Nonprofit, or Non-Profit, or Not-for-Profit, organizations are entities that are formed for a public purpose or mutual benefit and not the pursuit or accumulation of wealth. Most nonprofits are recognized by having a 501(c)3 designation granted by the Internal Revenue Service (IRS)---organizations must apply for this exemption.
501(c)3
501(c)3 is a specific tax-code that has been created by congress to allow public purpose or mutually beneficial organizations to function with different tax-rules than standard for-profit organizations or corporations. The two main benefits of nonprofit organizations are:
- Exemption from Revenue Taxes: Nonprofit organizations are not required to pay Federal taxes on their revenue. Note that nonprofit employees must still pay income tax
- Tax Deductible Donations: A major encouragement for individuals to donate to nonprofit organizations is that their charitable gifts are tax deductible on personal income taxes.
Why Start a Nonprofit?
Nonprofit organizations are formed for a wide variety of functions, and while the standard idea of the social service (soup kitchen, food bank, early education) predominates, those are by no means the only purpose nonprofit organizations are formed. Here are some of the broad needs and services nonprofits fill:
- Education
- Health Services
- Religiously Related
- Economic Development
- Arts and Culture
- Human Services (shelters, food banks)
- Environmental
- Disaster Relief
- Zoos, Aquariums, Gardens, Humane Societies
- Civic Benefit (public policy, civil rights)
- Historic Societies
More than anything, nonprofits are started because there is a pressing social need that is not being addressed by the Public Sector (government) or the Private Sector (business).
There were more than 800,000 nonprofit organizations registered with the IRS in 2005 with combined assets in excess of $1.5 trillion. Half of those assets are owned by less than 2,000 organizations. Most nonprofits are also fairly small with only a quarter of registered nonprofits with annual revenues above $100,000 (source: National Center for Charitable Statistics).
How Does a Nonprofit Form?
There are several legal steps necessary to successfully form a nonprofit organization. These steps occur at both state and federal levels. Here are some of the requirements needed to be a fully formed 501(c)(3) nonprofit (in rough chronological order):
Prohibitions on Nonprofits
Nonprofit organizations are prohibited from political campaign activities to influence elections to public office, though they can perform limited lobbying to influence legislation.
Nonprofits must avoid any conflicts of interest with board members, family members, or staff. This means they cannot engage in activities that privately benefit individuals such as getting paid to perform services that may not be relevant to the organization’s mission.
Excessive executive compensation is also prohibited; meaning nonprofit directors cannot be paid exorbitant salaries. Excessive compensation, which is overseen primarily by the IRS, is determined by the size and complexity of the organization along with the skills and experience of the executive.
One of the most important prohibitions is that nonprofits cannot share profits amounts private individuals (this does not mean salaries cannot be paid however). Any revenues must be put towards activity that goes towards serving the organization’s mission.
Distinctions Between For-profits and Nonprofits
Differences
There are several key distinctions between nonprofit organizations and for-profit companies. The most obvious difference is what the “bottom line” for each is. For-profits companies’ “bottom line” is making money and profit while the “bottom” line” focus for nonprofits is their mission and public benefit.
This public benefit “bottom line” makes nonprofit accountability and success difficult to quantify because, unlike for-profits who only need to look at profits, nonprofits need to look at a complex array of variables, outcomes, and impacts to determine if they’ve achieved their “bottom line.”
Similarities
However, nonprofits and for-profits are similar in that each requires large amounts or entrepreneurship to start up as there is substantial work and risk in founding any organization.
Nonprofits and for-profits are also alike in that each must have money and funding in order to survive and grow. In this sense, nonprofits have “a double bottom line” of both garnering enough funding to at least break even (and be account for fiscal performance for the IRS) while also ensuring it is achieving its mission and benefiting the public.
Nonprofit Management
The primary structure and management of a nonprofit organization is determined by its Articles of Incorporation and/or Bylaws. These documents usually describe the organization's mission and sets out general rules for oversight and management of the organization. These articles and bylaws are usually written by the Founder, who may wield considerable influence throughout the organization's lifespan.
Board of Directors
Most nonprofits have a Board of Directors that oversees the long term, and strategic vision of the organizations. They usually meet several times a year in "Board Meetings" to set these long-term goals. The Board of Directors is usually made up of socially influential persons, though sometimes there will be "diversity" positions in which other people from the community, youth or program participants can serve.
