There are very few organizations in the world whose activities are solely nonprofit or for-profit—nonprofits generate revenue and for-profits do nonprofit-like activities on a daily basis. Founders of sharing organizations and social enterprises often struggle early on with the question: should we be a nonprofit or a for-profit? The following is an outline of relevant topics when deciding whether to form as a nonprofit, tax-exempt organization.

What Is a Nonprofit?

Each state has its own statutes that govern “nonprofit” entities, but these statutes often do not clearly define what the word “nonprofit” means. Depending on the context, people understand nonprofits to be one or more of the following:

1.  “An organization that does not make a profit.” This understanding is inaccurate. Some nonprofits do not make profits and some do. There is nothing prohibiting a nonprofit from bringing in more revenues than expenses.

2.  “An organization that does not distribute profits to investors.” This is a much better candidate for a definition of a nonprofit. Federal tax laws governing tax-exempt organizations generally prohibit the distribution of profits to investors, and state laws governing nonprofits generally do the same.

3.  “An organization that is exempt from tax under Section 501(c)(3) of the Internal Revenue Code as a charitable and/or
educational organization.” This is certainly one definition of a nonprofit, but it is too narrow. There are other sections of the Internal Revenue Code that grant tax exemption to other types of organizations (discussed in more detail below). Also, there are some organizations that meet the definition under definition 2 above, but do not seek federal tax-exempt status. 1

4.  “An organization whose primary purpose is to benefit its constituency.” This definition is the reason why some people characterize cooperatives as nonprofits.

For the purpose of this particular section, we will limit our discussion to nonprofit organizations that are exempt from federal tax under Section 501(c)(3) of the Internal Revenue Code and are public charities (as opposed to private foundations). Other types of nonprofits will be discussed in the section below. The characteristics of public charities exempt under 501(c)(3) include the following:

1.  Incorporated at the state level: They are formed under a state statute. For example, in California the entity of choice generally is a Nonprofit Public Benefit Corporation.

2.  Receive tax exemption from the IRS and state: They apply for and receive exemption from federal income tax under Section 501(c)(3) of the Internal Revenue Code 2 and, if necessary, apply for and receive a comparable exemption from state income tax.

3.  Can receive tax-deductible donations: Unlike organizations that are exempt from income tax under other sections of the Internal Revenue Code, 501(c)(3)s have an additional tax advantage: donations made to them are tax-deductible to the donor—this is why most nonprofits choose this designation if they can.

4.  Regulated by the state: They are usually subject to state regulations governing how they raise money and how they distribute money. For example, in California, they must register with the Attorney General and report on certain types of fundraising activities and transactions with interested parties such as board members.

5.  Required to receive broad public support: They are required under federal tax law to have broad public support. 3

This section is not intended to be a complete overview of the laws governing 501(c)(3) public charities. Rather, it is a summary of some of the issues that a sharing organization or social enterprise might need to consider if it is going to operate as a 501(c)(3).

Rules Governing 501(c)(3) Organizations

Many social enterprises and organizations characteristic of the sharing economy will be attracted to the idea of forming a 501(c)(3) nonprofit. 501(c)(3)s benefit from the ability to receive grants and tax-deductible donations, exemption from taxes on net income, the ability to involve volunteers, and the public trust often conferred upon such organizations. Unfortunately, many social enterprises might fail to obtain tax exemption under 501(c)(3), since their activities and purposes may not meet the narrow list of purposes for which such organizations may operate. For example, some, but not all, farmers markets and car-sharing organizations have been found ineligible for 501(c)(3) status, because the IRS felt that their particular activities did not contribute primarily to a charitable or educational purpose. Social enterprises might also be denied tax exemption if their activities are too similar to regular commercial businesses.

In addition, a primary constraint of 501(c)(3)s is that they must be formed to benefit the public, and often to benefit a charitable class of people (poor, distressed, disadvantaged, and so on). Many people form sharing organizations—such as shared-housing arrangements, car-sharing organizations, and food cooperatives—to provide benefits to themselves, and not necessarily to the public at large. Even if such groups are not formed for the purpose of earning a profit, the types of benefits they confer upon themselves are sometimes legally inappropriate in the context of a 501(c)(3), which cannot operate to provide a private benefit to individuals. For this reason, many activities of the sharing economy are more easily fit into other types of nonprofits, discussed below.

To summarize the basic requirements of Section 501(c)(3) of the Internal Revenue Code, an organization:

  Purposes: Must be organized and operated exclusively 4 for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition […], or for the prevention of cruelty to children or animals […];

•  Prohibition against private benefit: No part of the net earnings may inure to the benefit of any private shareholder or individual;

•  Rules against lobbying and supporting political candidates: No substantial part of the activities may be carrying on propaganda or otherwise attempting to influence legislation, and the organization may not participate in, or intervene in any political campaign on behalf of (or in opposition to) any candidate for
public office.

An organization that seeks tax-exempt status under Section 501(c)(3) must meet both the organizational and operational tests:

  Organizational test (purposes): The organizational test looks at whether the organization is organized exclusively for exempt purposes. The articles of incorporation must limit the organization’s purposes to exempt purposes that are included in Section 501(c)(3). Also, the organizing documents must not expressly empower it to substantially engage in activities that are not in furtherance of one or more of those purposes.

•  Operational test (activities): The operational test looks at the activities of the organization. An organization must be operated primarily for exempt purposes, which means that it must engage primarily in activities that further exempt purposes. An “insubstantial part” of the charity’s activities may be devoted to nonexempt purposes.

Exempt Purposes and Activities in Furtherance of Exempt Purposes

There are thousands of pages of IRS opinions and court decisions that attempt to differentiate between activities that the federal government considers related to exempt purposes and those that it considers unrelated. Unfortunately, they are at times seemingly contradictory and unclear. This section provides some examples, but further research is necessary when considering a specific activity. Activities that seem obviously “related” using the ordinary English language definition of the word are often seen by the IRS and the courts as unrelated for somewhat obscure reasons. For example, if you are an educational organization, it seems obvious that publishing books that are related to your educational mission would be a related activity, right? Maybe! For details, read on.

Relief of the Poor, Distressed, or Underprivileged

Examples of activities that generally contribute to this purpose include 5

•  Vocational training;

•  Employment counseling and referral;

•  Financial and technical assistance to disadvantaged businesses;

•  Affordable housing;

•  Legal services, child care, food, health care, or transportation for low-income people;

•  Sale of handicrafts created by disadvantaged craftspeople or blind individuals.

