Nonprofit Organizations Law and Legal Definition
Nonprofit organizations are institutions that conduct their affairs for the purpose of assisting other individuals, groups, or causes rather than garnering profits for themselves. Nonprofit groups have no shareholders; do not distribute profits in a way that benefits members, directors, or other individuals in their private capacity; and (often) receive exemption from various taxes in recognition of their contributions to bettering the general social fabric of the community.
Nonprofit groups "are as diverse as the National Football League, Harvard University, and Fannie Mae. A third of these organizations are churches," Roz Ayres-Williams wrote in Black Enterprise. "Because nonprofits cover so many fields of interest—charity, religion, health, science, literature, wildlife protection, the arts, even sports—it's easy to find a niche, whatever your calling."
Nonprofit organizations are far more important to the overall U.S. economy than is generally recognized. Indeed, some sources indicate that the sum total of nonprofit groups comprise a third sector of the American economy, along with the private (business) and public (government) sectors. According to a report published by the National Center for Charitable Statistics there were just shy of 1.4 million nonprofit organizations active in the U.S. in 2004, 59 percent were public charities, and 41 percent private foundations.
TYPES OF NONPROFIT ORGANIZATIONS
A wide range of charitable and other institutions are classified as nonprofit organizations under the Internal Revenue Code. Many of these qualify under the definition provided in Section 501(c)(3) of the Code, which stipulates that all of the following qualify for tax-exempt status: "Corporations, and any community chest, fund or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes, to foster certain national or international amateur sports competition, or for the prevention of cruelty to children or animals," provided that the institutions adhere to basic standards of behavior and requirements of net earnings allocation.
Charitable institutions comprise the bulk of America's nonprofit organizations. These include a wide variety of institutions involved in the realms of poverty assistance (soup kitchens, counseling centers, homeless shelters, etc.); religion (churches and their ancillary possessions, such as cemeteries, radio stations, etc.); science (independent research institutions, universities); health (hospitals, clinics, nursing homes, treatment centers); education (libraries, museums, schools, universities, and other institutions); promotion of social welfare; preservation of natural resources; and promotion of theatre, music, and other fine arts.
"These groups attempt to influence the legislative process and/or the political process, or otherwise champion particular positions," explained Bruce R. Hopkins in The Law of Tax-Exempt Organizations. "They may call themselves 'social welfare organizations' or perhaps 'political action committees.' Not all advocacy is lobbying and not all political activity is political campaign activity. Some of this type of program can be accomplished through a charitable organization, but that outcome is rare where advocacy is the organization's primary undertaking."
This kind of nonprofit organization includes business associations, veterans' groups, and fraternal organizations.
Country clubs, hobby and garden clubs, college and university fraternity and sorority organizations, and sports tournament organizations all can qualify as nonprofit organizations, provided that they adhere to basic guidelines of net earnings distribution, etc. Unlike other tax-exempt organizations, however, their investment income is taxable.
Hopkins pointed out that "some nonprofit organizations are deliberately organized as auxiliaries or subsidiaries of other organizations." Such organizations include cooperatives, retirement and other employee benefit funds, and title-holding companies.
Employee Benefit Funds
Some profit-sharing and retirement programs can qualify for tax-exempt status.
ADVANTAGES AND DISADVANTAGES OF INCORPORATING
All nonprofit organizations are faced with the decision of whether or not to incorporate. As Ted Nicholas noted in The Complete Guide to Nonprofit Corporations, there are many benefits associated with incorporating: "Some are the same as those commonly enjoyed by for-profit business corporations. Others are unique to the nonprofit corporation. Perhaps the greatest advantages of all—granted exclusively to organizations with bona fide nonprofit status—is exemption from taxes at federal, state, and local levels." In addition to tax exemption, Nicholas cited the following as principal advantages of forming a nonprofit corporation:
- Permission to solicit funds—Many nonprofit organizations depend on their ability to solicit funds (in the form of gifts, donations, bequests, etc.) for their very existence. Nicholas noted that whereas some states bestow a fund-raising privilege on nonprofit corporations as soon as their articles of incorporation are filed, other states require groups to fulfill additional obligations before granting permission to solicit funds.
