Nonprofit Organization (NPO): Definition and Example

What Is a Nonprofit Organization?

A nonprofit organization is an entity that is created and operated for charitable or socially beneficial purposes rather than to make a profit. A nonprofit might serve religious, scientific, charitable, educational, literary, health, or animal welfare purposes.

In the U.S., nonprofit organizations are granted tax-exempt status. Donations made to a nonprofit organization are typically tax-deductible and the nonprofit itself pays no tax on donations or on money earned through other fundraising activities.

Nonprofit organizations are sometimes called NPOs or 501(c)(3) organizations based on the section of the Internal Revenue Service (IRS) tax code that permits them to operate.

Understanding Nonprofit Organizations (NPOs)

A nonprofit designation and tax-exempt status are given only to organizations that further religious, scientific, charitable, educational, literary, health, or other beneficial causes. Examples of nonprofit organizations include hospitals, universities, charities, churches, and foundations.

A nonprofit must serve the public in some way. It is also required to make financial and operating information public so that donors are informed about how their contributions have been used.

To receive a tax exemption, an organization must request 501(c)(3) status from the IRS. Once registered and running, the organization has to maintain compliance with the appropriate state agency that regulates charitable organizations. This often requires a dedicated CIO and accounting team.

NPOs cannot be political, which helps explain why many strive for a non-partisan tone in their communications. Organizations seeking 501(c)(3) status must state explicitly in their organizing papers that they will not participate in any political campaign on behalf of any candidate or make expenditures for political purposes.

There are 501(c) groups that can engage in political activities, but not 501(c)(3) organizations.

Operating Rules for NPO Status

Some not-for-profit organizations use only volunteer labor, but large or even medium-size non-profits often require a staff of paid full-time employees, managers, and directors. Despite having special tax advantages in other respects, nonprofits typically must pay employment taxes and abide by state and federal workplace rules.

Nonprofits are allowed to provide assets or income to individuals only as fair compensation for their services. The organization must explicitly state in its organizing papers that it will not be used for the personal gain or benefit of its founders, employees, supporters, relatives, or associates.

Nonprofit Funding Sources

Nonprofits receive income or donations from a variety of sources. Below are the most common ways nonprofits fundraise and earn revenue.

Individual Donations

Nonprofits often rely on individual donors who contribute money, goods, or services to support their mission. Donors can give one-time or recurring donations, and they may give through various channels, including online platforms, direct mail, or events.

Some private companies encourage donations to worthy causes by allowing employees to make automatic donations from their paychecks.

Grants

Nonprofits may receive grants from foundations, corporations, or government agencies. Grants are typically awarded for specific projects or programs and may require the nonprofit to meet certain conditions or reporting requirements.

Nonprofits usually have to apply for the grant, using an extensive application process.

Corporate Gifts

Corporations may donate money, goods, or services to nonprofits as part of their corporate social responsibility initiatives or to support causes that align with their values or mission.

Some companies match donations by their employees who contribute through payroll deductions.

Major Events

Nonprofits raise money and awareness by hosting events such as galas, auctions, or charity runs.

These events often involve ticket sales, sponsorships, or auctions of donated goods or services.

In-Kind Donations

Nonprofits may receive donations of goods or services such as office supplies, equipment, or professional services.

The donating party is eligible for tax benefits by gifting in-kind items.

Nonprofit vs. Not-for-Profit

The terms nonprofit organization (NPO) and not-for-profit organization (NFPO) are sometimes used interchangeably. There are, however, key distinctions:

• A nonprofit must offer some social benefit. A not-for-profit may exist to serve its membership rather than society at large. For example, a sports club may be jointly managed by its members as a NFPO and financed by member fees.
• NPOs and NFPOs are regulated by different sections of the IRS's 501(c) code.
• Both organization types are tax-exempt, as the income they earn is not subject to tax. But NPOs can deduct dues and donations from their taxable income while NFPOs cannot.

Nonprofits and Form 990

Nonprofits are tax-exempt entities. However, they are still required to file informational returns to the IRS using Form 990.

This tax form provides information about the organization's finances, programs, and activities to the public and the IRS. The form is used by charitable, religious, educational, and other types of tax-exempt organizations. Private foundations, charitable trusts, and political organizations also must file a Form 990.

Form 990 requires organizations to provide detailed information about their revenue, expenses, assets, and liabilities. The form is very different from an individual's tax form as there are many governance questions to ensure IRS compliance.

Many nonprofits post their completed 990 forms on their websites so that donors, stakeholders, and members of the public can review the organization's financial information and assess its operations and impact.

Advantages and Disadvantages of Nonprofits

Advantages

Nonprofits are typically focused on a specific mission or cause. They operate around a central vision such as addressing a social issue, promoting education or the arts, or providing healthcare to underserved populations. This vision can foster a sense of purpose for staff that may be lacking in a for-profit company.

Because nonprofits are exempt from federal and state income taxes, they can allocate more of their resources toward achieving their mission and serving their communities. Nonprofits also have access to a greater range of funding sources.

In many ways, nonprofits can capitalize on cheap or free labor to support their operations. Volunteers tend to be motivated by a strong sense of dedication to the organization's purpose.

Disadvantages

Nonprofits rely on donations, grants, and other sources that can be unpredictable and inconsistent. This can make it difficult for nonprofits to sustain their programs and operations over the long term. Donations are an optional expense that can easily be reduced or eliminated.

Nonprofits often have limited scalability that can inhibit their ability to achieve their goals effectively.

Nonprofits are often known for generally lower compensation scales than for-profit entities.

The Bottom Line

Nonprofit organizations are tax-exempt entities that operate to better the community.

By receiving funds from individuals, corporations, and governments, nonprofits undertake programs and strategies for the public good. Nonprofits must comply with government regulations to retain tax-exempt status.