Many nonprofit organizations generate revenue by conducting these kinds of activities. One successful example is Rubicon Programs, which operated a successful bakery and a landscaping business with the purpose of providing vocational training to economically disadvantaged individuals.

These kinds of programs must be truly beneficial for the trainees to be considered exempt by the IRS. In a recent denial letter, 6 the IRS denied exemption under Section 501(c)(3) for a program that hired part-time workers to stuff envelopes. The letter stated that hiring low-income individuals “in and of itself, does not constitute an activity that furthers the charitable purpose of providing relief of the poor and distressed or of the underprivileged . . .” and the training and education activities are “negligible.” 7

Lessening Neighborhood Tensions, Eliminating Prejudice and Discrimination, Defending Human and Civil Rights Secured by Law, and Combating Community Deterioration and Juvenile Delinquency

Examples of activities that generally further these purposes include 8

•  Renovation of housing that is then rented or sold at affordable rates,

•  Financial assistance to businesses unable to obtain conventional financing due to their location in a blighted community, and

•  Development of commercial or industrial real estate that is rented to businesses that agree to train and employ low-income community residents.

Lessening the Burdens of Government

This category of exempt activity is difficult to qualify for. Generally, the applicant must provide evidence that it is conducting an activity that would otherwise be undertaken by government. As the IRS puts it, “One should be skeptical of letters from government officials that praise an organization’s activities. The relevant determination is whether the activity engaged in by the organization is a burden of government, not whether the government approves of the activity or of the people involved.” 9

The IRS will consider evidence including 10

•  Whether there is a statute or ordinance creating or authorizing the organization,

•  The control exerted by governmental units over the organization’s activities,

•  The interrelationship between the governmental unit and the organization,

•  The organization’s funding,

•  Whether the organization’s activities defray general or specific expenses of the governmental unit,

•  Whether the governmental unit has previously engaged in the same activity prior to the organization taking over such activity, and

•  Whether the activity is one which the governmental unit may, under state or local law, conduct itself.

One activity that has had success securing 501(c)(3) status under this purpose is the Business Improvement District. This is a district created under state or local law that is created by a vote of the property or business owners for the purpose of assessing the property or business owners so that funds can be accumulated to conduct community improvement activities. Since such districts are created by local ordinance, the IRS can more clearly classify these activities as “lessening the burdens of government.”


Education is a category that encompasses a broad range of activities that are eligible for exemption under Section 501(c)(3). Education includes classroom instruction, providing scholarships, public education, museums, orchestras, art galleries, and zoos. The IRS may not deny exemption based on the beliefs and opinions advocated by an organization or the merits of the educational content presented. However, if an organization presents viewpoints unsupported by facts and uses inflammatory and disparaging rhetoric, the IRS may conclude that the organization is engaging in propaganda rather than education.

Educational Activities and the Sharing Economy

Some organizations that work to foster a sharing economy have obtained tax exemption on the grounds that they are educational. For example, many “time banks” obtain tax exemption under 501(c)(3), even though the primary activity of the time bank is to connect individuals for the purpose of exchanging favors without dollars. Time banks have obtained tax exemption, in part, by arguing that the operation of the time bank creates an educational laboratory where people can learn about and practice their skills of meetings their needs without dollars. It is not clear how many economic activities we could justify as “educational” under 501(c)(3). Given how much the world still needs to learn about and practice in the creation of new economies, perhaps a good number of activities could fall under an educational umbrella. However, the hope is that these activities will be less for the purpose of teaching about the new economy and more for the purpose of becoming the new economy. In that respect, the educational argument is limited.


One area that has caused some consternation for educational nonprofits is publishing. Publishing books, articles, or other content as part of an educational purpose may not qualify as an educational purpose under the Internal Revenue Code. Publications must meet the following (highly unclear) criteria to be exempt:

•  The content of the publication is educational;

•  The preparation of material follows methods generally accepted as “educational” in character;

•  The distribution of the materials is necessary or valuable in achieving the organization’s educational and scientific purposes; and

•  The manner in which the distribution is accomplished is distinguishable from ordinary commercial publishing practices. 11

In one ruling, 12 the IRS reviewed the publication of an ethnic newspaper. It found that a nonprofit organization, whose only activities were preparing and publishing a newspaper of local, national, and international news articles with an ethnic emphasis and soliciting advertising and selling subscriptions to that newspaper in a manner indistinguishable from ordinary commercial publishing practices, was not operated exclusively for charitable and educational purposes and did not qualify for exemption.

In contrast, however, if a nonprofit selects what it publishes based on content, rather than financial considerations, and sells its publications through non-commercial channels, it will likely qualify for tax-exempt status.

Consulting Services

Can a nonprofit organization provide consulting as part of its educational activities? This question has also led many a nonprofit attorney to tear out her hair late at night!

The leading case on this topic is BSW Group, Inc. v. Commissioner. 13 In that case, BSW Group was formed for the purpose of providing consulting services primarily in the area of rural-related policy and program development, and planned to enter into consultant relationships with five or six nonprofit organizations involved with the fields of health, housing, vocational skills, and cooperative management. It planned to charge a fee based on its clients’ ability to pay, well below market rate for such services and only slightly above cost.

The IRS denied exemption because it felt that BSW Group was “primarily engaged in an activity which is characteristic of a trade or business.”

The Tax Court agreed with the IRS, stating:

We must agree with the Commissioner that petitioner’s activity constitutes the conduct of a consulting business of the sort which is ordinarily carried on by commercial ventures organized for profit . . . . Petitioner [BSW Group] has completely failed to demonstrate that its own services, or the services performed by its consultants, are not in competition with commercial businesses such as personnel agencies, consulting referral services, real estate agents, housing rental services, banks, loan companies, trash disposal firms, or environmental consulting companies. [footnote omitted] Competition with commercial firms is strong evidence of the predominance of nonexempt commercial purposes. 14

Several other factors weighed against BSW Group—consulting was its sole activity, there was no showing that the research conducted by the consultants furthered an exempt purpose, the organization did not plan to seek grants or donations, no services were provided for free or below cost, and not all of the prospective clients were tax-exempt.

