How to Minimize KYC/KYB and AML Risks for 501(c)(3) and 501(c)(6) Nonprofits

In the 2020s, nonprofit revenues represent over ten percent of the US GDP. They operate well over two trillion of income and expenses yearly and support millions of jobs. This puts every nonprofit on the radar of numerous regulators that control financial transparency, efforts to identify sources of revenue, and its legality.

Anti-Money Laundering (AML) and Know Your Customer (KYC) compliance must be considered on the ground floor to ensure the long-term safety of your organization, its donors, employees, and the people a nonprofit serves. 

In this article, we’ll focus on AML and KYC risks and advice for 501(c)(3) and 501(c)(6) nonprofits. It expands on our recent in-depth article about making compliant payments in the US if you’d like to learn more about regulations that govern payments in general, who enforces which laws, and how to stay compliant.

Understanding 501(c) Nonprofit Organizations

Section 501 of the Internal Revenue Code includes requirements for tax-exempt organizations. Subsection “C” categorizes types of nonprofits based on their purpose and work type. There are more than 30 categories of nonprofit organizations, including charities, church and religious groups, private foundations, political organizations, and more. 

The difference between 501(c)(3) and 501(c)(6) non-profits

We’re focusing on nonprofits that fall under the 501(c)(3) and 501(c)(6) subsections as the most common examples that can either be used to serve a community or to further the interests of a group.

501(c)(3) nonprofit overview

Out of 1.8 million 501(c) nonprofits in operation, 1.5 million are 501(c)(3). This includes all religious organizations, most scientific foundations, and education centers. 

To fall within this category, the organization needs to adhere to the following rules:

• Must be used for charitable, educational, religious, or scientific purposes. 
• Can’t participate in political campaigns or other electioneering.
• Income can’t be used outside reasonable salaries and expenses. 
• Unrelated business income is subject to taxation.
• Donations are tax-deductible for donors, and receipts must state that. 

501(c)(6) nonprofit overview

On the other side of the nonprofit spectrum are organizations that further the interests of their members, such as leagues, associations, and unions. 

These organizations follow a different set of rules:

• Can be used to benefit members’ business interests.
• Can engage in lobbying, legislation, and electioneering. 
• Can pay members as long as it’s within the organization's mission.
• Report taxable income over $1,000 and engage in business activities easier than most other 501(c) types. 
• Donations aren’t tax-deductible but may be used as business expenses with correct receipts. 

What is Required for 501(c)(3) and 501(c)(6) to be Compliant?

Specific payment regulations depend on local governing bodies and the particulars of a business's operations. In addition to finding a compliant payments provider for nonprofits, it is important to consult a reliable local legal counsel and accountant specializing in your sector to ensure you’re not missing any important requirements.

That said, these are the most essential pieces of paperwork to file as a nonprofit and make compliant payments:

• IRS Form 990 – the primary form for both 501(c)(3) and 501(c)(6) files is the Return of Organization Exempt from Income Tax.
• Form 1023 – (Application for Recognition of Exemption) – needs to be filed by organizations seeking tax-exempt status as a 501(c)(3) nonprofit.
• Form 1024 – (Application for Recognition of Exemption) – other 501c entities apply for recognition of exemption using Form 1024.
• Schedule B—The Schedule of Donors includes all donors who contribute over $5,000 or more than 2% of the nonprofit’s revenue.
• Form 990-T – Exempt Organization Business Income Tax Return for unrelated business income in case you open a subsidiary for-profit project as part of your nonprofit.
• A Suspicious Activity Report (SAR) is filed for all unusual transactions and actions, such as attempts by the donor to avoid reporting. 

Compliant payment processing for 501(c)(3) and 501(c)(6) non-profits

Working with a compliant payment processor and financial institutions to manage your payments takes most of the regulatory load off your shoulders. They can handle most verification and activity tracking programmatically and provide all necessary documents, allowing you to focus on your nonprofit's development instead of transaction details analysis. 

However, as a 501(c)(3) or 501(c)(6) organization, you need to follow the fundamental rules for compliance. In the eyes of the regulators, you have the following primary responsibilities:

1. Verify identity and clarify the source of funds with receipts that meet IRS donation requirements. 
2. Protect customer data by partnering with reliable financial technology providers and enforcing staff responsibility. 
3. Implement AML procedures to check payment against databases like OFAC, UN, EU, and other sanctions lists.
4. Implement rules to track and flag suspicious activities automatically. Report suspicious activities by filing Suspicious Activity Reports (SAR).
5. Monitor transactions and maintain records of customer and transaction data. 
6. Carry out enhanced due diligence (EDD) for high-risk and high-value transactions.
7. Implement staff training to enforce identity verification and data security rules. 
8. Ensure compliance of your payment processor.
9. Implement cybersecurity measures to prevent data breaches and unauthorized access. 
10. Make a rule of regular compliance audits.
11. First and foremost, set reminders for filing necessary paperwork, such as Form 990. 
12. Maintain transparent reporting and board oversight of each program's income, expenses, and assets.
13. Keep records of payments, sources of income, and donations. If the nonprofit's income exceeds $25,000, it should maintain an official journal or an accounting ledger.

Payment Automation for Nonprofits by Payment Labs 

Payment Labs provides nonprofits with a payment automation platform for fully compliant international payment transactions. Our clients make compliant payments to and from 100+ countries, an essential differentiator for their business. Whether you work with payments from donors or to your members, contractors, content creators, or anyone else, the platform can pay anyone straightforwardly and compliantly, allowing you to focus on business development instead of regulations.  

Let’s discuss your nonprofit's payment processing needs and solve any payment challenges you may have. Schedule a call with our team to get started with Payment Labs.