Nonprofit Organizations

Nonprofit organizations are institutions that conduct their affairs for the purpose of assisting other individuals, groups, or causes rather than garnering profits for themselves. Nonprofit groups have no shareholders; do not distribute profits in a way that benefits members, directors, or other individuals in their private capacity; and (often) receive exemption from various taxes in recognition of their contributions to bettering the general social fabric of the community.

Nonprofit groups "are as diverse as the National Football League, Harvard University, and Fannie Mae. A third of these organizations are churches," Roz Ayres-Williams wrote in Black Enterprise. "Because nonprofits cover so many fields of interest—charity, religion, health, science, literature, wildlife protection, the arts, even sports—it's easy to find a niche, whatever your calling."

Nonprofit organizations are far more important to the overall U.S. economy than is generally recognized. Indeed, some sources indicate that the sum total of nonprofit groups comprise a third sector of the American economy, along with the private (business) and public (government) sectors. According to a report published by the National Center for Charitable Statistics there were just shy of 1.4 million nonprofit organizations active in the U.S. in 2004, 59 percent were public charities, and 41 percent private foundations.

TYPES OF NONPROFIT ORGANIZATIONS

A wide range of charitable and other institutions are classified as nonprofit organizations under the Internal Revenue Code. Many of these qualify under the definition provided in Section 501(c)(3) of the Code, which stipulates that all of the following qualify for tax-exempt status: "Corporations, and any community chest, fund or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes, to foster certain national or international amateur sports competition, or for the prevention of cruelty to children or animals," provided that the institutions adhere to basic standards of behavior and requirements of net earnings allocation.

Charitable Organizations

Charitable institutions comprise the bulk of America's nonprofit organizations. These include a wide variety of institutions involved in the realms of poverty assistance (soup kitchens, counseling centers, homeless shelters, etc.); religion (churches and their ancillary possessions, such as cemeteries, radio stations, etc.); science (independent research institutions, universities); health (hospitals, clinics, nursing homes, treatment centers); education (libraries, museums, schools, universities, and other institutions); promotion of social welfare; preservation of natural resources; and promotion of theatre, music, and other fine arts.

Advocacy Organizations

"These groups attempt to influence the legislative process and/or the political process, or otherwise champion particular positions," explained Bruce R. Hopkins in The Law of Tax-Exempt Organizations. "They may call themselves 'social welfare organizations' or perhaps 'political action committees.' Not all advocacy is lobbying and not all political activity is political campaign activity. Some of this type of program can be accomplished through a charitable organization, but that outcome is rare where advocacy is the organization's primary undertaking."

Membership Groups

This kind of nonprofit organization includes business associations, veterans' groups, and fraternal organizations.

Social/Recreational Organizations

Country clubs, hobby and garden clubs, college and university fraternity and sorority organizations, and sports tournament organizations all can qualify as nonprofit organizations, provided that they adhere to basic guidelines of net earnings distribution, etc. Unlike other tax-exempt organizations, however, their investment income is taxable.

"Satellite" Organizations

Hopkins pointed out that "some nonprofit organizations are deliberately organized as auxiliaries or subsidiaries of other organizations." Such organizations include cooperatives, retirement and other employee benefit funds, and title-holding companies.

Employee Benefit Funds

Some profit-sharing and retirement programs can qualify for tax-exempt status.

ADVANTAGES AND DISADVANTAGES OF INCORPORATING

All nonprofit organizations are faced with the decision of whether or not to incorporate. As Ted Nicholas noted in The Complete Guide to Nonprofit Corporations, there are many benefits associated with incorporating: "Some are the same as those commonly enjoyed by for-profit business corporations. Others are unique to the nonprofit corporation. Perhaps the greatest advantages of all—granted exclusively to organizations with bona fide nonprofit status—is exemption from taxes at federal, state, and local levels." In addition to tax exemption, Nicholas cited the following as principal advantages of forming a nonprofit corporation:

• Permission to solicit funds—Many nonprofit organizations depend on their ability to solicit funds (in the form of gifts, donations, bequests, etc.) for their very existence. Nicholas noted that whereas some states bestow a fund-raising privilege on nonprofit corporations as soon as their articles of incorporation are filed, other states require groups to fulfill additional obligations before granting permission to solicit funds.
• Low postage rates—Many nonprofit corporations are able to use the U.S. mail system at considerably lower rates than private individuals or for-profit businesses. To secure these lower rates, nonprofits must apply to the Postal Service for a permit, but this is generally not a major hurdle, provided that the nonprofit group has its affairs in order. "The importance of the mailing rate advantage is directly proportional to the volume of mail the nonprofit corporation generates in the course of its business," said Nicholas. "Membership solicitations are usually mailed third class. Nonprofit corporations that rely on membership income can use the mail even more extensively to service their members. So potential savings from a special mailing permit are considerable."
• Exemption from labor rules—Nonprofit organizations enjoy exemption from the various rules and guidelines of union collective bargaining, even if their work force is represented by a union.
• Immunity from tort liability—This advantage is not available in all states, but Nicholas observed that some states still provide nonprofit charitable organizations with immunity to tort liability. "It is important to recognize, however, that where it exists, the immunity protects only the nonprofit corporation—not the agent or employee where negligence injures someone."

In addition, nonprofit corporations enjoy certain advantages that are also bestowed on for-profit corporations. These include legal life (nonprofit corporations are guaranteed the same rights and powers of individuals), limited personal liability, continued existence beyond the involvement of original founders, increased public recognition, readily available information on operations, ability to establish employee benefits programs, and flexibility in financial recordkeeping.

