Nonprofit Organizations Defined
Nonprofit corporations share many of the same characteristics as for-profits, particularly since they are also separate from the actual human beings involved and so, for the most part, shield the individuals from direct liability. The larger issues relating to liability insurance for a nonprofit organization are addressed in Chapter 18.
The Core Element of a Nonprofit Organization
Unlike for-profit corporations, in which individual owners, partners, or shareholders may personally benefit from the organization, in a nonprofit corporation, no individual may directly benefit from any “profit” generated by the organization. Rather, the money generally considered to be “profit” must be turned back into the organization to continue its work. This effectively eliminates the profit motive and makes it truly a public organization.
What is meant by the term profit motive?
Profit motive is a term used to describe the chance of generating a surplus of revenue over all costs; it is the reason most people start and remain in a traditional for-profit business. The profit motive is the exact opposite of philanthropy, or giving for the common good, one of the foundations of nonprofit organizations.
The Origins of Nonprofits
The laws behind nonprofit organizations were formulated at the very beginning of the United States. Before formal government agencies and departments were created to handle the many tasks necessary for the smooth running of a government, people often formed small groups or societies to take care of issues themselves.
When the first regulations establishing an income tax were drafted, exemptions were made for community-based charitable groups. These exemptions allowed them to undertake necessary work that would never be profitable from a financial perspective, while relieving the government of the task.
Any organization seeking recognition under IRS section 501(c)(3) must exist for “purposes which are charitable, religious, educational, scientific, literary, involve testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.” This definition comes from the IRS Form 1023, which you will need to complete and submit to apply for tax-exempt status.
The federal government recognizes close to thirty distinct types of nonprofit organizations. Although this book will only focus on one — the 501(c)(3) and its slight variation, the 501(c)(4) — familiarity with the other types will help you and your organization understand where you fit in the larger scope of things. Each of these categories has its own sets of rules and regulations.
Nonprofits Can and Do Make Money
Nonprofit organizations can and do make money, but the funds in excess of the operating costs of the organization must be returned to the organization and may never be divided among investors, staff, or board members. By the same token, nonprofits may hire staff, engage private consultants, and operate as does any other corporation; the important distinction is that salaries or fees must be established as set amounts.
A sliding-scale compensation structure that depends on the success of the organization would place the individual in the position of directly benefiting from the organization, which would run contrary to the tax code and in all probability cause the nonprofit to lose its tax-exempt status.