What Is a 501(c)(3) Organization?

Section 501(c)(3) is a portion of the U.S. Internal Revenue Code (IRC) and a specific tax category for nonprofit organizations. Organizations that meet Section 501(c)(3) requirements are exempt from federal income tax. While the Internal Revenue Service (IRS) recognizes more than 30 types of nonprofit organizations, only those that qualify for 501(c)(3) status can say that donations to them are tax deductible.

Most of the organizations that may be eligible for 501(c)(3) designation fall into one of three categories: charitable organizations, churches and religious organizations, and private foundations. The rules outlined in Section 501(c)(3) are regulated by the U.S. Treasury through the IRS.

How a 501(c)(3) Organization Works

To be considered a charitable organization by the IRS, a group must operate exclusively for one of these purposes: charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, or preventing cruelty to children or animals.

Furthermore, the IRS defines “charitable” activities as “relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.”

Requirements of a 501(c)(3) Organization

To be tax exempt under Section 501(c)(3), an organization must not be serving any private interests, including the interests of the creator, the creator’s family, shareholders of the organization, other designated individuals, or other persons controlled by private interests. None of the net earnings of the organization can be used to benefit any private shareholder or individual; all earnings must be used solely for the advancement of its charitable cause.

A 501(c)(3) organization is also forbidden from using its activities to influence legislation in a substantial way, including participating in any campaign activities to support or deny any particular political candidate. It is typically not permitted to engage in lobbying (except in instances when its expenditures are below a certain amount).

People employed by the organization must be paid “reasonable compensation,” which is based on the fair market value that the job function requires.

To remain tax exempt under Section 501(c)(3), an organization is also required to remain true to its founding purpose. If an organization has previously reported to the IRS that its mission is to help less privileged individuals gain access to a college education, it must maintain this purpose. If it decides to engage in another calling—for example, sending relief to displaced families in poverty-stricken countries—the 501(c)(3) organization has to first notify the IRS of its change of operations to prevent the loss of its tax-exempt status.

While some unrelated business income is allowed for a 501(c)(3) organization, the tax-exempt charity may not receive substantial income from unrelated business operations. This means that the majority of the firm’s efforts must go toward its exempt purpose as a nonprofit organization. Any unrelated business from sales of merchandise or rental properties must be limited or the organization could lose its 501(c)(3) status. While the IRS doesn’t specify exactly how much is too much unrelated business income, the law firm of Hurwit & Associates, which specializes in representing nonprofits, estimates the amount at somewhere between 15% and 30%.

While organizations that meet the requirements of Section 501(c)(3) are exempt from federal income tax, they are required to withhold federal income tax from their employees’ paychecks and pay Social Security and Medicare taxes. They do not, however, have to pay federal unemployment taxes.

Special Considerations

Organizations that meet the 501(c)(3) tax category requirements can be classified into two categories: public charities and private foundations. The main distinction between these two categories is how they get their financial support. 

Public Charity

A public charity is a nonprofit organization that receives a substantial portion of its income or revenue from the general public or the government. At least one-third of its income must be received from the donations of the general public (including individuals, corporations, and other nonprofit organizations).

If an individual donates to an organization that the IRS considers to be a public charity, they may qualify for certain tax deductions that can help them lower their taxable income. Generally, the total amount of donations to a tax-exempt public charity that an individual can claim is limited to 50% of their adjusted gross income (AGI). However, there is no limitation on donations to qualified charitable organizations, such as a 501(c)(3).

Private Foundation

A private foundation is typically held by an individual, a family, or a corporation and obtains most of its income from a small group of donors. Private foundations are subject to stricter rules and regulations than public charities. All 501(c)(3) organizations are automatically classified as private foundations unless they can prove they meet the IRS standards to be considered a public charity. The deductibility of contributions to a private foundation is more limited than donations for a public charity.

To apply for tax-exempt status under Section 501(c)(3), most nonprofit organizations are required to file Form 1023 or Form 1023-EZ within 27 months from their date of incorporation. The charitable organization must include its articles of incorporation and provide documents that prove that the organization is only operating for exempt purposes.

However, not all organizations that qualify for the tax category need to submit Form 1023. For example, public charities that earn less than $5,000 in revenue per year are exempt from filing this form. Even though it is not required, they may still choose to file the form to ensure that donations made to their organization will be tax deductible for donors.

Advantages and Disadvantages of a 501(c)(3) Organization

The 501(c)(3) status offers a myriad of benefits to the designated organizations and the people they serve. For starters, 501(c)(3) organizations are exempt from paying federal income and unemployment taxes, and patrons who donate to them are allowed to claim a tax deduction for their contributions.

