Nonprofit Organizations: Myths and Facts
Recent news reports claimed that the IRS targeted extra scrutiny to conservative groups applying for nonprofit tax exemptions. It was much ado about nothing. But it’s time to clarify nonprofits’ legal status and their social roles in our culture.
Before that, for more than a year, teapartiers and other conservatives had jumped up and down, screeching and wailing about that horrible “Kenyan-Nazi-Marxist-socialist-dictator-Muslim-terrorist pal”, Barack Hussein Obama. They battled for camera time to see who could post the most outrageous insults about the President of the United States of America. And then, suddenly, they all applied for tax exempt status for their “nonpartisan, non-political, social welfare organizations”. Uh huh.
“Nonprofit” doesn’t just mean that you’re not making money. An organization is not “nonprofit” just because its managers say so. Thousands of state and federal regulations control the business of nonprofit corporations. These are just the basics.
Most nonprofits are corporations, just like General Motors, or Sears, or McDonald’s. But no one “owns” a nonprofit and there is no stock. The founders must designate the organization as nonprofit when they create it, and it can only conduct certain activities as permitted by law. The Board of Directors creates the corporate bylaws, sets all policies, hires the staff, and is legally responsible for the finances and all of the organization’s actions.
Categories, Types, and Restrictions
The terms “nonprofit” and “charity” are not synonymous. A charity is only one of the 57 types of nonprofit organizations in 31 categories recognized by the IRS. Most of the categories are in section 501 of the IRS Code; others are in Sections 521 and 527.
That would be U.S. Code Title 26, Subtitle A, Chapter 1, Subchapter F.
The largest category, 501.c.3, consists of charitable, religious, educational, scientific, literary, and amateur athletic organizations, private schools, and foundations. A foundation is an organization that collects money from various sources and distributes it to other charities. These nonprofits face strict limits on the types and amounts of lobbying they may do, and they absolutely may not support, endorse, or oppose any candidates for any public offices.
Some c.3 nonprofits, such as the United Way, don’t provide services directly to the public but they do provide support and services to other charities.
The recent IRS controversy involved 501.c.4 organizations. Those are civic leagues, social welfare organizations, volunteer fire companies, community associations, homeowners’ associations, and local employees’ associations. C.4 organizations can do unlimited lobbying, but still may not support or oppose political candidates.
Groups in the remaining categories – c.5 through c.22, c.25 through c.27, 501 and 527 – can lobby and can support or oppose political candidates. Some of those categories include: labor unions, trade associations, chambers of commerce, credit unions, veterans’ organizations, religious and apostolic associations, and child care organizations. That’s why labor unions can endorse political candidates and churches can’t. Political organizations such as political parties, candidates’ campaigns, political action committees, and superpacs are in section 527.
Creation and Regulations
Creating a nonprofit is a complex and expensive legal process. Only adults can do it. Regardless of their good intentions, children cannot “start a charity”.
First, the founders incorporate the organization in its home state. A nonprofit must have by-laws stating its structure, purpose, and rules of operation and it needs officers and a board of directors. There is an official address, board meetings, and minutes of those meetings. They must comply with all of the same wage payment, discrimination, and workplace health and safety rules as for-profit employers. Certain records are open to public inspection.
Then the new corporation applies for tax-exempt status from the IRS. That means that the organization does not pay taxes on the money it raises. Nonprofit employees pay taxes under the same rules as everyone else.
The organization must meet at least one of the nonprofit purposes listed in the IRS Code. Once the IRS grants tax exemption, the organization is a full-fledged nonprofit, tax-exempt corporation. Every nonprofit must file Form 990, similar to a tax return, listing its income and expenses with the IRS each year. The 990 records are open to the public.
Additional rules govern fundraising and other operations. The government can fine or shut down any agency that violates the rules.
Tax Exemption and Deductions
Congress has exempted nonprofit corporations from paying taxes because they provide vital services to the public. However, not all payments to nonprofits are tax deductible for the donors. IF you itemize deductions on Schedule A of your annual tax return, you may be able to include charitable deductions for most cash and material donations to section 501.c.3 nonprofit organizations only. You cannot deduct donations to nonprofits in any other categories as charitable contributions. Fees, membership dues, and some other payments might be deductible as business expenses or under other rules.
Nonprofit fundraising is a very complex specialty. You do not just create a website and sit back while the money flows in. Most c.3 and c.4 nonprofits rely heavily on public donations. They use many tools to raise that money, including their websites, special events, media advertisements, and direct mail appeals.
However, it is illegal to solicit money from the public without a state-issued license, and they only give those to valid nonprofit corporations. Violations can result in stiff fines and even jail time. Yes, really. We cannot allow just anyone to beg money from the public while claiming to “give it to poor people”.
C.3 and c.4 agencies can apply to foundations for funding. The foundations attach hoops and strings to that money. Federal, state, and local government agencies also offer grants to these nonprofits for specific projects. There are plenty of hoops and strings for that money, too.