A practical function of the Board of Directors is to fundraise and perform outreach, using their influence and connections to raise money and awareness of the organization. This fundraising need is sometimes referred to as the Three-Gs: "Give, Get, or Get Out", the idea that members of the Board of Directors have minimal value if they are not actively fundraising, either through their own donations or acquiring the donations of others.
The Board of Directors is ultimately responsible for the functioning and legality of the organization. In this respect, they assume liability for the organization, and in some cases can be directly sued. In response to this, most boards carry Board Insurance that removes some of the personal financial liability of the members of the board.
Advisory Boards
An Advisory Board, on the other hand, performs some functions similar to a Board of Directors, but has no governing power or responsibility. These types of boards provide advice, contacts, guidance, and their professional skills and experience to nonprofits. Advisory Board members also do not receive any monetary compensation usually for their services, as sometimes can be the case with members of a Board of Directors.
Executive Directors and Boards
Beneath the Board of Directors or Advisory Board, most nonprofit organizations have an Executive Director that acts as a liaison between the long-term priorities of the Board and the day-to-day activities of staff. The Executive Director is usually ultimately responsible for ensuring that the nonprofit is operating properly and effectively---though ultimate accountability rests with the Board.
Who funds nonprofits?
Nonprofits have multiple sources of income and these generally change and shift throughout a nonprofit’s lifespan. These come typically from public sources (federal, state, and local governments) and private sources (individuals, corporations, foundations, etc).
Here are some statistics on all private contributions in 2005 (from Giving USA Foundation – AAFRC Trust for Philanthropy/Giving USA 2005):
How are Nonprofits accountable?
Nonprofits are accountable to a wide cross-section of stakeholders. To funders, nonprofits must prove they are doing with donated funds what they specified in grant applications or understandings with donors. They must be good stewards of contributions and are often required (though less so by individual donors) to show ‘results’ backed up by impact data.
To the state government, nonprofits usually must file annual reports (includes statement of activities, financial data, and other relevant information) and also file documentation of any changes to their Board of Directors or Bylaws.
Nonprofits are accountable to the IRS by ensuring their organization does not engage in restricted political activity, filing appropriate documentation (such as the Form 990 detailing annual financial information), demonstrating they are not overcompensating employees, or operating for private gain.
Internally, nonprofit Board of Directors or Advisory Boards hold Executive Directors accountable for organizational development and day-to-day operations.
Nonprofit accountability within the communities they serve is not as strong as with the IRS, state governments, or funders. There are no official or standardized ways of ensuring the work that is done is consistent with the public good. While nonprofits are accountable to funders for “results” they are not beholden to community members.
Current Trends in the Nonprofit Sector
Here are some emerging trends in the nonprofit sector culled from Nonprofit.about.com and Worth.com that you may notice, become involved with, or have to confront head on during your service year:
- Increased competition for funding as the number of nonprofits grows with stagnating or decreasing funding
- Greater calls for nonprofit results accountability from the government, funders, and general public
- Increased focus on management and governance as an effect of calls for increased accountability
- Greater focus on “data-driven decision making” as more performance metrics and indexes are used in evaluating success
- Intergenerational challenges between old and new styles of management and leadership
- Work in the nonprofit sector is more “professionalized” as more colleges and universities offer nonprofit related degrees and programs
- Public perception is generally favorable towards nonprofits (much more so than the private sector or government), however the public does not have an understanding of what a nonprofit is or how it functions. There is also a credibility gap between the nonprofit sector and the public fueled by recent scandals and unethical activity.
Further Resources
Hutton, Stan and Phillips, Francis. Nonprofit Kit for Dummies. Wiley Publishing, Inc., 2005.
Welytok, Jill Gilbetrt and Welytok, Daniel S. Nonprofit Law & Governance for Dummies. Wiley Publishing, Inc., 2007
Nonprofit Trends @ About.com
(http://nonprofit.about.com/od/trendsissuesstatistics/Trends_Issues_Stati...)
Nonprofit Trends @ Worth.com
(http://www.worth.com/Current-Concerns/News-Briefs/NB-nonproift-trends-12...)
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