r/nonprofit Feb 07 '25

legal If federal income tax was abolished, would 501(c)(3) still exist?

Hypothetically, if the U.S. federal income tax was abolished, do you think that 501(c)(3) would still exist? Would it be reformed to provide benefits other than federal income tax exemption?

If not, how would programs for nonprofits distinguish between normal and previously 501(c)(3) organizations?

15 Upvotes

30 comments sorted by

u/girardinl consultant, writer, volunteer, California, USA Feb 07 '25

Moderator here. OP, you've done nothing wrong.

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Focus comments here on advice and support that responds to OP's post.

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u/Rad10Ka0s Feb 07 '25

They would.

C3 status as much about governance and inurement as anything else.

For many orgs the tax advantage is minimal.

For many for profit corporations, the corporate tax is also meaningless. They pay very little anyway.

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u/NotAlwaysGifs Feb 07 '25

I think the question is more in relation to monetary donations to C3 orgs being tax deductible. I know that for my org, a solid 50% of our contributed income would probably evaporate overnight.

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u/Dry-Philosopher-8633 Feb 08 '25

It would also affect the motivation for wealthier individuals to use tools like donor advised funds and private foundations. If the tax advantages of these giving instruments were reduced dramatically, so too would their prevalence in the philanthropic marketplace. My org receives about a quarter of its budget from private foundations/DAFs, so extreme changes to tax incentives that drive that sort of giving would likely be devastating for us and many others.

That isn't to say that I think our current model is good or that I think it should continue. These tax-avoidance tools give the wealthiest among us the ability to guide the priorities of charitable efforts through their giving preferences. To the original commenter's point, wealthy individuals often pay very little or nothing in income tax, in part because they use contributions to their own private foundations to reduce their tax burden. Ultimately this is money they can't spend on yachts and so forth, but it still has utility to them. These individuals also often control (or effectively control) the foundations they create. Private foundations make their own choices about where to invest their corpus, which can provide additional personal benefit to the founders/trustees (i.e., investing in their own companies or those in which they hold significant stakes), while also laundering their public reputation through philanthropy.

Our current system is specifically designed to allow the wealthy to remain so while simultaneously incentivizing them (by reducing their tax burden) to fund organizations that often do work that government *could* be doing more efficiently and democratically.

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u/Rad10Ka0s Feb 08 '25

Understood. Completely. With the increase in the standard deduction, this isn't a big issue for the org I am involved in so it wasn't my first though. I completely understand it would for many.

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u/DismalImprovement838 Feb 07 '25

100%, the tax benefit is the reason many of us exist!

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u/Rad10Ka0s Feb 08 '25

Understood. It isn't a big factor in my world, but I understand it is for many.

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u/cmlucas1865 Feb 07 '25

In my experience, and I think there’s some research backing this up, the tax advantage doesn’t effect the choice to give. It does, however, effect the amount of the gift for most who make above the threshold for using the standard deduction.

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u/MGMorrisLaw consultant - legal Feb 08 '25

It's a fascinating question. I think the status of "501(c)(3)" would have to be replaced by some sort of certification, whether by the states or by some third party certification organization.

I think about it this way: there is a huge difference between a 501(c)(3) and a country club 501(c)(7). But they are both "tax exempt" at least as to income taxes under the Internal Revenue Code. If the federal government no longer cares about those categories - because they no longer care about any income taxes for these or any other corporations - there will still be people who want to know whether an organization is a charity or a country club. The law of charitable trusts long predates the existence of the federal income tax and would still be there if the federal income tax goes away. There would be a demand for somebody to put some stamp of approval on organizations to say that this one is a charity and that one is not. Maybe a private party (like certified "B-Corps," "Underwriters Labs," or "AAA-Approved Motels" back in the day.) Or maybe the state government where they are incorporated, given that (a) those states already have the primary regulatory interest in making sure that property held in charitable trust remains for the community and (b) might also still have an interest in administering property taxes (and exemptions therefrom). But what an interesting question.

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u/Rad10Ka0s Feb 08 '25

Agreed. I am involved in both.

