You hear all the time that the difference between for-profits and non-profits is the tax deductions. Let’s dig a little deeper.
What is a Nonprofit?
Before we delve into how nonprofit organizations differ from other businesses and entities from a tax standpoint, let’s first look at what a nonprofit is.
First, nonprofits and not-for-profits are different. Nonprofit describes an organization that serves the public with its goods and services. But a not-for-profit can just serve a group of its members. According to Investopedia, 501(c)(3) nonprofit organizations are the most common. They are organizations that include “corporations, funds or foundations that operate for religious, charitable, scientific, literary or educational purposes.”
501(c)(3) organizations are split into two groups: public charities and private foundations. Public charities are what most people think if when they hear the word “nonprofit.” They are organizations that get their support (and income) from the general public and/or the government.
Conversely, private foundations are created to help distribute money and resources (usually using grants) to help fulfill a public need.
According to the IRS, there are several exempt organization types:
- Charitable organizations – “operated exclusively for religious, charitable, scientific, testing for public safety, literary, educational or other specified purposes that meet certain requirements”
- Churches and religious organizations
- Private foundations
- Political organizations
- Other nonprofits
Outside of 501(c)(3) classified organizations, there are several other special interest groups and businesses that fall under the nonprofit and not-for-profit umbrellas:
- 501(c)(4) – social welfare organizations, civic leagues, homeowners’ associations, volunteer fire departments
- 501(c)(5) – agricultural and horticultural organizations, labor organizations
- 501(c)(6) – business leagues (trade associations, chambers of commerce)
- 501(c)(7) – social and recreational clubs
- 501(k) – childcare-related organizations
Tax Exemptions
The big tax exemption that applies to 501(c)(3) organizations and other nonprofits is that they do not have to pay federal income tax.
And as we mentioned above, the IRS recognizes many different types of nonprofit organizations. But only those with 501(c)(3) status can also say that any donations made to the organization are also tax-deductible for the donor.
For nonprofits to reap the tax benefits, they must meet certain requirements as well. It must remain true to its founding purpose (or notify the IRS that the main purpose has shifted or changed).
The majority of the organization’s time and effort must also go toward this purpose. This also means they must not receive income from products and services that are unrelated to its core business operations. This unrelated business income doesn’t have a specific cap, but most agree that it can only be about 15-30% of its gross income.
They are also eligible for government and private grants.
Nonprofits are rewarding organizations that must prove their tax-exempt status by sticking closely to the regulations and requirements. You can learn more about nonprofits and their tax obligations on the IRS website.
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