What is a “nonprofit organization”?
A nonprofit organization (NPO) , (also known as a non-business entity), is an organization with the purpose of which is something other than making a profit.
A nonprofit organization is often dedicated to furthering a particular social cause or advocating for a particular point of view. In economic terms, a nonprofit organization uses its surplus revenues to further achieve its purpose or mission, rather than distributing its surplus income to the organization’s shareholders (or equivalents) as profit or dividends.
This is known as the non-distribution constraint. The decision to adopt a nonprofit legal structure is one that will often have taxation implications, particularly where the nonprofit seeks income tax exemption, charitable status and so on.
The terms nonprofit and not-for-profit are not consistently differentiated across jurisdictions. In layman’s terms they are usually equivalent in concept, although in various jurisdictions there are accounting and legal differences.
The nonprofit landscape is highly varied, although many people have come to associate NPOs with charitable organizations. Although charities do make up an often high-profile or visible aspect of the sector, there are many other types of nonprofit organization. Overall, they tend to be either member-serving or community-serving. Member-serving organizations include mutual societies, cooperatives, trade unions, credit unions, industry associations, sports clubs, retired serviceman’s clubs and peak bodies – organizations that benefit a particular group of people, i.e. the members of the organization. Typically, community-serving organizations are focused on providing services to the community in general, either globally or locally: organizations delivering human services programs or projects, aid and development programs, medical research, education and health services, and so on. It could be argued many nonprofits sit across both camps, at least in terms of the impact they make. For example, the grassroots support group that provides a lifeline to those with a particular condition or disease could be deemed to be serving its members (by directly supporting them) and the broader community (through the provision of a service for fellow citizens).
Many NPOs use the model of a double bottom line in that furthering their cause is more important than making a profit, though both are needed to ensure the organization’s sustainability.
Although NPOs are permitted to generate surplus revenues, they must be retained by the organization for its self-preservation, expansion, or plans. NPOs have controlling members or a board of directors. Many have paid staff including management, whereas others employ unpaid volunteers and executives who work with or without compensation (occasionally nominal). In some countries, where there is a token fee, in general it is used to meet legal requirements for establishing a contract between the executive and the organization.
Designation as a nonprofit does not mean that the organization does not intend to make a profit, but rather that the organization has no ‘owners’ and that the funds realized in the operation of the organization will not be used to benefit any owners. The extent to which an NPO can generate surplus revenues may be constrained or use of surplus revenues may be restricted.
Objectives and goals
Some NPOs may also be a charity or service organization; they may be organized as a profit corporation or as a trust, a cooperative, or they exist informally. A very similar type of organization termed a supporting organization operates like a foundation, but they are more complicated to administer, hold more favorable tax status and are restricted in the public charities they support. Their goal is not to be successful in terms of wealth, but in terms of giving value to the groups of people they administer to.
NPOs have a wide diversity of structures and purposes. For legal classification, there are, nevertheless, some elements of importance:
- Management provisions
- Accountability and auditing provisions
- Provisory for the amendment of the statutes or articles of incorporation
- Provisions for the dissolution of the entity
- Tax statuses of corporate and private donors
- Tax status of the founders.
Some of the above must be (in most jurisdictions in the USA at least) expressed in the organization’s charter of establishment or constitution. Others may be provided by the supervising authority at each particular jurisdiction.
While affiliations will not affect a legal status, they may be taken into consideration by legal proceedings as an indication of purpose.
Most countries have laws that regulate the establishment and management of NPOs and that require compliance with corporate governance regimes. Most larger organizations are required to publish their financial reports detailing their income and expenditure publicly.
In many aspects they are similar to corporate business entities though there are often significant differences. Both not-for-profit and for-profit corporate entities must have board members, steering-committee members, or trustees who owe the organization a fiduciary duty of loyalty and trust. A notable exception to this involves churches, which are often not required to disclose finances to anyone, including church members.
Formation and structure
In the United States, nonprofit organizations are formed by filing bylaws or articles of incorporation or both in the state in which they expect to operate. The act of incorporation creates a legal entity enabling the organization to be treated as a distinct body (corporation) by law and to enter into business dealings, form contracts, and own property as individuals or for-profit corporations can.
