A nonprofit organization (”NPO”) is designed to serve public or private interests, rather than to generate profits as in the case of traditional businesses. Nonprofits receive their funding through donations and grants.

Structure of Nonprofits

Nonprofit organizations come in all shapes and sizes. Some are organized with a traditional corporate structure, while others may operate more like a democracy in which members vote on policy.

Most nonprofits are run by a board of directors, which oversees business operations and makes decisions regarding fundraising and goals for the organization. This board can either be self-appointed or elected by members/employees of the organization.

Though nonprofits often seek volunteers to help with projects, nonprofits are run by paid employees. The IRS has guidelines limiting the portion of a tax-exempt organization’s earnings that can be paid to the board of directors in the form of salaries and bonuses. These limits prevent certain employees from profiting unfairly from charitable activities, and prevent nonprofits from shielding potentially taxable profits by transferring them to appointed directors.

Nonprofit Organizations and Tax Exemption

Nonprofit organizations must apply for tax exemption from the IRS under code 501(c)(3); it is not automatically granted when an organization is established as a nonprofit. The tax exemption granted under section 501(c)(3) only applies to federal income taxes, so NPOs are still liable for taxes associated with employees’ salaries, as well as other applicable state and local taxes.

Another benefit of being granted tax exemption under 501(c)(3) is that most donations to the organization are tax-deductible for the donors. For businesses or individuals facing a large tax liability, charity donations can offset that liability. Profit-seeking businesses pay exorbitant taxes on profits; tax-deductible donations are commonly used to eliminate the liability of taxable profits.

Not all charitable contributions are tax-deductible, just as not all nonprofit organizations are tax-exempt. Most charities will identify themselves as 501(c)(3)-certified, and potential donors are told whether their donations will be tax-deductible.

Particularly for capital campaigns or other large-scale fundraisers, offering tax relief for donors is crucial because you are seeking large donations. Donors are unlikely to give to your cause if there is no personal benefit. Tax-deduction can be enough of an incentive to recruit many donors for your cause.

Definition of 501(c)(3)

Many nonprofit organizations identify themselves as “501(c)(3)-certified.” The code 501(c)(3) refers to IRS tax provision 501(c), which lists the 27 types of nonprofit organizations that are eligible for tax exemption. Sections 503-505 of the IRS tax code include the requirements that companies must meet in order to be certified as tax exempt. The main requirement for tax exemption is that the majority of the revenue generated from the organization must be donated to a predetermined public or private interest. Even though they do not pay federal taxes, tax-exempt organization are required to disclose financial information to the IRS. The specific forms required for an organization depend on the organization’s annual revenue.

The code 501(c)(3) designates a specific subcategory of tax-exempt organization, including charities, nonprofits, schools, and churches.

Non-Charitable Activities

Nonprofit organizations are permitted to conduct some non-charitable activities, such as investing in stocks, in order to generate profits, but the majority of those profits, and the majority of the organization’s activities, must be dedicated to their stated tax-exempt purpose. The IRS has the right to monitor the organization’s financial records to assure that the required portion of company money is being used for exempt purposes.