Learn more about how nonprofit organizations work and the special tax treatment they receive from the federal government.
Definition and Examples of Nonprofit Organizations (NPOs)
A nonprofit organization can be a corporation, association, or one of several other entity types that does not distribute any profits for the benefit of its members or similar parties. In many cases, a nonprofit also does not intend to generate a profit, such as a charitable organization that raises money, then distributes grants or saves funds to be able to make future donations. This stands in contrast to a typical for-profit business, where the goal would be to make more than the company spends, and the profit could then be reinvested in new business areas, paid out as bonuses to employees, distributed as dividends, etc. However, not all nonprofits are charities. An industry trade association, for example, could be a nonprofit, as it’s not raising money for the public good, but it’s also generally not generating profits that go to the controlling members. Nonprofits are also not automatically tax-exempt, although many do qualify, including those that aren’t charities. Still, nonprofit status is generally a state designation, and nonprofits that want to be federally tax-exempt need to apply for this status with the Internal Revenue Service (IRS). Some types of nonprofits, however, do generate profits and operate more like a regular business. The difference is that these profits are used to support the nonprofit’s mission instead of being distributed to enrich others. For example, the Coolidge Corner Theatre in Brookline, Massachusetts, is a nonprofit movie theater. While the organization has strong cultural components that underpin its nonprofit status, and you can’t necessarily find the same showings that you would at other cinemas, you can still buy a ticket to see a popular film there, much like you would at a for-profit movie theater. In 2019, the Coolidge Corner Theatre had more revenue than expenses, although the revenue accounts for things such as contributions alongside ticket sales.
How Do Nonprofit Organizations (NPOs) Work?
Being a nonprofit organization often implies having a legal tax status, but that’s not always the case. Terms including “nonprofit,” “charity,” and “tax-exempt organization” are often used interchangeably, but it’s important to realize that the terminology an organization uses doesn’t necessarily align with its legal status. Instead, an organization must apply with state and federal tax authorities to obtain official designations. So, while an organization might informally consider itself to be a nonprofit, it would have to apply with the IRS for tax-exempt status. One of the more common ways an organization can qualify as tax-exempt is under the 501(c)(3) section of the tax code, which is generally for charitable organizations. That’s why you’ll often see a nonprofit market itself as 501(c)(3) charity. The 501(c)(3) code also applies to religious institutions, so you might see a nonprofit church, for example, operate under this exemption. That said, there are other non-charitable designations that a nonprofit can apply for to become tax-exempt. For example, a nonprofit social club, such as a country club, could be tax-exempt under section 501(c)(7). While a country club is certainly very different from, say, a food bank charity, both are nonprofits in the sense that they’re not distributing profits to members. Both can be tax-exempt, as social-club members are generally paying dues with after-tax income to be part of the group.