But there are also certain disadvantages associated with incorporating. Nicholas cited the following as principal drawbacks:

• Costs associated with incorporation—Although these costs are usually not too excessive, especially for organizations of any size, incorporation does generally involve some extra costs.
• Additional bureaucracy—"An unincorporated nonprofit organization can be structured so informally that its operators could keep whatever records they chose on the backs of envelopes or as scribbled notes on paper napkins," said Nicholas. "Not so in a nonprofit corporation. As a legal entity, the corporation is subject to some specific recordkeeping obligations set down by the state in which it is incorporated." In addition, there are certain activity guidelines to which incorporated organizations must adhere.
• Sacrifice of personal control—Depending on where incorporation takes place, the organization may have to appoint a board of directors to oversee operations (although founders of nonprofit groups can often exercise considerable control in influencing the composition of the board and the flavor of corporate bylaws and articles of incorporation). Founders and directors of unincorporated groups are under no such obligation.

"Generally, the advantages far outweigh the disadvantages," summarized Hopkins. "The disadvantages stem from the fact that incorporation entails an affirmative act of the state government: It 'charters' the entity. In exchange for the grant of corporate status, the state usually expects certain forms of compliance by the organization, such as adherence to rules of operation, an initial filing fee, annual reports, and annual fees. However, these costs are frequently nominal and the reporting requirements are usually not extensive."

ORGANIZING A NONPROFIT ORGANIZATION

"Being enthusiastic, imaginative, and creative about establishing a nonprofit organization is one thing," observed Hopkins. "Actually forming the entity and making it operational is another. For better or worse, the exercise is much like establishing one's own business. It is a big and important undertaking, and it should be done carefully and properly. The label 'nonprofit' does not mean 'no planning.' Forming a nonprofit organization is as serious as starting up a new company." He recommended that individuals interested in forming a nonprofit organization begin by determining the organization's main purpose and functions. The next step involves choosing a category of tax-exempt status to match its functions. From there, would-be founders need to study a wide range of issues, many of which are also basic considerations for small business owners and other individuals involved in for-profit endeavors. Often, the counsel of a good attorney and/or accountant can be valuable at this stage. Primary actions include the following:

• Decide what legal form the organization will take (public charity or private foundation, incorporated or unincorporated, etc.)
• If incorporating, take necessary legal steps to make that decision a reality (devise bylaws, submit articles of incorporation, etc.)
• Investigate options and decide on principal organization programs and emphases
• Determine the leadership of the organization (directors, officers, primary staff positions)
• Define compensation for such positions
• Find a physical location for the organization (factors here can range from variations in state law to availability of reasonable office space)
• Put together a strategic plan for achieving organization goals at both community and larger levels

• Decide how to go about funding those goals (gifts, grants, unrelated income, etc.?)
• Determine which media avenues will be best for publicizing the organization's goals and securing volunteers
• Devise an ongoing business plan that 1) serves as a blueprint for institution goals and development, and 2) can be periodically reviewed and adjusted as appropriate.

FUNDRAISING

Nonprofit institutions can turn to several different methodologies to raise funds designed to support their mission. This is especially true for nonprofits that have tax-exempt status, because it permits donors to deduct their gifts from their own personal income tax liability. Major avenues of fundraising used by nonprofit organizations include the following: fundraising events (dinners, dances, charity auctions, etc.); direct mail solicitation; foundation grant solicitation; in-person solicitation (door-to-door canvassing, etc.); telemarketing; and planned giving (this includes bequests, which are given to the organization after the donor's death, and gifts made during the donor's lifetime through trusts or other agreements).

Effective Solicitation and Revenue Management

In order to prosper, nonprofit institutions not only need to know where the sources of funding are, they also need to know how to solicit those funds and how to effectively manage that revenue when it comes into their possession.

Certainly, solicitation of donors (whether they take the form of individuals, corporations, or foundations) is a vital component of many organizations' operations. After all, most activities can only be executed with funding. But many nonprofit institutions are not accomplished in this area, either because they do not allocate adequate resources or because of problems with execution. Writing in Fund Raising Management, Robert Hartsook listed the following as common solicitation errors that nonprofit groups make:

• Not listening to donor expectations
• Unwarranted assumption of a donor's willingness to contribute
• Lack of follow-up after initial contact
• Inadequate research on potential donors and their ability to contribute
• Inability to close presentation with donor commitment
• Neglecting to establish rapport with potential donors prior to solicitation
• Framing solicitation as "begging" rather than as a reasonable request for help with a worthy cause
• Neglecting to tailor solicitation to individual donors
• Approaching potential donors without knowledge of how donations impact them in the realms of tax deductions, etc.

Of course, even the most effective solicitation campaigns will wither if the organization proves unable to allocate its financial and other resources wisely. Fundraising begins by determining exactly what financial and human resources are needed to accomplish the organization's mission. In the short run, fundraising may be successful based on the organization's vision and the promises it makes to help its clients and community. In the longer run, contributors will want to see results. Performance is what counts. Indeed, an organization may be devoted to addressing a perfectly worthwhile cause, and its membership may be enthusiastic and dedicated, but most nonprofit organizations—and especially charitable ones—rely on funds from outside sources. And poorly run nonprofits will find that their revenue streams will dry up quickly if they do not leverage their funds wisely.

TRENDS IN THE NONPROFIT WORLD

Observers have pointed to several trends in the nonprofit community that are expected to continue or develop in the next few years. These range from changes in fund-raising targets to expanded competition between nonprofit organizations to regulatory developments. The following is a listing of some issues that nonprofit organizations will be tracking in the coming years:

