Nonprofit, Not-for-Profit. How can two terms be so similar and yet be so different?
It’s easy to see or hear nonprofit and not-for-profit and assume they’re talking about the same thing. The concepts are fundamentally similar but differ in the minute details, which can confuse even the savviest of business readers and leaders.
Let us try to clear things up a bit by highlighting the similarities and both the distinct and subtle differences between nonprofits and not-for-profits. From business structures and tax implications to corporate governance, revenue distribution, and employee vs. volunteer classifications, each organization functions just a little differently.
If you’re looking to start a new operation or change direction with a current one, it’s essential to understand the nuanced differences between nonprofit and not-for-profit.
Nonprofit organizations are quite common in the U.S., with an estimated 1.5 million registered according to the Internal Revenue Service (IRS). Nonprofits provide charity or serve the public need through private fundraising and donations, as well as membership sales and grants. Organizations like hospitals, universities, and charity organizations often operate under the nonprofit structure all work to serve the greater good.
One distinctive feature of nonprofits is that any money collected from fundraising activities must go directly back to the organization's operational goals. These funds cannot be distributed to a particular individual or a select group.
Most people mistakenly believe nonprofits rely exclusively on an army of volunteers to keep the organization operational. While many do rely on volunteers to stay afloat, nonprofits are permitted to hire employees if the budget permits. Like employees in other industries, both part-time and full-time employees are subject to paying taxes, and the nonprofit is still required to remit payroll taxes.
However, it’s important to note that any salaries or compensation paid to part-time or full-time employees must not be funded by monies acquired through fundraising, and they must still remit payroll tax. The confluence of the rules and requirements around paying employees can make accounting and tax reporting quite challenging.
At the same time, the burden of tax compliance does come with some IRS-related benefits for nonprofits. Because nonprofits do not operate simply to generate revenue like for-profit businesses, they are given a financial incentive under the US tax code as a tax-exempt entity. As a result, they pay no income tax and often avoid property taxes if they operate from a physical location as well, on funds raised for the organization’s mission and purpose. Likewise, donors can deduct donations to the organization when they file their annual tax return as a charitable contribution to a 501(c)(3) charity.
Yet because of the complex tax picture, nonprofits must be more transparent in their financial reporting and be made publicly available to remain in good standing. Depending on the size of the organization, these details and nuances can be a daunting task for a cash-strapped operation that still relies heavily on manual accounting and tax management practices.
Then what does Not-for-profit mean?
On the other side of the nonprofit coin is the not-for-profit designation. Rather than serving the public good instead, not-for-profits serve the goals and interests of the private organization or the owner of the organization.
This can be an exclusive or selected cohort of members or causes, rather than a public service. Similar to nonprofits, any revenue and net profits must still be used to support the mission of the organization. Not-for-profits usually have volunteers that run the organization, but they can also hire employees to run the organization in pursuit of its goals.
Not-for-profit organizations often include recreational, sports, or women’s clubs, and include members who share a common goal, regardless of their contributions to the greater community. These organizations typically derive their income from running product or service sales or from private donations.
Because not-for-profits provide neither public services nor charity functions, they are not inherently tax-exempt under the US tax code and do not qualify for 501(c)(3). However, they can still be tax-exempt which includes avoiding sales and property taxes. Donations that come into the organization from individuals are also not tax-deductible on their tax returns and cannot be deducted as a charitable contribution.
Like nonprofits, not-for-profits also need personpower to keep the organization on track. Most positions in a not-for-profit organization are W-2 employed and can be paid from the organization's funds, but must still submit payroll taxes on behalf of the employees.
Final points to consider.
It’s become commonplace to use nonprofit and not-for-profit interchangeably. It’s completely understandable, as both:
Operate without earning profit
Still must remit payroll taxes
Must reinvest all monies back into the operation of the organization
Can be staffed/operated by volunteers, employees, or both.
The essential difference between the two lay in their missions. Not-for-profits do not necessarily provide a charity nor a public service but exist only to serve the organization's goals. Nonprofits can apply for 501(c)(3) designation which gives them many tax advantages over not-for-profits, whereas not-for-profits cannot, even though both can have certain tax-exempt benefits. Another key difference is the goal of earning profits or revenue. For nonprofits, the revenue is used towards the services of the organization and community and not to the benefit of a particular individual, while not-for-profits do not operate for the goal of revenue, but rather use funds to support their members and the organization as a whole as part of the mission. Transparency is much clearer with nonprofits, whereas not-for-profits operate more closely to for-profit entities, minus the distribution of profit to individuals.
Lastly, and probably the biggest and most consequential difference between the two is the tax implications. Both can be quite cumbersome and without streamlined tools to track how employees are paid, who is a volunteer, and where expenses are going, keeping compliant with the IRS requires more time, effort, and resources than most nonprofits are able to set aside.
Having a centralized and digital database of either type of organization’s business operations and the status of both employees and volunteers, and knowing tax-exempt vs non-exempt activities is critical in avoiding costly paper and manual entries or worse, fines for non-compliance come tax or reporting time.
Subtle differences can make a big impact.
On the surface, using nonprofit and not-for-profit interchangeably doesn’t seem like a big deal to the average person. But as an organizational leader, understanding the subtle differences between the two org structures can be the difference between a low-stress life spent serving your mission or constituents and having to spend time, money, and energy correcting tax-related documentation and reporting because you’d been operating under the wrong structure.
Contact a SyncHR tax management expert today to see how an integrated, purpose-built human capital management (HCM) platform can help simplify your tax and organization management activities — whether you’re running a nonprofit or not-for-profit team.