The Basics of Nonprofit Charitable Organizations

What Is a Charitable Nonprofit?

The term “nonprofit” covers much ground. In fact, there are many types of tax-exempt nonprofit organizations under IRS Section 501(c).

However, the most common nonprofit organization is the 501(c)(3), also known as a public charity or a charitable nonprofit.

We know public charities well because that is where we donate, volunteer and receive many social, educational or health services.

Nonprofit does not mean there can be no profit (as in more income than expenses). It just means that excess revenue can only go to the organization’s exempt purposes. It can never be distributed to shareholders or members.

Nonprofits can and should cover daily expenses, invest in an emergency fund, set up an endowment, and improve infrastructure. A well-funded nonprofit will be healthier and more sustainable.

Charitable nonprofits may be called non-profits, not-for-profits, or NGOs (non-governmental organizations).

Charitable nonprofits include the medical center and the state university as well as iconic charities such as the American Red Cross, the Salvation Army, and the World Wildlife Fund. These organizations employ thousands of people and have budgets of millions of dollars.

Foundations are also charitable nonprofits, although slightly different than the public charities that provide services. Foundations, to fulfill their missions, give money to public charities as grants. The Bill and Melinda Gates Foundation, the Ford Foundation, and the Rockefeller Foundation are all household names.

Although some charities are large, most are quite small. Of the approximately one million public charities in the US, the vast majority are local groups serving their communities. They are the homeless shelters, food banks, animal shelters and theater groups right in our hometowns.

In the US, the Internal Revenue Service defines the conditions that organizations must meet to be nonprofits. All nonprofits enjoy some measure of federal tax exemption, but only the 501(c)(3) public charity can provide a tax deduction for donations.

It is not especially easy to become a tax-exempt nonprofit organization.

The conditions include:

Nonprofits must also submit an annual tax form called a 990. Moreover, if they go out of business, nonprofits must give their assets to another nonprofit. Individuals can never receive personal benefit from their association with a charitable nonprofit.

Nonprofit vs. For-Profit Organizations

Surprisingly, nonprofit organizations share many similarities with for-profit businesses. They are usually incorporated, for instance. They can pay staff salaries and provide benefits. They can invest funds through their endowments.

Nonprofits can earn a portion of their income from selling something or charging for services. They can turn a profit as long as that profit is used to fulfill the organization’s charitable mission.

Nonprofit organizations are different from for-profit businesses because the public owns them.

That means no individual owns the organization or its property, and its income cannot go to members or shareholders.

A nonprofit charitable organization is governed by a board of directors (sometimes called trustees). Boards must make sure that the charitable nonprofit abides by the law and handles its money appropriately.

Board members can be liable if they do not fulfill their fiduciary responsibilities.

A charitable nonprofit’s employees may be different from business as well. Many small nonprofits fulfill their missions with volunteers. Others employ paid staff but then depend on volunteers to perform many tasks. Even large national charities use a healthy mix of paid staff and unpaid volunteers.

How a charitable nonprofit earns its income also differs from the typical business.

Although a nonprofit can enjoy earned income from the sale of services or products (consider a university or a hospital), it also depends on donations from the general public.

How Do You Start a Charitable Nonprofit?

Starting a charity begins with a cause.

An individual or group discovers that there is an unmet social need in their community or gaps in the social safety net.

However, that is only the beginning. Just as a potential business does research to see if there is a demand for a service or product, so must a charitable organization find out if its particular idea makes sense. Nonprofits should also prepare a business plan that is similar to what for-profits develop.

Every founder of a charitable nonprofit must answer several questions ranging from “Do I know what I am getting into?” to “Is someone else already doing this?” After responding to these issues and performing market research, the organization can start to take shape.

The first steps to starting a charitable nonprofit include:

It may pay to hire a lawyer to prepare all the paperwork and file for incorporation.

Not all nonprofit groups incorporate. Time-limited activities often spring up, accomplish a goal, and disappear. Some nonprofit groups stay small, use only volunteers, and have little income. These types of groups are known as unincorporated nonprofit associations. Typically, they receive less than $5,000 in annual revenue, have no paid staff and a simple structure.

