“Nonprofit,” “tax-exempt,” and “charity” get used interchangeably. They are three different things, and if you are starting an organization, donating to one, or sitting on a board, the differences matter.
Three different labels
Nonprofit is a state-law concept. It describes how an organization is formed and what happens to its money: a nonprofit corporation has no owners and cannot distribute profits to insiders. It can absolutely earn revenue and pay salaries. “Nonprofit” says nothing, by itself, about taxes.
Tax-exempt is a federal tax concept. An organization applies to the IRS for exemption from federal income tax. There are more than two dozen categories under Section 501(c) of the tax code: trade associations, social clubs, labor unions, and more. Most are tax-exempt, but donations to them are not tax-deductible.
Charity usually means the most famous category: 501(c)(3). These organizations must be organized and operated for purposes the law treats as charitable, such as relief of poverty, education, religion, health, and a handful of others. Donations to a 501(c)(3) are generally tax-deductible, which is why the status is valuable and why it comes with the most strings attached.
Public charity vs. private foundation
Inside 501(c)(3), the law draws one more line, and it is the one my title is about. Every 501(c)(3) is classified as either a public charity or a private foundation.
The core difference is where the money comes from:
- A public charity draws broad support from the general public, government grants, or fees for charitable services. Think food banks, schools, hospitals, community legal aid organizations, your local land trust.
- A private foundation is typically funded by one source: a family, an individual, or a company. It usually makes grants rather than running programs. Think of a family foundation that gives money to public charities.
Why does the line matter? Private foundations face stricter rules: an excise tax on investment income, minimum annual payout requirements, and tighter self-dealing prohibitions. Public charities get lighter regulation on the theory that broad public support is itself a form of accountability. If the public funds you, the public is watching you.
New 501(c)(3)s are classified when the IRS approves them, and an organization that stops meeting the public support test can be reclassified. Founders sometimes discover this the hard way when one big donor starts supplying most of the budget.
Who keeps charities accountable
Three layers, in practice:
Boards. A charity’s directors owe fiduciary duties, most importantly care and loyalty. Charitable assets are held for the mission, not for the people who manage them. A board member who steers contracts to their own business, or who simply never reads the financials, is failing a legal duty, not just an ethical one.
The IRS. It polices the tax side: whether the organization still qualifies for exemption, whether insiders are being overpaid (the “private benefit” and “excess benefit” rules), and whether the annual Form 990 gets filed. The 990 is public, which makes it the single best research tool for anyone evaluating a charity.
State attorneys general. This is the layer most people have never heard of. In most states, the attorney general oversees charitable assets on behalf of the public, because the “beneficiaries” of a charity (the public) cannot sue to protect themselves the way shareholders can. State charity regulators register nonprofits, review certain major transactions, and can go to court when charitable assets are misused. It is a quiet, structural area of law, and it is where a lot of the real accountability work happens.
Why this matters to real people
If you are donating, check that the organization is actually a 501(c)(3) public charity (the IRS has a public search tool) and skim its Form 990 before writing a large check.
If you are founding something, the choices you make at formation, state incorporation, IRS classification, public support planning, and board structure, will shape everything downstream. I spent thirteen years running a nonprofit before law school, and most of the painful problems I watched organizations hit were formation and governance problems that a few hours of good legal planning would have prevented.
If you are joining a board, understand that it is a legal role, not an honorary one. Read the bylaws, read the financials, and know what your duties of care and loyalty require.
Charity law sits at an interesting intersection: it is business law, tax law, and public interest law at the same time. That is part of why I find it worth writing about.
For more plain-English legal terms, see the glossary.
Further reading
- Who Oversees Nonprofits? State Attorneys General, Plainly
- Plain-language legal glossary
- Nonprofit Law: all posts
I am a law student, not a lawyer. Nothing on this site is legal advice. If you are facing a legal issue, talk to a licensed attorney in your state.
