What Do We Mean When We Say “Nonprofit”?

We often start our lectures by quizzing the participants on their understanding of “nonprofits.” By show of hands, how many think the following organizations are nonprofits?

The Bill Gates Foundation; your church, synagogue, or mosque; the local United Way; the local community foundation; a major local university such as Harvard; a local social service organization; the Sierra Club; the local private golf club; the National Football league; the New York Stock Exchange.

A whole lot of people do not raise their hands very often. The hands particularly start to drop after the United Way or the community foundation. Yet all of these organizations are nonprofits except the New York Stock Exchange. And even the New York Stock Exchange was a nonprofit until 2006.

We all think we know what we mean when we say “nonprofit.” But the key to understanding nonprofits is to understand that there are many different types of nonprofits. Different rules apply, depending upon the type of organization. An understanding of the difference is critical to understanding the world of nonprofit organizations.

Nonprofit

“Nonprofit” is a concept of state law, which means that an organization may not pay dividends or otherwise pass any surplus revenue, or “profits,” from the enterprise on to shareholders, members, or other individuals. Although a nonprofit may pay reasonable compensation for services actually rendered to it, in general, any surplus generated by the organization must stay within the organization and be used for its stated purposes.

(New York Attorney General Eliot Spitzer’s suit against Richard Grasso, former President of the New York Stock Exchange, was based on the provision of the New York Not-for-Profit Corporation Law which, like most nonprofit corporation laws, permits payment of reasonable compensation only. There is no corresponding limitation in the business corporation law. (See Ready Reference Page: “Spitzer Challenges Grasso Salary as ‘Objectively Unreasonable’.” )

A nonprofit corporation is not “owned” by anyone. It may be controlled by individuals or other entities, but those who control the nonprofit do not have an ownership interest in the organization. (See Ready Reference Page: “The Key Question: Whose Organization Is It?” )

Tax Exempt

When we say “nonprofit” we are usually thinking of an organization that is exempt from taxation. Most, but not all, nonprofit organizations are exempt from paying federal income tax on their earnings.

Section 501(c) of the Tax Code now spells out 29 separate categories of exempt organizations. These categories include:

Section 501(c)(2) title holding companies ( See Ready Reference Page: “Title Holding Companies Have Limited Uses.” ); Section 501(c)(4) social welfare and advocacy organizations like the Sierra Club or the new organizations set up to participate in political campaigns; Section 501(c)(5) agricultural or labor organizations; Section 501(c)(6) business leagues, professional and trade associations, like the National Football League; Section 501(c)(7) social clubs; Section 501(c)(8) and (10) fraternal organizations; cemetery organizations ((c)(13)); veterans organizations ((c)(19)) and so on down to (c)(28).

Charities

The largest category, and the one most people usually think of when they think of “nonprofit” or “tax exempt,” is Section 501(c)(3) “charitable” organizations. Virtually all charities are nonprofits; but not all nonprofits are charities.

Under the Tax Code definition, a Section 501(c)(3) charitable organization is one which is “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals.”

In addition, no part of the net earnings may inure to the benefit of any private shareholder or individual, no substantial part of the activities may consist of carrying on propaganda, or otherwise attempting, to influence legislation, (“lobbying”), and the organization may not participate in any political campaign for or against any candidate for public office (“electioneering”). (See Ready Reference Pages on Requirements for Federal Tax Exemption, and on Lobbying and Electioneering.)

When the U.S. Supreme Court decided in the Citizens United case in 2010 that corporations could spend unlimited amounts on “uncoordinated” political campaign advertising, many existing and newly created 501(c)(4) advocacy groups and 501(c)(6) trade associations significantly increased their electioneering activity, as they are permitted to do under the law. Unfortunately, in much of the media discussion of the expenditures, the media referred to spending by “nonprofits,” without distinguishing between those allowed to participate in elections and charities that are not so permitted. While the media was not wrong in calling these organizations nonprofits, the use of the term was hugely confusing because many people equate “nonprofit” with “charitable” and charities cannot participate in election campaigns.

The other critical distinguishing feature of charities, as opposed to almost all other types of federally exempt organizations, is that individuals and corporations may make charitable contributions to charitable organizations and claim a charitable contribution deduction on their own federal income tax returns.

Public charities and private foundations

Section 501(c)(3) charities are further subdivided under Section 509(a) of the Tax code between “public charities” which receive broad public support and “private foundations” which receive the great

bulk of their income from a very limited number of contributors and investment income. All charities are deemed to be private foundations unless they show the Internal Revenue Service that they qualify as public charities. (See Ready Reference Page: “Calculating Public Support.”)

Section 509(a)(1) describes publicly supported organizations such as churches, hospitals, and schools, which are considered publicly supported by virtue of what they do, and also organizations that receive a specified percentage of their revenue from a broad range of contributions such as the United Way, or a community foundation.

Section 509(a)(2) describes those that are deemed publicly supported because they receive a broad range of public support from contributions and fees for service, such as many social service organizations or a nursing home.

Section 509(a)(3) describes those organizations that are deemed publicly supported because they are “operated, supervised, or controlled by or in connection with” a publicly supported charity or govern mental unit. (See Ready Reference Page: “Supporting Organizations Are Public Charities.”)

