Did you know there are over 1.5 million nonprofit organizations in the US?
They come in all shapes, forms, and sizes. Nonprofits include religious organizations, educational institutions, scientific groups, service and charitable organizations, political and labor organizations, and more.
All must meet a set of requirements to qualify for nonprofit status, but not every group or organization will.
So, if you’ve been debating whether to start a nonprofit or for-profit practice, read on. Find out more about nonprofits, and if one might be right for you.
Most people know there’s a difference between nonprofit and for-profit. But if you’re considering starting one, you need to know more. For you, it’s critical to understand the difference before choosing one over the other.
I think all of us know what a for-profit business is; hence, there is no need to go into detail. And while most know about non-profits, frequently there is some confusion as to what that means.
So why not start there?
What is a Non-Profit?
It’s all about motivation…
The typical business or practice opens with the intent to generate a profit for the owner or owners. A for-profit corporation may be started for any reason, as long as it’s legal and meets state requirements, not so with non-profits.
They are not formed to generate a profit, but with the explicit intent to provide a service, raise funds for charity, provide education… to further the greater good.
Of course, nonprofits must generate revenue too. But one of the differences between nonprofit and for-profit is in what happens with the money.
And it brings up a question…
If there is no profit, how does the nonprofit pay for things? How do they pay their employees, for business expenses, and other overhead?
Just because an organization structures as a nonprofit doesn’t mean overhead and expenses go away… far from it.
Non-profits generate revenue and may pay their operating expenses from a variety of sources, including:
- fundraising activities
- passive income from investments, interest, or rents
- government and private funds.
Types of Nonprofits
Usually, but not always, nonprofits are tax-exempt. However, tax-exempt status is not automatic. While state law grants nonprofit status, the IRS grants tax-exempt status.
Nonprofits work to further the greater good and feed their proceeds back into the organization, in contrast to for-profit companies, which distribute profits to owners.
But not all nonprofits are created equal. Depending on the type, mission, and structure of the organization, different classifications may apply.
IRS publication 557 lists 27 different types of nonprofits and describes the rules and procedures to obtain exempt status from federal income tax under the Internal Revenue code.
Most NPs who want to form a nonprofit will apply to create an organization under section 501 (c)(3) of the Internal Revenue Code.
Establishing a nonprofit is a two-tiered process.
- First, you must incorporate in your state, effectively establishing a business entity.
- Second, you must apply for tax-exempt status with the IRS. Once approved, you must file the approval letter with your state tax or revenue office to obtain tax-exempt status in your state. Alternatively, depending on your state, you may have to apply for a state nonprofit corporate income tax exemption.
You should also request an EIN (Employer Identification Number), even if you don’t have employees.
Advantages of a 501 (c)(3) Nonprofit
Nonprofits enjoy several benefits, including:
Tax exemption from:
- Federal income tax
- State income, sales, and employment taxes (state-dependent)
- Possible exemption from county and city taxes
- Reduction in postal rates
- Advertising rates and, public service announcements
- Discounts on memberships, educational events
Ability to accept tax-deductible donations from:
- Public sources
- Private donors
Protection from personal liability, except in cases of:
- Intermingling of nonprofit and personal funds
- Failure to file necessary returns and reports
- Violation of corporate duties
- Criminal activity
Disadvantages of a 501 (c)(3) Nonprofit
Board of Directors:
Nonprofits must have a board of directors, as required by law. Check with your state for specific requirements. While having a board is not a real disadvantage, it may be an adjustment, particularly when accustomed to calling the shots.
In most cases, making decisions as a group tends to be more challenging and time consuming compared to making them by yourself.
Paperwork and Red Tape:
Some business entities are more straightforward to operate than others. Nonprofits require initial incorporation documents, including bylaws. Beyond that, annual returns must be filed, and minutes of all corporate meetings must be prepared. Additionally, there are ongoing filings and returns to be completed.
Attending all scheduled meetings, making sure all paperwork and reports get filed, and managing the day to day affairs of the nonprofit may take up more of your time compared to it would with the for-profit business.
Restrictions and Limitations:
Staff and directors may receive reasonable salaries and expenses, but nothing extra or extravagant. Upon dissolution, any remaining assets must go to another tax-exempt nonprofit. And finally, tax-exempt status limits political involvement.
The decision to form a nonprofit vs. a for-profit company is a personal one; only you can decide. Nonprofits that qualify for tax-exempt status have unique requirements that must be observed to maintain their status.
When considering a nonprofit, be sure to look at all the necessary information before you make your choice. Here are two resources that may help you find additional information: https://www.councilofnonprofits.org/, https://www.charitynavigator.org/.
And of course, if need be, get input and help from a professional.
What are your thoughts about nonprofits? Leave your comment below and let us know!
By Johanna Hofmann, MBA, LAc; regular contributor to the NPBusiness blog.