Non-Profit Vs. Not For ProfitDifferences You Need to Know Between the Two!
The terms non-profit and not-for-profit are easily confused.
However, they both refer to very different types of legal entities.
Though both of these entities contrast with for-profit organizations, these two types of organizations possess very different tax treatments, governance requirements, and purposes.
For those forming a new organization, it is crucial to understand both of these terms and their unique meanings before choosing a structure for your business.
Here is a closer look at what both of these terms mean and how they impact organizations.
- Both non-profit and not-for-profit organizations do not distribute profit to their owners.
- Non-profit organizations work to promote charitable purposes, whereas not-for-profit organizations work to fulfill a set of organizational objectives.
- Non-profits are separate legal entities that receive tax-exempt status under U.S. tax law. However, not-for-profit organizations cannot qualify as separate legal entities and are not tax-exempt.
What Are Non-Profit Organizations?
Non-profit organizations are a type of organization that exists in order to support a social cause that provides a public benefit.
As a result, the Internal Revenue Service (IRS) provides them with tax-exempt status. Common examples of non-profit organizations are hospitals and educational institutions.
Non-profit organizations can serve a wide range of functions so long as they provide a social benefit in some way.
Further, they are barred from distributing profits to anything that does not further its social cause and the organization.
Non-profit organizations generally raise money through donations and fundraising, and this income is not subject to taxation.
These financial operations are, however, subject to a considerable degree of oversight, and this information must be released publicly in order to allow its donors to ensure that it is being used appropriately.
What Are Not-for-Profit Organizations?
Just like non-profit organizations, a not-for-profit organization does not offer its owners any profits, and all revenue from operations or donations must be reinvested in the organization.
However, though not-for-profits may serve a charitable goal, they do not need to serve a cause that supports public welfare.
A not-for-profit organization can simply operate to serve the goals set by its members, such as a sports club that simply operates to provide its members with enjoyable recreation.
This structure of the organization is not intrinsically tax-exempt; however, it may apply for tax-exempt status with the IRS, including for sales and property tax.
As a result, donations made to these organizations may not be tax-exempt unless the organization receives tax-exempt status.
Non-Profit Vs. Not-for-Profit Organizations
There are a few key differences between non-profit and not-for-profit organizations.
- Non-profit organizations exist specifically to further a cause that benefits the public good, whereas not-for-profit organizations exist to further their organizational objectives regardless of their social benefits.
- Non-profit organizations are generally organized and function like a business while attempting to earn a profit that is used to further their charitable purpose. In contrast, not-for-profit organizations are generally smaller “recreational organizations” that do not aim to earn revenue.
- A non-profit organization may form a separate legal entity, unlike not-for-profits.
- Non-profit organizations may have paid employees like for-profit organizations. Not-for-profits are run by volunteers.
- Non-profit organizations receive 501(c)(3) status from the IRS, and though not-for-profits are covered by 501(c), they may receive a different classification. This is commonly 501(c)(7), which includes organizations related to social and recreational activities.
What Are For-Profit Organizations?
For-profit organizations are businesses that operate with the intent of earning money.
This includes the majority of companies that earn profits by providing their customers with goods and services.
The owner of the business earns an income off of the revenue generated by providing these products or services and may also pay investors and shareholders for their contributions as well.
Changing Legal Entities After Formation
It is possible to convert into another type of legal structure after formation.
However, the rules for doing this vary both in regulations and complexity depending on the type of organization in question.
Changing From Non-Profit to For-Profit
A non-profit organization may have several reasons for choosing to change its structure to a for-profit.
It may have better access to loans and other sources of funding as well as more freedom to act without the strict regulations governing non-profit organizations.
However, no matter the reasons, once all stakeholders are in agreement on the change, the organization will need to submit a “statement of non-profit conversion.”
This must include certain elements, including:
- The reason for the termination of non-profit status;
- A copy of the organization’s liquidation plan;
- The organization’s fair market value; and
- If assets are to be distributed, a list of all recipients.
It will also be necessary for the organization to contact state and local authorities in order to fill out any required forms for the specific jurisdiction.
Changing From For-Profit to Non-Profit
Converting a for-profit organization to a non-profit organization is often challenging as the IRS does not want to allow this move to be made in order to avert tax liability.
However, this can still be done through a process very similar to forming a non-profit organization from scratch.
The for-profit organization’s name may be retained.
However, a non-profit organization must exist for a specific purpose that provides social benefits, not to earn a profit.
In order to transition, the organization will be required to write a mission statement, create bylaws, and file articles of incorporation with the Secretary of State for the appropriate jurisdiction.
Non-profit and not-for-profit organizations are similar in many ways, particularly in that neither have the goal of earning a profit.
However, there are key differences between these two types of organizations.
Both of these structures aim to accomplish a set of goals without earning a profit, but what these aims are is a central defining characteristic of these organizations.
A non-profit organization exists to accomplish a goal that provides the public with benefits such as providing medical care or food to struggling populations.
In contrast, a not-for-profit organization may simply exist to offer its members recreational activities or entertainment.
As a result, there are significant differences in the regulations and tax treatment that apply to these structures.
How do you start a non-profit?
Whether starting a non-profit or any other type of organization, the first step will always be to file for a business entity in the state of formation.
This can be a sole proprietorship, LLC, corporation, or any other type of business entity.
Once the business entity has been formed, the next step is to apply with the IRS for an Employer Identification Number.
When filing for this tax identifier, the business owner may choose a tax-exempt status through Form 1024.
How do I choose a legal entity?
The most appropriate legal entity for an organization will depend on its founders’ goals.
If these are to earn an income for its owners and investors, then a for-profit organization is likely most suited.
However, if these goals are to offer a benefit to society, then a non-profit organization may be most suited.
There is no one size fits for every organization, but if a legal entity does not fit or if goals change down the line, it is possible to change the structure of the organization.
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