It is hard to know, given the unusual facts of this case, to what extent and in what manner tax-exempt organizations may conduct consulting activities without jeopardizing their tax-exempt status. In more recent rulings, the IRS seems to focus on the fee charged. If the fee charged is not only below market rates but also below cost, requiring a subsidy from other charitable funds, the IRS is more likely to grant exemption.

In a more recent ruling, 15 the IRS considered an organization that proposed to conduct grant management and administrative services for other tax-exempt organizations. The IRS began its analysis by noting that there are

dozens of for-profit companies that provide services similar to those you intend to sell. . . . Therefore, we find that the [services provided by for-profit companies] are nearly identical to those you propose to sell and that you are in direct competition with the for-profit foundation management industry. Nevertheless, the fact that commercial entities may also provide similar services, in and of itself is not determinative as to whether a particular service is or is not substantially related to exempt functions. If the provision of a service contributes importantly to benefiting the charitable class served by an organization’s activities, the commercial nature of the service should not be controlling.

The IRS then went on to group the various services that the organization intended to sell into three categories: grant-making, administrative, and clerical. The IRS concluded that the grant-making group of services contributed importantly to the accomplishment of the organization’s exempt purpose, which was to support charitable activities that benefit the local community. However, the administrative and clerical group of services, according to the IRS, did not contribute importantly to accomplishing the exempt purpose:

Although an argument may be made that these services assist charities [to] . . . conduct their charitable functions, this argument taken to its logical extreme would include any and all services that you could possibly provide to a charitable organization . . . . For example, providing janitorial services to maintain a charitable organization’s physical place of operations would assist the charity accomplish its exempt purpose by removing the burdens associated with routine organizational administration, thereby, allowing the charity to focus solely on charitable activities. Naturally, providing janitorial services or a host of other services that a charitable organization routinely conducts as part of its internal management or administration functions cannot be claimed to be a narrowly tailored activity that is conducted to accomplish the exempt organization’s purposes. Similarly, the administrative and clerical services you propose to sell are not narrowly tailored to be substantially related to your exempt purpose.

The IRS also noted that none of the services were being provided substantially below cost. The IRS concluded by stating that fees charged for the grant-making services would be considered related income, whereas fees charged for the clerical and administrative services would be treated as unrelated and therefore subject to unrelated business income tax (described in more detail below).

Retail Stores

What about the operation of retail stores? There are several rulings on museum gift shops that address this issue. In these rulings, the IRS looks at all of the items sold and determines that some items (such as reproductions of paintings in an art museum) are substantially related to the educational purpose of the museum, whereas others (such as children’s toys) are not. Similar reasoning will be applied to web-based sales.

Efforts to Preserve and Protect the Environment

Efforts to preserve and protect the natural environment for the benefit of the public will generally qualify for tax exemption.16

Examples of organizations found to be exempt for such activities include

•  An organization formed to preserve a lake as a public recreational facility and to improve the condition of the water in the lake to enhance its recreational features; 17

•  An organization formed to promote and assist in city beautification projects and to educate the public in the advantages of street planting; 18

•  An organization formed by residents of a city to cooperate with municipal authorities in preserving, beautifying, and maintaining an urban public park; 19 and

•  An organization formed to develop a sanctuary for wild birds and animals for the education of the public. 20

One ruling recognized that efforts to preserve and protect the natural environment for the benefit of the public serve as a charitable purpose in itself, even if there is no educational component. 21

However, in another ruling, an organization acquired real estate for the dual purpose of holding land for preservation of open space and farming. 22 However, the land contained no ecologically significant attributes. The ruling found that although there was some ecological preservation involved, the organization was not preserving land of any distinctive ecological significance and therefore was not eligible for exemption.

Since the date of that ruling, Congress has passed legislation governing “qualified conservation contributions”23 that significantly undermines the ruling’s validity. Agricultural land preservation organizations have successfully argued that, where agricultural preservation activities advance a well-defined governmental policy in favor of farmland conservation at the federal, state or local level, such activities meet the definition of charitable under Section 501(c)(3).24

If a property is designated as a “wilderness area” or a “wild and scenic river” or the like by federal, state, or local conservation agencies, this is one indication that the land is ecologically significant. The IRS may also consider whether the organization’s governing body and membership are composed of scientists, educators, conservationists, and representatives of the community-at-large and whether the organization has close working relationships with appropriate private and governmental conservation organizations.

Unrelated Income

Even if an organization can describe its activities in a way that it will meet the operational test and receive its 501(c)(3) exemption status, the organization must be careful not to later conduct an activity that the IRS would consider unrelated to its exempt purpose. Unrelated business income is revenue from a trade or business, regularly carried on, that is not substantially related to the charitable, educational, or other purpose that is the basis of the organization’s exemption. An exempt organization that has $1,000 or more of gross income from an unrelated business must file Form 990-T and pay tax on unrelated business income. An organization that receives a substantial portion of its revenues from unrelated business income risks losing its tax-exempt status.

Assets Dedicated to Exempt Purposes

A key characteristic of a 501(c)(3) is that it may not use its assets to benefit a private individual or entity. This means that it may not benefit private parties by doing things like paying excessive salaries, purchasing property at more than fair market value, paying dividends or paying assets remaining upon dissolution to private parties, or in any way allowing its earnings or assets to be used by private parties for private gain without reasonable compensation to the organization. This does not mean that private parties can’t benefit in any way from the activities of the organization—but any benefit must be incidental to the organization’s exempt activities.

Here is an example that illustrates this concept. An organization wishes to purchase a piece of property from a board member’s son. If the son receives more than fair market value for the property, this would be an excess benefit transaction. Thus, the organization should secure an independent appraisal of the property to determine fair market value. The board member that is the father of the property owner should leave the room during the debate and vote on the purchase of the property. The meeting minutes should contain a discussion of how the board made its determination to purchase the property at the agreed-upon price. Excess benefit transactions can result in sanctions for board members, as well as loss of tax-exempt status.

