Not for Profit: Definitions and What It Means for Taxes

What Does Not for Profit Mean?

Not-for-profit organizations do not earn profits for their owners. All of the money earned by or donated to a not-for-profit organization is used in pursuing the organization’s objectives and keeping it running; income is not distributed to the group’s members, directors, or officers.

Typically, organizations in the nonprofit sector are tax-exempt charities or other types of public service organizations; as such, they are not required to pay most taxes. Some well-known nonprofit organizations include the American Red Cross, the United Way, and The Salvation Army. There are also nonprofit corporations known as nonstock corporations, which are usually formed for such purposes as clubs, rescue squads, and religious and charitable organizations.

Charitable Purposes of a Not for Profit Organization

If someone sees a need in their community or elsewhere in the world, they can research their idea and put together a business plan outlining the proposed nonprofit’s objectives and how it plans to meet those goals.

Almost anyone can start a not-for-profit group and apply for tax-exempt status, but many not-for-profit organizations won’t qualify for 501(c)(3) status, as it is only for charitable organizations. Not-for-profit organizations can be social clubs that exist to serve their members, social welfare organizations, civic leagues, labor organizations, and business leagues. These would be tax exempt but not 501(c)(3).

Most not for profit organizations fall into one the following categories:

• Relieve Poverty. Not for profit organizations may engage in work to provide basic necessities to those without simple amenities.
• Advance Education. Not for profit organizations may engage in work to increase people's knowledge or skillsets.
• Advance Religion. Not for profit organizations may engage in work to establish, maintain, or follow a religious faith.
• May Community Benefit. Not for profit organizations may provide other resources not mentioned above for the betterment and welfare of the community, though this is not required.
  

Activities of Not for Profit Organizations

Not for profit organizations often classify their activities in one of the three ways: fundraising, program, and administrative. The fundraising activities of a not for profit may range from public major events to more private, smaller fundraising opportunities. Not for profit organizations may also solicit direct donations, sell products, or rely on major gifts.

These funds are used to pay for the two remaining types of activities. First, most of the fundraised funds should go to the not for profit's program. This is the mission it was created to serve, and money is spent to help solve the problem that caused the nonprofit to be formed in the first place.

Funds are also used to pay for administrative expenses. For example, some back office functions like a bookkeeper are not directly related to offering program services. However, a bookkeeper is an essential part in maintaining the reporting requirements necessary to remain a not for profit. For this reason, not for profits often must spend at least a small portion of donations on expenses not directly tied to their mission.

Not for Profit and Taxes

To achieve tax-exempt status, the organization needs to request 501(c)(3) status from the Internal Revenue Service (IRS). To qualify, the organization’s purpose must be one of the following: charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, or preventing cruelty to children or animals. 

If desired, a not-for-profit organization can also opt to incorporate. Once registered and running, it has to maintain compliance with the appropriate state agency regulating charitable organizations.

Thanks to their tax-exempt status, not-for-profit organizations are not subject to most forms of taxation, including sales tax and property taxes. In most cases, only donations made to nonprofit 501(c)(3) organizations are tax-deductible. Not-for-profit organizations can be social organizations, sports clubs, etc. without a charitable purpose, so even if they are tax-exempt, donations might not be tax deductible for donors.

For example, if a church is established as a not-for-profit organization, it does not pay property taxes on the house of worship that it owns. Similarly, if a not-for-profit charity accepts clothing donations, sells the clothing, and uses the money for its charitable purposes, it does not pay property tax on the building that it uses as its store.

However, not-for-profit organizations must remit payroll taxes on behalf of their employees. Similarly, the employees and directors who receive income from a not-for-profit organization must report the income to the IRS.

For-Profit vs. Not for Profit 

Aside from the distinguishing feature that a not-for-profit organization does not distribute profits to its owners, many nonprofits have much in common with for-profit organizations. For example, while some not-for-profit organizations use only volunteer labor, many large or even medium-sized ones are likely to require a staff of paid full-time employees, managers, and directors. Indeed, as not-for-profit enterprises wish to accomplish their objectives in the same way as for-profit enterprises, business tactics and management techniques honed in the for-profit world often work well in not-for-profit organizations, too.

Finally, while for-profit businesses can engage in a huge range of activities, not-for-profit businesses must operate exclusively as a charity or for scientific, religious, or public safety purposes. Additionally, not-for-profit organizations may exist to collect income to dispense to other qualifying charities.

Nonprofit vs. Not for Profit

Both nonprofits and not for profits exist to operate an entity that does not earn a profit for the owners of the entity. Both are often overseen by a board of directors, and all money raised by the entity are spent either on supporting the entity's mission and programmatic goals or used to support the administrative costs of running the entity.

Not for profit organizations vary from nonprofits in that they often may not offer a broad public benefit. Instead, not for profit organizations may exist to serve the best interest for a select few. Consider the example of a private sports club. This club's purpose is not to better the entire community but a select subset of community members. This organization may still be formed in a way to capitalize on favorable IRS legislation; however, they are not formed for the explicit benefit of the public good.

In addition, nonprofits may have a different legal structure. Nonprofits can have a separate legal structure while not for profit organizations can not. Nonprofits often operate to maximize the net proceeds collected (to then be spent on the mission), while not for profit organizations may simply exist to provide a non-financial benefit. Last, not for profit organizations are often run by volunteers, whereas non-profits are more likely to have paid staff.

Common Problems That Not for Profits Encounter

In a survey of nonprofits in the United States and Canada released by the Nonprofit Research Collaborative in 2019, staffing was the biggest problem encountered by those surveyed; 18% identified challenges managing transitions in staff and the staff being too small. Salaries, of course, are generally higher in the for-profit world. The next most common problem, at 11%, was with donors: their cultivation, acquisition, and retention, as well as communications with them. Tying for third place at 10% was the state of the economy and the concomitant national mood and the impact of tax laws.

Organizational issues (involving boards, leadership, fundraising, and budgeting) clocked in at 9%, while local issues (especially too many nonprofits competing for funds) and problems with articulating a mission or purpose and creating programs to fulfill it tied at 8%. Other concerns included starting and ending campaigns, changing demographics, and government funding.

One problem not specifically mentioned in the survey (it would fall under the rubric of organizational issues) is what is termed “founder’s syndrome,” according to the Maine Association of Nonprofits. This happens when the founder of a nonprofit organization resists changes necessary to keep the group alive and thriving.

The founder may have assembled a like-minded board when starting the organization, but as time passes and board members change, different ideas about what the group should be doing and how to go about it may arise, especially when external forces present new challenges.

If a founder is trying to preserve their original vision when the organization needs to grow and change, founder’s syndrome has set in. As the board, not the founder, is responsible for running the show, this can lead to the difficult step of replacing the founder when compromise proves impossible.

The Bottom Line

Not for profit organizations exist to better the world; as opposed to nonprofit organizations, they may exist to better not the general public but only a subset of people. Not for profit organizations may still receive favorable tax treatment through the IRS, and, compared to a business, its main intention is to not necessarily to maximize its net income or net assets.