A nonprofit organization operates with the primary purpose of serving the needs of a social or public cause. Profits earned by the organization are typically invested back into the organization, rather than being distributed to shareholders. Examples of nonprofit organizations include hospitals, religious organizations, charities, universities, homeless shelters, soup kitchens, and more.
Nonprofit organizations carry many benefits. For example, they may be tax-exempt, allowing for more of the revenue earned to be funneled toward achieving their goal. However, there are also downsides as many rely on donations, grants, and other potentially less predictable sources of income.
Nonprofit Organization Eligibility Criteria
Section 501(c)(3) of the Internal Revenue Code describes the conditions that must be met for an organization to have tax-exempt status as a nonprofit. The Internal Revenue Service (IRS) indicates that this process applies to charities, churches, religious organizations, and private foundations as follows:
- Exempt purposes: Allowable purposes include companies operating with tasks involved with charity, religion, education, science, literature, public safety testing, fostering of national or international amateur sports competitions, or the prevention of animal cruelty to children or animals.
- Use of earnings: Earnings must not benefit private interests such as the founder, family members, or shareholders.
- Organization type: Organizations looking to qualify for tax-exempt status under 501(c)(3) must not attempt to influence legislation as a substantial part of their daily activities. Additionally, they may not participate in campaign activities for or against political candidates.
How Nonprofit Organizations Work
Nonprofit organizations function to provide goods or services for the benefit of the public. A board of directors is typically established, along with bylaws that stipulate its operating rules and procedures. A management team is also generally responsible for recruiting, directing, and overseeing volunteers or full-time staff to help the organization accomplish its goals.
Nonprofit organizations often engage in fundraising activities to earn money. They can also accept donations, grants, and gifts. Other revenue can be earned through special events such as charity runs, auctions of donated items, sponsorships, and other sales-related events. Individuals donating items to the nonprofit organization can also generally deduct the costs from their own taxes, which can be a motivating factor for donations to be made.
Pros & Cons of a Nonprofit Organization
Operating as a nonprofit carries some advantages, such as tax treatment benefits and an easier ability to carry lower operating costs than an equivalent for-profit operation. However, it also has some downsides. If you’re thinking of starting your own business as a nonprofit organization, I recommend carefully considering the following pros and cons.
| Pros | Cons |
|---|---|
| Easy to achieve a positive brand reputation | Can be dependent on volunteers to achieve organizational targets and goals |
| Can attain tax-exempt status | Revenue can be unpredictable |
| Greater ability for donors to deduct items from taxable income | Use of profits can be more restrictive than for-profits |
Pros
- Positive brand reputation: Since nonprofit organizations typically operate for the benefit of the public, it’s often easier to establish a positive brand name presence in the communities they serve. This can result in lower barriers to acquiring a large social media following to spread awareness of the organization.
- Tax-exempt status: Qualifying organizations can be exempt from paying taxes, allowing for a greater portion of proceeds to be reinvested back into the company itself to accomplish its mission.
- Tax deductibility: To motivate the public to assist nonprofits, the IRS generally allows individuals making donations to a nonprofit organization to deduct those items from their taxable income.
Cons
- Dependent on volunteers: Even with full-time staff working at a nonprofit, many events and activities rely on volunteers to ensure adequate coverage for special events such as auctions and fundraising activities.
- Unpredictable revenue: Organizations that do not center their business around a core set of products or services but rather rely on charity, auctions, or other special events to earn revenue can have an especially difficult time managing cash flow. Should this be the case, it would not be unusual for the organization to be forced to dip into its financial reserves or borrow from lenders from time to time.
- Restrictions on the use of profits: Profits earned in a nonprofit organization are not allowed to be issued to shareholders. Rather, they must typically be reinvested back into the company.
Nonprofit vs. For-profit & Not-for-Profit Organizations
Although the terms are sometimes used interchangeably, nonprofits do have differences from not-for-profit organizations. Below is a table summarizing some of these differences, along with a comparison with for-profit companies:
| Nonprofit Organization | Not-for-Profit Organization | For-profit Organization | |
|---|---|---|---|
| Company Mission | Social or public good | Member goals | No restrictions |
| Income Tax Status | Tax-exempt eligible | Tax-exempt eligible | Taxable |
| Staff | May have employees on payroll | Run by volunteers | Has employees on payroll |
Not-for-Profit Organization
Not-for-profit organizations run for the benefit of their designated members. This can include homeowner’s associations where its members are all homeowners within the community. Similarly, it can include college clubs where membership is available only by meeting certain requirements. Not-for-profits do not typically have paid employees.
For-profit Organization
As the name suggests, a for-profit company exists to earn profits. There are no restrictions on how it can use its earnings, and funds can be disbursed to employees and shareholders however it deems appropriate.
Examples of Nonprofit Organizations
Nonprofit organizations share a similar goal of providing some form of positive social or public benefit but can have a wide range of activities, tasks, and goals. Below are some examples of popular nonprofit organizations.
American Red Cross
The American Red Cross’s mission is to prevent and alleviate suffering caused by emergencies. It’s highly dependent on volunteers and donors to assist with things like disaster assistance and blood donations. Disaster relief commonly provided includes those involved in home fires, hurricanes, floods, and other natural disasters.
The Museum of Modern Art
The Museum of Modern Art (MoMA) is an art museum in New York. Its goal is to collect and preserve art, give individuals opportunities for learning and experimentation, and act as a catalyst for spreading creativity and ideas.
UNICEF
UNICEF works across over 190 countries and territories to protect children’s rights. This includes providing and advocating for education, health, and nutrition services. Some examples of this include providing clean water and sanitization services, offering safety from disease and climate change, and protecting children from violence and abuse.
Frequently Asked Questions (FAQs)
No. Depending on the circumstances of your company, the IRS lists certain requirements you can meet in order to qualify for tax-exempt status outside of the popular 501(c)(3) designation.
Nonprofits exist to provide a positive social or public benefit. In exchange, many nonprofits can get tax-exempt status from the IRS, allowing for a larger portion of their revenues to be allocated toward achieving the company’s mission.
Yes. Tax regulations allow for nonprofits to have full-time employees being paid a salary. However, the nonprofit must be able to document that salaries paid are reasonable, just, and fair compensation for their services. It must also abide by all state and federal employment rules, including the requirement to pay payroll and other employment-related taxes.
Bottom Line
Running a company as a nonprofit can yield many benefits such as tax-exempt status and an easier ability to gain followers due to the company’s positive social or public impact. However, there are restrictions on how funds can be used, and it can be more difficult to earn revenue, as many nonprofits rely more heavily on fundraisers, donations, and other special events. If you’re considering running a nonprofit, I also recommend consulting with a tax professional to ensure your company can meet the applicable tax requirements.
