what is a nonprofit organization?

The role of the nonprofit organization is unique. Charitable nonprofit organizations provide essential services within our communities and fill a gap left by government and private business. Nonprofits provide direct services, research and document critical issues, give a voice to those unspoken for, and unite communities along common interests.

A nonprofit organization, upon incorporation, is a legal entity until it is dissolved. It is eligible to contract, to sue on its own behalf, and to be sued by an outside party. Income from a nonprofit organization does not belong to its members or board of directors. Thus members do not have a right to the organization's income or assets, as they could from for-profit, or private, companies.

Nonprofits require a different structure
Also referred to as the independent, or third sector, nonprofits are set apart from government and business. They are mission-focused and receive their funding from foundation grants, individual donations, government grants, and fees for services or products, rather than directly taxing recipients of services, or seeking profits from investors, producing, and distributing. Nonprofits also abide by a different structure and employ professionals and volunteers whose skills are specific to the nature of nonprofits.

Governance
A board of directors oversees the general operations of a nonprofit organization. In short, it is the board's responsibility to ensure the organization's effectiveness, manage resources, and assess its own performance. The individuals serving on a board are directly accountable for the actions of that organization and can be held financially responsible for any misdeeds of the organization.

Administration
A strong administration with management knowledge and experience is essential to running a successful nonprofit. As a nonprofit grows, it often becomes necessary to hire staff and increase administration, including the capital that supports programs. The Charities Review Council of Minnesota recommends that a charitable organization spend no more than 30 percent of its budget on administration and fundraising, leaving at least 70 percent of its funds devoted to programs (though there is no law requiring this and small and start-up organizations may have difficulty maintaining this standard). However, organizational growth requires investment in administrative functions that are unique to the nonprofit sector, such as development and fundraising, volunteer management, and public policy and advocacy.

Mission-related programs
Nonprofits are formed to fulfill a gap in the community and are driven by a focused mission. All programs should forward the organization's mission by accomplishing one more goals set by the board of directors.

Common types of tax exemptions
Nonprofits are defined primarily by their type of tax exemption status under Section 501(c) of the Internal Revenue Service tax code, exempting the organizations from federal corporate income tax requirements. (Nonprofits can also apply separately for exemption from Minnesota sales tax through the Minnesota Department of Revenue.) There are over 25 classifications for nonprofits under Section 501(c); three of the most common types of nonprofits and their IRS classifications are listed below.  

Click here to view a list of all categories of exempt organizations.

501(c)(3) Charities
Charities are exempt under Section 501(c)(3) of the tax code. This is the most numerous and best known type of nonprofit. The IRS grants this exemption status to organizations that 1) serve charitable, religious, scientific or educational purposes, and 2) ensure that no part of the income generated by the organization goes to the benefit of any one person. Donations to 501(c)(3) organizations are tax-deductible.

This category consists of many different sub-sectors, including: religious, arts, economic development, education, environment, health, housing and shelter, human services, international, public safety, recreation/sports, youth development, and community foundations.

Private foundations are also exempt under Section 501(c)(3). This type of foundation uses a single source of funding, usually from an individual, family, or business, to make investments and award grants to nonprofits. Foundations must also pay a 1-2 percent excise tax on interest and dividends on investments.

501(c)(4) Social welfare organizations
Also called advocacy organizations, these nonprofits are exempt under Section 501(c)(4) and given looser restrictions to lobby and participate in advocacy activities and political campaigns. To assure independence from business and government, donations to 501(c)(4) organizations are not tax-deductible.

501(c)(6) Professional and trade associations
This category includes organizations that support or promote the business sector, such as chambers of commerce or other industry professional associations. These nonprofits are exempt under Section 501(c)(6). Though contributions to these organizations are not tax-deductible, membership dues are deductible as professional development fees.

Other types of organization’s under Section 501(c) are fraternal societies, associations, veterans organizations, cooperative hospital service organizations, child care organizations, charitable risk pools, cemetery companies, social and recreational clubs, and more. For a complete listing of the types of tax exempt status, visit the IRS Web site at www.irs.gov

Legal requirements and non-legal administrative practice standards discussed in this section are subject to change due to new legislation, regulatory and judicial pronouncements, and evolving guidelines. This information does not constitute an engagement to provide legal, tax, or other professional services on the part of the Minnesota Council of Nonprofits or the professionals who authored and/or reviewed it. If you require professional assistance on these or other nonprofit tax or administrative issues, please contact an attorney, accountant, or other professional advisor, or the relevant government agency.

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Other resources:

Download the 2006 Minnesota Nonprofit Economy Report

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