Philanthropic nonprofits embody the best of America. They enable people to work together for the common good, turning shared beliefs and hopes into action. They give shape to our wildest dreams, highest ideals, and noblest goals. America’s 1.3 million nonprofit charities feed, heal, shelter, educate, inspire, educate, and nurture people of every age, gender, race, and socioeconomic background, from coast to coast, border to border, and beyond. They promote civic engagement and leadership, spur economic growth, and strengthen the fabric of our communities.In our article, we take an in-depth look at the structure of a nonprofit organization, its benefits and pitfalls.
What Is a Nonprofit?
When an organization is classified as a nonprofit, its main purpose is to exist for the public good rather than make a profit and distribute it among the owners. A nonprofit’s short- and long-term objectives tend to focus on advancing a specific standpoint or sometimes several humanitarian missions. Unlike for-profits, a nonprofit entity is not controlled by owners, members, or shareholders. Moreover, the leadership does not get a cut of whatever revenue the organization may generate through its philanthropic work.
Types of Nonprofit Organizations in The United States
As per the IRS classification, most nonprofits are categorized as either 501(c) organizations or other 501 types of similar tax-exempt status. While 501s generally don’t pay federal and some state taxes, the application of these exemption rules varies with each entity’s classification defined by its activities, interest representation, and donations.
The 501(c) types are numbered, ranging from 501(c)(1) to 501(c)(29), of which you will likely recognize type 501(c)(3) that includes organizations focusing on education, religion, charity, animal protection, and other activities with the aim to better the welfare of the community.
Other notable types included in the 501(c) category are:
- 501(c)(1): credit unions;
- 501(c)(4): social welfare, civic leagues, local employee associations;
- 501(c)(7): clubs and groups promoting recreation and social activities;
- 501(c)(19): groups for members of the armed forces.
Other forms of nonprofits also include:
- 501(d): religious-based organizations (not to be confused with religious entities such as churches classified as 501(c)(3));
- 501(e): cooperative services for hospitals;
- 501(f): cooperative services for educational organizations;
- 501(k): child care;
- 501(N): charitable risk pools;
- 501(q): credit counseling services;
- 521(a): agricultural cooperatives;
- 527: political organizations.
Advantages/Disadvantages of Becoming a Nonprofit Organization?
Reduced tax duties
An entity classified as nonprofit is by definition exempt from federal income taxes, though it typically applies to similar taxes on state and local levels. Not every nonprofit type qualifies for tax-deductible contributions, for example, 501(c)(2) or 501(c)(4) organizations can’t write off their donations. However, 501(c)(3) organizations are completely exempt, plus a great number of others may deduct tax on their donations if they meet certain conditions like 501(c)(1) entities that apply contributions for public purposes, as well as 501(c)(19) and 501(c)(23) provided over 90% of their members are war veterans.
Limited liability protection
Similar to the personal liability offered by certain for-profit structures like LLCs, nonprofits protect the individual assets of their leadership groups. These securities only apply as long as the members of the board, founders, and staff don’t use the organization to cover illegal activities and escape personal liability. Another exception to the rule concerns the fiduciary duties of the directors who must act in the best interests of the organization.
Qualifying for grants
When it comes to funding, nonprofits don’t rely on the same sources as for-profits, and even though whatever revenue a nonprofit makes goes into sustaining the organization, it’s generally not enough as a long-term solution. Most nonprofits, therefore, fund their activities through donations and grants, both private and those issued by the government. Nonprofits can receive grants with more ease, especially if it’s a public charity.
Recognized legal status
Similar to some business structures, a nonprofit is a clearly defined legal entity on its own that distinctly separates the organization itself and the individual who founded it or is involved in its operation.
Given their unique status with the IRS, nonprofits are required to be meticulous with their record-keeping and inform the agency of their financial activities on an annual basis.
Nonprofits are meant to serve the public, so the leadership of such an entity has its limitation to prevent abuse of power. In addition to following internal regulations, the directors in charge of running a nonprofit must adhere to federal, state, and local laws.
It’s impossible to form any legal entity entirely for free, and nonprofits are no exception. Although they are not designed for earning money, they still have to be maintained from the moment of their creation which includes formation expenses and various consultation fees.
Publicly available information
Entities of nonprofit designation that work for the public interest are required to provide free access to their financial information. This means that if a member of the public wishes to investigate the transparency of such an organization—or lack thereof—they may access certain records like how the revenue is managed, regular expenses, and salaries of the board members.
How Do I Start a Nonprofit Organization?
The first thing you should address before forming a nonprofit is your motivations. After all, running a nonprofit is a mission that often takes up the majority of the organizer’s free time. This is why this work is only suitable for those who are sincere about applying their time, effort, and assets to support the community. So where does one start?
Step 1: Research
- Establish that there is a need for your nonprofit’s mission in the target community. If not, it may be more prudent to simply join those that already exist to increase the chances of receiving a grant for the same cause without dispersing the funds;
- Consider other ways of supporting the community. Not all charitable causes are that easy to pursue, especially if a nonprofit fails to attract enough donors and stay afloat financially.
Step 2: Preparation
- Write the mission statement to establish the purpose of your nonprofit, its goals, and general values;
- Provide a business plan naming the primary sources of funding and revenue, the nonprofit’s capital structure, and operational costs for various programs;
- Recruit the initial board of directors and develop proper protocols for any future changes such as evaluating and training new members.
Step 3: Formation
- Look into specific requirements issued to legal entities in your jurisdiction;
- Create a formal structure to build your nonprofit’s integrity and protect the key members from personal liability.
Step 4: Filing with the IRS
This step is vital since the formation of a legal structure in itself doesn’t grant your organization tax-exempt status. To ensure your nonprofit is actually classified as a 501(c), you have to send the relevant application to the IRS along with the service fee. Nonprofits can cost between $275 and $600 upon filing, and the processing time may stretch up to 12 months due to the agency’s rigorous evaluation.
Step 5: Maintenance
- Register for charitable solicitation in your state for fundraising purposes and apply for renewals annually;
- File annual reports with the IRS to keep the government aware of your internal operations, staff changes, and financial activities;
- Send annual reports to the state to keep your information accurate;
- Send employment forms to the state Department of Labor if your nonprofit has employees.