If you don’t jump through the hoops, you don’t get the money. And then you won’t be able to serve your clients.
Sometimes, funders impose contradictory requirements, and the agency has to choose which hoops to jump through. Sometimes, the funders obstruct the agency’s work to the point where the hoops and strings turn into a swamp. They really need to relax. Just because you can attach hoops and strings to your money doesn’t mean that it’s a good idea. Swamps don’t generate progress.
Managing for-profits and nonprofits is similar in many ways but there are some important differences. Many universities offer degrees in nonprofit management as an occupational expertise.
Profit occurs when a business earns more money than it spends. It is usually distributed to the owners or corporate stockholders. When a nonprofit corporation collects more than it spends, the excess is called a “fund balance” and there is no distribution. The fund balance stays with the organization to continue its work.
Both profit and nonprofit organizations have expenses: rent – utilities – furnishings, supplies, and equipment – transportation – insurance – legal and accounting fees –wages and employee benefits – and much more. Believe me, they get nothing for free. Yes, wages. Ten percent of the American workforce works for nonprofits – paychecks, vacations, sick days, health insurance, pensions – the whole nine yards. Most American universities, hospitals, private schools, and churches are 501.c.3 and c.4 nonprofits, as well as the big organizations like Boy and Girl Scouts, the United Way, Red Cross, Salvation Army, American Civil Liberties Union, National Rifle Association, and nearly a million others. The millions of people who work for them do not do it for free.
The purpose of a for-profit business is to make a profit. Period. A nonprofit’s purpose is to serve its clients, members, or the public. Nonprofit managers must balance the organization’s financial needs with its duty to provide services. They must know about legalities, fundraising, recruiting and training staff and volunteers, program development and service delivery, marketing, budgeting, board relations, public relations, media relations, government relations, and financial management. They must also be experts in their organizations’ subject matter.
Operate Like a Business
I’ve worked as volunteer, staff, manager, board member, board president, consultant, and lobbyist for nonprofits for more than 30 years. There is a delicate balance between efficient management and dedicated service delivery.
Some nonprofit managers are idealistic and naive and need to operate in a more business-like, professional manner. Nonprofits that neglect their business are inefficient and ineffective. But when a nonprofit focuses too much on the bottom line, it abandons its mission and the quality of its service suffers. And then the public suffers.
A business’s purpose is to make a profit. Period. A nonprofit’s purpose is to provide a public service. Nonprofits aren’t supposed to be just like Wal-Mart. They’re supposed to be better.
There are good and bad agencies, just as in any industry. While the “cause” may be good – like protecting animals or feeding the hungry – the agency may or may not be run by reliable, qualified people. In my experience, most of the people who manage and work for nonprofits are honest, hard working, gifted, and dedicated. Unfortunately, there are always some exceptions.
Nonprofit donors always want to know how much of their donations actually go “to the cause” rather than to overhead. There are no legal limits, but a maximum of about 20% on overhead spending is generally considered to be acceptable. Ten percent is about average. But overhead spending is only one measure of an organization’s quality, and may not be the best. The nonprofit community wants donors to consider transparency, governance, leadership, and results as well.
There are several sources of information to evaluate an organization’s quality.
The Internal Revenue Service website contains all of the forms and instructions needed to apply for tax exemption. You can also learn whether a particular organization has official tax exempt status and file complaints against organizations. The site includes a terrific guide called “Life Cycle of a Nonprofit Charity” and much more education and training material.
Charity Navigator uses a four-star scale to rate charities on their finances accountability, and transparency.
The Better Business Bureau rates charities, accepts complaints, and provides and other resources through its Wise Giving Alliance.
You can read any 501.c.3 or c.4 nonprofit’s IRS form 990 at Guidestar.org.
USA.gov for Nonprofits contains links to all government nonprofit resources.
The Foundation Center connects nonprofits seeking funds with foundations offering funds. It also offers research, education, and training programs on philanthropy.
Role in Society
There are various opinions on the role of nonprofits in society. One holds that the government should perform all of the social services necessary for society. Another maintains that nonprofits should do all of that work and the government should stay out of the social service business. Really, we need both.
American nonprofits could not possibly handle all of the social services that the nation needs. The system is overwhelmed now. Government agencies truly can operate more efficiently on a large scale. They can follow a uniform set of rules and procedures, maintaining fairness to all. However, because of its size, government moves slowly and it can take years to make major changes in those rules. Smaller nonprofits can be more flexible when unusual things happen – such as natural or economic disasters (Hurricane Katrina or the collapsing steel industry). They can adjust their rules and procedures more quickly and effectively to help those in need.
The non-charity nonprofits connect, communicate with, provide services to, and advocate for their members’ issues with the government and the public.
So please, support the nonprofit agencies working on the issues that are important to you.
WE ARE ONE
For More Information
Internal Revenue Service: Charities and Nonprofits
Better Business Bureau
National Center for Charitable Statistics
The Overhead Myth
The Foundation Center
USA.gov for Nonprofits