While I’m an Estate and Medicaid planning attorney, I have also been involved in civic groups and charities for more than 20 years, and I often see a lot of confusion over how 501c3s and 501c4s act, especially when it comes to civic clubs and groups. That’s because the average club member just wants to go out into the community and do good works without getting bogged down in taxation and reporting minutia. However, this has recently come up as a major issue in Civitan International, so it’s worth going over the basics.
When it comes to civic groups and service clubs, they are most appropriately 501c4, non-profit organizations, classified by the federal government as “social welfare organizations.” Your average Civitan Club is comprised of members who want to volunteer in the community by helping people in need, whether it is helping deliver hot meals to seniors, volunteering at Special Olympics events, or building wheelchair ramps. The common theme among most civic clubs is that the members want to do something to help. This even extends to fundraising events, such as charitable bike rides, bake sales, and dinner & auction events, but usually the civic club will partner with a 501c3 in order to let them collect the money.
So, what are the hallmarks of a 501c4?
- They are technically corporate entities that do not pay local, state, or federal taxes.
- They are not “owned” by anyone, so there are no profits distributed to shareholders.
- All money collected has to be spent on the non-profit’s stated purpose, including administrative purposes and for expenses related to the functioning of the organization.
- An informational return has to be filed with the federal government and possibly other government entities.
- If the organization dissolves, all assets have to go to a 501c3 charity or charities.
- There is federal form to apply for 501c4 status that is comparatively simple compared to other status applications.
- People contributing money to 501c4s do not get to deduct those contributions on their taxes.
Taxing entities such as the IRS do not usually highly scrutinize 501c4 organizations unless there is some proof they are excessively lobbying or there is some evidence of funds benefiting particular members. So how are 501c3s different? The federal government insists that 501c3 organizations have an exempt purpose that is “charitable, religious, educational, scientific, literary, testing for public safety,” and so on. The hallmarks of a 501c3 look a lot like a 501c4 at first but there are a few big differences.
- They are the same in that they don’t pay taxes, there are no profits distributed to owners, money has to be spent furthering the organization’s purpose, tax returns have to be filed, and if the organization dissolves, the assets also have to go to a 501c3 charity.
- Where they are different is there is a fairly extensive application form to the IRS with lots of attachments and questions in order to get 501c3 status with the federal government, and, wait for it…
- People contributing money to a 501c3 get to deduct contributions on their taxes.
That last one is the whole ballgame, and it explains the huge difference between a 501c3 and a 501c4. If you give money to a 501c3, you get to deduct money on your taxes. Now, suddenly, there is a much greater scrutiny by the federal government in both the application process AND in scrutiny over expenditures. After all, the government doesn’t care that much about a non-profit spending money, but it cares greatly about rich people trying to falsely create a charity to funnel money back themselves while avoiding income taxes. In addition, the 501c3 charity has a lot more reporting requirements to donors on how much of their contribution is deductible, and that means a lot more record keeping.
Now imagine these reporting requirements and scrutiny being pushed onto a large civic organization like Civitan International where a lot of the work is service-oriented rather than fundraising but still having to comply with all of the extra paperwork for the whole organization because certain funds are tax-deductible for contributors but other revenues are not. It gets to be a huge, needlessly messy prospect.
This is why most civic organizations have two separate entities.The main civic group and all of the member clubs and other levels of organization will typically be 501c4 entities. This allows the International Organization to work towards the empowerment and betterment of its member clubs in fulfilling their mission, still without having to pay taxes, and the level of scrutiny and level of record keeping is minimized. On the other hand, these large civic organizations will separately create a 501c3 foundation where 100% of its work is focused on raising money and distributing it for purely charitable ends. Now the two entities are truly separate with different boards, and the “books” of each are more easily maintained consistent with their different purposes. When the civic club wants to raise money for a charitable purpose, it can simply partner with the foundation to handle the incoming donations rather than putting that responsibility on the civic club or its parent organization.
This is the difference between owning both a bicycle and a motorcycle versus trying to install an internal combustion engine on your average mountain bike and then having to meet all of the registration, licensing, and taxing requirements twice for the same vehicle and trying to separate the value of the motored part and the pedal part every single day. Plus, you now have to deal with explaining to a cop after getting pulled over that you were only pedaling your bike that day so you only have to wear a bicycle helmet and not a full motorcycle helmet.