What a 501(c)(3) Can and Cannot Spend Money On

A 501(c)(3) organization can spend money on anything that advances its tax-exempt mission, whether that’s direct program work, the overhead that keeps the organization running, reasonable pay for staff, capital assets, fundraising, or a limited amount of lobbying. What a 501(c)(3) cannot spend money on is narrower but absolute: no private enrichment of insiders, no political campaign activity for or against candidates, no lobbying beyond the legal cap, and no illegal conduct. Everything else is a question of degree, documentation, and whether the expense genuinely serves one of the exempt purposes the IRS recognizes: religious, charitable, scientific, literary, educational, public safety testing, amateur sports, or the prevention of cruelty to children or animals.¹

Program Spending Is the Core

Program expenses deliver on whatever the organization promised when it applied for exempt status. A food bank buying groceries, a tutoring nonprofit printing workbooks, a medical research charity funding lab work. The regulation requires that the organization be “operated exclusively” for its exempt purposes, which in practice means the bulk of spending flows toward mission delivery.²

Grants to other organizations count as program spending when the recipient’s work aligns with your mission. Public charities have fairly wide latitude here. Private foundations face more structure: they generally must grant to other 501(c)(3) organizations or exercise “expenditure responsibility” when giving to non-charities.³

International grants are permissible too. Private foundations sending money abroad typically need an equivalency determination, a written opinion from a qualified tax practitioner confirming that the foreign recipient would qualify as a U.S. public charity.⁴ Public charities have somewhat more flexibility but still need to document that the spending serves their exempt purpose.

Overhead, Salaries, and Reimbursements

No nonprofit runs on program spending alone. Rent, utilities, insurance, technology, accounting fees, and legal counsel all keep the organization functional. The IRS sets no fixed ratio for how much can go to overhead versus programs. What matters is that administrative costs are reasonable and genuinely support the exempt work rather than enriching insiders.

Compensation is usually the largest operational expense, and it must be “reasonable” relative to what comparable organizations pay for similar roles in similar markets. The safest way to set executive pay is to follow the IRS rebuttable presumption process. If the board follows three steps, the IRS presumes the compensation is reasonable and the burden shifts to the agency to prove otherwise:

The arrangement is approved in advance by board members or a committee with no financial interest in the outcome.
The board relies on comparability data such as compensation surveys, Form 990 filings from comparable nonprofits, or written offers from similar employers.
The board documents its decision and the basis for it at the time the decision is made.

Following these steps creates a legal presumption in the organization’s favor that is difficult for the IRS to overcome.⁵

Travel and expense reimbursements are fine when the organization runs an “accountable plan,” a written policy requiring a business connection for the expense, substantiation with receipts within a reasonable time, and return of any excess reimbursement. Reimbursements under an accountable plan are not treated as taxable wages.⁶ One boundary worth flagging: paying for an officer’s spouse to travel is generally taxable income to the employee unless the spouse is also an employee, the trip has a genuine business purpose, and the expenses would be deductible by the spouse independently. All three conditions must be met.⁷

Capital Assets, Reserves, and Endowments

A 501(c)(3) can buy buildings, vehicles, and equipment when they serve the mission. A shelter buying the building it operates from, a wildlife rescue purchasing a transport van, a theater investing in sound equipment. The rule is the same: the expenditure must advance the exempt purpose, and the asset can’t be used primarily for private benefit.

A widespread misconception is that a public charity must spend every dollar it receives. It doesn’t. The IRS imposes no requirement that a public charity spend down its funds by a specific deadline and sets no cap on how much a public charity can hold in reserves. Operating reserves, endowments, and investment portfolios are all permissible as long as the organization continues operating for its exempt purpose. Private foundations are different: they generally must distribute at least 5% of net investment assets annually. That distribution rule does not apply to public charities.

Fundraising Costs

Raising money costs money, and the IRS recognizes that. Fundraising events, direct mail, online donation platforms, and salaries for development staff all count as legitimate expenditures. There is no IRS-imposed cap on the fundraising percentage of a budget, though donors, watchdogs, and state regulators pay close attention to those ratios.

Lobbying Within Limits

A 501(c)(3) can spend money on lobbying, meaning efforts to influence specific legislation, but the amount is capped. Which cap applies depends on whether the organization has made an election.

The Default Substantial Part Test

Without any election, the organization falls under the substantial part test: no substantial part of activities can involve attempts to influence legislation.¹ The IRS has never defined “substantial” with a bright-line percentage. Courts have looked at both money spent and time devoted. Organizations doing meaningful lobbying often find this test uncomfortably vague.

The 501(h) Expenditure Test

Most public charities are better served by filing Form 5768 to elect the expenditure test under Section 501(h), which replaces the vague standard with specific dollar limits. The election must be signed and postmarked within the first tax year to which it applies and remains in effect until revoked. The permitted lobbying amount follows a sliding scale based on total exempt purpose expenditures:

Up to $500,000 in exempt spending: 20% can go to lobbying.
$500,000 to $1,000,000: $100,000 plus 15% of the amount over $500,000.
$1,000,000 to $1,500,000: $175,000 plus 10% of the amount over $1,000,000.
$1,500,000 to $17,000,000: $225,000 plus 5% of the amount over $1,500,000.
Over $17,000,000: $1,000,000 absolute cap.

