These organizations move between 5% and 6% of the gross domestic product (GDP) in the U.S.A. and there are more than 1.3 million entities, according to the National Council of Nonprofits and they are the instrument through which people with common ideals transform hopes into actions. Let's talk in this post about non-profit organizations in the U.S.A.
What are they? Duties or formalities, exemptions or benefits and some particularities at the accounting level.
What is a nonprofit organization in the U.S.A.?
A nonprofit organization in the United States is known as a Non-Profit Organization or NPO; sometimes, they are also called not-for-profit organization or non-business entity for any non-commercial entity; or simply "Nonprofit".
Although there are slight differences between an NPO and a not-for-profit organization or NFPO, that we will talk about later.
A non-profit is a legally organized entity that operates for a specific community or public, with a fundamental purpose, usually of a collective or social order; it is different from a for-profit entity, which purpose is to generate profits for its owners and shareholders.
In short, they are a legally formed organization which mission is focused on advancing a social cause or a shared goal or mission.
A common characteristic of all non-profits is that they are subject to a " non-distribution restriction" of their net income for purposes other than their stated purpose.
That is, when the income of the organization exceeds its expenses, said surplus or net result must be committed to the ultimate purpose or goal of the non-profit and not be used in initiatives, or for personal profit or purposes.
Under this fundamental premise of promoting a social cause or public benefit, the Internal Revenue Service (IRS) of the United States grants most nonprofits certain tax exemptions or benefits.
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What types of Non-Profits are there?
According to the tax code, specifically IRS code 501(c) there are two fundamental types of non-profits: non-profit organizations (NPOs) and not-for-profit organizations (NFPO).
When we talk about a non-profit organization, by default we might think of a NPO, since these serve a purpose to an open public or community, while a NFPO can serve a more closed group or only its members, rather than society at large.
Investopedia.com tells us that "a sports club" is a typical example of a NFPO.
IRS code 501(c) governs both NPOs and NFPOs and it establishes their differences.
In addition to this basic classification, the U.S. Congress has created nearly thirty types of nonprofits and entities exempt from federal income taxes, according to the section of the tax code that allows them to operate.
They cover a wide range of non-commercial entities and the most common are: social welfare organizations, homeowners' associations, trade unions, chambers of commerce, child care organizations and even religious organizations.
Here are some:
- 501(c)(1): Federal credit unions and other organizations enacted by Congress which contributions are intended solely for public purposes.
- 501(c)(2): Entities that transfer their revenue to a parent organization.
- 501(c)(3): NPOs and foundations: these include religious, scientific, charitable, or literary organizations.
Foundations, in particular, fund other non-profits, sponsor events and raise awareness of some social cause, are required to donate a portion of their revenue to maintain their foundation status.
Other types of non-profits
The list does not end there, among other types of non-profit organizations in the U.S.A, there are:
- 501 (c) (4): Civic Leagues, Social Welfare Organizations or Associations of Local Employees.
- 501 (c) (5): Organizations within the agricultural sector.
- 501 (c) (6): Professional associations, chambers of commerce, real estate boards.
- 501 (c) (7): Some NFPOs, such as social clubs or groups with a recreational-sports nature.
- 501 (c) (8): Fraternal societies, mostly for security and health purposes.
- 501 (c) (9): Association of Beneficiary Employees as self-managed health funds.
- 501 (c) (10): Domestic fraternal societies and associations
The list under the 501 (c) denomination extends to another 17 categories, up to 501 (c) (27); and it is complemented by the classification 501 (d) - Religious and apostolic associations; and it ends with 501 (e) for cooperative and hospital services organizations.
Any of these non-profit designations could be exempt from paying federal income taxes and for this, each type has its own eligibility, lobbying, donations and contributions criteria that qualify as deductibles.
IRS Publication 557 provides detailed information on the specific rules and regulations applicable to each nonprofit designation.
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What are the benefits of a Non-Profit Organization?
The NPO designation, or such legal conformation, does not necessarily lead to a tax-exempt status.
A nonprofit organization, either incorporated or not, can decide whether or not to apply for tax-exempt status before the IRS and at the state level.
However, classification within section 501(c)(3) of the Internal Revenue Code can lead to several benefits, including:
- Exemption from the payment of federal income taxes, as long as the revenue is generated by activities related to its fundamental purpose.
- Possible exemptions from income, sales, property and employment state taxes, depending on the applicable state legislation.
- Exemption from federal unemployment tax.
- Tax-deductible contributions.
- Reduced mailing rates.
- Tax-exempt financing.
In addition, the nonprofit itself may not have to pay taxes on donations received or on funds raised via charitable activities.
In order to encourage its members and the community at large, donations made to a non-profit organization are typically tax deductible for both individuals and the companies that make them.
Some duties of non-profits
We mentioned before that conformation, legal or corporate status as non-profit does not confer the status of exemption from federal income tax.
To be tax-exempt, the IRS requires nonprofit organizations to apply for exemption recognition to obtain a letter of resolution or determination recognizing such tax-exempt status under section 501(c)(3), or the section applicable for its fundamental purpose.
The IRS establishes by rule that to in order to enjoy such an exemption, the NPO must file the application within 27 months of its creation.
Another formality or duty of non-profits is to submit Form 990 or its variants (Form 990-EZ, Form 990-N, or Form 990-PF) to the IRS, including its attachments, and post it in a conspicuous place.
Although most non-profits, due to their size and purpose, employ voluntary labor, if they require payroll and/or managerial staff, they must comply with all HR formalities, pay taxes on payroll, Medicare and other SS contributions.
And obviously, comply with state and federal workplace safety and health rules as for-profit organizations do.
Recommended reading: List of documents needed to file your taxes.
Some basic accounting considerations for Non-Profits
Under the fundamental premise that a non-profit organization has no interest in generating profits for its members or owners, and instead it addresses a social need, there is an entire accounting sub-system for them.
Nonprofit accounting is a set of methods and principles for financial management, record keeping and reporting that is used exclusively by all non-profit categories.
In 2016, the Financial Accounting Standards Board (FASB) issued the Accounting Standards Update (ASU) No. 2016-14, specifically for Non-Profits.
Some of the basic accounting considerations for Non-Profits are:
- They have no owners or property interests, therefore the "equity" gives way to "net asset".
- The basic accounting equation Asset – Liability = Equity, is rewritten as: Asset – Liability = Net Asset.
- Instead of the balance sheet, they will generate a "statement of financial position" that describes their assets and debts.
- They receive contributions or donations from third parties who do not expect a refund.
- They have a purpose other than making a profit, so the "income statement" leads to the "statement of activities", with details of the revenues and expenses associated with or not linked to their fundamental purpose.
- They will be able to report a cash flow statement just as a for-profit entity.
Non-Profit Organization in the U.S.A. – To Recap
As we can see, the subsystem that moves non-profit organizations is wide and varied.
From their formation, to their tax benefits and accounting treatment, Non-Profits receive a particular treatment.
The lack of formality in non-profits, especially the smaller or newly formed ones, leaves them in the shadows along with their contributions to society.
Although the bulk of the sector is formed by the smallest, their combined impact can be felt.
Forming, incorporating and managing a non-profit organization is no easy task. If this is your case, in GBS Group we have a wide range of tools, methodologies and professionals to support you.