Nonprofit Versus For-Profit Organizations
When you have a great philanthropic idea, there are many things to consider about how you accomplish that goal. How you set up the legal entity is one of the critical first steps, and that includes the question of nonprofit versus for-profit organizations. The choice involves not only the legal definition of what qualifies as a nonprofit, but also what option makes the most sense for you. Each has its own benefits and drawbacks.
Keep in mind that there are many types of tax-exempt organizations. For the purposes of this article, we’re specifically talking about nonprofits that classify as public charities.
Most businesses are for-profit entities. They make money and pay taxes on that business income. This comes with more autonomy and less paperwork, but also with fewer tax benefits.
Public charities are nonprofit entities that the government has recognized as having a charitable mission. The mission in some way benefits the community, so the government chooses not to tax them on income. Since income tax dollars that are collected ultimately go back into the community, the government is basically eliminating the middle step and letting the nonprofit keep those funds to use. The drawback to being a public charity is that it comes with more rules and regulations plus reporting requirements to maintain your tax-exempt status.
When setting up your organization, there are three big questions to consider that will help you decide which option is right for you.
Do you have a charitable mission?
This is an important question, because it’s the key difference between a for-profit and nonprofit entity. If the answer is no, then your organization is clearly a for-profit business. If the answer is yes, there are a few more questions to explore. There are many different types of nonprofit organizations, and the tax benefits vary depending on the type you choose.
One thing that the government looks at is who is benefitting from your charitable mission. If the benefit is to the community as a whole, the tax benefits will be greater than if your mission benefits other businesses. For example, a business league that provides resources and education for area small businesses may qualify as a nonprofit and not have to pay taxes, but donors to that organization do not receive a tax deduction since the entity would not qualify as a public charity. It’s important to be sure you’re choosing the right non-profit classification from the beginning, as changing it later can be a costly process.
What role do you envision for your entity and family?
Even if your charitable mission qualifies to be a nonprofit public charity, it is important to take into consideration what being a nonprofit public charity means in terms of regulations and reporting. Because the government is essentially giving you money, there are strict regulations to follow about how decisions are made and how the organization operates.
Perhaps the biggest question to ask is “What role do you envision for your family in the organization?” If you intend to fill the board with family members or employ them, becoming a nonprofit public charity is not the right choice for you, as it requires that your leadership represent the public. A board or staff filled with your family members does not meet that requirement, and it creates a conflict of interest.
Also consider the reporting requirements for nonprofit public charities. The organization is held accountable for how money is used, and that means investing time, effort, and money to ensure all reporting is accurate. It also means you don’t have complete control over what happens with the funds, because you have to adhere to the requirements. If you want a higher level of control over how the organization operates, becoming a nonprofit public charity may not be the best option for you.
“If you want a higher level of control over how the organization operates, becoming a nonprofit public charity may not be the best option for you.”
Are you willing to get more complex?
If you have a charitable mission but don’t feel operating as a nonprofit is right for you, there are more complex options that a nonprofit lawyer can help you consider. For example, if you have a for-profit business with a philanthropic program, you can set up a partnership that combines a for-profit business with a singular program that is a nonprofit entity.
Taking the more complex approach does require an investment to set everything up legally, plus you need to ensure proper documentation that all benefit flows from the for-profit entity to the nonprofit side. This includes looking at where and how employees are paid and ensuring the benefits to the nonprofit entity are clearly understood. Using a partnership requires legal advice throughout the process and includes a lot of regulations and reporting requirements as well. Be prepared to spend the time and pay the legal costs involved if you choose this option.
Final thoughts
If taking a more complex approach isn’t the right fit but neither is starting a new nonprofit, you still have options. You can explore complex planned giving options or support a foundation or public charity that is already working toward the same goal. You can also start a for-profit business initially and then determine if a nonprofit is right for you at some point in the future when the purpose, time, and budget are more readily available.
Be sure to consult an attorney who specializes in nonprofit law as you create your organization or an estate planning attorney if you choose a planned giving approach. They can help ensure you are set up legally and don’t make any costly mistakes in the process.
