Initial Concepts

In the United States, non-profit organizations are primarily characterized by their ability to raise funds to support specific causes. All funds raised are reinvested into the organization’s institutional purposes, and profit distribution among members is strictly prohibited.

In this context, the central focus of non-profits lies in allocating resources toward activities aligned with their social objectives, rather than distributing profits among members, as occurs in traditional business models. This distinction underscores the community-oriented nature of non-profits, aimed at promoting direct or indirect benefits to society.

Because of this community purpose, non-profits may qualify for tax incentives. When legally organized as tax-exempt entities, the Internal Revenue Code (IRC) provides for federal tax exemption—a topic to be further addressed in a separate section.

Structural Model

The organizational structure of non-profits closely resembles that of corporations. However, despite these similarities, non-profits have unique characteristics that reflect their institutional nature and absence of profit-making objectives.

In general, forming a non-profit requires drafting basic corporate documents such as the Articles of Incorporation—the certificate that establishes the organization’s legal existence with the state—and the Bylaws, which govern the entity’s internal operations, division of responsibilities, and governance standards.

A non-profit is managed by a Board of Directors, responsible for defining the entity’s strategic direction and ensuring compliance with its mission. In addition, Officers (such as President, Secretary, Treasurer, and others appointed as needed) oversee day-to-day operations and coordinate activities.

These executive positions are also present in corporations, as are the Articles of Incorporation and Bylaws. Thus, certain organizational similarities exist between a non-profit and a corporation.

The main distinction, however, lies in shareholder presence. Corporations have shareholders who own stock and are entitled to profit and dividend distribution. Non-profits, on the other hand, have no shareholders. In some states, non-profits may have members, but these members do not hold equity interests and cannot receive profit distributions.

All financial surplus must be fully reinvested into the organization in line with its charitable and social purposes. Compensation to Directors and Officers may be provided for services rendered, but this is not considered profit distribution—rather, it is treated as pro rata compensation.

Tax Benefits

As mentioned, non-profits with philanthropic objectives may qualify for federal tax benefits. To do so, they must meet the requirements under Section 501(c)(3) or 501(c)(4) of the IRC, along with additional criteria imposed by the Internal Revenue Service (IRS), including restrictions on political activity and limitations on private benefit distribution.

These two categories represent the most common forms of tax-exempt organizations, each with distinct purposes and criteria. Both are considered tax-exempt entities, meaning they are exempt from paying federal income tax, provided applicable legal requirements are met.

  • Section 501(c)(3) covers organizations operated exclusively for charitable, religious, educational, scientific, or literary purposes, among others. In addition to tax exemption, this status allows donations to be tax-deductible for donors—an important incentive for fundraising.
  • Section 501(c)(4) includes entities organized to promote social welfare, such as civic leagues, community organizations, and advocacy groups. Unlike 501(c)(3), these organizations enjoy greater freedom in political engagement, including lobbying and certain limited political activities.

Choosing between 501(c)(3) and 501(c)(4) depends on the organization’s purpose and the degree of political activity it intends to pursue. Both provide relevant tax advantages and serve as critical tools for advancing public-interest initiatives in the U.S.

Non-profits may generate revenue by offering products or services related to their mission, and such income is typically tax-exempt. However, a portion of their activities may fall outside exempt purposes, in which case the organization becomes liable for taxes on Unrelated Business Income (UBI), as outlined in IRC Sections 511–515 and Treasury Reg. Sec. 1.501(c)(3)-1(e)(2).

UBI is generally defined as income from regularly conducted trade or business activities not substantially related to the organization’s exempt purposes, and which compete with for-profit businesses.

Both the IRS and federal courts have held that when non-exempt revenues exceed a certain threshold, a non-profit may lose its tax-exempt status.

Obtaining 501(c)(3) Status

After registering with the state via Articles of Incorporation, a non-profit seeking federal tax exemption under Section 501(c)(3) must file an application with the IRS.