1. Increased emphasis on retaining donors—According to Robert F. Hartsook of Fund Raising Management, "Non-profit organizations will focus on the renewal of donors rather than on the acquisition of new ones. As our country's population growth begins to plateau, it will be necessary for non-profits to more keenly target their marketing efforts."
2. Corporate giving—Corporate giving to philanthropic causes has emerged as a major marketing tool for corporations in recent years, and this source of funds is expected to assume even greater importance as federal and state governments pare back their spending on various social programs.
3. Increased reliance on volunteerism—Reduced government expenditures on social programs is also expected to spur increased demand for volunteers who can meet the expected growth in organization activity. This need will be especially acute for nonprofit organizations primarily involved in charitable activities.
4. Competition with for-profit enterprises—Many analysts believe that this issue could have tremendous implications for nonprofit organizations in the future. Spurred by representatives of the for-profit small business community, regulatory agencies have undertaken more extensive reviews of ways in which some activities of tax-exempt groups allegedly damage the fortunes of for-profit businesses (who, of course, are subject to local, state, and federal taxes). Much of the controversy in this area centers around the definition and treatment of unrelated business income (income generated by tax-exempt organizations from ventures that are unrelated to their primary mission). "There is a potential that all of this will lead to nothing," wrote Hopkins, "or it could bring an in-depth inquiry into the federal and state law distinctions between for-profit and non-profit organizations, the rationale for the tax exemption of certain types of nonprofit organizations, and whether some existing tax exemptions are outmoded and some new forms of tax exemption are required."
5. Continued emphasis on planned giving—"Nonprofit organizations will enjoy a significant increase in realized bequests," said Hartsook. "This will happen as a result of planned giving programs put in place 10 to 15 years ago. With the evidence at hand of how successful planned giving can be, many institutions will increase their dependence on this methodology."
6. Continued dominance of women in the nonprofit community—According to Fund Raising Management, women occupied approximately two-thirds of all staff positions in nonprofit organizations in the mid-1990s, a percentage that may increase in the coming years.
7. Increase in government regulation among nonprofits—Government oversight of fundraising activities may continue to increase at both the state and federal levels, at least in part because of the solicitation practices of some "fringe philanthropic groups," said Hartsook. "Unfortunately, telemarketing for nonprofit organizations has received a bad name because of fringe philanthropic organizations that solicit and collect large sums of money—while dedicating most of those funds to the costs of fund raising and salaries." According to Hopkins, this increase in government regulation may be especially evident at the state level: "States that have formerly foregone the desire for a fund-raising law have suddenly decided that their citizens now need one. States with fund-raising regulation laws are making them tougher. Those who administer these laws—the state regulators—are applying them with new vigor."
8. Growth in self-regulation within the nonprofit community—Self-regulation within various sectors of nonprofit operation underwent a noticeable increase in the late 1980s and early 1990s, and this trend is expected to continue with the introduction of new certification systems, codes of ethics, and watchdog groups.
9. Major donors will maximize benefits from contributions—According to Hartsook, major donors will increasingly incorporate aspects of planned giving into their philanthropic efforts in order to maximize their tax deductions. "Significant gift giving will incorporate an aspect of planned gifts in order to afford the donor maximum tax deductions," he stated. "As the level of tax recognition diminishes, major donors will turn to this methodology in order to maximize tax advantages."

BIBLIOGRAPHY

Ayres-Williams, Roz. "The Changing Face of Nonprofits." Black Enterprise. May 1998.

Bray, Ilona M. Effective Fundraising For Nonprofits: Real World Strategies That Work. Nolo, March 2005.

Drucker, Peter F. Managing the Non-profit Organization: Principles and Practices. Harper Business, 1990.

Hartsook, Robert F. "Predictions for 1997." Fund Raising Management. January 1997.

Hartsook, Robert F. "Top Ten Solicitation Mistakes." Fund Raising Management. March 1997.

Hopkins, Bruce R. The Law of Tax-Exempt Organizations. Eighth Edition. John Wiley & Sons, 2003

Hopkins, Bruce R. A Legal Guide to Starting and Managing a Nonprofit Organization. Second Edition. John Wiley & Sons, 1993.

Mancuso, Anthony. How to Form a Nonprofit Corporation. Seventh Edition. Nolo, July 2005.

Nicholas, Ted. The Complete Guide to Nonprofit Corporations. Enterprise Dearborn, 1993.

Schoenhals, G. Roger. On My Way in Planned Giving. Planned Giving Today, 1995.

"U.S. and State Profiles." National Center For Charitable Statistics. Available from http://nccsdataweb.urban.org/PubApps/profileStateList.htm. Retrieved on 2 May 2006.

Warwick, Mal. "Outsider-In Marketing: A New Way to Look at Marketing for Nonprofits." Nonprofit World. 1997.

                              Hillstrom, Northern Lights

                               updated by Magee, ECDI

Nonprofit Organizations

In the United States, nonprofit organizations (NPOs) are organizations that qualify for tax-exempt status under the U.S. Internal Revenue Code. About half are public charities, to which donors can deduct contributions from their taxes. Private foundations also are charitable organizations, but they are not public charities. They exist primarily to fund charities or individuals. Other types of tax-exempt organizations include social welfare, labor, or agricultural organizations, business leagues, and fraternal beneficiary societies. Nonprofit organizations are not prohibited from earning a profit or paying salaries and wages, but they must devote any surplus to the organization.

Nonprofit organizations also are known as not-for-profit organizations, or as the “independent sector,” as opposed to business or government. Nonprofits constitute about 10 percent of U.S. employees. These organizations play a unique role in society, falling between the concepts of public and private entities. Public agencies provide goods and services that are considered to be universally desirable (such as national security or infrastructure). Private enterprises serve individual tastes and preferences

and depend on market-based competition to prosper. By contrast, nonprofit organizations supply services that are considered good for the community as a whole or for specific community members, but which do not elicit widespread taxpayer support for direct provision. The distinction may be characterized as the difference between “it is right” that these services should exist, and the idea that all members of society “have a right” to such services.

While the nonprofit organization exists in many countries, the focus here is on the American NPO. The primary factors unique to this American sector are volunteers, contributions, and tax-exempt status.

THE ROLE OF NONPROFITS IN THE AMERICAN ECONOMY

Nonprofit organizations play a large role in the American economy. It is difficult to get an accurate count of nonprofits, because only organizations with more than $5,000 in annual gross receipts must register with the IRS and only those with receipts in excess of $25,000 must file with the IRS. According to the National Center for Charitable Statistics (NCCS), in 2006 there were 1.47 million total nonprofit organizations in the United States. This figure includes those registered and filing with the IRS. Of these, 904,313 were registered public charities, and 109,852 were private foundations. According to The United States Nonprofit Sector 2003, human services organizations make up 34 percent of the charitable nonprofits; education is the second largest field with 18 percent, and healthcare/mental health is the third with 13 percent. The remaining nonprofit categories include community improvement and social benefit groups; arts, culture, and humanities groups; environmental and animal groups; religious institutions; and various research organizations, which make up only 1 percent of all nonprofit organizations.

