While every entrepreneur has their own reason for starting a business, most businesses fall under the “for profit” category. Yet, despite being the most common type of business to start, it’s not the only path to building a business with an impact. Starting a nonprofit organization is an equally viable path if you’re looking to test the waters of entrepreneurship.
Although you’ve likely heard of nonprofits before, it can be challenging to fully understand exactly what they entail, how they operate, and the different types that exist. Whether you’re looking to start a non-profit or simply interested in learning more about them, this guide will cover everything you need to know.
What is a nonprofit?
A nonprofit organization (NPO) is a business that has been granted tax-exempt status by the US Internal Revenue Service (IRS) on the basis that it advances a social cause benefiting the public in some way. (Think: historical preservation, scientific research, animal welfare, economic development.) These entities are not permitted to distribute profit toward anyone or anything other than advancing the organization.
Nonprofits are sometimes referred to as non-stock corporations, or 501(c)(3) organizations—depending on the subsection of the tax code’s Section 501 that provides for their tax-free status. While enjoying federal tax benefits on income, nonprofits typically must pay employment taxes for hired staff. Individual states may offer even more tax benefits to nonprofit organizations, such as exemption from paying sales taxes on items they purchase for use by the business.
Nonprofits run with the purpose of maximizing revenues for the causes they support—a key point of distinction from other types of tax-exempt organizations, which may not necessarily run with the goal of generating revenues but simply maintaining an ability to pay overhead. Virtually all charitable organizations carry a non-profit status.
What are the qualifications to be a nonprofit?
Because a nonprofit institution must serve the public benefit in some way, they are required to make financial and operating data public so that potential donors are informed as to how contributions are being used.
Before receiving tax-exempt status, an organization must request recognition from the IRS as a 501(c)(3) or other type of nonprofit. Once the organization is registered, it must comply with the rules set by state charity authorities in addition to IRS protocols:
- Promoting welfare. Nonprofits should first and foremost promote social good and public benefit, whether their mission involves educating the public, feeding the hungry, advocating criminal justice reform, or funding research to cure diseases.
- Political activity. In general, a nonprofit organization must avoid direct political involvement. While some 501(c) organizations can engage in political campaigning or making expenditures for political purposes (such as a labor union donating to a candidate’s campaign), organizations with 501(c)(3) status are prohibited from engaging in these activities.
- Adherence to mission. To receive 501(c)(3) tax treatment, a nonprofit organization may not deviate from its core purpose or mission.
- Fair pay. 501(c)(3) status organizations must pay all employees fair market value wages.
Nonprofit vs. not-for-profit
The term “nonprofit” is often used interchangeably with “not-for-profit”—neither generates profits for its owners. All money earned by either format goes back into operating the organization. But unlike nonprofits, not-for-profits are not required to operate for the benefit of the public—they can simply serve the personal purposes of its members. A sports team, for example, might operate as a non-business entity or a not-for-profit.
The goals and operation requirements of a nonprofit and not-for-profit organization can differ drastically, so it’s important to understand the distinction.
Benefits enjoyed by a nonprofit organization
Forming and operating a nonprofit can be an immensely rewarding experience. And the benefits can match—both in terms of making a difference and the practicality of running a business. Here are some of the many benefits nonprofit organizations have:
- Tax exemption. The most obvious benefit of forming and running a nonprofit organization is that it does not pay federal income tax under the Internal Revenue Code. That said, the tax exempt status can vary on the state level and vary by state. For example, a nonprofit in Florida that purchases office supplies may be exempt from paying sales tax on those items, while a nonprofit in California is not exempt from paying sales tax. Tax code benefits provided to nonprofits are often a considerable financial benefit.
- Limited liability. When formed as a nonprofit limited liability corporation (LLC), directors, officers, and members of a nonprofit are protected against being held personally liable for the organization’s debts or legal liabilities. Informally organized nonprofits—that is, those that don’t take the form of a corporation—will generally not enjoy this liability shield.
- Access to grants. Some nonprofits, such as certain religious organizations, are eligible to receive public and private grants. However, access to grants may be limited based on the type of nonprofit applying for it—for example, some grants are only available to 501(c)(3) organizations.
- Fundraising. Nonprofits can also generate operating capital from donations made by individuals. Individuals can be incentivized to make such donations, depending on the type of nonprofit receiving the gift. For example, donations to 501(c)(3) organizations are federally tax-deductible for the donor. Some states also offer benefits to the receiving organization, such as exemption from sales or property taxes on the gift.
- Helping others. A commitment to promoting social good can lend a deep sense of purpose and personal satisfaction to those involved. While it is entirely possible to earn a comfortable living from the operation of a nonprofit, the intangible rewards of doing so often outstrip any material benefits.