To help with funding and further their mission, these organizations are eligible to receive government and private grants. To qualify, the organization must have a mission aligned with the purpose of the grant and a need for it. In addition, 501(c)(3) organizations often receive discounts from retailers, free advertising by way of public service announcements, and food and supplies from other nonprofit organizations designed to help in times of need.

A 501(c)(3) could be the lifelong dream of its founder; however, once established as a 501(c)(3), it no longer belongs to its founder. Rather, it is a mission-oriented organization belonging to the public. To maintain its favorable tax treatment, it must operate within the confines of the law pertaining to 501(c)(3) organizations.

Because the organization serves the public, it must operate with full transparency. Therefore, its finances, including salaries, are available to members of the public and subject to their review.

Example of a 501(c)(3) Organization

The American Red Cross, established in 1881 and congressionally chartered in 1900, is one of the United States’ oldest nonprofit organizations. Its mission statement says that the Red Cross “prevents and alleviates human suffering in the face of emergencies by mobilizing the power of volunteers and the generosity of donors.” Since its inception, its goal has been to serve members of the armed forces and provide aid during disasters.

Located in 191 countries, the Red Cross operates the largest network of volunteers in the world. This 501(c)(3) organization is segmented into three divisions: the National Red Cross and Red Crescent Societies, the International Federation of Red Cross and Red Crescent Societies, and the International Committee of the Red Cross.

The National Red Cross and Red Crescent Societies, which include the American Red Cross, aim to relieve human suffering globally by empowering subordinate organizations to operate within their nation’s borders to provide disaster relief, education, and other related services. The International Federation of Red Cross and Red Crescent Societies provides global humanitarian aid during peacetime, such as assisting refugees. The International Committee of the Red Cross provides humanitarian relief for people affected by war or other armed conflicts.

People who itemize their tax deductions can contribute to the Red Cross and claim the amount donated as a deduction. Taxpayers who use the standard deduction may still claim up to $600 of their 501(c)(3) contributions as a tax deduction in 2021.

The Bottom Line

501(c)(3) organizations are nonprofit groups with a dedicated mission. Most people are familiar with them as churches and charities, but they also include private foundations. As long as they operate to support their mission, they receive favorable tax treatment, such as avoiding federal income and unemployment taxes.

What Is Adjusted EBITDA?

Adjusted EBITDA (earnings before interest, taxes, depreciation, and amortization) is a measure computed for a company that takes its earnings and adds back interest expenses, taxes, and depreciation charges, plus other adjustments to the metric.

Standardizing EBITDA by removing anomalies means the resulting adjusted or normalized EBITDA is more accurately and easily comparable to the EBITDA of other companies, and to the EBITDA of a company’s industry as a whole.

The Formula for Adjusted EBITDA Is


$\begin{aligned} ∋+IT+DA=EBITDA\\ &EBITDA +\!\!/\!\!-A = \text{Adjusted }EBITDA\\ &\textbf{where:}\\ ∋\ =\ \text{Net income}\\ &IT\ =\ \text{Interest \& taxes}\\ &DA\ =\ \text{Depreciation \& amortization}\\ &A\ =\ \text{Adjustments} \end{aligned}$​NI+IT+DA=EBITDAEBITDA+/−A=Adjusted EBITDAwhere:NI = Net incomeIT = Interest & taxesDA = Depreciation & amortization​

How to Calculate Adjusted EBITDA

Start by calculating earnings before income, taxes, depreciation, and amortization, i.e. EBITDA, which begins with a company’s net income. To this figure, add back interest expense, income taxes, and all non-cash charges including depreciation and amortization.

Next, either add back non-routine expenses, such as excessive owner’s compensation or deduct any additional, typical expenses that would be present in peer companies but may not be present in the company under analysis. This could include salaries for necessary headcount in a company that is under-staffed, for example.

What Does Adjusted EBITDA Tell You?

Adjusted EBITDA is used to assess and compare related companies for valuation analysis and for other purposes. Adjusted EBITDA differs from the standard EBITDA measure in that a company’s adjusted EBITDA is used to normalize its income and expenses since different companies may have several types of expense items that are unique to them. Adjusted EBITDA, as opposed to the non-adjusted version, will attempt to normalize income, standardize cash flows, and eliminate abnormalities or idiosyncrasies (such as redundant assets, bonuses paid to owners, rentals above or below fair market value, etc.), which makes it easier to compare multiple business units or companies in a given industry.

For smaller firms, owners’ personal expenses are often run through the business and must be adjusted out. The adjustment for reasonable compensation to owners is defined by Treasury Regulation 1.162-7(b)(3) as “the amount that would ordinarily be paid for like services by like organizations in like circumstances.”

Other times, one-time expenses need to be added back, such as legal fees, real estate expenses such as repairs or maintenance, or insurance claims. Non-recurring income and expenses such as one-time startup costs that usually reduce EBITDA should also be added back when computing the adjusted EBITDA.