Most charitable organizations, however, do incorporate. There are advantages and disadvantages to incorporation. The most significant benefit has to do with personal liability protections for board members and staff.

Once incorporated, a nonprofit will want to apply to the IRS for 501(c)(3) tax exemption.

What Is Tax-Exemption?

Although filing for 501(c)(3) exempt status can be complicated, it has so many advantages that most nonprofits seek it eagerly.

Tax-exempt status does far more than just provide a tax break for the charity.

Besides providing a "seal of approval" from the federal government and avoiding many federal and even state taxes, exempt charities can give their donors a tax break.

Donors who itemize deductions can earn a tax deduction for donations to qualified charities when they file their personal income taxes. Even businesses can often take a deduction for charitable contributions.

Charities with tax-exempt status can also apply for grants from the government and foundations. These sources of funds are not available unless an organization becomes tax-exempt.

The Internal Revenue Service (IRS) grants 501(c)(3) tax exemption. ​Charitable organizations must meet three tests. They are the organizational test which is about your mission; the political test that ensures political neutrality; and the asset test, which demands that a charity’s assets always be used for the public good.

Small organizations can now use a simplified online form to apply for tax- exemption while larger groups must file a more in-depth form. To make sure that everything is in order and that their application receives a speedy approval or is not turned down, most nonprofits use an attorney for this labor intensive task.

Churches and religious organizations qualify for special treatment from the IRS. They might not need to fill out the forms for 501(c)(3) tax exemption, yet they will automatically be treated as tax exempt. Most churches and religious groups do apply formally for tax exemption because it gives additional capabilities such as applying for grants.

How Do Charitable Nonprofits Support Themselves?

A healthy charity makes sure that it has a diverse income. It does not depend on one source, but a basket of sources.

Many start-up charities think they can raise enough money from grants, events, or corporate philanthropy to support their activities. However, most of a charity’s revenue comes from three sources: ​mission-related earned income, state and federal government, and charitable contributions.

Surprisingly, close to half of nonprofit revenue comes from earned income. How does a nonprofit get this earned income? From fees for services or by selling products, or some combination of those.

For example, a university charges tuition and sells textbooks and tickets to athletic and cultural events.

Similarly, a small equestrian therapy charity that provides horseback riding for disabled children charges a fee for those services. The YMCA charges a membership fee.

One well-known organization, the Girl Scouts, earns much of its income from the sale of cookies.

Most earned income must be from mission-related activities. Unrelated earned income may trigger a tax bill.

Government supplies about a third of charitable income through grants and tax supported programs for medical care and education. Charitable contributions account for a smaller, but crucial portion of revenue (The Urban Institute).

Charitable donations run in the billions of dollars every year to public nonprofits. Charitable contributions include money from foundations, corporations, and individuals.

However, more than 70 percent of charitable donations come from individuals (GivingUSA 2016). That is why charities spend so much time and energy fundraising.

While some charities depend only on donations, or grants, or government money, most create a well-balanced portfolio of income sources.

The Role of the Nonprofit Organization’s Board

It cannot be overstated the important role a nonprofit board plays in the success of any charitable organization.

Nonprofit board members usually serve without pay. While public corporations and some large nonprofits pay board members for their services, most board members do not receive compensation. They are volunteers. However, their expenses can be paid when necessary, including travel to a board meeting or hotel rooms for a conference or annual meeting. Board members can also take a personal tax deduction for unreimbursed expenses.

While nonprofit board members have legal responsibilities, such as hiring and firing the organization’s CEO and making sure that resources are used responsibly, they have other obligations as well. One of those is to help with fundraising. They can do that in many ways, such as making a personal donation, contacting well-connected peers to ask for donations, and helping with fundraising events.

Successful charities have active boards, so choose board members well. Consider the talents and skills they bring to the table, their generosity, and their community connections. All of those things make for success.

