Choosing a type of nonprofit organization

Establishing a nonprofit is a multistep process that begins with choosing an organizational structure. There are several types of nonprofits you can start, each of which has its own requirements and guidelines. Comparing the various types of nonprofit organizations and how they operate can help you determine which structure makes the most sense.

What is a nonprofit?

In simple terms, a nonprofit is any entity or organization that does not operate to profit stakeholders. Nonprofit organizations enjoy tax-exempt status under the Internal Revenue Code (IRC).

Tax-exempt organizations may generate income from selling goods and services or raising funds from donors. Any income received may be used to cover the nonprofit's operating expenses, pay benefits to members, or fund the organization's mission. Again, that income is not subject to federal income tax.

What are the three types of nonprofits? Section 501(c)(3) of the Internal Revenue Code categories them as:

• Charitable organizations
• Churches and religious organizations
• Private foundations

However, the IRS recognizes five categories of nonprofits as tax-exempt organizations. Political organizations are governed by Section 527 of the IRC. There's also a separate category for other nonprofits, which includes social welfare organizations, civic leagues, social clubs, labor organizations, and business leagues. The type of nonprofit organization determines which section of the Internal Revenue Code applies.

Types of nonprofit organizations

Within the five broad categories established by the IRS, there are numerous nonprofit types to choose from. Some types of nonprofits are more common than others, although it's helpful to understand the various options when deciding how to structure your organization.

1. Corporations organized under act of Congress—501(c)(1)

As the name suggests, this type of nonprofit organization is created by an act of Congress. Some of the most recognizable examples of 501(c)(1) organizations include federal credit unions, federal national mortgage associations, and the 12 Federal Reserve banks that operate as part of the central banking system.

2. Title-holding organizations—501(c)(2)

Title-holding organizations hold the title to property on behalf of other tax-exempt organizations. For example, a title-holding organization may hold title to properties on behalf of a pension fund. Any income generated by the property must be passed on to the parent organization.

3. Charitable organizations—501(c)(3)

The Internal Revenue Code defines 501(c)(3) charitable organizations as organizations that are "organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, educational, or other specified purposes." A 501(c)(3) charitable organization may rely on funding from donors, government grants, or the payment of dues by members to fund operations.

4. Churches and religious organizations—501(c)(3)

Under IRS rules, churches that meet the requirements of Section 501(c)(3) of the IRC for charitable organizations are automatically considered tax-exempt. Churches and other eligible religious organizations aren't required to file an annual return with the IRS. Donations made to churches or religious organizations may be tax-deductible for the donor.

5. Private foundations—501(c)(3)

Private foundations are independent entities that are established for charitable purposes. Rather than raising funds from public donors, private foundations may be funded exclusively by individuals, members of the same family, or corporations. That distinguishes them from other foundations that operate as public charities. Donations may also be tax-deductible for the donor.

6. Community social welfare organizations—501(c)(4)

Section 501(c)(4) of the IRC allows social welfare organizations and civic leagues to qualify as nonprofits and claim tax-exempt status. These types of nonprofits are organized to promote social welfare, although they can also engage in political lobbying if those activities are intended to advance their overall mission.

7. Labor, agricultural, and horticultural organizations—501(c)(5)

An organization that qualifies for nonprofit status under Section 501(c)(5) of the IRS is one that operates in connection with the cultivation of land or the raising of livestock. This type of nonprofit can also include agricultural organizations involved in aquaculture. Labor, agricultural, and horticultural organizations may aim to improve working conditions for laborers or develop farming practices that are more efficient or environmentally friendly.

8. Trade or professional associations—501(c)(6)

Trade and professional associations can operate on a nonprofit basis for the benefit of their members. This type of tax-exempt organization funds its operations through dues paid by the organization's members. Examples of 501(c)(6) nonprofits include real estate boards, business leagues, chambers of commerce, trade organizations, and other professional associations for individuals working in a specific industry.

9. Social and recreational clubs—501(c)(7)

A 501(c)(7) nonprofit is an organization that has social activity or recreation as its primary purpose. Social and recreational clubs that can qualify as nonprofit organizations include country clubs, athletic leagues, alumni groups, and hobby clubs.

10. Fraternal beneficiary societies—501(c)(8)

Fraternal beneficiary societies established under IRC Section 501(c)(8) provide benefits to members, hence their "fraternal" nature. Members of this type of nonprofit can receive accident, sickness, or death benefits. There may be a single-parent organization that holds the charter for multiple local fraternal societies. Examples of 501(c)(8) organizations include the Knights of Columbus and the Loyal Order of Moose (Moose Lodge).