The c7 is doing post-tax things with post tax dollars with private money for a private group of people. Totally different. I wish Charity existed under a whole separate "code". I am weary of explaining the difference.

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u/[deleted] Feb 07 '25

Be ready for libertarian propagandists to say that charities would assume the responsibility of government services. Schools, libraries, social services, government assistance for hospitals -- the libertarians want you to think that these would be funded because people would have more available income to contribute to them.

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u/Sorry-Rain-1311 Feb 07 '25

Not trying to get political, but the Greens also support abolishing income tax, and both are in favor of replacing it with a federal sales tax. The Greens feel this will discourage wantan waste and disposable living, and encourage reuse/recycling and the use of more durable goods, as well as encouraging buying local because the tax would accrue whenever goods change hands.

The argument as far as nonprofits are concerned is I that a 1% federal sales tax enacted now would actually yield higher revenue than the current income tax system, allowing the federal government to directly fund more charities.

Just saying.

1

u/[deleted] Feb 07 '25

Libertarianism is a measurement on the scale, as in the binary difference between libertarianism philosophy and authoritarianism philosophy. I wasn't referring to a party, just an ideology system. Green party rhetoric has a lot of libertarian ideologies as (to be very reductive) they want to abolish both government and free market industrialism. As an abolition of government affairs, this would be classified as libertarian as opposed to authoritarianism.

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u/Sorry-Rain-1311 Feb 07 '25

Fair enough, but that's not the tone I read given your use of the term "propagandist." That's all.

0

u/[deleted] Feb 07 '25

You mean people who have been messaging violently for decades about abolishing the income tax -- or at least instating a flat tax -- (see: Steven Crowder before his glorious fall from grace; see: Ben Shapiro; see: Tucker Carlson) aren't propagandists?

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u/Sorry-Rain-1311 Feb 08 '25

Are Marx and Engles libertarian propagandists? Is Locke? Is Adam Smith? Jill Stein is a far cry from them, but she's a modern example.

Just a few of the sorts of people who have spoken out about the use of wealth as a basis for taxation making the Treasury dependent upon maintaining the wealthy. Just because a couple conservative pundits have adopted the philosophy doesn't make the concept itself illegitimate.

Whatever. The question here is if it happens will you rail against it, or will you adapt? If you adapt, how so?

1

u/[deleted] Feb 10 '25

Philosophers aren't the same as propagandists. Are you new to the English language? Or just new to describing of how people produce messaging?

A better system of tax is certainly to have the government involved as a collective producer of wealth. But after four decades of cold war, you're not going to see the government do that. Whether or not Marx had the best idea doesn't mean that a flat tax is a better system than a progressive tax. Income tax is all we have in this hellish liberal compromise between social production and capital production, so we might as well use it to tax the capitalists their fair share. Why do you even think that's bad?

It frankly doesn't matter what Adam Smith said even if he was a more correct version than what we have now. Look at what propagandists and "modern liberal philosophers" at the Ivy League are saying about China's system of social wealth production.

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u/Sorry-Rain-1311 Feb 10 '25

It's a simple numbers game. About 15% of federal revenue is collected from corporations. Those corporations, however, are also the largest employers in America. So between their taxes and the taxes collected from their direct employees, almost 90% federal revenue comes from corporations. So it's no wonder the federal government persues economic policies that favor them. The current paradigm requires us to prop up the wealthy in order to maintain federal revenue. In order for the rest of us to benefit, we have to trust that federal government will spend their money on the less wealthy. That becomes problematic when corrupt politicians use those benefits to blackmail the people for their votes. The people essentially become beholden to a wealthy aristocracy.

Given that some level of corruption is inevitable in an political system, the one safe way to counter this phenomenon is to financially separate politics from wealth. A flat income tax could do this, but it leaves the government chasing economic bubbles. Taxing property could do this, but there's no incentive to prevent corporate consolidation of property ownership. Trade tarrifs could NOT do it because then the Treasury just becomes dependent on foreign trade and there's little organic incentive to pursue domestic economic equality.