How Volunteers Help Nonprofit Organizations

Volunteers play a unique role for nonprofits. Volunteers serve on the boards of nonprofits, but they also provide many of their services.

Many smaller nonprofits have limited staff and depend on volunteers for much of their work. Volunteers might perform very basic tasks such as office work. They also might bring unique skill sets to complex tasks such as marketing, accounting, website design, or social media outreach.

Volunteers might help a diaper bank repackage donated diapers, but they might also go to disaster sites to help distribute much-needed services to survivors of an earthquake or flood.

Volunteers also donate money to their favorite charities. Indeed, volunteers are some of the best donors. Providing volunteer opportunities helps charities keep donors engaged for a lifetime.

Corporate volunteering has also become hugely popular. Younger employees especially favor companies that have volunteer programs and that match their employees’ donations to favorite charities. Any charity that can open its doors to corporate volunteers has found a new entry to corporate giving.

Recruiting volunteers takes skill. Moreover, preparing an organization to receive them and keep them happy takes dedication and knowledge. Charities would not be able to operate without the help of their volunteers.

Trends for Nonprofit Charitable Organizations

Change happens at breakneck speed now. It is no different for nonprofits.

Online 24/7

Probably the internet has brought the most change to how nonprofits operate, both for delivering services and fundraising.

Online giving, although still a small part of philanthropy, has grown much faster than any other type of giving. Donors use their credit cards to make donations online, through their mobile devices, and even with social media.

Consequently, fundraising has gone online, or rather multichannel. No one way of fundraising or giving works alone. For instance, the donor who gets a mailed fundraising letter might go to the computer to make his or her donation.

Younger donors especially love online giving and respond well to appeals sent by email or social media.

Many donors use apps on their smartphones to donate small amounts of money while they live their lives. For instance, CharityMiles lets donors pick charities for a small donation when they walk, run, or cycle.

Volunteering too has become more skills-based and virtual. Volunteers can now do work right online, sign up online, check in online, and search online for just the right volunteer opportunity.

Meanwhile, social media permeate the activities of almost every charity. Social media keeps donors engaged, can be used to recognize volunteers, and to broadcast news. Moreover, social media is everywhere because of smartphones and tablets. No charity can afford to ignore it.

Corporations Turn to Nonprofits to Help With Corporate Social Responsibility

It turns out that consumers like companies that give back. Businesses have taken notice and work with nonprofits to please customers and their socially conscious employees.

Sponsorship of charitable events and cause-marketing programs have grown every year, making it nearly impossible for nonprofits and companies not to take part.

Almost any product you can think of has been used for cause marketing. Prominent examples include yogurt cartons sporting pink ribbons during Breast Cancer Awareness Month. The checkout charity campaigns that most consumers find at grocery stores and shopping malls have been particularly popular and fruitful.

This integration of business and charity will likely grow even more.

Meanwhile, social entrepreneurs take charitable activities to a new level. Social entrepreneurs develop products and services that can be sold at reasonable prices to at-risk populations, thus combining profit and social good.

New organizational structures bring nonprofit and business even closer together. These hybrid organizations include benefit corporations (B Corporations) and L3Cs (low-profit limited liability companies).

Demand for Transparency and Accountability

The public requires that charities be trustworthy and show results for the donations they receive. Most people, especially young ones, want to see the consequences of their charitable giving.

With online giving so easy, many personal fundraising campaigns have sprouted. Donors can give and raise money from friends for a particular person, group of individuals or victims of some injustice. ​Crowdfunding sites proliferate to make this possible, thus competing with the fundraising of organizations.

Charities must do more to deliver an immediate result to donors or find that many charitable donations bypass formal nonprofits and go directly to recipients.

Several watchdog organizations keep tabs on charities and set standards for efficiency, effectiveness, and transparency. The pressure on charities to make sure every dollar counts has increased.

It is an exciting time to be part of the nonprofit sector, despite its challenges and rapid change. Starting a nonprofit, working for one, volunteering, and financially supporting charitable work are all ways to make the world a better place.

Learn More About Nonprofit Organizations