- Low postage rates—Many nonprofit corporations are able to use the U.S. mail system at considerably lower rates than private individuals or for-profit businesses. To secure these lower rates, nonprofits must apply to the Postal Service for a permit, but this is generally not a major hurdle, provided that the nonprofit group has its affairs in order. "The importance of the mailing rate advantage is directly proportional to the volume of mail the nonprofit corporation generates in the course of its business," said Nicholas. "Membership solicitations are usually mailed third class. Nonprofit corporations that rely on membership income can use the mail even more extensively to service their members. So potential savings from a special mailing permit are considerable."
- Exemption from labor rules—Nonprofit organizations enjoy exemption from the various rules and guidelines of union collective bargaining, even if their work force is represented by a union.
- Immunity from tort liability—This advantage is not available in all states, but Nicholas observed that some states still provide nonprofit charitable organizations with immunity to tort liability. "It is important to recognize, however, that where it exists, the immunity protects only the nonprofit corporation—not the agent or employee where negligence injures someone."
In addition, nonprofit corporations enjoy certain advantages that are also bestowed on for-profit corporations. These include legal life (nonprofit corporations are guaranteed the same rights and powers of individuals), limited personal liability, continued existence beyond the involvement of original founders, increased public recognition, readily available information on operations, ability to establish employee benefits programs, and flexibility in financial recordkeeping.
But there are also certain disadvantages associated with incorporating. Nicholas cited the following as principal drawbacks:
- Costs associated with incorporation—Although these costs are usually not too excessive, especially for organizations of any size, incorporation does generally involve some extra costs.
- Additional bureaucracy—"An unincorporated nonprofit organization can be structured so informally that its operators could keep whatever records they chose on the backs of envelopes or as scribbled notes on paper napkins," said Nicholas. "Not so in a nonprofit corporation. As a legal entity, the corporation is subject to some specific recordkeeping obligations set down by the state in which it is incorporated." In addition, there are certain activity guidelines to which incorporated organizations must adhere.
- Sacrifice of personal control—Depending on where incorporation takes place, the organization may have to appoint a board of directors to oversee operations (although founders of nonprofit groups can often exercise considerable control in influencing the composition of the board and the flavor of corporate bylaws and articles of incorporation). Founders and directors of unincorporated groups are under no such obligation.
"Generally, the advantages far outweigh the disadvantages," summarized Hopkins. "The disadvantages stem from the fact that incorporation entails an affirmative act of the state government: It 'charters' the entity. In exchange for the grant of corporate status, the state usually expects certain forms of compliance by the organization, such as adherence to rules of operation, an initial filing fee, annual reports, and annual fees. However, these costs are frequently nominal and the reporting requirements are usually not extensive."
ORGANIZING A NONPROFIT ORGANIZATION
"Being enthusiastic, imaginative, and creative about establishing a nonprofit organization is one thing," observed Hopkins. "Actually forming the entity and making it operational is another. For better or worse, the exercise is much like establishing one's own business. It is a big and important undertaking, and it should be done carefully and properly. The label 'nonprofit' does not mean 'no planning.' Forming a nonprofit organization is as serious as starting up a new company." He recommended that individuals interested in forming a nonprofit organization begin by determining the organization's main purpose and functions. The next step involves choosing a category of tax-exempt status to match its functions. From there, would-be founders need to study a wide range of issues, many of which are also basic considerations for small business owners and other individuals involved in for-profit endeavors. Often, the counsel of a good attorney and/or accountant can be valuable at this stage. Primary actions include the following:
- Decide what legal form the organization will take (public charity or private foundation, incorporated or unincorporated, etc.)
- If incorporating, take necessary legal steps to make that decision a reality (devise bylaws, submit articles of incorporation, etc.)
- Investigate options and decide on principal organization programs and emphases
- Determine the leadership of the organization (directors, officers, primary staff positions)
- Define compensation for such positions
- Find a physical location for the organization (factors here can range from variations in state law to availability of reasonable office space)
- Put together a strategic plan for achieving organization goals at both community and larger levels
- Decide how to go about funding those goals (gifts, grants, unrelated income, etc.?)
- Determine which media avenues will be best for publicizing the organization's goals and securing volunteers
- Devise an ongoing business plan that 1) serves as a blueprint for institution goals and development, and 2) can be periodically reviewed and adjusted as appropriate.
