Non-profit vs. Tax-exempt: Nonprofit and Charity Law Jargon Buster

When you visit your lawyer or C.P.A, do you feel like you have entered a foreign land where people speak in ambiguous terms and obscure numerical references? If so, you have experienced  the mind numbing qualities of non-profit and charity law jargon. Those of us who practice non-profit law are all guilty of it. To pay my debt to society, I will attempt to demystify a bit of non-profit law jargon from time to time on this blog. I welcome feedback regarding the clarity of the explanation.

Non-profit vs. Tax-exempt.

Non-profit. The designation of an organization as “non-profit” 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. Designating an organization as “non-profit” 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. For more about how to form a non-profit under state law, see my earlier post on starting a non-profit.

Tax-Exempt.  Designation of an organization as “nonprofit” under state law does not mean the organization is also “tax-exempt”. With few exceptions, organizations 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.  For more information about the process of applying for tax-exempt status, see my earlier post on applying for tax-exempt status.

Both Nonprofits and Tax-Exempts Can Make Money.

This seems so obvious, but I get at least one call a year to settle an argument about whether all the organization’s money has to be spent by the end of the year. Really! So, just to be clear, the designation of an organization as “non-profit” or “tax-exempt” does not mean that the organization can’t have money left over in its bank accounts at the end of the year. Money that is not required to meet current expenses should be used to further the organization’s mission or can be set-aside as a reserve to cover future expenses.

Ellis Carter is a nonprofit lawyer with Caritas Law Group, PC. To contact Ellis, call 602-456-0071 or email us at info@caritaslawgroup.com.


More Nonprofit and Charity Law Jargon Busters…
Private Foundation v. Public Charity
Private Inurement v. Private Benefit
Tax-exempt Purpose


7 thoughts on “Non-profit vs. Tax-exempt: Nonprofit and Charity Law Jargon Buster

  1. 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!)

  2. 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

  3. 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?

  4. 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.

Comments are closed.