Nonprofits: What They Are (and Aren’t)

Because so much dialogue is happening RE: Kony, Invisible Children, and all of that other stuff, I decided to make this handy little guide to what a nonprofit organization is and what it does, for people who may not be familiar with what the term actually means (and the legality of it). I think it’s important to get this information out there and allow it to be accessible to concerned individuals. 

All of the following information comes verbatim from my notes and workbook from my course in Grant Writing for Nonprofits (a recommended but not required class for museum studies graduate students). All added emphasis is my own.

Are you ready? Let’s start with the basics: 

Characteristics of a Nonprofit:

  • They are registered with the State Attorney General and the IRS.
  • Many are altruistic, dedicated to the public good.
  • They may also be neutral, such as those based on hobbies.
  • They are not part of the government. 
  • Individuals cannot be owners or shareholders of nonprofits.
  • They *can* make a profit. (I’ll expand on this later.)
  • They are self governing and have at least three board members.
  • They provide a private means to pursue public purpose outside of the confines of the market and the state.

Benefits of the 501(c)(3) Status: 

501(c)(3)s nonprofits have at least four major benefits under IRS law:

  1. They do not pay property tax or federal and state income tax.
  2. Individuals and organizations can give to them and take a tax deduction.
  3. They are generally eligible for grants.
  4. The individuals that work or volunteer for them are generally protected from personal liability in legal or financial matters. 

Disadvantages of the Nonprofit Corporation:

  1. Paperwork - complying with the red tape of organizing will include the preparation of initial incorporation documents (articles of incorporation, bylaws and forms) and paperwork to document ongoing corporate action (minutes of regular and special meetings of the board of directors, tax documents, etc).
  2. Incorporation costs and fees - if you hire an attorney to set up the corporation, you can expect to pay $1,000 to $3,000. A Nolo Press book titled, “How to Form a California Nonprofit Corporation” allows diligent individuals to do most of the work and create the organization for about $200 to $400.
  3. Time and energy - With more accountability comes a nuber of new tasks beyond program management and fundraising: setting up and balancing books and bank accounts, depositing and reporting payroll taxes, meeting with an accountant, filing taxes. 
  4. Keeping the effort viable and healthy - Like private businesses, not all nonprofits thrive. To implement its mission, a nonprofit needs hard working individuals, community support, and strong leadership. It takes commitment. Keeping a nonprofit funded is not always an easy task, as many board members will tell you. No money, no mission.

From NOLO.com (NOLO is a free, online resource concerning legal matters for business owners and individuals. We frequently used it in class, specifically for the following important information) - 

Making a Profit from “Related” Business Activities:

Tax-exempt nonprofits often make money as a result of their activities and use it to cover expenses. In fact, this income can be essential to an organization’s survival. As long as a nonprofit’s activities are associated with the nonprofit’s purpose, any profit made from them isn’t taxable.

Let’s take as an example a group called Friends of the Library, Inc. It’s a 501(c)(3) nonprofit (which means it has a federal tax exemption), organized to encourage the appreciation of literature and to raise money for the support and improvement of the local public library. (This is the organization’s mission statement; anything they do that is related to the mission is thereby a related business activity.) It makes a profit from a lecture series featuring famous authors and from an annual volunteer-run sale of donated books.

Because these activities are educational and literary in nature, they do not jeopardize the group’s tax-exempt status, and the proceeds from them are not taxable. The organization may use this income for its own operating expenses (including salaries for officers and staff) or for the benefit of the local library. What it cannot do is distribute any of the income to the nonprofit’s officers, directors, or others connected with Friends of the Library.

Making a Profit from “Unrelated” Business Activities:

 Sometimes nonprofits make money in ways that aren’t related to their nonprofit purposes. While nonprofits can usually earn unrelated business income without jeopardizing their nonprofit status, they have to pay corporate income taxes on it, under both state and federal corporate tax rules. (Generally, the first $1,000 of unrelated income is not taxed, but the remainder is.)

Let’s go back to the Friends of the Library nonprofit corporation for an example of unrelated income. People donate many thousands of books to Friends of the Library for an annual book sale, one of its major fund raising events. Although the sale is always successful, let’s say that one year thousands of books are left over, and the group decides to sell the more valuable of these books by advertising in sources for rare and out-of-print books. The response is overwhelming, and before long the Friends of the Library has six employees cataloging books for sale. Soon, Friends of the Library finds itself in the business of buying books from other dealers and reselling them to the public. The nonprofit will have to report these earnings to the IRS, which will tax them as income from unrelated business activities.

Why?  In some situations, excessive unrelated business activities can also prompt the IRS to reconsider a nonprofit’s 501(c)(3) tax-exempt status. To avoid this, a nonprofit should never let its unrelated business activities reach the point where it starts to look like a regular commercial business. For instance, unrelated business activities shouldn’t absorb a substantial amount of staff time, require additional paid staff or volunteers, or produce much more income than that generated by the organization’s exempt activities.

Activities That Are Not Taxed:

Because the difference between “related” and “unrelated” activities can be confusing, the IRS has said that some activities will not be taxed, even if they aren’t related to the nonprofit’s purpose. Here’s a quick rundown of the activities that aren’t taxed:

  • Activities in which nearly all the work is done by volunteers
  • Activities carried on primarily for the benefit of members, students, patients, officers, or employees (such as a hospital gift shop for patients or employees)
  • Sales of merchandise that has been mostly donated to the nonprofit (such as a thrift store)
  • The rental or exchange of mailing lists of donors or members, and
  • The distribution of token or insubstantial items as incentives for donating money (such as stamps or pre-printed mailing labels).

Some Useful Websites:

http://www.fdncenter.org

A comprehensive website for nonprofit organizations, grantseekers and grantmakers. Lists of the largest corporate and private foundation funders. Products, grantwriting advice, giving statistics, and links to many of the 70,000 U.S. foundations.

http://www.guidestar.org

Tax records and other information about U.S. nonprofits online. A great place to research a specific private or corporate foundation. Funders must list all grants made each year in their IRS document, the 990 PF.

http://www.ojp.usdoj.gov

The Office of Justice Programs coordinates the dissemination of homeland security funds to state administering agencies, which then pass the funds on to counties and agencies or collect proposals for grants.

http://www.philanthropy.org

Center on Philanthropy and Civil Society

http://www.philanthropyjournal.org

Online Nonprofit News

http://www.charitywatch.org

Charity Watchdog Organization

I hope this post helped you understand nonprofit organizations a little better! Knowledge is power, my friends! Please pass this on to others!