Nonprofit institutions can turn to several different methodologies to raise funds designed to support their mission. This is especially true for nonprofits that have tax-exempt status, because it permits donors to deduct their gifts from their own personal income tax liability. Major avenues of fundraising used by nonprofit organizations include the following: fundraising events (dinners, dances, charity auctions, etc.); direct mail solicitation; foundation grant solicitation; in-person solicitation (door-to-door canvassing, etc.); telemarketing; and planned giving (this includes bequests, which are given to the organization after the donor's death, and gifts made during the donor's lifetime through trusts or other agreements).
Effective Solicitation and Revenue Management
In order to prosper, nonprofit institutions not only need to know where the sources of funding are, they also need to know how to solicit those funds and how to effectively manage that revenue when it comes into their possession.
Certainly, solicitation of donors (whether they take the form of individuals, corporations, or foundations) is a vital component of many organizations' operations. After all, most activities can only be executed with funding. But many nonprofit institutions are not accomplished in this area, either because they do not allocate adequate resources or because of problems with execution. Writing in Fund Raising Management, Robert Hartsook listed the following as common solicitation errors that nonprofit groups make:
- Not listening to donor expectations
- Unwarranted assumption of a donor's willingness to contribute
- Lack of follow-up after initial contact
- Inadequate research on potential donors and their ability to contribute
- Inability to close presentation with donor commitment
- Neglecting to establish rapport with potential donors prior to solicitation
- Framing solicitation as "begging" rather than as a reasonable request for help with a worthy cause
- Neglecting to tailor solicitation to individual donors
- Approaching potential donors without knowledge of how donations impact them in the realms of tax deductions, etc.
Of course, even the most effective solicitation campaigns will wither if the organization proves unable to allocate its financial and other resources wisely. Fundraising begins by determining exactly what financial and human resources are needed to accomplish the organization's mission. In the short run, fundraising may be successful based on the organization's vision and the promises it makes to help its clients and community. In the longer run, contributors will want to see results. Performance is what counts. Indeed, an organization may be devoted to addressing a perfectly worthwhile cause, and its membership may be enthusiastic and dedicated, but most nonprofit organizations—and especially charitable ones—rely on funds from outside sources. And poorly run nonprofits will find that their revenue streams will dry up quickly if they do not leverage their funds wisely.
TRENDS IN THE NONPROFIT WORLD
Observers have pointed to several trends in the nonprofit community that are expected to continue or develop in the next few years. These range from changes in fund-raising targets to expanded competition between nonprofit organizations to regulatory developments. The following is a listing of some issues that nonprofit organizations will be tracking in the coming years:
- Increased emphasis on retaining donors—According to Robert F. Hartsook of Fund Raising Management, "Non-profit organizations will focus on the renewal of donors rather than on the acquisition of new ones. As our country's population growth begins to plateau, it will be necessary for non-profits to more keenly target their marketing efforts."
- Corporate giving—Corporate giving to philanthropic causes has emerged as a major marketing tool for corporations in recent years, and this source of funds is expected to assume even greater importance as federal and state governments pare back their spending on various social programs.
- Increased reliance on volunteerism—Reduced government expenditures on social programs is also expected to spur increased demand for volunteers who can meet the expected growth in organization activity. This need will be especially acute for nonprofit organizations primarily involved in charitable activities.
- Competition with for-profit enterprises—Many analysts believe that this issue could have tremendous implications for nonprofit organizations in the future. Spurred by representatives of the for-profit small business community, regulatory agencies have undertaken more extensive reviews of ways in which some activities of tax-exempt groups allegedly damage the fortunes of for-profit businesses (who, of course, are subject to local, state, and federal taxes). Much of the controversy in this area centers around the definition and treatment of unrelated business income (income generated by tax-exempt organizations from ventures that are unrelated to their primary mission). "There is a potential that all of this will lead to nothing," wrote Hopkins, "or it could bring an in-depth inquiry into the federal and state law distinctions between for-profit and non-profit organizations, the rationale for the tax exemption of certain types of nonprofit organizations, and whether some existing tax exemptions are outmoded and some new forms of tax exemption are required."