Lobbying and Candidate Electioneering

There has been a great deal written on this topic, so suffice it to say that a 501(c)(3) may not support or oppose political candidates and may not engage in “substantial” lobbying. However, if the subject matter of the “lobbying” regards legislation that could affect the organization’s “existence, powers, duties, tax-exempt status, or the deductibility of contributions” to the organization, then the 501(c)(3) is exempt, in that case, from such prohibitions on lobbying and attempting to influence legislation. 25 For example, a time bank that is exempt under 501(c)(3) could engage in lobbying if the topic of the legislation is one that would prevent the time bank from operating effectively. A great resource on the topic of lobbying by nonprofits is Alliance for Justice. 26

Public Charity versus Private Foundation

There is another important consideration for 501(c)(3)s. A 501(c)(3) may be either a private foundation or a public charity. The default presumption is that it is a private foundation. However, most 501(c)(3)s would rather be a public charity because private foundations are somewhat more constrained in their activities. To be a public charity, the 501(c)(3) must have broad public support as opposed to receiving most of its funds from one or two private individuals, family foundations, or corporations. The tests for what is sufficient public support are very complicated and beyond the scope of this website, but it is yet one more thing that the managers of 501(c)(3)s must concern themselves with.

State Law Issues

In addition to the numerous complicated federal tax law rules that govern 501(c)(3)s, nonprofits are also governed by the laws of the states in which they are formed and operate. Most states regulate fundraising activities of charities, require charities to register with the state, and regulate charities to ensure they are serving public purposes. In addition, gaining tax-exempt status at the federal level does not guarantee you exemption from all state taxes.

Pros and Cons of 501(c)(3) organizations

  • How They Can Raise Capital

501(c)(3)s have almost exclusive access to one source of capital: grants and donations. This is because grants and donations to 501(c)(3)s are tax-deductible to the donor and because most foundations only make grants to 501(c)(3)s (due to regulations governing foundations). This is a great advantage to an organization that thinks it might be attractive to donors.

On the other hand, unlike for-profit entities, 501(c)(3)s cannot raise equity capital from investors. 501(c)(3)s are not and cannot be “owned” by investors, so they have no equity to sell to investors, and they cannot pay returns to investors. 501(c)(3)s can raise money using loans, but they must not pay more than “market rate” interest (to avoid violating the private inurement rules).

  • Limitations on Activities

As discussed in detail above, 501(c)(3)s are extremely limited in the activities they can conduct.

  • Limitations on Use of Funds

Funds cannot be used to reward investors. And they cannot be used to provide “excess benefit” to any private person or business. And (except on a very small scale), they cannot be used for lobbying or to conduct “unrelated activities.”

  • Highly Regulated

In addition to all of the limitations described above, 501(c)(3)s generally have a fairly heavy burden in terms of reporting, record keeping, adopting, and implementing policies to ensure compliance, etc. This can all impede the ability of an organization to achieve its goals in helping to build the sharing economy.

  • Involvement of Volunteers

There is one major benefit of using a 501(c)(3) form. People are generally able to volunteer for charitable or humanitarian purposes without triggering the protections of employment law, thus it is much easier for 501(c)(3)s to utilize volunteers without running afoul of employment law.

Other Nonprofit and Tax-Exempt Variations

State Law Variations

Every state has at least one statute that authorizes the formation of a nonprofit organization. For example, in California, we have nonprofit unincorporated associations, nonprofit public benefit corporations, nonprofit mutual benefit corporations, nonprofit religious corporations, nonprofit corporations for medical services, nonprofit health care service plans, nonprofit legal services corporations, nonprofit hospital service plans, nonprofit cooperative agricultural marketing associations, and nonprofit medical associations.

And to make things even more complicated, some structures that are normally considered for-profit can be structured as nonprofits. For example, it is possible to form an LLC that has certain characteristics and then to apply to the IRS for tax exemption. 27

Once an organization chooses a state statute to form under, the next step is to consider tax exemption. There is state and federal income tax exemption (not to mention state exemptions from sales and use tax, property tax, etc.), but generally it is a good idea to think about federal taxation first because most states follow the federal income tax exemption framework.

Other Federal Tax Exemption Categories

There are 28 categories of tax-exempt organizations listed in Section 501(c). Note that there are also other sections of the Internal Revenue Code that create other tax-exempt statuses, such as 521 cooperatives (discussed below), 501(d) apostolic organizations, and 528 homeowners associations.

The most commonly used exemption is 501(c)(3) because a 501(c)(3) is eligible to receive tax-deductible donations. However, some organizations that do not qualify under that exemption need to consider other options. An organization that wants to be able to participate in substantial lobbying activity should probably not apply for 501(c)(3) tax exemption—other exemptions do not impose the strict limitations on lobbying that Section 501(c)(3) does. Also, if an organization’s activities don’t fall within the activities that may be conducted by a 501(c)(3), the organization will need to consider other categories.

Section 501(c)(4)

Many organizations characteristic of a sharing economy could likely obtain tax exemption under 501(c)(4), even though they likely could not have under 501(c)(3). Examples of activities that are somewhat better suited to 501(c)(4) exemption include farmers markets, time banks, local currencies, and car-sharing organizations that offer membership to the public.

An organization exempt under 501(c)(4) is known as a civic league or social welfare organization. It operates primarily to further the common good and general welfare of the people of the community. Examples include community associations that work to improve public services, housing, and parking, that publish a free community newspaper, that sponsor community sports leagues, or that contract with a private security service to patrol the community.

Some practitioners call this exemption 501(c)(3) “light.” In other words, an organization that looks a lot like a 501(c)(3) but does not quite meet the stringent requirements for exemption under that section may qualify for this exemption. The IRS has sought to explain the purpose of 501(c)(4)s as follows:

There is no official Congressional or Service pronouncement construing the terms “civic league” or “social welfare” as embodied in section 501(c)(4). However, [the Sixth Circuit Court of Appeals] described [501(c)(4)s] as embodying “the ideas of citizens of a community cooperating to promote the common good and general welfare of the community.” [The Fourth Circuit] described a civic organization as being “a movement of citizenry or the community,” whereas the [the Third Circuit] while acknowledging the difficult task in arriving at a specific definition of “civic organization,” stated that “the organization must be a community movement designed to accomplish community ends. 28

For example, IRS Revenue Ruling 75-286 concluded that an organization formed by the residents of a city block to preserve and beautify that block may qualify for exemption under Section 501(c)(4), even though the element of private benefit is sufficient to disqualify it from exempt status under Section 501(c)(3).

