By Roger Robinson, Ph.D. SCORE, Mentor
We ended part 1 of Do You Really Want to Become a Nonprofit? with:
While making a profit is not their primary motivation, nonprofits must generate revenue in excess of expenses (in fact make a profit / surplus). This means that nonprofits do not exist to make money for owners or investors. Instead they are dedicated to a specific mission.
Another obvious issue lies in the assumption that acquiring nonprofit status creates the advantage of being a tax-exempt entity. Nothing could be farther from the truth. Nonprofit is not the same as tax-exempt. Organizing as a nonprofit is done under state law, preferably as a corporation. The articles of incorporation must contain a clear statement of exempt purpose and indicate the assets are dedicated to exempt purposes. A dissolution clause should also be included.
Nonprofits are not automatically entitled to a 501(c)(3) or any other tax-exempt designation under the Internal Revenue Code. As Stacy Schnieder, CPA, noted there are over 27 types of 501(c) categories. To be tax-exempt the organization’s activities must benefit the public. The original reason for the tax-exempt concept was that nonprofits could stand in for government in areas and activities in which government was not able to do so.
There are several other differences
Both profits and nonprofits operate in the competitive world. Nonprofits operate in a grant (donation) economy. For-profits operate in a market economy. Nonprofits must file Form 990 annually with the IRS unless they are church related. Additionally there may be filing and tax requirements specific to individual states. In terms of personnel, nonprofits may have the complex problem of dealing with unpaid employees, i.e. volunteers.
The 501(c)(3) designation is primarily for charitable, education, scientific, religious or literary activities that are of value to and benefit the public. This determination under the IRS Code exempts designated organizations (not individuals) from a variety of taxes. It also allows donors of gifts, under appropriate circumstances, to deduct these donations for tax purposes. To attain this status requires filing a completely detailed form 1023 or 1023 EZ, including by-laws, directors, purpose, etc. For all activities give the IRS lots of information – use key words like volunteers, etc. to show nonprofit status. Develop a three to four year budget and indicate funding plans. Where needed use attachments. Remember to put your previously obtained EIN on all pages. Note also that all pages are in duplicate (one for you and one for the IRS). The application must also be accompanied by the appropriate check ($400 for the 1023 EZ or $850 for the full form, depending on future receipt estimates). Approval, under the best of circumstances, can take to up to six months or more.
In summary 501(c)(3) tax-exempt status is an IRS determination. Application should be submitted within 27 months of formation. The entity must be organized and operate for a tax-exempt purpose, i.e. charitable, education, scientific, religious or literary purpose. The organization:
- Cannot intervene for any candidate
- Cannot lobby on broad policy issues except in self self-defense
- To make lobbying a substantial part of organization activities
- Cannot have other then a public benefit purpose
- Cannot benefit any private interest
- Cannot grant excess benefits to disqualified persons
- Must be of value to the public and/or service to the community
One easy way to differentiate between for profit and a tax-exempt nonprofit can be simply stated in terms of for-profit R O I and nonprofit I O I.
- R O I = Return on Investment (for the investor)
- I O I = Impact of Investment (for the public at large)
About the Author:
Roger Robinson, PhD has been a SCORE mentor for over 16 years. His specialties include nonprofits, business planning, specifically in restaurants and hospitality, recreational and arts and Entertainment verticals. Read more about Roger here. Click here to schedule a free mentoring session with Roger or another SCORE mentor.