⁸

Grassroots lobbying, which asks the general public to contact legislators, is capped at 25% of the overall lobbying limit.⁹ If the overall lobbying limit is $100,000, no more than $25,000 of that can go toward grassroots efforts. Discussing policy issues in an educational way, such as publishing research or hosting panels, doesn’t count as lobbying. The line is crossed when the communication refers to specific legislation and expresses a position on it.¹⁰

Unrelated Business Income Is Allowed but Taxed

A 501(c)(3) can earn revenue from activities unrelated to its mission, such as a museum gift shop or a university’s parking lot rentals, but that income is taxed at the standard 21% corporate rate when three conditions are met: the income comes from a trade or business, the activity is carried on regularly, and the activity is not substantially related to the exempt purpose.¹¹ Organizations with $1,000 or more in gross unrelated business income during the year must file Form 990-T and pay the tax due.¹² Some unrelated income won’t endanger exempt status, but if the unrelated activity starts consuming a significant share of resources, the IRS may question whether the organization is still operating exclusively for exempt purposes.

What a 501(c)(3) Cannot Spend Money On

Four categories of spending can trigger excise taxes, revocation of tax-exempt status, or both.

Private Inurement and Excess Benefits

No part of a 501(c)(3)’s net earnings may benefit any private individual who has influence over the organization. This applies to founders, board members, officers, key employees, and their family members. The rule isn’t limited to obvious theft. It covers any transaction where an insider receives more than fair market value: paying an executive twice the going rate, renting a board member’s building at inflated prices, or issuing interest-free loans to insiders.¹³

Even minimal inurement can support revocation of exempt status. There is no safe harbor amount. The IRS can also impose intermediate sanctions under Section 4958 without revoking status, hitting the insider with a 25% excise tax on the excess benefit. If the transaction isn’t corrected within the taxable period, a second tax of 200% of the excess benefit applies.¹⁴ Organization managers who knowingly approve an excess benefit transaction face their own 10% tax, capped at $20,000 per transaction.¹⁵

Political Campaign Activity

This is the absolute prohibition. A 501(c)(3) cannot participate in or intervene in any political campaign for or against a candidate for public office at the federal, state, or local level. The ban covers financial contributions to campaigns, public endorsements or statements of opposition, distributing campaign materials, and even selectively presenting voter guides in a way designed to favor one candidate.¹⁶ There is no dollar threshold, no insubstantial exception, and no election to opt into a different standard. A single violation can trigger revocation.

Lobbying That Exceeds the Cap

For organizations that elected the 501(h) expenditure test, going over the lobbying nontaxable amount in a single year triggers a 25% excise tax on the excess.⁹ If lobbying or grassroots expenditures exceed 150% of the permitted amount over a four-year averaging period, the organization loses its tax-exempt status.¹⁷

Illegal Activities

Spending funds on illegal activities is incompatible with operating for a charitable purpose. An organization that devotes a substantial part of its operations to illegal conduct does not qualify for exemption. This covers both the direct conduct of illegal activities and the planning or sponsoring of them.¹⁸

How Spending Gets Scrutinized

How spending is reported matters almost as much as what it’s spent on. Nearly every 501(c)(3) must file an annual information return, and the Form 990 is a public document that discloses officer compensation, major expenditures, and transactions with insiders on Schedule L.¹⁹ Donors, journalists, watchdogs, and state regulators all read it.

Failing to file any required return, even the smallest e-Postcard version, for three consecutive years results in automatic revocation of tax-exempt status. The IRS cannot waive this, and there is no appeal. The organization becomes taxable, loses its ability to receive deductible contributions, and must apply for reinstatement from scratch.²⁰

1
Office of the Law Revision Counsel. 26 USC 501 – Exemption From Tax on Corporations, Certain Trusts, Etc.
2
eCFR. 26 CFR 1.501(c)(3)-1 – Organizations Organized and Operated for Religious, Charitable, Scientific, Testing for Public Safety, Literary, or Educational Purposes, or for the Prevention of Cruelty to Children or Animals
3
Internal Revenue Service. Grants to Noncharitable Organizations
4
Internal Revenue Service. Grants to Foreign Organizations by Private Foundations
5
eCFR. 26 CFR 53.4958-6 – Rebuttable Presumption That a Transaction Is Not an Excess Benefit Transaction
6
Internal Revenue Service. Nonresident Aliens and the Accountable Plan Rules
7
Internal Revenue Service. Spousal Travel
8
Internal Revenue Service. Measuring Lobbying Activity – Expenditure Test
9
Office of the Law Revision Counsel. 26 USC 4911 – Tax on Excess Expenditures to Influence Legislation
10
Internal Revenue Service. Lobbying
11
Office of the Law Revision Counsel. 26 USC 511 – Imposition of Tax on Unrelated Business Income of Charitable, Etc., Organizations
12
Internal Revenue Service. Unrelated Business Income Tax
13
Internal Revenue Service. Inurement/Private Benefit – Charitable Organizations
14
Office of the Law Revision Counsel. 26 USC 4958 – Taxes on Excess Benefit Transactions
15
Internal Revenue Service. Intermediate Sanctions – Excise Taxes
16
IRS. Election Year Activities and the Prohibition on Political Campaign Intervention for Section 501(c)(3) Organizations
17
eCFR. 26 CFR 1.501(h)-3 – Lobbying or Grass Roots Expenditures Normally in Excess of Ceiling Amount
18
IRS. Activities That Are Illegal or Contrary to Public Policy
19
Internal Revenue Service. Exempt Organizations Annual Reporting Requirements – Form 990, Part VI and Schedule L – Transactions Reportable
20
Internal Revenue Service. Automatic Revocation of Exemption