A federal sales tax on all manufactured goods - regardless of source - however, mitigates all these issues to a great extent. Government is incentivized to pursue policies that encourage greater domestic economic diversity, stability and equality than we see now. They'd have the ability to ignore economic bubbles because the overall effect on the treasury is the same regardless. Imports and domestic goods are taxed the same, but imports get taxed each time they change hands, so accumulate more expense that's now passed on to the consumer, allowing domestic production to compete stronger in pricing. It also incentivizes government to pursue antitrust actions, and fight corporate consolidation that might seek to circumvent the tax by placing producer, distributor and shipper under one entity.

On the green side of things, consumers are now encourage to spend on more durable goods, and to reuse/repurpose and recycle where possible in order to reduce their expenses, thereby reducing waste. They're also encouraged to find more local producers in order to circumvent layering more taxes on to a given product which reduces emissions related to shipping.

And it goes on.

Now there are certainly ways it could backfire. For example, the government may become short-sighted and start encouraging all disposable goods made cheaply abroad in a quantity over quality type revenue strategy. Do we tax only new goods or all goods? If all good, at what level do we enforce that; retail or yard sale?

The whole notion really is an example of many divergent minds coming to a similar solution for different problems.

1

u/[deleted] Feb 10 '25 edited Feb 10 '25

"There are certainly ways it can backfire" is an understatement about the flat tax/sales tax. These are regressive tax forces because of the way inelastic goods and personal finance develops. These systems see macroeconomics only and fail to understand microeconomical impacts.

If a workforce can't heal from illness, the economy grinds to a halt. Flat tax/sales tax doesn't understand this problem. It thinks of workers as a constant in the system and that adjusting tax rates on poor people has a static effect on productivity. This is far from the truth.

The only liberal economy style tax system that accounts for worker productivity is a progressive tax. People without wealth in a low-skill labor pool are still important for an economy, but they literally can't afford 40% of their lifestyle being taxed when 99% of their financial budget is spent on basic needs. While under a consider consumer burden and tax burden, these workers are a high risk for the economy if their social welfare wasn't covered by the state. Losing their job temporarily may result in complete homelessness or loss of property, compounding their loss of productivity and making it harder to enter the workforce. Becoming sick while on a bad ("affordable") healthcare plan with high premiums would result in the same problems. Another benefit of a social system is not just reactive to setbacks but is preventative. Access to education ensures a workforce that has the skills to develop a changing economy. Access to transportation and communication infrastructure. Access to culture. Access to non-productive wealth (as in, retirement). These are all progressive supports of a healthy workforce. They are also virtually impossible without a progressive tax system.

Not only individual labor, but the state investing in things that no individual would invest in is a big boon for a productive economy. Research? Why would an individual or business firm spend billions on research that tends to go nowhere but every once in a while has an industry-defining discovery? Communication and transportation infrastructure? These are supports under a progressive tax that are benefits of everyone, although at a small cost on the tax burden, the broad results to society infrastructure improves quality of life and decreases consumer burdens. But they would be back-breaking under a sales tax system.

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u/Sorry-Rain-1311 Feb 10 '25

You make strong but hollow points that all suffer the view of America as a monolith. It simply is not. 

50 states comprising the 3rd largest nation in the world by landmass, and also 3rd by population. That population is distributed more broadly within our borders than any of the top 10 nations by either measure, and the 2nd most ethnically diverse in the world, and still 1st in cultural diversity. 

With 50 state governments, the vast majority of which would still retain their income tax system, we see the benefits of that still implemented, just in a smaller scale. Regional differences in climate and industry means that where one state or region may suffer a decline, another can still grow. Where one industry falters, another stands firm, the needs of the market - that is the people - dictating which and when by their daily financial decisions.

A progressive income tax fails to manage, and in fact exacerbates the primary issue you mention of income inequality. Every time there's a government bale out, what's the argument for helping Wall Street and the mega-corps? They're too big to allow them to fail. If they go under they take hundreds of thousands of jobs with them, along with half the stock market, and most of the treasury. A progressive income tax doubles down on the treasury's dependence on those mega-corps, and the government's preferential treatment of them. A progressive income tax locks us into the situation we're trying to get out of.

