How Does a Nonprofit Organization Work?

Starting a Nonprofit Organization

A nonprofit organization, though it receives special tax treatment and is subject to unique rules and regulations, starts off much like any other corporation. In other words, most need startup capital, a business plan, bylaws and a board of directors, though some exist as legal trusts or similar associations. And, if it is going to be successful, a nonprofit needs to provide a service that is not already being met or must do so in a way that offers concrete advantages for consumers. Nonprofits do charge for services and take in money, they are just restricted in what types of operations they can conduct and what they can do with their revenue.

Obtaining Nonprofit Designation

The official nonprofit designation can only be granted by the Internal Revenue Service (IRS) according to Section 501 of the Internal Revenue Code. To obtain this designation, the organizing documents of the corporation and its federal Employer Identification Number (EIN) must be submitted with the proper application, usually Form 1023 or Form 1024. The most common types of nonprofit organizations are religious, education or charitable in nature, and many of these qualify for 501(c)3 tax exempt status and can receive tax-deductible charitable contributions. Depending on where they are incorporated, a nonprofit organization may also have to apply for state and municipal tax exemptions.

Restrictions on Nonprofits

Legally recognized nonprofit corporations are not taxed by the federal government, but must file an annual return with the IRS, Form 990, if its gross receipts normally exceed $25,000. To earn and maintain their tax exempt status, they must only engage in activities of public interest or mutual benefit easily identifiable as charitable, religious, educational, scientific or literary, or which enhance public safety, foster amateur sports competition or work for the prevention of cruelty to children or animals. Though many nonprofits rely heavily on contributions for their funding, many also take in revenue in ways similar to for-profit ventures. They usually must pay for goods and services they consume, like any business, and they usually pay their employees competitive wages and salaries. A revenue surplus occurs if the money they earn exceeds their operating costs. These funds would represent profits to a normal business, but in a nonprofit cannot benefit owners, board members or investors of the organization. They instead must be spent in pursuit of the public interest goals outlined in their organizing documents. Failure to do so can lead to the revocation of their tax-exempt, nonprofit status.

Resources

• Starting a Nonprofit Organization
• Tax-Exempt Status
• Tax Information for Charities & Other Non-Profits