Though nonprofit organizations can be very large, most are small. The United States Nonprofit Sector 2003 notes that 44 percent of such organizations have less than $100,000 in assets. Only 5 percent have more than $10 million.

It is estimated that there are twice as many organizations not required to file with the IRS because they did not take in $5,000 annually. This would include such familiar organizations as PTAs and Little Leagues. No statistics are available regarding these organizations.

The NCCS collects and disseminates statistics on the U.S. nonprofit sector. This data is gathered from the IRS and other government agencies, private sector service organizations, and the scholarly community. The NCCS builds compatible national, state, and regional databases and develops uniform standards for reporting on the activities of charitable organizations. Excellent charts representing this data are presented in The United States Nonprofit Sector 2003, which is available from The National Council of Nonprofit Associations.

In 2004 nonprofit organizations contributed about 5 percent of the gross domestic product. In 2006 more than 12.9 million people were employed by nonprofit organizations. This means that employment in the nonprofit sector is significant. According to the Council of Foundations, the average annual turnover rate for associations is 24 percent, but there appears to be wide variation among nonprofit subsectors. For example, employee turnover in child welfare agencies can show rates between 100 and 300 percent.

The nonprofit sector relies heavily on volunteers. This can be a problem for nonprofit managers who must provide creative incentives in “psychic income,” such as recognition to volunteers who are motivated to support a particular cause despite the lack of pay and benefits. In addition, attendance may be sporadic, leading to variable levels of capacity at any given time. Some organizations in this sector exist primarily to supply employment to those who have traditionally been considered unemployable, with the goal of boosting both morale and self-sufficiency.

FINANCIAL INFORMATION

To generate revenue, NPOs rely on direct appeal to those individuals, corporations, and other entities that value the underlying cause represented by the organization. Fund-raising events, including door-to-door appeals and mass mailings, are highly visible means of garnering funds. According to The United States Nonprofit Sector 2003, charitable nonprofits had about $945 billion in expenditures in 2003. This revenue came primarily from fees, government grants and contracts, as well as investments. About 14 percent came from private contributions, while 72 percent came from what is termed “Program Service Revenue.” Competition for funds is more complex than in the corporate world, as there is no financial reward for the contributor. Each year, the American Association of Fundraising Counsel (AAFRC) publishes national giving estimates in its Giving USA report. For 2006, Giving USA reported the following national totals:

• Individuals: $222.89 billion (75%)
• Foundations: $36.5 billion (13%)
• Bequests: $22.91 billion (8%)
• Corporations: $12.72 billion (4%)

Some organizations rely heavily on competitive grants from governmental or philanthropic institutions. Nationally generated funds may be redistributed to local communities on the basis of need, as is done by the United Way and the Red Cross. Increasingly, nonprofits have

Figure 1

National Taxonomy of Exempt Entities Summary

A - Arts, Culture & Humanities

B - Education

C - Environment

D - Animal-Related

E - Health Care

F - Mental Health & Crisis Intervention

G - Diseases, Disorders & Medical Disciplines

H - Medical Research

I - Crime & Legal-Related

J - Employment

K - Food, Agriculture & Nutrition

L - Housing & Shelter

M - Public Safety, Disaster Preparedness & Relief

N - Recreation & Sports

O - Youth Development

P - Human Services

Q - International, Foreign Affairs & National Security

R - Civil Rights, Social Action & Advocacy

S - Community Improvement & Capacity Building

T - Philanthropy, Voluntarism & Grantmaking Foundations

U - Science & Technology

V - Social Science

W - Public & Societal Benefit

X - Religion-Related

Y - Mutual & Membership Benefit

Z - Unknown

relied on participant dues, fees, or charges. Such charges can range from the minimal “suggested contribution” for a senior center lunch to the bill for costly medical procedures at a major hospital.

The United States Nonprofit Sector 2003 states that in 2003, hospitals had the greatest percentage of total sector assets (about 30 percent), followed by higher education with approximately 20 percent. Human services, health-care (excluding hospitals), and lower education, each had about 10 percent. Interestingly, lobbying accounts for a sizeable portion of nonprofit expenditures. According to the report, large nonprofit organizations spend the most on lobbying.

The accuracy of financial information regarding this sector of the economy is limited. First, the ongoing initiative to collect and computerize data in standardized form began in the late 1980s to early 1990s. While the Bureau of Labor Statistics tabulates employment figures, the financial information lags due to attempts to standardize and code the data. Second, while all tax-exempt organizations must apply for such status, only those with total annual revenues of at least $25,000 are required to file a Form 990 with the Internal Revenue Service. These non-filers represent about two-thirds of all registered nonprofit organizations. Third, churches are not required to file a Form 990, leaving this data estimation to private sources. Fourth, pass-through contributions (for example, revenues to both the United Way and the local charities it supports) may be double-counted. Therefore, financial figures are at best an estimate.

There is no single agency with oversight for nonprofit organizations. The IRS serves as one control, but some states have instituted more rigorous guidelines than those at the federal level. The Financial Accounting Standards Board, a private self-regulatory body for the accounting profession, developed Financial Accounting Standards 116 and 117 covering nonprofits, but these prescriptions allow a different form of generally accepted accounting practices (GAAP) from private organizations with similar functions.

The BBB Wise Giving Alliance collects and distributes information on national nonprofit organizations. It routinely asks such organizations for information about their programs, governance, fund-raising practices, and finances. Although The BBB Wise Giving Alliance does not recommend charities, it does select charities for evaluation based on the volume of donor inquiries about individual organizations. The BBB Wise Giving Alliance was formed in 2001 with the merger of the National Charities Information Bureau and the Council of Better Business Bureaus Foundation and its Philanthropic Advisory Service. The BBB Wise Giving Alliance is a nonprofit charitable organization, affiliated with the Council of Better Business Bureaus.

