Everyone knows about nonprofits—they are groups or organizations that help. Some organizations help people, some have a mission to help animals or the environment, and some are formed to help communities or society. As common as nonprofits are, there are a few myths about nonprofits that are just as common, and that I dispel with clients on a regular basis.
MYTH #1: Nonprofits can’t make a profit. (Or, shouldn’t make a profit.) This myth is, in my opinion, the most common and the most detrimental. Nonprofits can make a profit, and those that are run well do make a profit. If a nonprofit breaks even, or loses money every year, it won’t be around long at all. The word “nonprofit” is a misnomer–nonprofits can make a profit; what matters is what is done with the profit.
A nonprofit is like a for-profit business except that profits can’t be distributed to any private individual. With for-profit corporations, profits are distributed typically through dividends to shareholders. Nonprofits belong to the public, and profits come back to the organization so it can fulfill its mission in helping the public, not to private individuals. This leads to the second common myth…
MYTH#2: Nonprofit directors, officers and staff can’t be compensated. To the contrary, nonprofit employment makes up about 10% of private employment in the United States. Much discussion and controversy surround how much the director of a nonprofit should make. Naturally, people want to donate money to an organization to help its cause, not to excessively compensate its director or officers. The key with compensation is for it to be “reasonable.” For nonprofits with the financial means to compensate its director (desirable to attract qualified people—see Myth #1), a very general rule to determine “reasonable compensation” is that director compensation should not exceed 10% of revenue. A salary of $200,000 would likely be considered reasonable for a nonprofit with $2 million in revenue.
MYTH#3: Donations to nonprofits are tax deductible. If the nonprofit has received tax-exempt status from the IRS, then a donor can take a deduction on his or her taxes.
A nonprofit is a state entity. Donations to a nonprofit are tax deductible only if the nonprofit has received federal tax-exempt status from the IRS, designated most commonly as a 501(c)(3) charity (donations to some 501(c)(4) organizations and organizations under other IRS sections are tax deductible but are less common). If a nonprofit does not have tax-exempt status, either as a 501(c)(3) or other organization, donations to it are not deductible to the donor. People see “nonprofit” and often assume donations are automatically tax exempt. If you plan to claim a deduction on your taxes, check if the nonprofit has tax-exempt status from the IRS first.
MYTH #4: Tax-exempt nonprofits do not pay taxes. Tax-exempt nonprofit organizations do not pay federal taxes, sales tax and property taxes. They do, however, pay employee taxes (Social Security and Medicare) and, in some situations, pay income tax.
If you would like to form a tax-exempt nonprofit organization, contact me at email@example.com.