11. Voluntary employee beneficiary associations—501(c)(9)

An employee beneficiary association is another type of nonprofit that's organized to pay financial benefits to its members and their dependents. Employee membership is optional, not mandatory, but joining an employee beneficiary association can yield benefits in the form of payments for accidents, illness, or death. A labor union is one type of employee beneficiary association.

12. Domestic fraternal societies—501(c)(10)

Domestic fraternal societies are similar to 501(c)(8) nonprofits in terms of the way they're organized using a lodge system. However, this type of nonprofit doesn't pay benefits to members. Instead, any money that comes into the nonprofit is used to fund charitable works or other purposes. Shriners International is one example of a domestic fraternal society.

13. Teacher's retirement fund associations—501(c)(11)

A teacher's retirement fund association manages teachers' retirement funds. These organizations can qualify as tax-exempt if they're funded solely by investment income, public taxes, and income derived from assessments of teacher salaries. Once member teachers retire, the organization will then pay benefits to them.

14. Insurance and services at cost organizations—501(c)(12)

An entity with 501(c)(12) status exists to provide insurance to its members at the lowest possible cost. Examples of this type of nonprofit include benevolent life insurance associations; mutual irrigation; telephone companies; and other organizations that have a similar structure and function. Under the Internal Revenue Code, at least 85% of its income must come from its members.

15. Cemetery companies—501(c)(13)

The main function of 501(c)(13) cemetery companies is managing the disposal of members' bodies through burial or creation once they've passed away. These nonprofits may also engage in charitable works by providing the same services for indigent non-members. A tax-exempt cemetery company cannot operate a mortuary directly, but it can sell products affiliated with burial services, such as grave markers or flower arrangements.

16. State-chartered credit unions and mutual reserve funds—501(c)(14)

Tax-exempt state-chartered credit unions are governed by the Federal Credit Union Act. In terms of the regulatory guidelines that apply, these organizations and other mutual financial organizations must be organized as corporations and have existed before Sept. 1, 1957. A 501(c)(14) organization cannot earn a profit, but it may be funded through government grants or business operations.

17. Mutual insurance companies—501(c)(15)

Mutual insurance companies provide insurance benefits to members at cost. The types of policies offered are typically designed to cover property damage or provide financial benefits to help with burial and funeral expenses. These nonprofits may operate in a smaller geographic area and serve local communities.

18. Cooperative organizations to finance crop operations—501(c)(16)

This type of nonprofit, also referred to as a farm co-op, can be organized by farmers to help jointly fund operations related to the planting, care, and harvesting of crops. For example, the organization may help members with funding the purchase of farming equipment, cultivating new types of crops, agricultural activities related to livestock, warehousing or shipping crops, and marketing crop products.

19. Supplemental unemployment benefits trusts—501(c)(17)

Supplemental unemployment benefits trusts are what they sound like: nonprofit organizations that provide supplement unemployment benefits to employees. Any money held in trust must be reserved solely for the purpose; it can't be used for anything else. Eligibility requirements and benefits payable cannot be discriminatory toward any employee, regardless of status or salary.

20. Employee-funded pension trust—501(c)(18)

An employee-funded pension trust qualifies as a 501(c)(18) organization if it was created before June 25, 1959, to provide pension benefits to employees. As the name suggests, this type of pension trust is funded by member employees.

21. Veterans' organizations—501(c)(19)

Nonprofit veterans organizations provide benefits to military members. This type of nonprofit can be established as an auxiliary unit, trust, or foundation. At least 75% of members must be past or present members of the armed forces, and the nonprofit must be operated exclusively to assist veterans and their dependents, including spouses and children of deceased veterans.

22. Black lung benefits trust—501(c)(21)

Black Lung trusts are nonprofits that hold funds used to pay monthly compensation benefits to coal miners who were disabled because of exposure to coal dust. The Black Lung Benefits Act mandated those payments, and the act was later amended to require payment funds to be held in trust. In addition to miners, Black Lung trusts can also pay benefits to eligible surviving spouses.

23. Withdrawal liability payment fund—501(c)(22)

A withdrawal liability payment fund is designed to help cover the liability of employers who withdraw funds from multi-employer pension plans. This type of nonprofit organization is uncommon.

24. Veterans' organizations established before 1880—501(c)(23)

Section 501(c)(23) of the IRC covers veterans' organizations that were created before 1880. Similar to 501(c)(19) nonprofits, more than 75% of members must be past or present members of the armed forces. This type of nonprofit must exist primarily to provide insurance and other benefits to veterans and their dependents.

25. Multiple parent title holding companies—501(c)(25)

Multiple parent title-holding companies hold title and pay income from properties held on behalf of a tax-exempt organization. Specifically, they operate for properties with 35 or fewer parents or beneficiaries.