An organization claiming exemption under Section 501(c)(4) must operate for the benefit of the community as a whole rather than for the benefit of a limited group:

Compare Rev. Rul. 78-69, 1978-1 C.B. 156, which holds that an organization providing rush hour commuter bus service to all residents of a community qualifies for exemption under IRC 501(c)(4), with Rev. Rul. 55-311, 1955-1 C.B. 72, which holds that a local association of employees operating a bus primarily for the convenience of its members does not so qualify. Also compare Rev. Rul. 62-167, 1962-2 C.B. 142, which holds that an organization retransmitting television signals for the benefit of an entire community qualifies for exemption under IRC 501(c)(4), with Rev. Rul. 54-394, 1954-2 C.B. 131, which holds that an organization providing television on a cooperative basis does not qualify. See also GCM 39357 (May 3, 1985) which concluded that an employee health club in which membership is available only to salaried employees can qualify under section 501(c)(4), but as a local association of employees. 29

Similarly, cooperative organizations formed to benefit their members, such as an organization to purchase food in bulk for its members, have been denied exemption under Section 501(c)(4). 30

Section 501(c)(5)

Organizations that work to better the conditions of agriculture or horticulture may be eligible for tax-exempt status under Section 501(c)(5). 31 The activities of these organizations may include raising livestock, managing forests, cultivating land, raising and harvesting crops or aquatic resources, cultivating useful or ornamental plants, and similar pursuits.

The primary purpose of exempt agricultural and horticultural organizations under Section 501(c)(5) must be to better the conditions of those engaged in agriculture or horticulture, develop more efficiency in agriculture or horticulture, or improve the products, for example:

  Promoting various cooperative agricultural, horticultural, and civic activities among rural residents by a state and county farm and home bureau;

•  Exhibiting livestock, farm products, and other aspects of agriculture and horticulture;

•  Testing soil for members and nonmembers of the farm bureau on a cost basis, the results of the tests and other recommendations being furnished to the community members to educate them in soil treatment;

•  Guarding the purity of a specific breed of livestock;

•  Encouraging improvements in the production of fish on privately owned fish farms;

•  Negotiating with processors for the price to be paid to members for, but not acting as an agent to help members sell, their crops; and

•  Operating an educational rodeo show promoting agriculture.

Section 501(c)(6)

An organization exempt under 501(c)(6) is known as a business league or chamber of commerce. The purpose of the organization must be to promote the common business interest of a group of persons. It may not engage in a regular business of a kind ordinarily carried on for profit. In addition, the organization must receive support from its members.

An organization does not qualify for exemption under Section 501(c)(6) if any of its net earnings inures to the benefit of any member. Members may nevertheless receive some kinds of benefits from the organization, such as newsletters and similar material, and may benefit indirectly from the organization’s activities (i.e., the successful promotion of a common business interest will indirectly benefit the members).

Many organizations that promote the interests of socially responsible, sustainable business use this exemption category. For example, most of the local chapters of Business Alliance for Local Living Economies and American Independent Business Alliance are exempt under 501(c)(6). These organizations conduct activities like promoting Shop Local First, member networking events, educational workshops, etc.

Section 501(c)(7)

Section 501(c)(7) is a category of exemption designed for social, recreational, and “other nonprofitable purposes.” 32 Section 501(c)(7) is designed to provide tax exemption to organizations that groups form for their own benefit, rather than for a public benefit. In that respect, many activities of the sharing economy may fall within 501(c)(7). A community association whose primary function is to own and maintain recreational areas and facilities for its members can likely obtain exemption under 501(c)(7). A group of people that get together to share recreational equipment or facilities could seek tax exemption under this section. See Chapter 9 for additional discussion of 501(c)(7)s and the provision of amenities in relation to shared housing.

The rationale for granting tax exemption to a social club is that since individuals can participate in social and recreational activities without tax consequences, individuals that form a group to do such activities should be in the same position tax-wise as they would be if they did the activity on their own. Because of this reasoning, 501(c)(7) organizations must derive most of their income from their members and any income received from nonmember sources is taxed as unrelated business income. 33

Note that even though the phrase “other nonprofitable purposes” may sound like a catch-all to include many types of activities, the IRS will generally deny exemption for activities that are not sufficiently connected to or in furtherance of social, recreational, or other pleasure activities. 34 It’s easy to see how this can become a gray area in the sharing economy. Many things we do for the purpose of providing for ourselves will also, preferably, be enjoyable, like meal sharing, community gardening, neighborhood home repair groups, shared workshop spaces, tool-lending libraries, and so on. It’s odd that the IRS has so clearly carved out a form of tax exemption to allow us to spend money and have fun together, but there is not a perfect category to allow us to spend money and share practical things.

Under 501(c)(7), a group could likely share a boat or recreational vehicle; however, if a group forms a nonprofit mutual benefit corporation simply to share one or a few cars for regular and practical use, the IRS might deny exemption, unless the group could prove that the purpose is truly social or recreational. The question is: how much fun do these activities have to be or how much socializing must happen in connection with such activities in order to obtain exemption under 501(c)(7)? Could the IRS be persuaded that we do all of this for social purposes? Could the IRS be persuaded that all of this is for the purpose of making life more enjoyable? It will be fun, at the very least, to have this conversation with the IRS.

Sections 501(c)(8) and 501(c)(10)

The IRS is aware of more than 100,000 fraternal organizations, which is evidence that they play a significant role in our society and economy. 35 It is worth further inquiry to determine the extent to which fraternal organizations, and their related tax-exemption categories, could serve as platforms for the sharing economy. Mutual aid societies—groups of people who come together to provide support to one another in times of need—are key institutions for the creation of a more sharing economy. Fraternal beneficiary societies that provide for the payment of life, sick, accident, or other related benefits are exempt from taxation under Section 501(c)(8). Fraternal societies exempt under Section 501(c)(10) are essentially the same as fraternal beneficiary societies except that no payments of benefits are offered. Both types of societies must engage in “fraternal activities,” such as social activities, ceremonies, rituals, and so on, and an organization found to be lacking in such things will not be found to be tax-exempt.36 For example, an organization formed simply to provide financial support and insurance to its members would not be found exempt under this category.

