The distinction between being nonprofit vs. tax-exempt is an important one.
Nonprofit
The designation of an organization as nonprofit or for-profit is a concept of state law. Under state law, for-profit organizations are created to make money for their owners and investors.
For-profit entities can include business corporations, business trusts, sole proprietorships, partnerships, benefit corporations, and limited liability companies. The common thread that binds these entity types is that they all have one or more owners.
Designating an organization as “nonprofit” only means that the organization is created for some purpose other than making a profit for owners or investors, but not necessarily for a purpose that would qualify it for exemption from taxes. Nonprofit entities can include nonprofit corporations, charitable trusts, and unincorporated associations. These entities are related in that they do not have stock or an ownership structure.
Tax-Exempt
Designation of an organization as “nonprofit” under state law does not mean the organization is also “tax-exempt”. Organizations that wish to be tax-exempt must be formed in a manner that qualifies for tax-exempt status under 501(c) and must apply to the IRS for a determination of tax-exempt status.
There are numerous types of organizations that qualify for various tax exemptions including exemptions from tax on income that is earned in the course of conducting activities related to the organization’s tax-exempt purpose. The most common type of tax-exempt organization is a 501(c)(3) organization. To qualify as a 501(c)(3) organization, the organization must apply to the IRS on Form 1023.
Some states also require non-profits to submit an application to the state to qualify for exemption from state income tax as well as various other state taxes.
Ultimately, whether an entity is nonprofit vs. tax-exempt depends on how it is formed at the state level and whether it has successfully met the criteria for tax-exempt with the IRS and state tax authorities.
Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on corporate, tax, and fundraising regulations nationwide. Ellis also advises donors with regard to major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form.
4 thoughts on “Nonprofit vs. Tax-exempt: Nonprofit”
Thanks for helping to explain these law concepts to everyone. It is very helpful and necessary. I like to think I know a lot about nonprofit management and operations but I know that I need to know more when it comes to the legal side. I will have to look at more of your older blog posts too. T.J.
Thanks for your blog. I am an attorney who is pursuing a Master's in Nonprofit Mgmt, here in Chicago. Have you had any experience with the idea of smaller nonprofits merging? There are so many small nonprofits that seem to be doing the same thing as other nonprofits in another part of town. I know mergers are always scary (for profit or nonprofit) but in this economy, it seems like a way to keep nonprofits afloat and would probably be favored by organizations who make grants. Your thoughts?
Great fundamental information.
Taking your last paragraph a step further, I have seen fundraisers slow down or stop completely when they realize that they have reached their goals or have "too much" money in their accounts. Oy vay! (Did I spell that right?) Companies have cash reserves, charities should too. As the last year has taught us, one never knows when that rainy day fund will come in handy.
Shuey Fogel
@nonprofitbanker
Thank you Ellis for clarifying the terminology. I continue to be amazed by board directors who do not understand the difference (or that money doesn't have to be spent by the end of the year!)
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