TAX-EXEMPT STATUS

In exchange for the supply of quasi-public goods and services, nonprofit organizations are exempt from federal taxation on the excess of revenues over costs within the

Figure 2

10 Broad Categories of the National Taxonomy of Exempt Entities

1. Arts, Culture, and Humanities A
2. Education B
3. Environment and Animals C, D
4. Health E, F, G, H
5. Human Services I, J, K, L, M, N, O, P
6. International, Foreign Affairs Q
7. Public, Societal Benefit R, S, T, U, V, W
8. Religion Related X
9. Mutual/Membership Benefit Y
10. Unknown, Unclassified Z

fiscal year. This practice was established in 1913 with the passage of the first federal income tax law. In addition, they also may be forgiven state and local property taxes, and may receive discount postal privileges. Thus, these organizations are publicly subsidized while not directly supported by all taxpayers.

To qualify for tax-exempt status, the nonprofit organization must satisfy a variety of prerequisites. Among these is the declaration of a primary purpose or cause that qualifies under the Internal Revenue Service code. There is no ownership of assets or income other than that of the organization itself. Externally, this implies that there is no income distribution in the form of dividends or other such payments. Internally, there is the further requirement that the organization does not exist for the benefit of individual employees or board members; the IRS scrutinizes payment to such individuals in the form of salary, rent, or contractual arrangement. However, the only available penalty is the withdrawal of tax-exempt status, a punishment that the IRS has historically rarely delivered.

Examples of nonprofit organizations include such well-known giants as the United Way, the Red Cross, and the Boy Scouts and Girl Scouts. At the other end of the spectrum are local volunteer fire departments, churches, crisis intervention centers, and civic centers. Many hospitals and universities function as nonprofit institutions as well.

Figure 1 lists the full range of categories of American NPOs as defined by the National Taxonomy of Exempt Entities. This classification system offers a definitive classification system for nonprofit organizations recognized as tax-exempt under the Internal Revenue Code. Figure 2 lists the major categories by which summaries relating to this sector are frequently reported.

From 1940 to the early 1990s, human services and health accounted for approximately half of the NPOs in the United States. In some NPOs, benefits are limited to a select group, such as senior citizens (local agencies on aging) or those suffering from a specific disease (the American Cancer Society). Other groups have relatively open membership for those willing to pay the fee; an example is the YMCA, which provides recreational facilities.

CHALLENGES FOR NONPROFIT MANAGEMENT

Management must contend with the unique aspects of nonprofit organizations: volunteer labor, solicited contributions, and maintaining tax-exempt status. In addition, Herzlinger suggests that NPOs are highly antithetical to business in other important ways: they lack ownership,

competition, and the profit motive. Without these incentives it may be difficult to maintain effectiveness and efficiency. Even measurement of customer satisfaction may prove elusive, as customers may have no alternatives against which to compare the services received. Some controversy exists over several aspects of nonprofit organizations:

1. For example, some question the rationale of the tax-exempt status of open-membership facilities, such as the YMCA. For-profit providers of similar services submit that the subsidy of NPOs diminishes the for-profit organization's ability to compete. This situation has led to as yet unsuccessful legislative attempts to level the playing field.
2. Some people question how much nonprofits spend on programs. The BBB Wise Giving Alliance (a nonprofit organization itself) recommends that nonprofits spend at least 50 percent on program activity. Other organizations set this level as high as 80 percent. The remainder is to be spent on non-program expenses, such as administrative and fund-raising costs. The amount spent on fundraising can vary widely based upon whether the nonprofit is new or established with many donors. However, no regulation exists to ensure that the majority of revenues are spent on the cause for which the funds were collected.
3. Others question how nonprofits are regulated and who regulates them. State agencies are increasingly requiring reports from active NPOs to monitor fundraising activity; the agency in turn responds to individual inquiries about the NPO's self-reported record. As in the corporate and governmental groups, administrative salaries occasionally make the news, encouraging contributors to reconsider how their contributions are being used.

Nonprofit organizations are a valuable part of the economy in America and many other countries, providing a broad range of services that might not otherwise be affordable or available without the subsidy of tax exemption. As NPOs grow in number and scope, there is increasing pressure to report on financial activity and performance fulfillment in this sector. The future of nonprofits may rely on disclosure and accountability.

SEE ALSO Balance Sheets; Financial Issues for Managers; Income Statements

BIBLIOGRAPHY

“BBB Wise Giving Alliance.” BBB Wise Giving Alliance. Available from: http://Give.org

Council of Economic Advisors. 2005 Economic Report of the President. Washington, D.C.: Government Printing Office, 2005. Available from: http://www.gpoaccess.gov/eop/

“FC Stats–Grantmaker.” Foundation Center. Available at http://foundationcenter.org/findfunders/statistics/listing01.html.

Frequently Asked Questions, 2008. National Center for Charitable Statistics. Available at http://nccs.urban.org/resources/faq.cfm.

Herzlinger, R.E. “Can Public Trust in Nonprofits and Governments be Restored?” Harvard Business Review 74, no. 2 (1996): 97–107.

Langer, Stephen. “How Much Are You Really Worth? Here's the Latest on Nonprofit Salaries.” Nonprofit World 23, no. 1 (2005): 27.

Lewis, Robert L. Effective Nonprofit Management: Essential Lessons for Executive Directors. Gaithersburg, MD: Aspen Publishers, 2001.

———.The New Nonprofit Almanac & Desk Reference. Washington, D.C.: Independent Sector/Urban Institute, 2002.

“Nonprofit Organizations Part II.” Journal of Business & Finance Librarianship 10, no. 1 (2004): 63–79.

———.The Non-Profit Sector in a Changing Economy. Paris: Organisation for Economic Co-operation and Development, 2003.

Number of Nonprofit Organizations in the United States 1996–2004. The National Center for Charitable Statistics at the Urban Institute. Available from: http://nccsdataweburban.org/PubApps/profile1.php?state=US

Number of Nonprofit Organizations in the United States, 1996–2006. National Center for Charitable Statistics. Available at http://nccsdataweb.urban.org/PubApps/profile1.php?state=US.