Fraternal beneficiary societies have been described as follows:

A fraternal beneficiary society … would be one whose members have adopted the same, or a very similar calling, avocation, or profession, or who are working in union to accomplish some worthy object, and who for that reason have banded themselves together as an association or society to aid and assist one another, and to promote the common cause. The term “fraternal” can properly be applied to such an association for the reason that the pursuit of a common object, calling, or profession usually has a tendency to create a brotherly feeling among those who are thus engaged. 37

An interesting and inconvenient characteristic of organizations seeking exemption under Section 501(c)(8) or Section 501(c)(10) is that they must operate under the “lodge system.” Treasury Regulation 1.501(c)(8)-1 states that operating under the lodge system means “carrying on its activities under a form of organization that comprises local branches, chartered by a parent organization and largely self governing, called lodges, chapters, or the like.” 38 The requirement to operate under a lodge system makes it somewhat difficult for minority groups to form new fraternal beneficiary societies, since they would need to, in theory, first form multiple organizations and then subsume them under a parent organization. By virtue of being part of a minority, it may be hard for such groups to find enough people to achieve a “lodge system.” For example, if a group of Eritrean immigrants wished to form a society to provide “life, sick, accident or other related benefits” to one another, they might need to find or form a second group of Eritrean immigrants to do the same. Nevertheless, it is worth further inquiry to determine how 501(c)(8) and 501(c)(10) exempt organizations could be employed to serve the sharing economy.

Section 501(c)(12)

Section 501(c)(12) exemption is for benevolent life insurance associations, mutual ditch or irrigation companies, mutual or cooperative telephone companies, and “like organizations.” 39 They are organized to provide these services to their members at the lowest possible cost. These organizations must use their income solely to cover losses and expenses, with any excess being returned to members or retained for future losses and expenses. They must collect at least 85 percent of their income from members for the sole purpose of meeting losses and expenses. “Like organizations” may sound like a catch-all, but it is somewhat narrowly defined and does not include organizations in most other sectors. For example, a housing cooperative applied for and was denied exemption under 501(c)(12). 40 However, funeral cooperatives, 41 cable television cooperatives, 42 and energy services 43 have been found to be “like organizations.” This leaves open the question of what other kinds of modern communication cooperatives (like internet service providers), personal services, or renewable energy cooperatives might be found to be exempt under 501(c)(12). 44

Sections 521 and 501(c)(16)

Section 521 provides favorable tax treatment (though not complete exemption) to farmer cooperatives that meet a list of requirements, which include that the “primary activity must be to market the products of members and other producers and/or purchase supplies and other equipment for members and other persons” and “[t]hey must pay patronage refunds to all patrons (members and nonmembers alike) on the same basis.” 45 Nonprofit organizations exempt from tax under Section 501(c)(16) are organized by Section 521 cooperatives for the purpose of financing the ordinary crop operations of members or other producers.

Nonprofits Without Tax Exemption

Some organizations form under a state nonprofit statute but do not apply for tax-exempt status for various reasons. For example, nonprofit corporations that primarily engage in social enterprise business activities may be happy to be taxed like normal corporations, since applying for tax exemption might put too many constraints on how they operate or might completely prevent them from engaging in business activities. If the entity is designed to operate at cost, it will likely have very little net income on which to pay taxes, though it may be subject to payment of minimum taxes in some states.

Even without tax exemption, there are benefits to operating a social enterprise as a nonprofit rather than a for-profit. In a nonprofit, no individual will be entitled to a share of the profits, which removes some of the incentives typical business owners have to steer away from the mission and focus only on profits. Being a nonprofit may also bring a business greater public trust than if the business were owned by private individuals.

State nonprofit corporations statutes may or may not specify the purposes for which the corporation may operate. In California, for example, nonprofit public benefit corporations must operate for “public or charitable purposes.” 46 It’s not entirely clear what can constitute a “public” purpose, but this could conceivably include many more social enterprises than would be permitted under 501(c)(3).

Some nonprofit statutes like the California nonprofit mutual benefit corporation statute do not restrict what types of activities may be done by organizations formed under them. In those cases, almost any type of business could form under such a statute and not apply for tax-exempt status. This would generally mean (depending on the details of the statute) that during the life of the organization, no distributions would be made to investors. Although they are generally prohibited from distributing profits, under some state laws, mutual benefit nonprofits may, upon dissolution, distribute assets to members. 47 This means that individual members may have some incentive to cash out by selling assets of the enterprise and dissolving the entity.

Another example of nonprofits that operate without tax exemption are medical marijuana collectives (legal under California law) formed as California nonprofit mutual benefit corporations. They do not apply for federal tax exemption because trafficking in marijuana is not legal under federal law.

Nonprofit/For-Profit Hybrids

As discussed above, tax-exempt 501(c)(3) nonprofits are constrained in the kinds of activities they can do, how they can raise money, and how they can share profits. However, there are many successful models for social enterprises or entrepreneurial nonprofits. They differ from traditional nonprofits because their funding tends to come from a blend of traditional nonprofit sources (grants and donations) and entrepreneurial activities. This section provides some examples of these models as well as guidance on their legalities.

Fee for Service

Underwriters Laboratories (UL) generates a good portion of its revenue through fees received from a safety certification process. Others, such as Business for Social Responsibility (BSR), generate revenue from membership fees, conference fees, and a store that sells books and other materials on corporate social responsibility. Many nonprofit schools charge tuition. Generally, nonprofits may charge fees for the related services they provide so long as the fees are designed to cover costs.

Revenue-Generating Activities and Subsidiaries

Nonprofit organizations may generate revenue from their activities so long as the activities are related (see above[link] regarding related versus unrelated activities). Nonprofits may also generate revenue from unrelated activities as long as these unrelated activities are not “substantial.” If a nonprofit wishes to conduct a substantial activity that it fears the IRS will see as unrelated, the nonprofit will often create a for-profit subsidiary to conduct the activity. The nonprofit can receive profits from the subsidiary in the form of dividends or can collect other kinds of payments from the subsidiary such as rent or consulting fees. The for-profit can make donations to the nonprofit, but they would not be tax-deductible. 48he subsidiary cannot make tax-deductible contributions to the Section 501(c)(3) organization because the organization controls the subsidiary”).] Income from rents, royalties, or interest that flows to the nonprofit will result in Unrelated Business Income Tax (or UBIT), if the nonprofit owns more than 50 percent of the subsidiary for-profit. The nonprofit does not pay tax on dividends received. 49