- Continued emphasis on planned giving—"Nonprofit organizations will enjoy a significant increase in realized bequests," said Hartsook. "This will happen as a result of planned giving programs put in place 10 to 15 years ago. With the evidence at hand of how successful planned giving can be, many institutions will increase their dependence on this methodology."
- Continued dominance of women in the nonprofit community—According to Fund Raising Management, women occupied approximately two-thirds of all staff positions in nonprofit organizations in the mid-1990s, a percentage that may increase in the coming years.
- Increase in government regulation among nonprofits—Government oversight of fundraising activities may continue to increase at both the state and federal levels, at least in part because of the solicitation practices of some "fringe philanthropic groups," said Hartsook. "Unfortunately, telemarketing for nonprofit organizations has received a bad name because of fringe philanthropic organizations that solicit and collect large sums of money—while dedicating most of those funds to the costs of fund raising and salaries." According to Hopkins, this increase in government regulation may be especially evident at the state level: "States that have formerly foregone the desire for a fund-raising law have suddenly decided that their citizens now need one. States with fund-raising regulation laws are making them tougher. Those who administer these laws—the state regulators—are applying them with new vigor."
- Growth in self-regulation within the nonprofit community—Self-regulation within various sectors of nonprofit operation underwent a noticeable increase in the late 1980s and early 1990s, and this trend is expected to continue with the introduction of new certification systems, codes of ethics, and watchdog groups.
- Major donors will maximize benefits from contributions—According to Hartsook, major donors will increasingly incorporate aspects of planned giving into their philanthropic efforts in order to maximize their tax deductions. "Significant gift giving will incorporate an aspect of planned gifts in order to afford the donor maximum tax deductions," he stated. "As the level of tax recognition diminishes, major donors will turn to this methodology in order to maximize tax advantages."
Ayres-Williams, Roz. "The Changing Face of Nonprofits." Black Enterprise. May 1998.
Bray, Ilona M. Effective Fundraising For Nonprofits: Real World Strategies That Work. Nolo, March 2005.
Drucker, Peter F. Managing the Non-profit Organization: Principles and Practices. Harper Business, 1990.
Hartsook, Robert F. "Predictions for 1997." Fund Raising Management. January 1997.
Hartsook, Robert F. "Top Ten Solicitation Mistakes." Fund Raising Management. March 1997.
Hopkins, Bruce R. The Law of Tax-Exempt Organizations. Eighth Edition. John Wiley & Sons, 2003
Hopkins, Bruce R. A Legal Guide to Starting and Managing a Nonprofit Organization. Second Edition. John Wiley & Sons, 1993.
Mancuso, Anthony. How to Form a Nonprofit Corporation. Seventh Edition. Nolo, July 2005.
Nicholas, Ted. The Complete Guide to Nonprofit Corporations. Enterprise Dearborn, 1993.
Schoenhals, G. Roger. On My Way in Planned Giving. Planned Giving Today, 1995.
"U.S. and State Profiles." National Center For Charitable Statistics. Available from http://nccsdataweb.urban.org/PubApps/profileStateList.htm. Retrieved on 2 May 2006.
Warwick, Mal. "Outsider-In Marketing: A New Way to Look at Marketing for Nonprofits." Nonprofit World. 1997.
Hillstrom, Northern Lights
updated by Magee, ECDI
Legal Definition list
- Nonprofit Organization [Patents]
- Nonprofit Municipal University [Education]
- Nonprofit Institution [Education]
- Nonprofit Food Establishment [Food and Drugs]
- Nonprofit Entity
- Nonprofit Organizations
- Nonprofit Organizations and Human Resources Management
- Nonprofit Organizations and Taxes
- Nonprofit School Food Service
- Nonproprietary ATM
- Nonprovable Debt
Related Legal Terms
- 527 Organizations
- Central Nonprofit Agency
- Charitable or Nonprofit Activity (Gaming Law)
- Charitable Organizations
- Collegiate Entrepreneurial Organizations
- Community-Based Nonprofit Housing Developer [Banks & Banking]
- Cooperative Hospital Service Organizations
- Cooperative Service Organizations of Operating Educational Organizations
- Disaster Organizations
- Establishment of a Facility for a Public or Nonprofit Community Rehabilitation Program [Education]