a grant is key to not wasting time and money compiling an application that will not even be considered. While terms like nonprofit, tax-exempt, and 501(c)(3) may seem interchangeable when reviewing grant eligibility statements, they have key differences that are important to understand when effectively assessing your organization’s grant eligibility.
Nonprofit
Nonprofit means an entity is organized for a nonprofit purpose – its mission is not to make a profit; it is to contribute a benefit to society. Interestingly, nonprofit status is a state law concept. While organizing as a nonprofit at the state level may make an organization eligible for certain benefits (such as state tax exemptions), it does not automatically grant the organization exemption from federal income tax.
Tax-Exempt
Most commonly, organizations gain exemption from federal income tax by formally requesting tax-exempt status from the Internal Revenue Service (IRS). To maintain this status, organizations must then meet ongoing requirements, such as the annual submission of Form 990. Most state and local government entities (including public schools) are not required to pay federal income tax and are not required to apply for this exempt status. The IRS will instead issue a letter describing the tax status of government entities. Most groups will accept this letter as the substantiation that they need to prove a government entity’s tax-exempt status.
501(c)
Section 501(c) of the Internal Revenue Code (IRC) is what designates certain types of nonprofit organizations as tax-exempt (again, meaning that they pay no federal income tax). There are twenty-nine types of 501(c) organizations in the United States. The 501(c)(3) organization is the most common, making up over 75% of all tax-exempt organizations.
501(c)(3)
Being classified as 501(c)(3) means that a nonprofit organization has been recognized by the IRS as a tax-exempt charitable organization. The key here is that the IRS recognizes the organization as being tax-exempt due to its charitable programs. In the eyes of the IRS, “charitable” is defined as being established for purposes that are religious, educational, charitable, scientific, literary, testing for public safety, fostering of national or international amateur sports, or prevention of cruelty to animals and children. One of the main advantages of being tax-exempt under 501(c)(3) is being able to accept donations that are tax-deductible to the donor. Additional benefits include exemption from federal income taxes, possible exemption from certain state taxes (this varies by state), the public legitimacy of formal IRS recognition, and the ability to apply for grants available only to IRS-recognized 501(c)(3) organizations, among others.
501(c)(3) Documentation
For a qualifying entity to receive 501(c)(3) status, it must apply to the IRS for this recognition by filing Form 1023 (or Form 1023-EZ), titled “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code”. Once the IRS approves an organization’s 501(c)(3) status, they will receive a written notice called a “letter of determination”. Charitable organizations not required to obtain recognition of exemption via Form 1023 are limited to churches (including synagogues, temples, and mosques), integrated auxiliaries of churches and conventions or associations of churches, or any organization that has gross receipts in each tax year of not more than $5,000. While these organizations are not required to seek recognition of exemption, they may still choose to file Form 1023 simply for the broader public legitimacy that a determination letter brings.
501(c)(3) Types
There are three types of 501(c)(3) organizations, namely 1) private foundations, 2) public charities, or 3) private operating foundations. Private foundations (as per IRC 509(a)) are non-operating foundations that support the work of public charities and receive most revenue from a small number of donors. Public charities (as per IRC 509(a)(1)) are organizations with active programs that receive a substantial portion of their revenue from the general public or the government. Finally, private operating foundations are hybrid organizations with active programs but other attributes that are more like private foundations.
Why Does it Matter?
To meet eligibility requirements, most funders specifically require grant applicants to possess an approved IRS 501(c)(3) determination letter. Some funders will further note that they require applicants to be classified as a certain type of 501(c)(3); namely a public charity (versus a private foundation). If your organization does not yet hold this status, your funding opportunities are severely limited. In such cases, it might be beneficial to consider fiscal sponsorship.
Fiscal Sponsorship
Fiscal sponsorship is an arrangement wherein a 501(c)(3) public charity sponsors a project that lacks exempt status. This allows the project to apply for grants under the sponsor's 501(c)(3) exempt status. This fiscal sponsor will then provide ongoing fiscal management and administrative support to help build the capacity of that charitable project. Most funders denote whether or not they are open to considering grant applications from fiscal sponsors within their grant materials, but when in doubt, reach out to the funder directly to confirm.
Next Steps
If you plan to utilize grants as a key source of funding but do not yet have 501(c)(3) status, start taking steps now to make this a reality. The IRS clearly outlines all requirements on its website with direct links to required forms and accompanying instructions. Concurrently, consider forming partnerships that will enable you to utilize a fiscal sponsorship relationship to apply to grant opportunities in the meantime. Search out 501(c)(3) organizations doing similar work in your region and contact them to discuss their willingness to sponsor your organization. If yes, work together to develop a formal fiscal sponsorship agreement that will guide your partnership while you await receipt of your own 501(c)(3) determination letter. And finally, enjoy the broader range of grant eligibility that 501(c)(3) status and fiscal sponsorship provide.