501(c)(3) vs. 501(c)(6): What You Need to Know
These two basic nonprofit designations are common within the association sector. While their goals can be quite similar, their structures are significantly different. Here’s how.
The 501 nonprofit designations set by the Internal Revenue Service are some of the most important classifications for associations to know about, as they spell out what a nonprofit organization can do within its regulatory structure.
While these designations vary from 501(c)(1) to 501(c)(29), the two most common designations that those in the association space might run into fall into two categories:
- 501(c)(3). An organization generally focused on greater-good goals such as religious, educational, charitable, or scientific needs.
- 501(c)(6). A business league or chamber of commerce. Associations generally fall under this category.
Beyond designating what these organizations do, these specifications also help to broadly articulate how they can legally operate. Read on to learn how.
What Are the Differences Between a 501(c)(3) and 501(c)(6)?
Gene Takagi, principal of NEO Law Group and contributing publisher for the Nonprofit Law Blog, has written about this subject at length. He said that the differences come down to the organization’s mission, and who that mission benefits.
“The main distinction between the two types of exempt organizations is related to the purpose of the organization and its intended beneficiaries,” he said in an email.
He noted, for example, that while a 501(c)(3) is generally focused on the charitable needs associated with a larger mission, a 501(c)(6) focuses on improving the common business interests of the collective.
Some of the most important differences between a 501(c)(3) and 501(c)(6) concern tax deductions. Charitable organizations, for example, allow donations to be deducted as qualified charitable contributions, while payments to business groups, such as membership dues or attendance fees, are tax-deductible as traditional business expenses.
Another key difference is political activity—which is usually barred for 501(c)(3) groups but allowed with a degree of transparency for 501(c)(6) organizations.
“These differences impact their respective permissible and impermissible activities and the deductibility of contributions or payments,” Takagi said.
Depending on your group’s focus, other IRS designations may make more sense. For example, AARP, which represents older Americans, is a 501(c)(4) “social welfare” organization. This categorization allows it to, among other things, politically advocate for the interests of the demographic group it supports.
Do You Have to Choose Between Being 501(c)(6) and 501(c)(3)?
Yes, but that doesn’t mean you can’t accomplish the goals of both. An association formed as a collective to further common interests can accomplish charitable goals, and it’s common in the association space for a 501(c)(6) to create a nonprofit foundation that manages charitable interests. For example, ASAE—a 501(c)(6)—has the ASAE Research Foundation, which is a 501(c)(3).
However, Takagi noted that it is important to understand the complexities of this plan.
“If such an option is pursued, it is critically important to respect the legal separateness of the two affiliated organizations,” he said. “Separate governing documents, separate books and accounts, distinct purposes and activities are critical.”
While there might be some overlap between organizations—and a board for one of the organizations may have a controlling interest in selecting the board members on the other—Takagi noted that the guidance is generally to ensure that the boards are otherwise independent from one another, even if they share resources in other ways.
“The organizations may also share resources and employees, but these arrangements should be properly approved and memorialized in arm’s-length written agreements,” he said.
Does Converting Between These Designations Make Sense?
It might, but Takagi suggested that it makes more sense to convert a 501(c)(6) to a 501(c)(3), rather than the other way around. The reason for that comes down to the charitable goals of a 501(c)(3), which may make it impossible to disperse assets to the new, noncharitable organization.
“The assets of a 501(c)(3) organization are dedicated to the charitable/exempt purposes of the organization,” he said. “Generally, they may not simply be distributed to the organization’s members, to the extent the organization has members.”
As a result, Takagi suggested that a 501(c)(3) may need to disburse its assets, often to another charitable organization, to convert to a 501(c)(6).
Going from a 501(c)(6) to a 501(c)(3) is largely easier, he explained, as it would only require sending a Form 1023 application to the IRS; if the agency approves the application, an organization could make a relatively smooth transition.
“There may be some risk, however, to the board members of a 501(c)(6) organization that goes through the process of such a conversion if a dissenting member raises a breach of fiduciary duty claim,” he said.