26. State-sponsored organizations providing health coverage for high-risk individuals—501(c)(26)

This type of nonprofit is pretty straightforward. A 501(c)(26) organization is sponsored by the state and exists to provide health insurance coverage for individuals who are deemed high-risk and may lack access to adequate health care.

27. State-sponsored workers' compensation reinsurance organizations—501(c)(27)

State-sponsored workers' compensation reinsurance organizations return extra income to workers' compensation policyholders. Specifically, this type of nonprofit serves workers' compensation plans funded by government grants and/or member dues.

28. National Railroad Retirement Investment Trust—501(c)(28)

This type of nonprofit status was created following the passage of the Railroad Retirement and Survivors' Improvement Act of 2001. This is a tax-exempt organization that holds funds in trust that are used to pay retirement benefits for railroad workers and their dependents.

29. Religious and apostolic associations—501(d)

Religious and apostolic associations are nonprofits that have a common or community treasury that is used to hold funds from business operations. These organizations are religious in nature, and members must belong to a church or church group.

30. Cooperative hospital service—501(e)

A cooperative hospital service is a type of nonprofit that provides services for two or more hospitals, exists as part of a larger medical complex, or is owned and operated by a qualifying government entity. A 501(e) nonprofit can engage in several activities, including data processing, billing, and laboratory services.

31. Cooperative service organizations of operating educational organizations—501(f)

Cooperative service organizations have a singular purpose, which is to provide investment services for member educational organizations. A 501(f) pools funds and invests them into different securities on behalf of its members.

 

32. Publicly available child care organizations—501(k)

A 501(k) can provide child care to the general public on a nonprofit basis. This type of childcare organization may exist to allow parents, guardians, or other relatives to seek employment outside of the home.

33. Charitable risk pools—501(n)

Charitable risk pools can be considered tax-exempt if they operate for charitable purposes. This type of nonprofit pools insurance risk for its members.

Choosing types of nonprofits to start

With so many different types of nonprofits, deciding on an organizational structure can feel overwhelming. But it's possible to find the right option with a bit of strategic planning.

Morgen Cheshire, the founder and managing attorney of Philadelphia-based Cheshire Law Group, says nonprofit founders should consider three things:

• What they're trying to accomplish with their nonprofit
• How their initiative will be funded
• What they want their role to be in the organization

Answering those questions can help to inform your decision-making when choosing which type of nonprofit to start.

"The most overlooked aspect of starting a nonprofit is that founders rush the process and don't thoroughly think through their options," Cheshire says. "Although most nonprofit startups move forward with incorporating a nonprofit corporation, there are other structural options to consider."

It's also important to consider the legal ramifications involved in creating a nonprofit, both at the state and federal levels.

"The act of forming a nonprofit under the laws of a particular state does not guarantee that the nonprofit will be eligible for tax-exempt status," says Mary Kogut-Lowell, a business attorney at Orlando-based Private Corporate Counsel. You'll need to weigh the various formation and filing requirements dictated by state law to ensure your organization qualifies.

Once you've worked out the preliminary wrinkles, you can work through the next step—applying for tax-exempt status with the IRS. Kogut-Lowell says it's important to understand which of the five tax-exempt categories your organization falls into. The IRS has additional rules for annual reporting that you may or may not be subject to, based on the type of nonprofit you establish.

It may be wise—and even necessary—to seek out legal advice to talk through choosing and forming the right type of nonprofit entity, particularly if you anticipate unique issues or challenges involved. "Doing so helps minimize risk and helps founders make the most of their limited startup budgets," Cheshire says.

Frequently asked questions (FAQs)

What are four different types of nonprofits?

There are many nonprofit types to choose from, all of which hold tax-exempt status under the Internal Revenue Code. The four most common types of nonprofits include 501(c)(3) charitable organizations, 501(c)(2) title holding trusts, 501(c)(3) private foundations, and 501(c)(4) social welfare organizations.

What is the best type of nonprofit to start?

There is no single answer to this question, as every organization's needs differ. Comparing different types of nonprofits and their structure, as well as the potential pros and cons, can help you to decide which nonprofit type makes the most sense for your needs.

What is the difference between an NGO and a nonprofit?

An NGO is a nongovernmental organization that operates for the purpose of benefiting social welfare and the public good. NGOs are autonomous and do not have any government affiliation. Nonprofits can also operate for the public good, although they may have a different focus from NGOs. For example, an NGO may provide humanitarian relief to citizens of countries affected by war, while a nonprofit or NPO may focus its efforts on funding the arts in local communities.

What is the most common type of nonprofit?

The most common type of nonprofit is a 501(c)(3) organization. Again, that can include charitable organizations, churches and religious organizations, and private foundations. Other types of nonprofits include political organizations and miscellaneous entities, such as social welfare organizations, civic leagues, social clubs, labor organizations, and business leagues.v