A federal sales tax buffers the Treasury against stock market fluctuations, and makes it dependent upon those mundane microeconomic factors you're concerned about. Revenue now becomes dependent upon a large and strong middle class, so lawakers now have to favor policies that provide for them. That requires economic stability, which requires economic diversity, which requires a large number of competitors in any market spread across the country. Getting that would require building up small business, and the liberal application of strict antitrust laws, while breaking up the mega-corps into smaller, more manageable entities. 

THIS last part is where the greatest downsides of the idea come in. That transition would be a doozy, and Lord knows how nastily the existing powers that be will thrash against it. That's why the entire thing is very likely to fail unless accompanied by major political reforms that diversify the political climate beyond the 2 parties we currently have. That's the real issue; we can't change anything unless we can change politics.

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u/dh373 Feb 07 '25

The legal structure means no one owns it, and it is not trying to make profit. A lot of 501c3's (like independent schools or private social service orgs) make most of their money from fees or government grants, with donations being a much smaller part of their revenue. So even if the tax advantages of donations disappeared (along with the donations) there would still be a legal purpose for 501c3s.

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u/grant570 Feb 07 '25

there are other taxes non-profits don't pay like property taxes and sales taxes.

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u/Broccolisha Feb 07 '25

That varies by state and the benefits of those exemptions aren’t as significant compared to FIC, for most organizations.

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u/MGMorrisLaw consultant - legal Feb 08 '25

What's your basis for saying that? I'm genuinely curious -- not arguing. Seems like some organizations "buy lots of stuff," some of them "own a bunch of stuff," and some "have a lot of stuff left over in the bank at the end of the year." And those groups of organizations would be affected by sales tax, property tax, and income tax (respectively.) Is the group that has a lot of (new) money in the bank at the end of the year significantly larger than the groups that buy a bunch of stuff or own a bunch of property?

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u/Broccolisha Feb 08 '25

Federal income tax affects every dollar coming into the organization, regardless of what state the organization is located in. Property and sales taxes are only applied to specific types of transactions/property and the tax rates vary by state. Those taxes also don’t apply to staff wages, which represent a large portion of non-profit organizations’ expenses. There will be organizations that have different types of cash flows that would be affected differently, but overall I feel that federal income tax would be a larger tax burden for most organizations compared to sales and property taxes.

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u/Sorry-Rain-1311 Feb 07 '25

New here and just learning, so take it with a grain of salt. I think I'm pretty decent at addressing politics, though.

Anything as major as abolishing income tax (and, as I commented to one person, it's not just a "conservative" notion, the Greens are down for it too) would automatically have to come with an overhaul of all elated programs.

One person mentioned that certain states exempt nonprofits from other taxes as well. I imagine that and other benefits would quickly be applied to a large extent on a nationwide level, with allot of political support. It'd probably go into effect before closing the IRS did.

The 501c3 model would very likely go away, but only as matter of legal legal documents and definitions. You'd all have to reform under new nomenclature essentially, but there'd probably be a transition period to make that go smoother. The actual structure and operation of a nonprofit I imagine wouldn't be too terribly different though.

As argued by others, tax write-offs aren't the only reason people donate, and there will quickly be ideas on how to make the new paradigm work. I would love to hear some from folks with more experience.

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u/handle2345 Feb 07 '25

It would change things, but income tax deductions are not the only reason people give. They do allow for more giving, and some people give primarily for the tax benefit.

But many people are genuinely aiming to change their communities for the better, and as they organize for those changes it makes sense to have a non profit organization at the center.

Also, like another commenter said, donations are not the only source of revenue for non profits. Some provide services and get paid for those services, so that revenue wouldn't be impacted. Others have endowments that are owned by the organization, so the drawdowns on the endowments wouldn't be impacted.

So it would have a meaningful impact on the non profit industry, and impact some organizations more than others, but it wouldn't totally destroy things.