Not every business venture is out to make somebody rich (though it never hurts). In fact, a good number of altruistic entrepreneurs start businesses that aim to benefit society at large.
If this sounds like you, it’s good to know that Uncle Sam rewards these kind souls by reducing a lot of the tax load for businesses that aren’t in it for the big bucks. But when starting a business, do these benefits counterbalance the freedom and flexibility of being in it…for yourself?
In this blog, we cover the differences between nonprofit, not-for-profit, and for-profit businesses. We look at how to become a nonprofit, as well as what financial benefits exist for nonprofits. And who knows? It might just save you a ton of money on taxes while you save the world.
First things first: Nonprofit vs Not-for-Profit
Nonprofit, not-for-profit. Tomāto, tomäto. Right?
While the two sound very similar, they reference two distinct types of organizations. So what’s the difference?
When it comes to mission, a nonprofit needs to have the express purpose of bettering society. No pressure there. A not-for-profit organization may have a mission of serving others but not necessarily for “the greater good.” A nonprofit could be a hospital. A not-for-profit might be a club or association that seeks to serve its members.
In both instances, funds raised are poured back into the organization. Neither pays shareholders.
Once the necessary paperwork is filed, nonprofits are considered tax-exempt by the IRS. This means they don’t pay income tax. Thanks, 501(c)3 status!
Not-for-profits can fall under the 501(c) grouping but in a different category. For example 501(c)7 is for social clubs. But these organizations can still apply for tax-exempt status which might allow them to skip property or sales tax.
Finally, the goals of nonprofits tend to exist on a larger, global scale. Most not-for-profit organizations tend to serve smaller communities or groups.
Why choose to be a nonprofit?
Lighter tax bills and balancing the karmic scales aside, there are plenty of practical reasons to register as a nonprofit.
For-profit businesses can still do good in the world. Which means you’ll want to consider where your funding will come from. If you plan on using grants and donations as your main source of revenue, you don’t necessarily need the ability to make a profit to sustain your organization.
Speaking of grants — being a nonprofit can also give you access to certain grants and opportunities reserved for organizations with this status.
On a legal note, nonprofits are almost always incorporated and thus become legal, separate entities. You know…that business structure that counts as a person? At least they’ll probably be a good person. This can help to protect the legacy of a nonprofit’s mission since corporations can exist in perpetuity. (Yep, the Salvation Army will outlive us all.)
This offers limited liability for founders and board members. That being said, someone performing criminal activities cannot hide behind a nonprofit shield and can still be held accountable for illegal financial actions.
Differences between nonprofit and for-profit?
Still not sure a nonprofit status is for you? Here are a few more comparisons between nonprofits and for-profits to help you sort it out.
- Mission: Nonprofits must have a purpose focused on serving the greater good and society. They do not aim to make any one individual money. For-profit organizations can have any mission they’d like, including making owners or shareholders Scrooge McDuck-style rich!
- Ownership: For-profit organizations can have one owner or multiple shareholders. Depending on the business structure, decision-making can fall to one or multiple people. Nonprofits have founders but they do not have shareholders. Instead, these organizations are guided by a board of directors and appointed officers.
- Revenue vs Income: Nonprofits can actually make a profit. How that profit is used is what separates it from its for-profit friends. For the most part, nonprofits rely on grants and donations to function. If there’s ever a surplus of revenue, it cannot distribute it to individuals. For-profits earn revenue through the sale of goods or services. After operating costs are paid, dividends are distributed amongst shareholders.
- Accounting: There are strict regulations for a nonprofit’s finances. For one, nonprofits must make their financial records public for transparency’s sake. Nonprofits must also use certain funds or gifts solely for their designated purpose. For-profits operate from a central set of financial statements and a single balance sheet, allocating funds where needed.
- Tax Exemption: Nonprofits are exempt from federal income taxes under the 501 (c) tax grouping. As long as revenue is earned through “related” activities. Those who donate to nonprofits are able to write off their “gift” on their own income taxes. For-profit businesses are not tax exempt (sorry) but can deduct qualifying business expenses when filing taxes.
Best of both worlds?
Still unsure? You can always opt for a hybrid structure.
If you want the best of both worlds, link a for-profit business to a nonprofit to enjoy maximum benefits. But entrepreneur beware — this can get complicated.
A nonprofit can work with a for-profit organization as either a subsidiary or through contractual agreements. This allows the nonprofit to enjoy its tax exempt status while allowing its for-profit arm to raise money to support it. And you guessed it: that’s a tax-deductible gift on the part of the for-profit company.
It’s important to remember these two organizations are separate. Which means you need to plan on running two separate companies with all the overhead and legal housekeeping that entails.
Have you made a decision?
Knowing the nature of your business is crucial to its longevity. It can also offer insight into how you debut your idea to the world. Choosing between a nonprofit and for-profit business structure can be a strategic decision with lasting implications for your organization and the people it serves.
Have some questions about the 501(c) tax code? Reach out to KYN Accounting today for friendly advice on how to structure your business.