Nonprofit organizations are usually exempt from paying taxes on income they earn. To be nontaxable, the income must be related to activities connected to the nonprofit’s mission. Although there are no laws restricting how much money a nonprofit organization can make, the nonprofit sector must reinvest any profits into advancing its nonprofit mission. A nonprofit is allowed to have net revenue left over at the end of the year to build a reserve fund.
Key Characteristics of Nonprofits
Nonprofit organizations exist not to make money but to fulfill a particular purpose. A dedication to the mission is a key strength, with the focus on the importance of mission often taking priority over business strategies. Yet effectively managing the organization’s finances is fundamental to the success of the mission. A board of directors or trustees manages the organization and sets its policies. Another common characteristic of a nonprofit is that many operate on limited financial resources and may rely heavily on both the effort and time that volunteers contribute in helping the organization to deliver its services.
A nonprofit can earn more money than it spends as long as the organization operates for a nonprofit purpose. Nonprofit organizations have operating costs and expenses, and must pay employees just like for-profit businesses. The major difference between nonprofits and for-profit businesses and corporations is that nonprofits do not distribute profits to owners or shareholders, but must reinvest any surplus revenue back into the organization to support the nonprofit’s mission. For-profit businesses are organized as corporations, partnerships or sole proprietorships and are basically founded to make money.
To qualify for tax-exempt status for federal income tax purposes under section 501(c)(3) of the Internal Revenue Service code, none of an organization’s earnings may go to a private individual or shareholder, nor may the organization actively lobby for or against a political candidate. A nonprofit organization must be created and operated solely to serve the community by aiding in a charitable goal such as helping the poor or underprivileged, defending human rights, advancing education or religion, maintaining historic buildings and monuments or supporting medically relevant scientific research. These are but a few of the qualifying charitable purposes the IRS allows. If any of these IRS guidelines apply, the organization does not have to pay taxes on activities related to the organization’s nonprofit status.
To some extent, the IRS, a state’s attorney general office and private watchdog groups monitor whether a nonprofit organization is complying with the law. One particular area of interest is how much nonprofits pay their top executives. Despite federal laws prohibiting nonprofit organizations from paying excessive salaries to executives, weak enforcement of regulations governing compensation paid to chief executive officers has generated closer attention from the IRS. In addition, private groups that evaluate nonprofits report receiving more complaints about executive pay each year than any other issue. Although public officials are beginning to enforce the laws that do exist regulating salaries paid to nonprofit CEOs, most of the state and federal agencies responsible for monitoring nonprofit charities are understaffed.