Below I’ve listed five common misconceptions about non-profit organizations along with a brief explanation setting the record straight. Understanding the true nature of what non-profits are and what they can do is essential in order to make an informed decision about whether a non-profit entity might be right for your next venture.
Here are my 5 myths:
1. All non-profits are tax exempt. People often use the term “non-profit” too loosely, to refer to an entity that has been declared exempt by the IRS under section 501(c)(3) of the Internal Revenue Code. This is not necessarily correct. A non-profit entity may be exempt under section 501(c)(3), may be exempt under another provision of the revenue code, or may simply be a state-created non-profit entity without an IRS exemption at all. Depending on what you want to do with a non-profit, each of these three options may make sense.
2. Non-profits can’t make money. While I’d hesistate to say that most non-profits make money, a good number of them do, and some make an awful lot. While non-profits can make money, what they cannot do is distribute that money — as profits — to their shareholders/members/owners. All money contributed to a non-profit must be used exclusively to further the non-profits charitable purposes. If the non-profit ever dissolves, its money and assets must be contributed to another non-profit.
3. Non-profits can’t conduct business. There is some truth to this myth, but the full reality is more nuanced. An tax exempt non-profit cannot conduct business for profit. But even an exempt non-profit can be involved in business when its purpose in doing so is primarily to further its charitable purposes and its business involvement doesn’t overwhelm its charitable activities. And it may be possible to use a for-profit subsidiary in appropriate cases. Answering the question of whether an exempt non-profit has, by being directly or indirectly involved in business, strayed beyond the bounds permitted for exempt organizations is perhaps the most complicated and uncertain area of non-profit law. If you have questions about whether an activity is appropriate for a non-profit, you need to talk to an attorney.
4. If you can, it’s always better to use a non-profit rather than a for-profit entity. This again is a much more difficult question than it might appear to be on its face. At first, one might be tempted to conclude that having a tax exemption is always better than not having a tax exemption, but there are other significant factors in play. Tax exempt status comes with an awful lot of strings attached, strings which do include limits on what can be done by the non-profit, who it can hire to do it, and ongoing restrictions on what may be produced as a result. Sometimes, in light of the particular goals, the constraints imposed by tax exemption are just too onerous to justify the financial benefits that accrue to exempt non-profits. Which leads me to my fifth and final myth . . . .
5. It is never worthwhile to incorporate as a non-profit entity if you can’t get a tax exemption. Again, this is a myth that may often be true, but not always. This myth is probably true so long as your primary reason for incorporating as a non-profit is for favorable tax status and deductibility of contributions. But if (1) your primary reason for wanting to use a non-profit is to convince the political powers that be of your goodwill and socially responsible motive, and (2) full tax exempt status threatens to put unreasonable constraints on your ability to effectively accomplish your goals, simply incorporating as a non-profit without seeking an exemption may make sense. By incorporating as a non-profit you are subject to the restriction on distribution of profits, but are not subject to the IRS-developed restrictions that arise out of the requirement that exempt non-profits be operated solely for charitable purposes. More on this last option in a coming post . . . .
If you have questions or comments, you can post them here, or email Curt Bentley at email@example.com.