Adjusted EBITDA should not be used in isolation and makes more sense as part of a suite of analytical tools used to value a company or companies. Ratios that rely on adjusted EBITDA can also be used to compare companies of different sizes and in different industries, such as the enterprise value/adjusted EBITDA ratio. 

Example of How to Use Adjusted EBITDA

The adjusted EBITDA metric is most helpful when used in determining the value of a company for transactions such as mergers, acquisitions or raising capital. For example, if a company is valued using a multiple of EBITDA, the value could change significantly after add-backs.

Assume a company is being valued for a sale transaction, using an EBITDA multiple of 6x to arrive at the purchase price estimate. If the company has just $1 million of non-recurring or unusual expenses to add back as EBITDA adjustments, this adds $6 million ($1 million times the 6x multiple) to its purchase price. For this reason, EBITDA adjustments come under much scrutiny from equity analysts and investment bankers during these types of transactions.

The adjustments made to a company’s EBITDA can vary quite a bit from one company to the next, but the goal is the same. Adjusting the EBITDA metric aims to “normalize” the figure so that it is somewhat generic, meaning it contains essentially the same line-item expenses that any other, similar company in its industry would contain.

The bulk of the adjustments are often different types of expenses that are added back to EBITDA. The resulting adjusted EBITDA often reflects a higher earnings level because of the reduced expenses.

EBITDA Adjustments

Common EBITDA adjustments include:

• Unrealized gains or losses
• Non-cash expenses (depreciation, amortization)
• Litigation expenses
• Owner’s compensation that is higher than the market average (in private firms)
• Gains or losses on foreign exchange
• Goodwill impairments
• Non-operating income
• Share-based compensation

This metric is typically calculated on an annual basis for a valuation analysis, but many companies will look at adjusted EBITDA on a quarterly or even monthly basis, though it may be for internal use only.

Analysts often use a three-year or five-year average adjusted EBITDA to smooth out the data. The higher the adjusted EBITDA margin, the better. Different firms or analysts may arrive at slightly different adjusted EBITDA due to differences in their methodology and assumptions in making the adjustments.

These figures are often not made available to the public, while non-normalized EBITDA is typically public information. It is important to note that adjusted EBITDA is not a generally accepted accounting principles (GAAP)-standard line item on a company’s income statement.

What Is the 48-Hour Rule?

The 48-hour rule is a requirement that sellers of to-be-announced (TBA) mortgage-backed securities (MBS) communicate all pool information regarding the MBS to buyers before 3 p.m. Eastern Time, 48 hours before the settlement date of the trade. The Securities Industry and Financial Markets Association (SIFMA) enforces this rule. SIFMA was formerly known as the Public Securities Association or Bond Market Association.

Understanding the 48-Hour Rule

An MBS is a bond that is secured, or backed, by mortgage loans. Loans with similar traits are grouped to form a pool. The pool is then sold as a security to investors. The issuance of interest and principal payments to investors is at a rate based on the principal and interest payments made by the borrowers of the underlying mortgages. Investors receive interest payments monthly rather than semiannually.

A to-be-announced (TBA) trade is effectively a contract to buy or sell mortgage-backed securities (MBS) on a specific date. It does not include information regarding the pool number, the number of pools, or the exact amount involved in the transaction, which means the underlying mortgages are not known to the parties. This exclusion of data is due to the TBA market assuming that MBS pools are more or less interchangeable. This interchangeability helps facilitate trading and liquidity.

The 48-hour rule is part of the mortgage allocation process, the period when the underlying mortgages will be assigned and made available to a specific MBS, which was created to bring transparency to TBA trade settlements.

The 48-hour rule states that the seller of a specific MBS must make the buyer of that MBS aware of the mortgages that make up the MBS 48 hours prior to the trade settling. Because of the standard T+3 settlement date, this usually occurs on the day after the trade is executed.

The 48-Hour Rule as Part of the TBA Process

The TBA process benefits buyers and sellers because it increases the liquidity of the MBS market by taking thousands of different mortgage-backed securities with different characteristics and trading them through a handful of contracts.

Buyers and sellers of TBA trades agree on a few necessary parameters such as issuer maturity, coupon, price, par amount, and settlement date. The specific securities involved in the trade are announced 48 hours before the settlement.

The TBA market was established in the 1970s to facilitate the trading of MBS issued by Fannie Mae, Freddie Mac, and Ginnie Mae. It allows mortgage lenders to hedge their origination pipelines.

The TBA market is the most liquid secondary market for mortgage loans, resulting in high levels of market activity. In fact, the amount of money traded on the TBA market is second only to the U.S. Treasury market.

Example of the 48-Hour Rule

Company ABC decides to sell a mortgage-backed security (MBS) to Company XYZ and Company XYZ accepts. The sale will take place on Tuesday. On Tuesday, when the sale is made, neither Company ABC nor Company XYZ knows the underlying mortgages that make up the mortgage-backed security (MBS).

