For-profit and not-for-profit organizations share many qualities but also have some distinct differences.
People have all sorts of questions around starting and operating a nonprofit business. If my business doesn’t make any money, can I turn it into a nonprofit; how am I supposed to run a business if it doesn’t make any money; can I set up a nonprofit organization under my for-profit company, and then just donate all the money I make in order to avoid taxes (no); do nonprofits make money?
It’s important to differentiate between a nonprofit organization and a non-for-profit organization. These two terms get thrown around a lot, and the assumption is that they mean the same thing, but that’s not the case.
What is a nonprofit organization?
A nonprofit organization qualifies for tax-exempt status by the IRS due to its mission and purpose being to provide a public benefit, or further a social cause. Common examples are hospitals, charities, foundations and colleges or universities. To be a nonprofit your business must serve to advance the public good in some way. The reason they are designated as “nonprofits” is that none of the money the company brings in as a profit is distributed to owners (such as members in an LLC or shareholders in a corporation), and the revenues are used to advance the mission of the company.
Typically, information on finances and operations are made available to the public in order to show donors that contributions are being used for their intended purpose, and to benefit the cause of the company. Individuals and businesses can make donations or contributions to nonprofits and deduct those contributions from their own tax returns. Nonprofit organizations pay no taxes on the money they receive from fundraising.
What is a not-for-profit organization?
Not-for-profit organizations have some similarities to nonprofit organizations, such as not earning a profit that can be paid out to the owners. All the money and funds generated from business activities is put back into running the organization.
A big difference here is that not-for-profit organizations are not required to operate for the public good, and can be set up to simply benefit the goals of its members. Common examples of not-for-profit organizations are social groups and sports clubs, organizations that are set up for the benefit and enjoyment of the members. Not-for-profit organizations do apply for tax exempt status from the IRS. Many of these organizations will not be considered qualifying charitable organizations, meaning that donations and contributions are not tax deductible for the individuals or companies that made them.
Nonprofits, Foundations and Charities
A common question that comes up is what’s the difference between a nonprofit and a foundation? Typically, when this question is being asked, it’s in reference to private foundations and public charities. Private foundations (foundations) are organizations that don’t qualify as public charities. A foundation is still an entity set up for charitable purposes, but unlike a charity, which relies on public donations and fundraising to support its activities, funding for foundations typically comes from a family, corporation or single individual. The main difference between the two being where they get their financial support. It’s common for private foundations to make grants and give funds to public charities, whereas public charities are usually more geared towards providing the services or activities to support their mission.
Along the same lines, there is often confusion between a nonprofit vs charity. These terms are often used interchangeably, but they technically do have different meanings. Nonprofit is often a concept of state law, you can form a nonprofit by registering for the appropriate entity with your designated state office. For example in Virginia, most non-stock corporations are formed for nonprofit purposes, such as clubs, rescue squads and religious organizations. Charity status on the other hand is a concept that comes into play at the federal level. There are Treasury regulations that define what “charitable” means, and all nonprofit organizations don’t meet those definitions. In order to qualify for tax exemption at the federal level an organization must first be appropriately organized at the state level, and file to be recognized as a tax-exempt charity on the federal level. The bottom line is that there are many types of nonprofits other than charitable ones, for example credit unions, chambers of commerce, labor unions, homeowners associations and social clubs are some types of nonprofit organizations that aren’t organized exclusively as charitable organizations and likely don’t meet the federal requirements for a charity.
Nonprofits and For-Profits
How do nonprofits and for-profits differ, what are the benefits of nonprofit vs for-profit? For starters they exist for very different reasons. A nonprofit organization exists to drive its mission and activities to support that mission. For-profits on the other hand are organized to maximize profits and pass the profits onto the owners of the company.
Some of that leads to confusion around what it means to be a “nonprofit” since the goal isn't’ to generate profits; do nonprofits even make money? The answer is yes (some of them make significant amounts of money), it’s just directing that money in a different direction.
At the core of a nonprofit are a few elements that guide how it’s set up and operates: it’s mission based, and usually has a charitable, religious, educational, scientific, literary, or other societal benefit; there is public ownership where no person owns shares in the company or is a member of the company; income is never distributed to any owners but is recycled back into the mission and purpose.
On the other hand, you have for-profits, which under most circumstances are set up to generate income for the owners. The goal is to make money, by sales of products or services, and the success of the company is usually measured by its ability to generate revenue. Profits can then be shared with owners, employees and shareholders.
LLC’s are a common form of business structure, and often questions arise about nonprofits vs LLC. Since limited liability companies are usually easy and affordable to set up, many people looking to start a nonprofit want to take advantage of the relaxed formalities. Unfortunately, using an LLC as the entity for a nonprofit isn’t likely to be an option, and it's usually a business structure reserved for for-profit businesses. There may be some limited circumstances where an LLC can be used as a nonprofit, but that’s pretty limited to situations where it’s a wholly owned subsidiary of an existing nonprofit or charitable organization.
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