Pidgeon, Walter P. The Not-for-Profit CEO: How to Attain and Retain the Corner Office. New York: John Wiley, 2004.

Taylor, Barbara E., Richard P. Chait, and Thomas P. Holland. “The New Work of the Nonprofit Board.” Harvard Business Review 74, no. 5 (1996): 36–46.

“The United States Nonprofit Sector 2003,” 2006. National Center for Charitable Statistics. Available at http://www.ncna.org/_uploads/documents/live//us_sector_report_2003.pdf.

White, Gary W. “Nonprofit Organizations.” Journal of Business & Finance Librarianship 9, no. 1 (2003): 49–80.

Nonprofit Organizations

Sections within this essay:

Background

Nonprofit organizations exist in the United States for a number of reasons. Many of these organizations are formed for the purpose of fulfilling needs in society by providing an organization that handles what the government would handle otherwise. Nonprofit organizations exist along with two other types of entities: for-profit businesses and government agencies. Each of these serves different purposes in society.

Many people associate nonprofit organizations and tax exemption, though not all nonprofit entities are exempt from taxation. Moreover, a nonprofit organization is not prohibited from earning a profit, for many of these organizations generate profits. To the contrary, the law governing nonprofit entities sets forth requirements as to what each entity must do with the profits it earns. More specifically, the law expects nonprofit organizations to devote any profits to the goal of furthering the purposes and activities of the organization.

Additionally, not all nonprofit organizations are charitable in nature. Although contributions to charitable organizations generally qualify for a charitable contribution deduction, some nonprofit entities that are not charitable in nature are also tax exempt.

Purpose of a Nonprofit Organization

One of the first steps in forming a nonprofit entity is to define the purpose of the entity. This statement of purpose, which must be made in writing, will define the type of tax exemption for which that organization is qualified. The following list provides examples of the types of tax-exempt nonprofit organizations:

• Organizations formed for charitable purposes
• Organizations that advocate for social welfare
• Professional associations
• Labor organizations
• Chambers of commerce and business leagues

• Social clubs
• Homeowners associations
• Employee benefit funds
• Fraternal societies
• Political organizations

The purpose driving a for-profit business is to benefit the owners of the business. By comparison, the activities of a nonprofit entity must be conducted for the benefit of the organization and not the owners. In order to qualify for tax exempt status, the organization must benefit the public.

Location of the Organization

Once a person or group decides to form a nonprofit organization, one of the first issues that must be addressed is where this entity will be formed. Some states may be more attractive than others due to several factors. For instance, states such as New York and California are more intense in terms of regulating nonprofit entities than other states. Moreover, state laws may differ about the requirements the entity must satisfy in order to qualify for taxexempt status.

A nonprofit organization may form under the laws in one state but operate in a different state. This option may be advantageous when the laws of one state allow those who form the nonprofit entity to fulfill the purpose of the entity better than the laws of another state. On the other hand, this option is usually more costly because both the state in which the entity is formed and the state where the entity operates will charge fees.

Choice of Organizational Form

Another complicated decision that those who form nonprofit entities must make is what organization form the entity will take. In general, nonprofit entities appear in four organizational forms, including the following: corporations, charitable trusts, limited liability companies, and unincorporated associations. Each of these forms has some benefits and some disadvantages that must be considered when the organization is formed.

Corporations

The most common form of nonprofit organization is the corporation. A corporation is a creation of the law. Those who create a corporation must file a document known as articles of incorporation, which sets forth important information about the corporation itself. Once a corporation is formed, it becomes its own "person" under the law, separate from its directors, officers, or owners. The corporation itself may sue others or be sued.

A nonprofit entity benefits from forming as a corporation for two primary reasons. First, the laws governing corporations provides considerable protection to officers, directors, members, employees, and volunteers against personal liability. This means that if the corporation itself incurs liability (e.g., a third person successfully sues the corporation), those who act on the corporations behalf usually do not incur liability. Second, the law governing corporations is generally well-settled, meaning that the rules that govern the operation of the corporation are more clearly defined.

Several states have adopted the Model Nonprofit Corporation Act, which was first drafted by the Business Law Section of the American Bar Association in 1964. It was subsequently revised in 1987.

Unincorporated Associations

Unlike a corporation, which must be created and structured according to the directives of state law, two or more people may form an unincorporated association without following those formalities. Those who form an unincorporated association may choose how the association should be governed, which is one of the benefits of this form of entity. Such an entity may be formed as a nonprofit entity.

However, whether those associated with the entity are liable for the entity's debts is not clear. In several states, including those that have adopted the Uniform Nonprofit Unincorporated Association Act, an unincorporated association is treated as an entity separate from its members. Where a state recognizes the association as a separate entity, then the members of the entity are probably shielded from personal liability for the association debts. On the other hand, some states may not recognize the association as separate, meaning that the members could incur personal liability.

Limited Liability Companies

The limited liability company (LLC) is a newer form of business entity. The organizational structure of an LLC borrows from the structures of both unincorporated entities and corporations. The benefit in forming an LLC is its flexibility, since someone who creates an LLC may form the entity to appear more like a partnership or more like a corporation, depending on the needs and preferences of the person who is forming it. An LLC may elect to be taxed as a corporation or as a partnership.

Although the LLC form of organizational structure may provide some benefits, the use of the LLC for nonprofit entities is not well settled. Questions about the taxation of a nonprofit LLC have yet to be answered, and in some states, state law is not clear whether an LLC may be formed for nonprofit purposes. On the other hand, this form of entity provides flexibility in terms of structure and may be preferable to some nonprofit entities.

Charitable Trusts

A person who wishes to set aside property for the benefit of another may form a trust. Unlike a corporation or LLC, a person may form a trust without filing anything with the government. Instead, the trust is formed when a person transfers property to a person or an entity, known as a trustee, and directs the trustee to use the transferred assets for the benefit of a third person, known as a beneficiary. State law dictates how a trustee must handle the property that is being used for the benefit of the beneficiary.