  • Eligible small organizations may use Form 1023-EZ, a streamlined version of the traditional application designed for entities with simpler operations and limited revenue.
  • Larger or more complex organizations must file Form 1023, which provides detailed information about governance, finances, and activities (e.g., hospitals, universities, and research institutions).

Once recognized as tax-exempt under 501(c)(3), the organization’s income is generally free from federal tax, donors may deduct contributions, and mission-related revenue is exempt.

This exemption, however, does not extend to individuals working for the organization. Employees, Officers, Directors, and service providers must report compensation as taxable income under IRS rules.

Obtaining 501(c)(4) Status

Non-profits primarily dedicated to promoting social welfare may seek tax exemption under Section 501(c)(4) of the IRC. Unlike 501(c)(3), they are not limited to charitable, educational, or religious purposes but must be organized exclusively to advance public welfare and civic engagement.

To obtain 501(c)(4) status, organizations must file Form 1024-A, which requires detailed information about governance, funding, operations, and planned activities. Unlike 501(c)(3), there is no simplified version of this form.

Once approved, revenues related to the mission are exempt from federal tax. However, unlike 501(c)(3), donations to 501(c)(4) entities are not tax-deductible for donors, except in rare cases.

Retroactive Effect of Tax-Exempt Status

When an organization files its application, the IRS reviews it and, if approved, issues a Determination Letter granting tax-exempt status.

  • Processing times vary: about 90 days for Form 1023-EZ and up to 180 days for Form 1023.
  • Approval is retroactive to the filing date, meaning donations made while the application was pending may still qualify as deductible once exemption is granted.

During review, the organization must comply with all federal and state filing obligations, reinforcing the importance of accounting oversight from the outset.

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Transfer of U.S. Non-Profit Funds to NGOs in Brazil

Private non-operating foundations are often used to distribute funds to other organizations that will conduct charitable activities. These U.S. foundations may transfer funds to foreign entities, including Brazilian NGOs, provided they comply with IRS rules to avoid excise taxes under IRC Sections 4942 and 4945.

A foreign organization may seek recognition as a 501(c)(3) charity by obtaining an IRS Determination Letter, qualifying it to receive tax-deductible contributions. If no determination exists, the U.S. foundation must either:

  • Make a good-faith equivalency determination (Revenue Procedure 2017-53), certified by a qualified tax professional (attorney, CPA, or enrolled agent), valid for two tax years; or
  • Exercise expenditure responsibility, requiring oversight of how grants are used, collection of detailed reports, and compliance reporting to the IRS.

Failure to comply results in taxable expenditures, subjecting both the foundation and its managers to excise taxes under IRC Section 4945(a) and (b).

Case Study

The case of Memorial Hermann Accountable Care Organization (MHACO), a Texas-based non-profit, illustrates challenges under Section 501(c)(4). The U.S. Court of Appeals for the Fifth Circuit denied MHACO’s request for exemption, ruling that its activities primarily benefited private health insurers rather than the community at large.

The Court applied the stricter Substantial Nonexempt Purpose Test rather than the Primary Purpose Test, holding that even one substantial non-exempt activity is sufficient to disqualify an organization.

MHACO argued that federal courts should defer to agency interpretations under the Chevron Deference doctrine. However, following the Supreme Court’s recent ruling in Loper Bright Enterprises v. Raimondo, which overturned Chevron, the Court of Appeals exercised independent judgment, rejecting MHACO’s position.

This shift increases judicial discretion and legal uncertainty, as courts may now apply varying interpretations of what constitutes “primarily” social welfare activity under Section 501(c)(4).

The ruling underscores the need for non-profits to carefully structure operations to ensure all significant activities—not just their primary purpose—align with statutory requirements for tax exemption.


Written by Marina Saraiva, Corporate Team Intern at Drummond Advisors, and Flavia Sobral, Deputy Leader at Drummond Advisors