A question we often get about nonprofits is: “Do nonprofits ever have to pay taxes on what they bring in?” It can be a confusing topic that affects many of our clients who, understandably, want to stay on the right side of the IRS and their state governments.
So in this post, we’ll take a look at how much profit can a nonprofit make before they’re required to change how they file their taxes. Hopefully, it can help answer many of your questions.
Can Nonprofits Make Money?
When most people hear the term “nonprofit”, they automatically picture a charity that doesn’t make any money (and possibly is barely squeaking by on meager donations.) But that isn’t always accurate.
Nonprofits come in all shapes and sizes (as we discussed in a recent post on “How to Make Filing Taxes for a Nonprofit Easy”). They do incredibly valuable work in their neighborhoods and around the world in areas of charity, education, science, and literacy.
Nonprofits can, and often do, make quite a bit of money. Speaker, author, and humorist Rita Davenport put it well when she said, “Money isn’t everything, but it’s right up there with oxygen.”
Money for a nonprofit, just like any other business, is actually extremely important. Everything costs money, and we don’t usually think about how important it is until we don’t have it. No individual, family, or organization (whether “for profit” or not) can exist very long without some amount of money they can live off of.
When it comes to the question of “can nonprofits make money,” the answer is a definite “yes!”
Can A 501(c)3 Make a Profit?
The idea that a nonprofit cannot make a profit simply isn’t true. In fact, the Council of Nonprofits puts it at the top of its list of myths about nonprofits.
Nonprofits have real expenses just like any ordinary business. There are salaries, utilities, and operating costs to pay. Those things don’t go away simply because you are providing a charitable service. A nonprofit that wants to keep functioning needs money.
Not only does a nonprofit want to make money in order to survive, but they also want to make more than enough so they can grow and do even more good work.
In the business world, any revenue left over after expenses is profit. The same is true when it comes to operating a nonprofit as well. So, yes, 501(c)3 organizations (as well as other categories of nonprofits) are allowed to make a profit. And as long as it comes from activities related to their stated mission and purpose, those profits are tax-exempt.
The real difference between a “for-profit” business and a “nonprofit” organization is what they’re allowed to do with those profits.
What Happens When A Nonprofit Makes a Profit?
A traditional business that makes a profit is able to distribute those earnings to its shareholders. That may take the form of payment to the owner if it is a sole proprietorship or multiple owners if it is a partnership or LLC. In the case of a corporation, profits are distributed among several shareholders. Profits are a reward for investing in the company when it performs well.
Nonprofits, however, must funnel all of their surplus funds back into the organization. Individuals are not allowed to benefit financially from the profits a nonprofit makes.
As you can imagine, there can be a lot of ways to enrich oneself by misusing charitable donations. That’s why there is quite a bit of oversight and transparency when it comes to nonprofits.
Accountability for nonprofits comes from several places:
- When donors give to a nonprofit, they expect it to be used the way they were told it would be.
- That’s one reason boards of directors are in place…to make sure no one person controls all the purse strings. And nonprofits must make financial records available to their donors/members regularly.
- Also, because the government allows nonprofits to enjoy tax-exempt benefits and has approved of the organization’s stated mission to serve its community in some way, they naturally expect that organization to manage its finances appropriately.
So when a nonprofit makes a profit, it must be used to benefit the nonprofit (and, as a result, the community they serve).
How Much Profit Can A Nonprofit Make?
The IRS basically looks at nonprofit income in two ways: related and unrelated.
Related business activities, as we mentioned earlier, are things a nonprofit does that directly correspond to its stated mission goals. For instance, if a nonprofit hosts weekly bingo games where people pay to play and uses that money to support its homeless shelter and food pantry, those events and the income they generate would be related to its primary activity.
Unrelated business activities (UBI) are a little more subjective. They occur when a nonprofit conducts business beyond the scope of its primary purpose.
Revenue generated this way may be subject to income tax (although, the first $1,000 of UBI is tax-exempt). Generally, the IRS is ok with nonprofits making money outside of their stated mission…to a point. If UBI activities grow to where they become the primary focus of the organization, a nonprofit could risk losing its tax-exempt status.
The IRS states, “An organization does not operate primarily to promote social welfare if its primary activity is carrying on a business with the general public in a manner similar to organizations operated for profit.” They go on to give the example of a nonprofit establishing a semiprofessional baseball club as a way to raise money. By doing that, baseball becomes their primary activity…not whatever social welfare activity they were established to engage in.
Let’s take our example above. If our nonprofit decides to expand “Bingo night” to 7 nights a week and then adds slot machines, blackjack tables, and a delicious “free” buffet, the IRS would reasonably question whether they were a nonprofit or a small casino.
If you’re unsure about whether or not your organization is crossing over into UBI territory, get in touch with a good CPA who can help you stay legal and protect your tax-exempt status.
Nonprofit Tax Help Is Here
Our team of accounting experts has over 40 years of experience guiding all kinds of nonprofits through their tax questions. So schedule a call today to see how we can help you as you work hard to make your community better!