Joint Ventures

Nonprofits may enter into “joint ventures” with for-profits. For example, a nonprofit could form an LLC and sell 99 percent of the ownership interest in the company to outside investors. There are strict rules governing these kinds of ventures. The venture must be set up to achieve one of the nonprofit’s charitable purposes. Joint ventures are common in the affordable housing sector. A nonprofit whose purpose is to develop affordable housing can raise money to be able to complete a project by selling interests in the project (owned by an LLC) to investors. In a joint venture involving a pass-through entity like an LLC or limited partnership, the activities of the venture will be imputed to the nonprofit. To ensure that participation in the joint venture is not deemed unrelated activity, the nonprofit must maintain control of the venture to ensure that the charitable purpose (and not investor profit) remains primary. The nonprofit can maintain control in the venture by including certain provisions in the operating agreement, including provisions that require the nonprofit to approve certain decisions, or allow the nonprofit to appoint the governing body, etc. Investors’ return should be reasonable and not excessive. 50


Sponsorships are a method by which nonprofits can receive revenue without it being considered unrelated business income. If a business provides funds, goods, or services to the nonprofit and the nonprofit publicly acknowledges the sponsor by, for example, including its name and logo on the nonprofit’s website, the funds are not considered unrelated business income. This is in contrast to a situation in which a business pays a nonprofit for advertising.

What is the difference between advertising and sponsorship? If the nonprofit merely acknowledges the business, then it is a sponsorship, but if it endorses or recommends the business, it is advertising. Also, if payment to the nonprofit is contingent on factors such as the number of eyeballs on a website or the number of attendees at an event, the payment will be treated as unrelated business income and therefore subject to taxation.


Another way that a 501(c)(3) can generate revenue that is not subject to the unrelated business income tax is through royalties. A royalty is a payment related to the use of a right. Examples include payments for the use of trademarks, trade names, service marks, or copyrights. When you see a credit card with the logo of a nonprofit on it, this is an example of a royalty arrangement. When a nonprofit rents its mailing list to a for-profit, this is also considered a royalty arrangement. Royalty arrangements must be passive to be exempt from taxation. So, if a nonprofit provides services in conjunction with the use of its mailing list or logo, the payment will likely be subject to tax.

Nonprofits Can Fund For-Profits Entities, Within Limits

Nonprofits are not completely barred from assisting for-profit entities, including through the transfer of funds.  On the contrary, it happens all the time.  The key is that the nonprofit remains within its tax-exempt purpose and the for-profit generally must treat any funds received as income for tax purposes.  Here are some typical examples:

1.  A nonprofit can pay a for-profit to do work as long as the payment is beneficial and fair to the nonprofit. For example, a nonprofit that receives a grant to build a model green home and does not have the expertise to build the home itself may contract with a for-profit to build the home, as long as the payment to the for-profit is not above market rate and is negotiated at arms’ length.

2.  A nonprofit can conduct activities that directly benefit private businesses if those activities further the nonprofit’s charitable purpose. So, for example, a nonprofit whose mission is to help disadvantaged small businesses can make low-interest loans to such businesses. And a nonprofit whose mission is to help low-income individuals find employment can provide free employee training services that benefit for-profit businesses.

3.  Foundations can make loans to and invest in for-profit businesses to achieve their mission if the primary purpose of the loan or investment is charitable or educational. This is called a Program Related Investment (PRI) and is becoming increasingly popular (though still relatively rare) among foundations.

4.  A for-profit business that conducts activities that would be eligible for tax-exemption can receive grant funds via a fiscal sponsorship arrangement. For example, let’s say a for-profit acupuncture business would like to conduct free or low-cost community workshops about alternative medicine. The for-profit could find a nonprofit fiscal sponsor for the educational program it wants to conduct and could apply for grants under the fiscal sponsor’s name. The nonprofit could contract with the for-profit to conduct the workshops at market rate.

Local Government Ownership of Enterprise51

Municipal enterprises have different goals and time horizons than traditional companies. The aim is not to maximize profits but to develop a community asset that meets the needs of residents and benefits the community. As a number of experts have noted, a new strategy may be emerging: instead of offering incentives for businesses to relocate, municipalities are using their own investment capacity to start city-run businesses.

City-owned enterprises operate in areas such as energy, telecommunications, solid waste services, convention centers, ports, airports, transit systems, hospitals, parking garages, golf courses, and even hotels and liquor stores.

Hutchinson, Minnesota, owns a recycling business that collects organic material for its Creek Side Soils brand of compost and colored mulch, which is sold to retailers, golf courses, and individuals. The city also owns a hospital, electric plant, liquor store, local cemetery, and airport.

When city leaders in Glasgow, Kentucky (pop. 14,000), became concerned about the high price of cable services, they decided to create a community-owned service that now charges just $27.50 a month. They are also one of the few cities to offer an alternative to the local commercial phone service.

Some two dozen rural towns in Vermont have joined together to create the East Central Vermont Community Fiber Network, to bring state-of-the-art broadband services to their residents.

Checklists for Forming a Nonprofit

Below are straightforward checklists to help in the establishment of a nonprofit corporation in various states:


