What Is a Nonprofit Organization?

People hear the term nonprofit organization and picture Mother Hubbard’s cupboard, as in awfully bare or zero bank balance. But in fact, some nonprofit organizations turn very tidy profits on their operations, and that’s good, because cash flow keeps an enterprise humming, whether it’s a for-profit business or not.

For-profits compared with nonprofits

The main difference between a for-profit and a nonprofit enterprise is what happens to the profit. In a for-profit company like Exxon, Microsoft, Disney, or your favorite fast-food establishment, profits are distributed to the owners, including shareholders. But a nonprofit can’t do that.

Any profit remaining after the bills are paid has to be plowed back into the organization’s service program or kept in reserve. Profit can’t be distributed to individuals, such as the organization’s board of directors.

What about shareholders — do nonprofits have any shareholders to pay off? Not in terms of a monetary payoff, like a stock dividend. But in a broad, service sense, nonprofits do have “shareholders.” They’re the people who benefit from the nonprofit’s activities, like the people who tune in to public radio or enroll their children in a nonprofit preschool.

501(c)(3) Nonprofits

The term nonprofit organization, for the most part, refers to an organization that has been incorporated (or recognized in some way) under the laws of its state and that the Internal Revenue Service (IRS) has classified as a 501(c)(3) and determined to be a public charity.

If the term 501(c)(3) is new to you, add it to your vocabulary with pride. In no time, “five-oh-one-see-three” will roll off your tongue as if you’re a nonprofit expert.

Other kinds of nonprofit organizations do exist; they’re formed to benefit their members, to influence legislation, or to fulfill other purposes. They receive exemption from federal income taxes and sometimes relief from property taxes at the local level.

Nonprofit organizations classified as 501(c)(3) receive extra privileges under the law. They are, with minor exceptions, the only group of tax-exempt organizations that can receive contributions from individuals and organizations that are tax deductible for the donor.

The IRS tax code describes allowable purposes of 501(c)(3) nonprofit organizations as serving religious, educational, charitable, scientific, and literary purposes.

Being a nonprofit organization doesn’t mean that an entity is exempt from paying all taxes. Nonprofit organizations pay employment taxes just like for-profit businesses do. In some states, but not all, nonprofits are exempt from paying sales tax, so be sure that you’re familiar with your local laws.