When you hear the word “nonprofit”, what does it mean to you? Many people use that term, but don’t *really* know what they’re referring to, or understand the many different forms that nonprofits can take.
Simply put, a nonprofit’s primary goal is not to make money, but to provide some benefit to its members or the general public. Yet, even though that definition of a nonprofit is simple, there’s so many layers underneath that definition that I will unpack for you in this post.
Today, we’re going to dispel some of the myths about nonprofits and give you clarity about what nonprofits are, and how to distinguish between other classifications or statuses. If you need help starting a nonprofit, read this post HERE.
So what does nonprofit mean? The term, “nonprofit” is an all-encompassing word that is often used interchangeably with other terms like charitable organizations, 501c3 organizations, not-for-profit organizations, non-governmental organizations (NGOs), etc. Nonprofits can take many different forms including hospitals, universities, homeowner associations, membership societies, museums, foundations, and more. You may not realize that a nonprofit does not have to be a charitable organization - it does NOT have to provide a service to the general public. In fact, there are some nonprofits that are member organizations, that only serve their members, and not the general public.
It’s also important to note that nonprofits are formed at the state level. So what states consider nonprofits depend on state laws and regulations. States also may use different terminology such as nonstock corporations.
The common thread for all of these nonprofits is that they are not primarily formed to make a profit - they are primarily formed to meet their missions, which MAY include a charitable service, but doesn’t necessarily have to be (I will explain more about this later). There’s some discussion online about the differences between not-for-profits and nonprofits, which adds to the confusion about the meaning of nonprofit. There’s no difference between those two terms - they essentially mean that the organization was not primarily formed to make a profit. It’s all the same.
The reason you may be confused is that we traditionally think of nonprofits as charitable organizations that operate to serve those in the community, or provide a charitable service, like mental health services, or environmental preservation. And that’s true, many nonprofits fulfill that purpose. But there are so many other organizations that don’t operate as a charity but still use the nonprofit structure to operate. So next, let’s walk through some commonly asked questions and misconceptions about nonprofits.
Are all nonprofits tax-exempt?
No. When people use the term tax-exempt, they are typically referring to exemption from federal income tax. That means that the federal government will not tax any money your organization makes when fulfilling any mission-related activities. In some states, nonprofits may ALSO be exempt from sales tax on items they wish to purchase, but it depends on the state, and it depends on the vendor you wish to purchase from. Many traditional nonprofits (meaning those formed for a charitable reason), apply for 501c3 tax-exempt status which is the most popular tax exemption with the IRS, and are typically called charitable organizations.
Which leads me to the next set of questions….
Are all nonprofits 501c3 organizations? What is a 501c3 organization?
The only nonprofits that are automatically designated 501c3 organizations are churches and religious organizations like mosques and other houses or worship. Otherwise, nonprofits are not automatically deemed 501c3 organizations. 501c3 status is just one status that the IRS uses for federal tax-exemption.
In order to qualify as a 501c3 nonprofit organization, you have to be organized for specific reasons and ensure that you are not organized for the benefit of private interests (which may include direct benefits to the founder or board of directors). To keep it simple, I’ll directly link from the IRS site - which is the one place you should be doing your research to confirm any questions you have:
“The exempt purposes set forth in section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. The term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.”
If your organization fits within those purposes, you will likely be approved for 501c3 status. There are 29 different tax statuses that nonprofits may apply for. So, you do not have to be a 501c3 organization if you are a nonprofit. However, if you are seeking grants, most funders only fund grants to 501c3 public charities (learn more about public charities below). To see a list of other types of tax-exempt organizations (or other 501cs), see this list HERE.
One more thing: In order to qualify as a 501c3 organization, you cannot use the majority of your time influencing legislation and you cannot participate in campaigning activities for or against political candidates. If a large portion of your work will involve lobbying for legislation, you should consider 501c4 tax-exempt status. Find out more HERE.
If you need help setting up your nonprofit, download my nonprofit startup workbook by clicking below:
Are all nonprofits charitable organizations?
No. As mentioned above, not all nonprofits are formed to serve the public. In order to qualify as a charitable organization, you would generally meet the requirements outlined for 501c3 organizations. There are homeowners associations, mutual insurance companies, health insurance issuers, etc. designated as nonprofits, and only exist to serve their members. Even though they are designated as nonprofits, they are not defined as charitable organizations. Because they do not have a charitable purpose, they would not qualify for 501c3 tax-exempt status.
What is the difference between nonprofits and 501c organizations?
As mentioned above, there are 29 different tax-exempt statuses designated by the IRS, of which most of them are not required to provide a charitable service. If you plan to provide a service to your community, you generally should look to be tax-exempt as a 501c3 organization.
What is the difference between nonprofits and non-governmental organizations (NGOs)?
Non-governmental organizations (NGOs) are those not affiliated with the government and organized by a group of individuals for a common purpose. NGOs can be for-profit or nonprofit organizations. NGOs is an international term typically used outside of the United States, and in many instances, comparable to nonprofits that operate as charitable organizations inside the US.
What is the difference between public charities and private foundations?
You may not realize how important it is to distinguish between these two types of nonprofits. When applying for 501c3 tax exempt status, you have to choose the type of organization you want to be-whether it be a public charity or private foundation. Nonprofits using form 1023 or 1023EZ to apply for 501c3 status are defaulted to a private foundation status, and have to self-identify as a public charity.
Public charities fall into the qualifications set in the U.S. tax code, section 509(a)(1), (2), (3), or (4). These organizations receive at least a third of their income from a variety of sources, including fees charged for program activities related to their missions; they are affiliated with organizations that fit those guidelines; or they’re organized for testing of public safety.
Private foundations, on the other hand, typically have one or few sources of income and provide grants to other nonprofits (public charities) rather than operate their own charitable programs. The tax deduction for a donor’s contribution to a private foundation is less than when provided to a public charity. There is a hybrid of public charities and private foundations, referred to as private operating foundations, which you can learn more about HERE.
If you’re thinking about forming a nonprofit that operates as a charitable organization, it is very important that you understand the terminology so that you don’t make a mistake in forming the wrong type of organization, and risk having to start over. My video breaks down the biggest mistake I see nonprofits make when applying for 501c3 tax-exempt status. Watch it ---->HERE.
Does being a nonprofit mean I can’t make a profit?
Not at all. Nonprofits should make a profit if they want to survive. Nonprofits are still businesses, they just have different structures and abide by different laws. There is not one business that can survive without a clear profit making strategy. The difference with a nonprofit is that if you are fortunate to make a profit, that money cannot be dispersed to the founder or board of directors. Any additional monies must be used to support the ongoing development of the organization. It’s to your advantage to build as many different avenues to make income to become sustainable. If you need help developing fundraising strategies for your new nonprofit, check out my post on the 11 ways nonprofits raise money.
So there you have it! Hopefully you have a better understanding of the definition of nonprofit and it will help you identify the type of organization you want to form. If you need help forming a nonprofit organization that qualifies as a 501c3 public charity, read my post----->HERE.
