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For Profit versus Non-Profit

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Is there a reason for the existence of non-profit organizations? Yes!

They augment and, in many cases, replace the role of government by responding to society’s problems, and in some cases preventing society’s problems. Many non-profit organizations are in the field of human social services, performing a service for the social good, and so the government offer benefits in returns.

If you are thinking about becoming a non profit corporation, enjoying tax exempt status let’s look at the advantages and disadvantages.

But first, .......... what is a corporation?

There are two types of corporations. The for profit is intended for the benefit of its owners. The non profit is intended to further a purpose. Both are legal entities, formed for business activities. The corporation acts as a separate “person” and makes the contracts, pays the taxes, incurs the debt and protects the individuals involved from being personally liable for the consequences of business activity. Now you are personally hidden behind the corporate veil. If you get into trouble, financially, it’s the corporation that is liable and your personal assets cannot be touched.

Advantage number 1: limited liability..........and this applies to all corporations, profit and nonprofit.

Advantage number 2: tax exemption In 1924, the United States supreme court decided that for the purposes of tax exempt status, the destination of the funds, rather than the source, was the key determinant. So if the funds you received were used (again) for the good of society, you could be exempted. If you qualify as a 501(c)3, this eliminates your federal and state income taxes, sales and use tax. Many non profits do not pay property taxes on real estate they own. Again you have to apply for, and be granted property tax exemption.

Advantage number 3: grants As a non profit, you are eligible for both private and government grants.

Advantage number 4: lower costs The postal service offers special rates for non-profits. However, only agricultural, educational, fraternal, labor, philanthropic, religious, scientific, veterans and some political non-profit organizations are eligible. Also there is a $150 annual fee. In addition, every mailing must consist of 200 envelopes and first class mail is excluded. Most newspapers, magazines, radio stations and other media give discounted rates to non profits. Some allow public service announcements free. Food stamps and the food bank are also available for non profits.

Advantage number 5: deductibility of contributions This applies only if you’re a 501(c)3 status. Any contributions made to you if you have that status allows your contributors to deduct their contribution from their taxes. The other 501’s classifications don’t. What makes this interesting, is that you can put a professional on your board, i.e., an accountant or attorney and they can deduct their work on your behalf on their taxes. Local businesses, (such as restaurants that have made deals with you for discounted meals, charity minded local groups that aid in the form of paying for insurances, gasoline, and other expense items and caterers that stipulate any leftover food from a job goes to your board and care) can use these as a charitable contribution on their tax return. Everyone gains.

Advantage number 6: the so called “halo effect” The public is more willing to offer money or time or do business with a nonprofit because of a real or perceived view that your organization is founded and operated in the public interest. You’re doing something for the public good, and so will they by supporting you.

Advantage number 7: zoning freedom Certain types of non profit organizations can go into any neighborhood without concern about the zoning requirements. Most for-profit organizations have to apply for approval or a variance, or fight the neighbors who don’t want their clients in the neighborhood.

There are disadvantages

Disadvantage number 1: loss of control The non profit organization is not “owned” by its founders. Unlike a private business that can be sold after it has grown big and profitable, a nonprofit organization “belongs” to the public at large. If it dissolves, its assets must be given to another nonprofit organization with a purpose similar to yours. If its assets are misapplied or used for private benefit by the officers, they can be seized.

As a non profit, you have no “bottom line”. The basic principle at work here is that a for profit is intended to benefit its owners, whereas a non profit is intended to further a purpose. So you will be working under a structure that you may or may not like! You’ll get a salary, and operate with a board of directors (A minimum of 3 are required in Tennessee, but they don’t have to be residents), but there’s a general legal doctrine that prohibits non-profits from acting in a manner that results in “private inurement” to individuals.

So if you’re going to put a lot of time, money and effort into a business, are you willing to settle for a reasonable salary? This is a very key question, you have to answer.

As a nonprofit, you would become an officer of the corporation, you would have a board of directors whose responsibility it is to ensure excellent, or at least adequate, management of the organization. They would help you set policy and together you would carry it out. You would also be working for a salary that the corporation would pay you. The board can fire you. These factors, a board and a salary might make you think.....hey!.... I’m not in control! But, that can be looked upon another way. The board and you will set the salary in accordance with what your particular numbers allow,..... and there is strength in collegial decision making. Members of a board bring different experience and talents, and they can bring services that would not otherwise be available. You stop operating in a vacuum, carrying every decision on your own.

Disadvantage number 2: paperwork, paperwork, paperwork Even in the smallest non-profit corporation, the paperwork load related to corporate status can at times be overwhelming if you’re doing it yourself. If you can find an accountant or volunteer board member who will perform that task, so much the better. There are deadlines for virtually every filing. Keeping ahead of the paperwork wave requires discipline, commitment and a sense of humor. It does eventually become routine though.

Federal law provides that nonprofit corporations pay federal taxes on unrelated business income. Corporations with at least $1,000 of such income are required to file a 990-T annually. Income is defined as ‘unrelated” if it is derived from a trade or business, is regularly carried on, and is substantially unrelated to the exempt purpose of the corporation. Income clearly exempt from UBIT (Unrelated Business Income Tax) includes that generated from activities performed by volunteers, from selling merchandise received as gifts or contributions, and dividends, interest, royalties, and capital gains. Income from business operations conducted for the “convenience” of an organization’s members, students, patients, and staff, such as a hospital cafeteria or college bookstore is exempt.

Disadvantage number 3: limited purposes You can only perform certain functions listed under the law. You may be forbidden from contributing to political campaigns and may only do a limited amount of lobbying.

Disadvantage number 4: public scrutiny Because your organization is dedicated to the public, your finances are open to public inspection. This means that the public can obtain copies of your tax returns and can learn about your salaries and other expenditures.

Disadvantage number 5: continual challenges There seems to be a constant challenge to the non profit status, whether it’s over tax exempt property, the sale of goods and services that compete with the for profit sector, or for profits moving in on your territory.

Among the differences between nonprofit charitable organizations and for-profits are the following:

1. A nonprofit is driven by its service mission philosophy rather than by the profit motive.
2. A nonprofit serves those who cannot afford to pay full costs.
3. Excess revenue over expenses is used to further the organization’s exempt purpose.
4. A nonprofit likely will remain in the community even if it suffers financial losses.
5. A nonprofit is more accountable to its board for public than for-profit organizations.
6. A nonprofit looks for ways to respond to community needs without regard to profit.
7. A nonprofit may not compensate its employees higher than reasonable” rates.
8. A nonprofit’s board of is typically unpaid community leaders motivated by public service.
9. A charity attracts thousands of hours of volunteer time and philanthropic contributions.

Nonprofits should:

1. Not publicly advertise products/services to compete price-wise with the for-profit sector.
2. Refrain from entering markets not related to the mission of the organization.
3. Review their activities that could be construed as commercial, and identify all those that require the filing of a 990-T and payment of UBIT.
4. Periodically review their bylaws and tax-exempt status purposes, and update these documents to reflect changing conditions.

Note: Most of the contents of this handout were taken from a presentation made by Betty Nelson, a Greater Knoxville SCORE Chapter volunteer during June 2002.

H67 - July 2002

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