Nonprofit organizations often find it difficult to generate enough funding to stay above water. Especially in today’s challenging financial times.

One strategy nonprofit companies employ to generate income is through for-profit ventures. It’s certainly a do-able arrangement. However, both federal tax codes and the law place limits on how nonprofits can coordinate with for-profit businesses.

The Difference Between a Nonprofit and For-Profit Organization

The purposes for establishing and running for-profit and non-profits differ greatly. For-profit companies produce income above and beyond their expenses. In other words, the services or products they sell are a means to an end.

Conversely, non-profit organizations aim to provide a service for a community or public. The non-profit collects income through membership fees or donations. Alternatively, it must generate funds through fees charged for direct services provided to their clients.

However, non-profits can, and definitely, do make a profit sometimes. These corporations aren’t actually designed to make money for shareholders or owners, though. Rather, a non-profit organization’s purpose is to serve a government-approved cause and as a result, it receives special tax treatment. Whether or not the organization is taxed on the profit all depends on whether that profit was generated from activities unrelated or related to the purpose of the non-profit organization.

Unrelated Activities and Profit

There are times when non-profits earn a profit on activities that aren’t related to their tax-exempt purpose. When this happens, the organization must pay taxes on that profit. While they won’t have to worry about losing their tax-exempt status, it’s important that the profit is merely a small part of overall operations.

To avoid losing that tax-exempt status, a non-profit should keep all unrelated activities that generate a profit as small as possible. The company should also avoid spending staff time on any unrelated activities and avoid hiring someone solely for the purpose of performing such unrelated activities.

Related Activities and Profit

Just like any business, a non-profit organization must cover operating costs and pay the staff. To pay employees their salaries, keep things running, and even to expand, the non-profit must generate some sort of revenue.

Sometimes the organization generates a revenue greater than the amounts of its expenses, and this is, therefore, a profit. How the business generates the profit is a big deal. To avoid taxes on the profits, the non-profit must make money on activities related to its particular nonprofit status.

Let’s say there’s a non-profit organization that collects used clothing. They clean and repair and then donate the clothing to people in need. The non-profit then generates an income by hosting fundraisers, raffles, charity dinners, and the like.

The organization can then use the income from those activities to cover operating expenses and salaries. In this example, the non-profit won’t have to pay taxes on those profits it receives. That’s because the activities were directly related to its mission – providing those in need with clothing.

Activities That Aren’t Taxed

It’s clear that the difference between unrelated and related activities can get confusing. As a result, the IRS has promised that it won’t tax certain activities, even if they don’t relate to a non-profit’s purpose. Such activities that the IRS won’t tax include:

  • Those activities where almost all the work is done by volunteers
  • Sales of merchandise mostly donated to the non-profit organization
  • Activities carried out for the benefit of employees, members, patients
  • Distribution of goods that are worth less than $5 as incentives for donations
  • Rental or exchange of mailing lists of members and donors

Protect Your Non-Profit Organization

Running a non-profit organization, especially a brand-new one, can be a challenge. Since there are ongoing issues with compliance, it’s important to have an expert tax law attorney on your side to ensure your non-profit is on solid ground.

Get in touch with us today to make sure you’re meeting your tax-exempt requirements.

Book a consultation with Principal Law Firm today for expert advice and guidance.

 

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