Charities that don’t meet the criteria of Section 509(a) are considered private foundations. Like the Gates Foundation, essentially all of their income has come from a single or limited number of individuals, families, or corporations and income on their investments. Private foundations are subject to more stringent regulation. (See Ready Reference Pages on Private Foundations.)

Nonexempt nonprofits

Although rare, there are nonprofit organizations that are not tax exempt, like the New York Stock Exchange immediately before it converted to a for-profit so that it could sell stock to provide an ownership interest to investors. A “nonprofit” organization partakes of some of the “halo effect” of the term, even though most people do not understand that the term is not completely descriptive.

Some state nonprofit corporation laws make distinctions between charitable, mutual benefit, religious and other types of nonprofit corporations, and apply different rules for each, but many nonprofit corporation laws have only a single classification that includes all nonprofits.

State tax exemption

State tax exemption in most states is an entirely separate matter. Although most nonprofits are likely to be exempt from state corporate income taxes, if any, many states have separate criteria, often more stringent than the federal 501(c)(3) criteria, for real estate or state sales tax exemption.

If you can’t identify the category in which a nonprofit fits, you can’t know the rules by which it is regulated.

The Fine Print...

Although this article discusses an aspect of the law of tax-exempt organizations, neither the author nor CharityChannel Press is rendering legal advice. No attorney-client relationship is formed between the reader and the author or between the reader and CharityChannel Press. A qualified attorney should be consulted on all important questions of law.
Don Kramer

About the Contributor: Don Kramer

Don Kramer is editor and publisher of Don Kramer’s Nonprofit Issues®, a national newsletter of "Nonprofit Law You Need to Know." He writes and lectures frequently on nonprofit legal issues, including a daily question and answer feature on Twitter @DonKramer .

Don is chair of the Nonprofit Law Group at the Philadelphia law firm of Montgomery, McCracken, LLP. He has worked with nonprofit organizations of all types and sizes, helping structure start-up situations and restructure multi-organizational foundations, health and educational systems. He counsels on a wide range of corporate, governance, tax, real estate, charitable giving and other nonprofit issues. Mr. Kramer has more than 40 years of experience dealing with the concerns of nonprofit organizations, not only as a lawyer, but also as a teacher, writer, publisher, and board member.

He also serves on the Boards of the Pennsylvania Association of Nonprofit Organizations, the Philadelphia Council for Community Advancement and the Philadelphia Fire Department Historical Association. Don has taught a course on nonprofit organization law at the University of Pennsylvania Law School and Eastern University and currently teaches a similar course for the School of Social Policy and Practice at the University of Pennsylvania. A graduate of Princeton University, he earned an LL.B. degree from Harvard Law School.

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2 thoughts on “What Do We Mean When We Say “Nonprofit”?

  1. Don, thanks so much for this very useful and timely clarification.

    The Catalogue for Philanthropy has been saying for some years now that “nonprofit” is very far from synonymous with “philanthropy.” We combed through the IRS Nonprofit Master Data File for Massachusetts, and found that only 10% of the organizations were “private initiatives, for public good, engaged in public fundraising for grants and donations.” This is a conventional definition, but has not been rigorously applied to identify the philanthropic cohort among nonprofits. We found that 75% of nonprofits have nothing whatever to do with philanthropy, and 15% might be philanthropic but need further research—e.g., Little League teams supported by parents for their children, PTAs where parents volunteer and contribute to support their children’s schools, etc.

    By inference, this suggests that the total number of. philanthropies of broad interest to donors nationwide is about 200-300,000, not up to 2 million “nonprofits”. This estimate is independently corroborated by the donor-generated datasets of the national donor-advised funds—Fidelity, Schwab, Vanguard, et al. Fidelity’s 104,000 donors since 1991 have supported only about 180,000 charities. The top four firms in the field raise that total to 214,00 with many duplications. These folks are not choosing among 1-2 million organizations, but a much smaller number.

    Philanthropists both professional and amateur need to stop using the term “nonprofit”, which has no meaning apart from the tax code and related state laws of incorporation. Phrases like “nonprofit management” are meaningless—referring to condo associations, cemeteries, teachers retirement funds, social and professional associations, the NFL, etc., etc.

    So many thanks for your help on this fundamental issue!

  2. Thanks for the comment. The actual numbers are hard to pin down. According to the National Center for Charitable Statistics, there were 1,409,430 registered tax-exempt organizations in 2013, including 948,769 public charities, 96,655 private foundations, and 364,006 other types of organizations including chambers of commerce, fraternal organizations and civic leagues. There were also an estimated 324,804 church congregations that do not have to register.

    Of the public charities, only 652,719 filed tax returns for the latest year. Of these, 303,667 (about 47% of all those reporting) filed the Form 990-N electronic postcard available to groups with income of less than $50,000. 451,149 (about 69% of those reporting) reported income of less than $100,000, a total of 555,098 (85% of the total reporting) with income of less than $500,000, and 584,930 (89.6% of the total reporting) with income of less than $1 million.

    The picture is one of predominately small organizations, probably of significance to those who participate in their activities, but not broadly appealing to a wider community.

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