Types of nonprofit organizations
The IRS recognizes over 20 different types of nonprofit organizations—ranging in specificity from the general charitable organization with a broad mission to support a community to benefit trusts for coal miners to teachers’ retirement fund associations. Note that while all nonprofits enjoy an exemption from federal income tax, not all types are able to extend tax deductions to their donors.
Five common types of nonprofit organizations include:
- 501(c)(3) organizations: Religious, educational, charitable, scientific, and literary organizations, private foundations, and animal welfare charities. Churches, cancer research organizations, and literary author’s estates can be 501(c)(3)s. Contributions to a 501(c)(3) are tax deductible.
- 501(c)(4) organizations: Civic leagues, social welfare organizations, and local employee associations. Local government advocacy organizations would qualify as 501(c)(4)s. Contributions to a 501(4)(c) are not generally tax-deductible.
- 501(c)(5) organizations: Labor organizations. Contributions are not tax deductible.
- 501(c)(7) organizations: Social and recreational clubs. Fraternities, country clubs, and hobby clubs all qualify as 501(c)(7)s. Contributions are not tax-deductible.
- 501(c)(9) organizations: Voluntary employee benefit associations. These pay out insurance to the families of sick or deceased workers. Contributions are not tax deductible.
How to start or become a nonprofit
A nonprofit corporation can be designated as such from the start. Additionally, a for-profit organization can be converted into a nonprofit legal entity.
Starting a nonprofit from scratch
The process for founding a nonprofit varies state by state, but generally speaking, founders must:
- Complete and file articles of incorporation. These formation documents must include the nonprofit’s name, contact information for its registered agent, and a designated incorporator (the person who signs the formation documents and submits them to the state governing agency).
- Draft and adopt bylaws. These are the rules that will govern the nonprofit. You’ll attach these to your IRS application when filing for federal tax exemption. Bylaws will be adopted at your first official meeting, where you will elect officers—a president, secretary, treasurer, etc.
- Apply for a federal employer identification number (EIN). This can be done online through the IRS or independent application services.
- Apply for federal tax exemption. Forms necessary will vary depending on the type of nonprofit you’re registering as.
- Register as a charity with the appropriate state authority. State attorney generals and secretaries of state will have charity registries to promote necessary nonprofit transparency.
Converting a for-profit into a nonprofit
The rules for converting a for-profit organization to a nonprofit will vary state by state. But generally speaking, organizers must:
- Check business conversion laws in your state. Some business entity types are not eligible for conversion into nonprofits, and sometimes they are prohibited altogether. New York, for example, does not permit statutory conversions of business entities; organizers must establish a new company, then merge the for-profit business into the nonprofit.
- File conversion paperwork. This is usually done with the local secretary of state’s office. Based on the state of incorporation, rules and forms required will vary. For example, in California, amended articles of incorporation, reflecting the change in tax status, will need to be filed with the attorney general’s office at least 20 days prior to filing conversion paperwork.
- Apply for tax-exempt status with the IRS. This process will generally follow the same procedure as starting a nonprofit from scratch.
- Reorganize for-profit assets. After you convert, all existing business assets must be held in a charitable trust, which means they will only be used for the organization’s purposes going forward. Assets might include cash, intellectual property, or real property.
Ultimately, whether you go the for-profit route or the nonprofit route, the best choice comes down to your specific business goals.
If the basis for forming and running your organization is the advancement of some social good, starting a nonprofit organization might be for you.
What is a nonprofit FAQ
What’s the difference between not-for-profit organizations and nonprofit organizations?
Both terms refer to organizations that operate with the primary goal of fulfilling a social, cultural, or environmental mission rather than generating profits for owners or shareholders. These organizations are typically exempt from paying taxes on their income and donations.
However, a not-for-profit organization does not have to operate solely for the benefit of the public good.
How does a nonprofit make money?
Although for different purposes, both for-profit organizations and nonprofits need to generate money.
Here are some ways nonprofits make money.
- Fundraising: soliciting donations from individuals, foundations, corporations, and government agencies.
- Membership fees: charging dues or fees for membership in the organization.
- Program fees: charging fees for services or programs offered by the organization.
- Grants: receiving grants from foundations, corporations, or government agencies.
- Investments: earning income from investments or endowments.
What are the common types of nonprofit organizations?
While there are many types of nonprofit organizations, here are some of the most common:
- Charitable organizations: A nonprofit organization that is established to provide assistance and often raise money for those in need, such as the poor, sick, or disadvantaged.
- Religious organizations: These are organizations that are established to promote and practice a particular religion or faith.
- Educational organizations: A nonprofit organization that is designed to promote education and learning, such as schools, colleges, and universities.
- Cultural organizations: These are organizations that are established to promote and preserve cultural heritage, such as museums, art galleries, and libraries.
- Environmental organizations: These are organizations that are established to promote environmental conservation and sustainability, such as wildlife trusts and green advocacy groups.
- Professional organizations: These are organizations that are established to support and promote the interests of a particular profession or industry, such as medical or legal associations.
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