The standard industry settlement is T+3 days, meaning this trade will settle on Friday. According to the 48-hour rule, on Wednesday before 3 p.m. Eastern Time, Company ABC will have to notify Company XYZ of the mortgage allocations it will receive when the trade settles.

What Is the 2011 U.S. Debt Ceiling Crisis?

The 2011 U.S. Debt Ceiling Crisis was a contentious debate in Congress that occurred in July 2011 regarding the maximum amount of debt the federal government should be allowed.

Understanding the 2011 U.S. Debt Ceiling Crisis

The federal government has rarely achieved a balanced budget, and its budget deficit ballooned following the 2007-08 Financial Crisis. In the 2008 fiscal year, the deficit stood at $458.6 billon, widening to $1.4 trillion in 2009 as the government engaged in a massive fiscal policy response to the economic downturn.

Between 2008 and 2010, Congress raised the debt ceiling from $10.6 trillion to $14.3 trillion. In 2011, as the economy showed early signs of recovery and federal debt approached its limit once again, negotiations began in Congress to balance spending priorities against the ever-rising debt burden. 

Heated debate ensued, pitting proponents of spending and debt against fiscal conservatives. Pro-debt politicians argued that failing to raise the limit would require immediate cuts to spending already authorized by Congress, which could result in late, partial, or missed payments to Social Security and Medicare recipients, government employees, and government contractors.

Moreover, they asserted the Treasury could suspend interest payments on existing debt rather than withhold funds committed to federal programs. The prospect of cutting back on already promised spending was labeled a crisis by debt proponents.

On the other hand, the specter of a technical default on existing Treasury debt roiled financial markets. Fiscal conservatives argued that any debt limit increase should come with constraints on the growth of federal spending and debt accumulation.

Outcome of the 2011 U.S. Debt Ceiling Crisis

Congress resolved the debt ceiling crisis by passing the Budget Control Act of 2011, which became law on August 2, 2011. This act allowed the debt ceiling to be raised by $2.4 trillion in two phases, or installments.

In the first phase, a $400 billion increase would occur immediately, followed by another $500 billion unless Congress disapproved it. The second phase allowed for an increase between $1.2 trillion and $1.5 trillion, subject to Congressional disapproval as well. In return, the act included $900 billion in slowdowns in planned spending increases over a 10-year period. It also established a special committee charged with finding at least $1.5 trillion in additional savings.

In effect, the legislation incrementally raised the debt ceiling from $14.3 trillion to $16.4 trillion by January 27, 2012.

Following the passage of the act, Standard & Poor’s took the radical step of downgrading the United States long-term credit rating from AAA to AA+, even though the U.S. did not default. The report says, “The downgrade reflects our opinion that the fiscal consolidation plan that Congress and the Administration recently agreed to falls short of what, in our view, would be necessary to stabilize the government’s medium-term debt dynamics.” The credit rating agency cited the unimpressive size of deficit reduction plans relative to the likely future prospects for politically driven spending and debt accumulation.

Debt Approval Process Leading to the 2011 U.S. Debt Ceiling Crisis

The U.S. Constitution gives Congress the power to borrow money. Before 1917, this power was exercised by Congress authorizing the Treasury to borrow specified amounts of debt to fund limited expenses, such as war-time military spending, which would be repaid after the end of hostilities. This kept the national debt directly linked to authorized spending.

In 1917, Congress imposed a limit on federal debt as well as individual issuance limits. In 1939, Congress gave the Treasury more flexibility in how it managed the overall structure of federal debt, giving it an aggregate limit. However, by delegating debt management authority to the Treasury, Congress was able to break the direct connection between authorized spending and the debt that finances it. 

While allowing greater flexibility to raise spending, this practice also created a need for Congress to repeatedly raise the debt limit when spending threatens to overrun available credit. Due to occasional political resistance to the idea of continually expanding the federal debt, this process of raising the debt limit has at times engendered controversy, which occurred during the 2011 Debt Ceiling Crisis.

The Bottom Line

Following the 2007-08 Financial Crisis, in an effort to slow down the severe recession as well as the persistently high unemployment rate, the government increased federal spending. As a result, the federal debt reached its limit on multiple occasions from 2008 to 2011 which led to a series of increases of the debt limit. In 2011, the Treasury asked for its borrowing capacity to be extended.

The 2011 U.S. Debt Ceiling Crisis was a contentious debate in Congress that occurred in July 2011 regarding the maximum amount of debt the federal government should be allowed. Congress resolved the debt ceiling crisis by passing the Budget Control Act of 2011, which became law on August 2, 2011. This act allowed the debt ceiling to be raised by $2.4 trillion in two phases, or installments.