Nonprofit organizations exist to improve the quality of life for others. Although they can pay employees with the money raised and even earn a profit, the Internal Revenue Service grants them tax-exempt status under IRS code 501(c)3. The IRS scrutinizes nonprofits carefully, so it's important to know the rules and regulations.
There is no set limit on the amount of money a nonprofit organization can earn, but there are rules about how it can be spent and when it can be taxed.
The IRS grants tax-exempt status, called 501(c)3 status, to organizations that meet specific guidelines. The guidelines include the following:
- The organization may not exist to support a private interest.
- Earnings may not go to any private shareholders.
- Earnings may not go to any individuals except as legitimate salaries.
- The organization must not exist to campaign for or against a political party or individual candidate.
- The organization must not substantially engage in activities designed to influence legislation. In other words, there is a limit on lobbying.
See the IRS website for more details on qualifying for 501(c)3 status. To file for 501(c)3 status, you need to complete Series 990 forms, also on the IRS website.
Not-for-profit is a broad term that describes activities and organizations that do not aim to — or are prohibited from — earning a profit. As a simple example, walking your dog would be a not-for-profit activity since you don't do it to earn any money. If you started an organization to walk shelter dogs, you might be able to form a nonprofit that raises money, provided the money goes back into the organization.
Nonprofits are generally organizations that take on social, environmental or economic missions. Well-known examples are The American Red Cross, The United Way and Habitat for Humanity. On the local level, food pantries and animal shelters operate as nonprofits. Not-for-profit organizations typically exist for activities that cater to special interests, such as business and trade organizations and amateur sports leagues.
Many nonprofit organizations benefit from the work of volunteers, but there is no requirement that a nonprofit be exclusively run and staffed by volunteers. Volunteers, because they are not paid, can work when and how much they choose. They can leave the organization at any time, either for paid work or because they're no longer willing or able to volunteer. A nonprofit may need the skills and dependability afforded by salaried employees.
Nonprofit salaries must be "reasonable" and "not excessive". The actual dollar amounts vary greatly depending on the size and scope of the organization, but be aware that the IRS looks closely at organizations with 501(c)3 status, and they're at high risk for an audit. If the IRS determines that an organization has wrongfully used its tax-exempt status, it could revoke the 501(c)3 status, and the organization could be subject to penalties.
When setting nonprofit salaries, compare salaries for comparable positions with for-profit and nonprofit organizations in your geographic area. Salaries must be competitive to attract top talent. You can offer benefits such as health insurance, paid leave and opportunities for education and professional development. You can even pay bonuses for a job well done, but know that the IRS scrutinizes bonuses when paid by nonprofits.
When paying salaries to employees of a nonprofit, an organization must:
- Pay the legally mandated minimum wage (state or federal minimum wage, whichever is higher)
- Pay overtime compensation for hourly employees working more than 40 hours per week
- Withhold and remit payroll taxes to federal and, if applicable, state governments