Some nonprofit entities are formed as charitable trusts, where the beneficiaries are not specific individuals. Instead, the trustee of a charitable trust uses the property for the benefit of a specified purpose, such as education of disadvantaged youth. The laws that apply to trusts in general also apply to charitable trusts. Because modern corporations are generally easy to form, those who wish to form a charitable nonprofit entity are more likely to form a corporation than they are to create a charitable trust.

Meaning of Tax Exemption

Although some people associate nonprofit organizations with tax-exempt organizations, certainly not all nonprofit entities are exempted from taxes. Moreover, even though a tax-exempt organization may be free from paying federal income taxes, such an organization may still be liable for other types of taxes. For instance, a tax-exempt organization may be liable for taxes on net investment income as well as income derived from business activities that do not relate to the organization's exempt functions (known as unrelated business activities, discussed below).

Determining Tax-Exempt Status

Statutory law generally determines whether an organization is exempt from taxes. Section 501 of the Internal Revenue Code (IRC) provides the basic rules for tax-exempt status at the federal level. The Internal Revenue Service (IRS) is the federal body responsible for recognizing that an organization qualifies for tax-exempt status. An entity that wants to seek recognition for this status must file a form entitled "Application for Recognition of Exemption."

State laws regarding tax exemptions vary. Those who form nonprofit entities should consult the laws of relevant states to determine which organizations are eligible for tax-exempt status and which steps, if any, the organization must take in order for the state to recognize that status.

Categories of Tax-Exempt Organizations

The IRC contains a laundry list of organizations that qualify as tax-exempt organizations. The most common of these are charitable organizations, though the IRC also includes educational, scientific, and religious organizations. Moreover, the Code includes several other types of entities, such as labor organizations, social clubs, credit unions, employee benefit trusts, and farmers' cooperatives.

Charitable Organizations

Federal law recognizes several different forms of charitable organizations. Charitable organizations are often referred to as Section 501(c)(3) organizations, named after the section of the IRC section under which these organizations are formed. The definition of charitable has been developed through the promulgation of tax regulations and tax rulings, as well as through federal and state judicial cases. The following list includes the purposes that are generally recognized as charitable:

• Relief of poverty
• Relief of the distressed
• Advancement of religion
• Advancement of education
• Advancement of science
• Lessening the burdens of government (e.g., erecting a public building)
• Community beautification and maintenance
• Promotion of health

• Promotion of social welfare
• Promote environmental conservation
• Promotion of patriotism
• Promotion of the arts

Taxation of Unrelated Business Activities

Federal tax law distinguishes between activities that relate to the exempt functions of a nonprofit and those activities that are unrelated. Gross revenues that are gained on unrelated business activities are subject to taxation. Because most nonprofit organizations conduct some sort of business, most of these organizations must determine whether any aspect of their businesses may be characterized as an unrelated business activity.

In order for income of a tax-exempt organization to be taxable, the income must be produced from a trade or business that the organization carries on regularly. An organization carries on a trade or business regularly if it does so frequently and continually, as opposed to sporadically or infrequently. The income must also be unrelated to the purpose for which the organization has been formed and which forms the basis for the tax exemption. Income from activities that bear a substantial relationship to the purpose of the nonprofit entity are not subject to tax, while income from activities that do not bear a substantial relationship to the purpose of the entity are subject to taxation.

Revenue that a tax-exempt organization gains on an unrelated business activity is subject to the federal corporate income tax that applies to non-exempt entities. An exempt organization is entitled to certain deductions related to the business that earned this income, much like a for-profit entity may be entitled to deductions for certain activities.

Public Charities and Private Foundations

The Internal Revenue Code distinguishes between nonprofit entities that are public charities and those that are private foundations. A public charity is one that has involvement from the public in general, earns financial support from the public in general, or has an operating relationship with a public organization. By comparison, a private foundation usually derives its financial support from one source; earns money through investment assets, rather than through contributions from the public; and makes grants to other charitable organizations instead of operating its own activities.

Private foundations are subject to certain restrictive rules and taxes for which public charities are not subject. Thus, those who form nonprofit organizations often would like to avoid the status of a private foundation. Several types of institutions are exempted from the rules governing private foundations. These institutions include certain churches, educational institutions, health care providers, and govern-mental units.

Reporting Requirements

Those organizations that are exempt from federal taxes must file what is known as an information return with the IRS. Most organizations that are entitled to tax exemptions must file a Form 990 with the IRS. This form, which is about 20 pages long including schedules, requires an exempt entity to report on items of revenue, including a balance sheet. The form also asks the organization questions about the organization's operation, mostly relating to issues dealing with the organizations tax-exempt status. The public is entitled to inspect this form.

Disclosure Requirements

In addition to annual information returns, nonprofit organizations are required to disclose information about their operations. The reason behind these requirements is to ensure that each nonprofit organization is acting in a transparent manner. Those items that are subject to disclosure requirements include the following:

• Substantiation of charitable gifts
• Quid pro quo contributions (i.e., where a donor pays an amount in excess of the value of goods or services received by the nonprofit entity)
• Gifts of property
• Dispositions of contributed property
• Appraisals
• Tax shelters

Legal Protections for Officers, Directors, Employees, and Volunteers

State laws generally provide some protection for directors, employees, and volunteers against liability. One type of law includes volunteer protection statutes, which limit liability that may be incurred by volunteers of a nonprofit entity. Congress also enacted the Volunteer Protection Act of 1997 to provide additional protection. However, several commentators have noted that these statutes have largely failed in their purpose because the statutes generally do not prohibit lawsuits against volunteers but rather merely limit liability in some circumstances.

Other state laws limit liability for directors and officers of nonprofit organizations. These laws restrict the amount that someone can recover for damages stemming from the activities of an officer or director of a nonprofit entity. Much like volunteer protection acts, however, commentators often note that these statutes that limit liability are fairly weak.

