As I pointed out in my previous blog entry, non-profit does not mean no-profit. Nor does it mean unprofitable. In this discussion, I am focusing on the kind of non-profit entity that is also known as a charitable organization.
Why is there a concept of a non-profit organization? It’s all about taxes. A non-profit organization is tax exempt under Internal Revenue Code. Specifically:
To be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual.
The IRS.gov website goes further to say that such an organization must not be organized or operated for the benefit of private interests, and none of the organization’s net earnings (viz., profits) may “inure to the benefit of any private shareholder or individual.” Coming from the opposite direction, the point of a for-profit organization is to generate, through its profits, benefits for individuals or shareholders, such as those who own stock in the company. A for-profit sole proprietorship benefits the owner, if the business generates a profit. A publicly traded for-profit company does what it does to generate more profits – or at least the promise of more profits – so that the stock becomes more valuable for the shareholders; they become richer by having the opportunity to sell the stock at a higher price than that at which they bought it.
What difference does it make knowing for whom or for what a profit benefits? Non-profit organizations do not have to pay taxes on their profits, but for-profit companies do.
Non-profit companies can also leverage a key advantage the tax code affords – donors may donate to the non-profit company and can take a tax deduction for some or all of their donation. The donations a non-profit organization receives is a critical source of income. I’ll discuss why donations are so important in another post.