Article: XX

Library Home

Getting Started

Planning

Library Index

Policies | Site Map | Guarantee | FAQs | Contact Us

Need More Help?

Find out more about our unique educational program!

Ask Our Experts

Ask a question today!

Blog | Courses | eBooks

Home Courses
Ebooks Resources
About LaunchX

Is Nonprofit Status the Right Decision for Your Venture?

As social entrepreneurs begin developing business ideas, there is often some confusion as to whether they should go with a for-profit venture or nonprofit status. The right choice depends on the type of product or service you plan to provide, the target market you will be serving, and several other logistical issues. It is essential to understand exactly what "nonprofit status" means...and what it doesn't mean.

Nonprofit Status is a State Law Concept

If your business qualifies for this status in your state, it may also make the organization eligible for other specific benefits, such as exemptions from sales tax, property tax, and income tax. Registering as a nonprofit organization at the state level does not automatically grant the venture federal income tax exemption, however. The IRS has its own requirements for an organization to qualify for tax-exemption, typically more stringent than state laws.

Federal Tax Exemption

Federal tax exemption means the organization is exempt from federal taxes, but only on income from activities that are "substantially related" to the stated purpose of the nonprofit. That is, if a nonprofit has income from unrelated business (such as a dog rescue group running a coffee stand), that income will be subject to regular corporate federal taxes. Therefore, if your business idea isn't directly (and substantially) related to the cause you want to help, you are likely just as well off to organize as an LLC and make hefty contributions to a separate nonprofit. Remember, LLCs are not subject to federal income tax on profits, either.

Personal Income Taxes

The other factor that is often misunderstood is that any money you personally take home is subject to the same federal income tax -- at the self-employment rate if the organization does not pay it as salary. That is, if you receive a salary from either a for-profit or nonprofit organization, you and the organization will pay the usual share of federal income tax on those amounts, just as with a regular job.

Any profits you take from an LLC, or untaxed payments you receive from a nonprofit, are subject to the self-employment tax rate on your personal income taxes. The self-employment rate is basically your share and the employer's share together, at a total of 15.3% of the earnings. The point here is that nonprofit status does not exempt you from federal taxes, just the profits of the business. Again, the same outcome can be achieved by registering a for-profit business as an LLC.

If you are in a state with income tax, keep in mind that obtaining exemption for your nonprofit from those taxes may well require a separate application. That is, the IRS exemption does not necessarily extend to protecting your nonprofit from state level income taxes on earnings, related to your purpose or otherwise.

Why Tax Exemptions are Granted

The reason the IRS (and the states, for that matter) allows exemption from taxes on related income for nonprofits is to encourage philanthropy in the areas and issues not handled effectively by the government and private industry. The theory is that exempting organizations that are working to improve society's ills allows them to commit 100% of their resources toward their actual mission -- thus the government is technically doing its part to help. They are not intended for individuals to profit, in fact the entire body of nonprofit regulations are built around the idea that no single person can be enriched at the hands of a nonprofit organization. The laws are quite well-developed, and the few loopholes available to shield ineligible profits from federal taxes are under heavy scrutiny.

Bottom Line

The bottom line regarding nonprofit status is that it should only be pursued for organizations whose primary purpose is within the federally approved definition of exempt organizations. If you are looking to improve your own lot in life AND give back to society, your best bet is to organize as an LLC and donate a portion of profits to a separate nonprofit organization.

About the Author

LaunchX.com is dedicated to training entrepreneurs to turn their good ideas into great companies. The LaunchX System provides step-by-step education in the mindset and skill set entrepreneurs need to succeed. Our program includes intensive seminar training, key business software, and specialized workbooks that teach you the fundamental skills you need to achieve your financial and worklife goals through entrepreneurship. Register today for our introductory course and see what LaunchX can do for you!