You do NOT have to be a 501(c)3 to accept donations with Paypal. Just register as a regular business and use the donate button. What may have happened here is that you registered with PayPal as a "non-profit" to get the lower transaction fees, but that's NO-NO if you are not a 501(c)3.
Supporting documentation:
https://merchant.paypal.com/cgi-bin/marketingweb?cmd=_render...
Click on the pricing tab, then open up the "Standard Rates" section at the bottom. The relevant quote on this page about the donate button is this: "If you are not a 501(c)(3), you can still accept donations with our standard pricing."
A few months ago, I helped my son to set up a non-profit organization and a website to collect online donations (http://sujal.org), mostly from family and friends. I chose the non-profit option for the business type when the PayPal account was created, since the organization was registered as non-profit in my state and also because we intended to file for exempt status with the IRS (until we found that it costs $400 to do that, which is a story for another time.)
A few weeks later, PayPal suspended the account. I contacted PayPal and after a few days going back-and-forth, I was told to change the business type to something that is not non-profit, and also to add a disclaimer along with the donate button to convey that the donations are not tax-deductible (see the above link for exact text of the disclaimer if interested). After doing this, the account was restored.
Supporting documentation: https://merchant.paypal.com/cgi-bin/marketingweb?cmd=_render... Click on the pricing tab, then open up the "Standard Rates" section at the bottom. The relevant quote on this page about the donate button is this: "If you are not a 501(c)(3), you can still accept donations with our standard pricing."