What is a 501c3 Organization?

Excerpts from "Family Foundations and the Law" by John A. Edie and Kelly Shipp Simone, published by the Council on

What Is a Section 501(c)(3)organization?

Section 501c3 of the Internal Revenue Code ("Code") provides a long list of different types of organizations that are exempt from federal income tax. The third part of Section 501(c),namely Section 501(c)(3), is Specifically designed for all charitable organizations. All public charities and private foundations qualify as tax exempt under this section of the Code. To qualify, an organization must be formally structured and currently operating exclusively for charitable purposes. In addition, while nonpartisan political activity is permitted, none of its funding or activities may involve participating in activities to support or oppose candidates for public office. Limited lobbying activity is permitted for public charities, but private foundations(with limited exceptions) may not lobby. Finally, Section 501(c)(3)strictly forbids the organization from privately enriching any individual person.

What does "charitable" mean?

The definition of "charitable” is not finite or static...."Charitable" purposes are defined in Section 501(c)(3) of the Internal Revenue Code To be "religious, charitable, scientific, testing for public safety, literary, or educational, or to foster national or international sports cooperation..or for the prevention of cruelty to animals."

No single inclusive list of every activity that is charitable exists, though the income-tax regulations do mention specific activities. To name a few: relief of the poor and distressed or underprivileged, erection or maintenance of public buildings, lessening the burdens of government, lessening neighborhood tensions, eliminating prejudice and discrimination, defending human and civil rights secured by law, and combating community deterioration and juvenile delinquency.

What are "fiscal agents,” and are they legal?

The term "fiscal agent" does not appear anywhere in the Code or regulations. It is legally undefined but, as most often used, amounts to an intermediary grantee, which functions as a "laundering agent." Using such agents can lead to legal complications. Foundations might use fiscal agents to make grants safe or to avoid involved administrative requirements of expenditure responsibility or equivalency determination. The idea is for foundation A to make a grant to public charity B (a safe grant) and direct (or earmark) the funds to be re-granted to organization C. Treasury regulations consistently disallow using public charity B as a fiscal agent.

In essence, the rules state that a grant from A to B earmarked for C Is a grant to C; using the fiscal agent as a middleman does not work. Earmarking is defined as an 'oral or written agreement" whereby B must redirect the funds to C. Typical examples of situations in which a foundation might like to-but should not-use a fiscal agent are grants to 1.) a non-charity such as a chamber of commerce, 2.) a charity that does not yet have its IRS tax-determination letter, 3.) a non-U.S. organization, 4.) a small charity that might be vulnerable to tipping, 5.) another private foundation, and 6.) individuals for certain purposes.

There are nonetheless circumstances under which using an Intermediary grantee is appropriate. The key factor is that the grant to the intermediary must not be earmarked. In fact, the intermediary must control the ultimate disposition of the funds. The term frequently used for these relationships is "fiscal sponsorships."

The Rules Against Taxable Expenditures

If a foundation makes a "taxable expenditure" by spending funds that in any way violate one or more special problem areas, then the foundation and the foundation manager (directors) can be penalized.

The penalty on the foundation for any taxable expenditure is 20% of the amount of the expenditure. The penalty is 5% on any foundation manager who willingly and without reasonable cause participates in the making of such an expenditure with knowledge that such an expenditure constitutes a violation....Once this tax is imposed, the IRS may levy an additional tax of 100% on the foundation and 50% on the foundation managers for failure to correct the violation.

The special problem areas are:

• Non-charitable purpose

• Influencing public elections

• Voter Registration

• Lobbying

• Grants to individuals

• Grants To organizations

A grant to any organization that is not a public charity will subject the foundation to penalty unless the

foundation exercises “expenditure responsibility," which means ensuring that the grant is used for charitable purposes.