  1. One example is nonprofit medical marijuana collectives formed under the laws of several states that permit such collectives but require them to be operated as nonprofits. These organizations do not seek federal tax-exempt status because their activities would not qualify for it; in fact, they are federally illegal.
  2. Note, however, that IRS Publication 557 (Oct. 2011, at 25) indicates that an organization that normally receives less than $5,000 per year in gross income need not submit a Form 1023 application for tax exemption in order to be tax exempt. Such organizations are exempt automatically if they meet the requirements of section 501(c)(3).
  3. I.R.C. § 170(b)(1)(A)(vi).
  4. IRS Regulations state that it must be operated substantially, not exclusively, for these purposes. Treasury Regulation § 1.501(c)(3)-1(c)(1) (as amended in 1990) states that an organization will be regarded as “operated exclusively” for one or more exempt purposes only if it engages primarily in activities which accomplish one or more of such exempt purposes specified in section 501(c)(3). An organization will not be so regarded if more than an insubstantial part of its activities is not in furtherance of an exempt purpose.
  5. Brad Caftel, Nat’l Econ. Dev. & Law Ctr., Legal Structure Issues in the Development of Business Ventures (Apr. 2001), (citing Rev. Rul. 76-37, 1976-1 C.B. 148 (1976); Rev. Rul. 66-257, 1966-2 C.B. 212 (1966); Rev. Rul. 74-587, 1974-2 C.B. 162 (1974); Rev. Rul. 68-167, 1968-1 C.B. 255 (1968); Rev. Rul. 78-428, 1978-2 C.B. 177 (1978)).
  6. IRS Release No. 200802036, available at
  7. IRS Release No. 200802036, available at
  8. Brad Caftel, Nat’l Econ. Dev. & Law Ctr., Legal Structure Issues in the Development of Business Ventures (Apr. 2001),, note 52 (citing Rev. Proc. 96-32, 1996-1 C.B. 717 (1996); Rev. Rul. 74-587, 1974-2 C.B. 162 (1974); Rev. Rul. 76-419, 1976-2 C.B. 146 (1976)).
  9. Robert Louthian & Amy Henchey, Lessening the Burdens of Government (IRS Exempt Organizations Topic 93, 1993), available at
  10. Robert Louthian & Amy Henchey, Lessening the Burdens of Government (IRS Exempt Organizations Topic 93, 1993), available at
  11. IRC 501(c)(3) Organizations and Publishing Activities (IRS Exempt Organizations Topic 88, 1988), available at
  12. Rev. Rul. 77-4, 1977-1 C.B. 141.
  13. BSW Grp., Inc. v. Comm’r, 70 T.C. 352 (1978).
  14. BSW Grp., Inc. v. Comm’r, 70 T.C. 352 (1978).
  15. I.R.S. Priv. Ltr. Rul. 2008-32-027 (Aug. 8, 2008).
  16. Environmental and Historical Preservation Under IRC 501(c)(3) (IRS Exempt Organizations Topic 79, 1979), available at
  17. Rev. Rul. 70-186, 1970-1 C.B. 128.
  18. Rev. Rul. 68-14, 1968-1 C.B. 243.
  19. Rev. Rul. 78-85, 1978-1 C.B. 150.
  20. Rev. Rul. 76-204, 1976-2 C.B. 152.
  21. Rev. Rul. 76-204, 1976-2 C.B. 152..
  22. Rev. Rul. 78-384, 1978-43 I.R.B. 8.
  23. Pub. L. No. 96-541, Sec. 6 (1980).
  24. William T. Hutton, Agricultural Perservation: A Model Letter for Protesting Denial of Tax-Exempt Status, in The Back Forty Anthology: Selected Articles from the Newsletter of Land Conservation Law 1.13-1.18 (Hastings College of Law ed. 2003).
  25. IRM § (Feb. 22, 1999).
  26. Alliance for Justice,
  27. For details, see Richard A. McCray & Ward L. Thomas, Limited Liability Companies as Exempt Organizations (IRS Exempt Organizations Topic 00, 2000), available at
  28. Social Welfare: What Does It Mean? How Much Private Benefit Is Permissible? What Is a Community? (IRS Exempt Organizations Topic 81, 1981), available at
  29. Virginia Richardson, Roderick Darling & Marvin Friedlander, Health Clubs 18–19 (IRS Exempt Organizations Topic 00, 2000), available at
  30. Social Welfare: What Does It Mean? How Much Private Benefit Is Permissible? What Is a Community? (IRS Exempt Organizations Topic 81, 1981), available at, at 15.
  31. John Francis Reilly, Carter C. Hull, & Barbara A. Braig Allen, IRC 501(c)(5)
    Organizations  (IRS Exempt Organizations, 2003).
  32. See Jim Langley & Conrad Rosenberg, Social Clubs—IRC 501(c)(7) (IRS Exempt Organizations-Technical Instruction Program 1996), available at
  33. See Jim Langley & Conrad Rosenberg, Social Clubs—IRC 501(c)(7) (IRS Exempt Organizations-Technical Instruction Program 1996), available at
  34. See Rev. Rul. 75-494, 1975-2 C.B. 214.
  35. For more information, see Sean M. Barnett & Ward L. Thomas, IRC 501(c)(8) Fraternal Beneficiary Societies and IRC 501(c)(10) Domestic Fraternal Societies (IRS Exempt Organizations Continuing Professional Education Topic 2004).
  36. Phila. & Reading Relief Ass’n, 4 B.T.A. 713 (1926).
  37. See Sean M. Barnett & Ward L. Thomas, IRC 501(c)(8) Fraternal Beneficiary Societies and IRC 501(c)(10) Domestic Fraternal Societies (IRS Exempt Organizations Continuing Professional Education Topic 2004)(quoting Nat’l Union v. Marlow, 74 F. 775, 778–79 (8th Cir. 1896)).
  38. Fraternal Beneficiary Societies and Fraternal Societies (IRS Exempt Organizations Topic 80, 1980), available at
  39. For more information, see Organizations Exempt Under IRC 501(c)(12), IRM § 7.25.12.
  40. Rev. Rul. 65-201, 1965-2 C.B. 170.
  41. Thompson v. White River Burial Ass’n, 178 F.2d 954 (8th Cir. 1950).
  42. Rev. Rul. 83-170, 1983-2 C.B. 97.
  43. I.R.S. Priv. Ltr. Rul. 97-15-045 (Jan. 16, 1997).
  44. For more information about 501(c)(12)s, see Michael Seto & Cheryl Chasin, General Survey of I.R.C. 501(c)(12) Cooperatives and Examination of Current Issues (IRS Exempt Organizations Continuing Professional Education Topic 2002).
  45. Donald A. Frederick, Income Tax Treatment of Cooperatives: Internal Revenue Code § 521, pt. 4 (2005 ed.), available at
  46. Cal. Corp. Code § 5111.
  47. See, e.g., Cal. Corp. Code § 8717.
  48. Brad Caftel, Nat’l Econ. Dev. & Law Ctr., Legal Structure Issues in the Development of Business Ventures (Apr. 2001), (citing Rev. Rul. 68-296, 1968-1 C.B., which provides that “[t
  49. IRS Publ’n 598, Tax on Unrelated Business Income of Exempt Organizations.
  50. Brad Caftel, Nat’l Econ. Dev. & Law Ctr., Legal Structure Issues in the Development of Business Ventures (Apr. 2001),
  51. This section is adapted from Marjorie Kelly & Shanna Ratner, Keeping Wealth Local: Shared Ownership and Wealth Control for Rural Communities (Tellus Inst. & Yellow Wood Assocs. 2009).