State Laws Governing Nonprofit Corporations

Several states have modeled their state laws after the Model Nonprofit Corporation Act, which was approved by the Business Law Section of the American Bar Association in 1964 and revised in 1987. Other states have not explicitly adopted either version of the model act but may borrow provisions from the model legislation. Another source of law governing nonprofit entities appears in the form of the Uniform Unincorporated Nonprofit Association Act, which was approved by the National Conference of Commissioners on Uniform State Laws in 1996. Eleven states have adopted this uniform law, which serves as a complement to the model act.

ALABAMA: Alabama has adopted both the Model Nonprofit Corporation Act and the Uniform Unincorporated Nonprofit Association Act.

ARKANSAS: Arkansas has adopted both the Model Nonprofit Corporation Act and the Uniform Unincorporated Nonprofit Association Act.

COLORADO: Colorado has adopted the Uniform Unincorporated Nonprofit Association Act.

DELAWARE: Delaware has adopted the Uniform Unincorporated Nonprofit Association Act.

DISTRICT OF COLUMBIA: The District of Columbia has adopted the Uniform Unincorporated Nonprofit Association Act.

HAWAII: Hawaii has adopted the Uniform Unincorporated Nonprofit Association Act.

IDAHO: Idaho has adopted the Uniform Unincorporated Nonprofit Association Act.

INDIANA: Indiana has adopted the Model Nonprofit Corporation Act.

MISSISSIPPI: Mississippi has adopted the Model Nonprofit Corporation Act.

MONTANA: Montana has adopted the Model Nonprofit Corporation Act.

NORTH CAROLINA: North Carolina has adopted the Model Nonprofit Corporation Act.

SOUTH CAROLINA: South Carolina has adopted the Model Nonprofit Corporation Act.

TEXAS: Texas has adopted the Uniform Unincorporated Nonprofit Association Act.

WASHINGTON: Washington has adopted the Model Nonprofit Corporation Act.

WEST VIRGINIA: West Virginia has adopted the Uniform Unincorporated Nonprofit Association Act.

WISCONSIN: Wisconsin has adopted the Uniform Unincorporated Nonprofit Association Act.

WYOMING: Wyoming has adopted both the Model Nonprofit Corporation Act and the Uniform Unincorporated Nonprofit Association Act.

Additional Resources

The ABCs of Nonprofits. Runquist, Lisa A., American Bar Association, 2005.

Nonprofit Law Made Easy. Hopkins, Bruce R., John Wiley & Sons, Inc., 2005.

Starting and Managing a Nonprofit Organization: A Legal Guide, 4th Edition. Hopkins, Bruce R., John Wiley & Sons, Inc., 2005.

Organizations

Action Without Borders

360 West 31st Street
New York, NY 10001 USA
Phone: (212) 843-3973
Fax: (212) 564-3377
URL: http://www.nonprofits.org

Society for Nonprofit Organizations

5820 Canton Center Rd., Ste. #165
Canton, MI 48187 USA
Phone: (734) 451-3582
URL: http://www.snpo.org/index.php

NONPROFIT

A corporation or an association that conducts business for the benefit of the general public without shareholders and without a profit motive.

Nonprofits are also called not-for-profit corporations. Nonprofit corporations are created according to state law. Like for-profit corporations, nonprofit corporations must file a statement of corporate purpose with the secretary of state and pay a fee, create articles of incorporation, conduct regular meetings, and fulfill other obligations to achieve and maintain corporate status.

Nonprofit corporations differ from profit-driven corporations in several respects. The most basic difference is that nonprofit corporations cannot operate for profit. That is, they cannot distribute corporate income to shareholders. The funds acquired by nonprofit corporations must stay within the corporate accounts to pay for reasonable salaries, expenses, and the activities of the corporation. If the income of a corporation inures to the personal benefit of any individual, the corporation is considered to be profit driven. Salaries are not considered personal benefits because they are necessary for the operation of the corporation. An excessive salary, however, may cause a corporation to lose its nonprofit status.

Nonprofit corporations are exempt from the income taxes that affect other corporations but only if they conduct business exclusively for the benefit of the general public. State laws on

corporations vary from state to state, but generally states give tax breaks and exemptions to nonprofit corporations that are organized and operated exclusively for either a religious, charitable, scientific, public safety, literary, or educational purpose, or for the purpose of fostering international sports or preventing cruelty to children or animals. Nonprofit organizations may charge money for their services, and contributions to tax-exempt nonprofit organizations are tax deductible. The internal revenue service must approve the tax-exempt status of all nonprofit organizations except churches.

A vast number of organizations qualify for nonprofit status under the various definitions. Nonprofit organizations include churches, soup kitchens, charities, political associations, business leagues, fraternities, sororities, sports leagues, colleges and universities, hospitals, museums, television stations, symphonies, and public interest law firms.

A nonprofit corporation with a public purpose is just one organization that qualifies for tax-exempt status. Under Section 501 of the internal revenue code (26 U.S.C.A. § 501), more than two dozen different categories of income-producing but not-for-profit organizations are exempt from federal income taxes. These other tax-exempt organizations include credit unions, civic leagues, recreational clubs, fraternal orders and societies, labor, agricultural, and horticultural organizations, small insurance companies, and organizations of past or present members of the armed forces of the United States.

The number of nonprofit corporations in the United States continued to increase into the twenty-first century. Although nonprofit corporations cannot produce dividends for investors, they provide income for the employees, and they foster work that benefits the public.

The activities of nonprofit corporations are regulated more strictly than the activities of other corporations. Nonprofit corporations cannot contribute to political campaigns, and they cannot engage in a substantial amount of legislative lobbying.

further readings

Barrett, David W. 1996. "A Call for More Lenient Director Liability Standards for Small, Charitable Nonprofit Corporations." Indiana Law Journal 71 (fall).

Hammack, David C., ed. 1998. Making the Nonprofit Sector in the United States. Bloomington: Indiana Univ. Press.

Ott, J. Steven, ed. 2001. Understanding Nonprofit Organizations: Governance, Leadership, and Management. Boulder, Colo.: Westview Press.

non·prof·it / ˈnänˈpräfit/ • adj. not making or conducted primarily to make a profit: charities and other nonprofit organizations.