Nonprofit organization: Definition & meaning
The term ‘non-profit organization’ refers to an organization that:
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Operates for the common good and not for generating individual wealth.
Does not distribute its profits to individuals who control the organization such as its members,
officers, directors, or trustees.
While a non-profit organization can make a profit, the profit it earns must be used toward the
core missions of the organization and not towards any personal benefits.
Other differences between a ‘for-profit’ and a ‘non-profit’ organization
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Typically a non profit organization cannot issue stocks to its constituent members while a ‘forprofit’ organization can issue stocks/equity shares amongst its members. Quasi non-profit
organizations like cooperatives can issue stocks to its members.
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If a non-profit is dissolved or liquidated, it can transfer its assets only to another non-profit
organization. It cannot distribute the assets amongst its members. If a ‘for-profit’ organization is
liquidated, the assets can be apportioned and distributed amongst its constituent members.
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A non-profit organization can seek tax exemption while a ‘for-profit’ organization is generally
not exempted from paying taxes.
NPOs: Advantages & Disadvantages
Advantages of starting a non-profit organization
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Most of the income of a non-profit is exempt from income taxes.
The contribution from a donor is also tax exempt in most of the cases.
A non profit organization can receive grants or aid in contrast to business entities that have to
use loans as a means of raising funds.
The satisfaction at being able to contribute to social development is immense.
Disadvantages of starting a non-profit organization
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Non-profit organizations are subject to stricter reporting requirements.
Benefits arising out of the nonprofit organization cannot be inured for the personal benefit of its
members, directors, officers beyond a permissible limit.
Getting grants is a tedious job.
In case, the incorporators decide to move onto some other pursuits in life, they cannot take
along the assets accumulated by the non profit organization.
Types of Nonprofit Organizations
There are many types of nonprofit organization and they have been classified into different
categories as per Section 501 of the IRS rules.
501 (c)(3) organizations
A new start up nonprofit organization falls under the jurisdiction of section 501 (c)(3) if it is:
a) Charitable,
b) Educational,
c) Literary,
d) Religious,
e) Scientific,
f) Concerned with public safety ,
g) Promotes amateur sporting activities OR
h) Works for the prevention of cruelty towards children or animals.
Most of the nonprofit organizations do actually fall into ‘charitable’ category of IRS
classification.
The term ‘charitable’ in itself allows for inclusion of vast variety of nonprofit organizations and
is thus applicable in most of the cases.
Thus organizations like alumni associations, clubs, schools, chapters of international
organizations also qualify as relevant for this section.
If your organization does not fall into any of these categories, you may first have to identify the
relevant category by studying the IRS publication 557 before you proceed.
Besides this IRS classification, the nonprofit organizations can also be classified as follows:
Private Foundations
A Private foundation solicits funds and donations from a limited number of members who
contribute a major portion of donations to the organization.
Foundations generally do not actively or directly engage in actual charitable work. Instead, they
fund other organizations that work on the chosen causes.
Public Charitable organization
A public charitable organization on the other hand accepts donations and funds from a large
section of people through membership subscription or from a variety of funding agencies.
To be classified as a Public charitable organization the body must have an active or continuing
program to raise funds and receive donations from a number of sources which could include
the private organizations, funding agencies, the general public, or the agencies set up by the
Government.
Public charity organizations can obtain tax exemption. The most common type of public charity
organizations include charitable hospitals, churches, medical research centers, educational
institutions including schools, colleges and universities,
Quasi Nonprofit organizations
These are hybrid organizations with a mix structure of different types of profit and non profit
organization structures. We can ignore these for now as they are structured in a complex
fashion and are not recommended for new startups.
Other types of Nonprofit organizations
…(that do not come under 501(c)(3) classification)
a) Advocacy groups – These kind of organizations are formed to influence the legislations or
Government policies on particular issues.
Such nonprofit organizations do not classify as charitable organizations and as such cannot
claim tax exemption under section 501(c)(3). Selective tax exemptions are available under
different clauses of Section 501 (c) for such organizations.
b) Membership Organizations – The are usually setup for the benefit of the members of the
organization as opposed to a public charity that works for a community. Examples include –
Veteran’s groups, Trade Associations etc.
c) Recreational Clubs – The primary activity of such groups is providing recreation facilities and
platform for its members. Charitable activities may also be undertaken but not as a priority.
Examples include – country clubs, sports club etc.
d) Auxiliary organizations – These organizations are set as a subsidiary or as a support
organization to a parent organization. The parent organization may be a ‘for-profit’ or a ‘notfor-profit’ organization in this case.
e) Employee Benefit Funds -These are organizations which may or may not be supported by the
employer of the organization but are established with the prime objective to formulate plans
and raise funds for employee benefits.
Conclusion
The rules and processes that will govern your nonprofit organization will depend on the
classification that you decide for your organization.
It is therefore vital that you identify the classification under which you seek to start your
organization at the very beginning.
Sources:
http://www.startnonprofitorganization.com/types-of-non-profit-organizations
http://www.startnonprofitorganization.com/nonprofit-organization-definition-meaning
http://www.startnonprofitorganization.com/npos-advantages-disadvantages
A listing of the 32 IRS categories of NPO classifications can be found at:
http://www.startnonprofitorganization.com/types-of-npos-irs-classification