Nonprofits can have members, but many do not. The nonprofit may also be a trust or association of members. The organization may be controlled by its members who elect the Board of Directors, Board of Governors or Board of Trustees. A nonprofit may have a delegate structure to allow for the representation of groups or corporations as members. Alternatively, it may be a non-membership organization and the board of directors may elect its own successors.
The two major types of nonprofit organization are membership and board-only. A membership organization elects the board and has regular meetings and the power to amend the bylaws. A board-only organization typically has a self-selected board and a membership whose powers are limited to those delegated to it by the board. A board-only organization’s bylaws may even state that the organization does not have any membership, although the organization’s literature may refer to its donors or service recipients as ‘members’; examples of such organizations are Fairvote and the National Organization for the Reform of Marijuana Laws. The Model Nonprofit Corporation Act imposes many complexities and requirements on membership decision-making. Accordingly, many organizations, such as Wikimedia, have formed board-only structures. The National Association of Parliamentarians has generated concerns about the implications of this trend for the future of openness, accountability, and understanding of public concerns in nonprofit organizations. Specifically, they note that nonprofit organizations, unlike business corporations, are not subject to market discipline for products and shareholder discipline of their capital; therefore, without membership control of major decisions such as election of the board, there are few inherent safeguards against abuse. A rebuttal to this might be that as nonprofit organizations grow and seek larger donations, the degree of scrutiny increases, including expectations of audited financial statements. A further rebuttal might be that NPOs are constrained, by their choice of legal structure, from financial benefit as far as distribution of profit to members and directors is concerned.
In many countries, nonprofits may apply for tax exempt status, so that the organization itself may be exempt from income tax and other taxes. In the United States, to be exempt from federal income taxes, the organization must meet the requirements set forth by the Internal Revenue Service.
After a nonprofit organization has been formed at the state level, the organization may seek recognition of tax-exempt status with respect to U.S. federal income tax. That is done typically by applying to the Internal Revenue Service (IRS), although statutory exemptions exist for limited types of nonprofit organization. The IRS, after reviewing the application to ensure the organization meets the conditions to be recognized as a tax exempt organization (such as the purpose, limitations on spending, and internal safeguards for a charity), may issue an authorization letter to the nonprofit granting it tax-exempt status for income-tax payment, filing, and deductibility purposes.
The exemption does not apply to other federal taxes such as employment taxes. Additionally, a tax-exempt organization must pay federal tax on income that is unrelated to their exempt purpose. Failure to maintain operations in conformity to the laws may result in the loss of tax-exempt status.
Individual states and localities offer nonprofits exemptions from other taxes such as sales tax or property tax. Federal tax-exempt status does not guarantee exemption from state and local taxes, and vice versa. These exemptions generally have separate applications, and their requirements may differ from the IRS requirements. Furthermore, even a tax-exempt organization may be required to file annual financial reports (IRS Form 990) at the state and federal levels. A tax-exempt organization’s 990 forms are required to be available for public scrutiny. An example of a nonprofit organization in the US is Project Vote Smart.
The board of directors has ultimate control over the organization, but typically an executive director is hired. In some cases, the board is elected by a membership, but commonly, the board of directors is self-perpetuating. In these ‘board-only’ organizations, board members nominate new members and vote on their fellow directors’ nominations. Part VI, section A, question 7a of the Form 990 asks ‘members, stockholders, or other persons who had the power to elect or appoint one or more members of the governing body?’
A nonprofit organization in the United States can receive an accreditation by undergoing a third-party review from the Standards for Excellence Institute to ensure efficient use of resources.
Founder’s syndrome is an issue organizations face as they grow. Dynamic founders, who have a strong vision of how to operate the project, try to retain control of the organization, even as new employees or volunteers want to expand the project’s scope or change policy.
Resource mismanagement is a particular problem with NPOs because the employees are not accountable to anybody who has a direct stake in the organization. For example, an employee may start a new program without disclosing its complete liabilities. The employee may be rewarded for improving the NPO’s reputation, making other employees happy, and attracting new donors. Liabilities promised on the full faith and credit of the organization but not recorded anywhere constitute accounting fraud. But even indirect liabilities negatively affect the financial sustainability of the NPO, and the NPO will have financial problems unless strict controls are instated. Some commenters have argued that the receipt of significant funding from large for-profit corporations can ultimately alter the NPO’s functions.
Competition for talent
Competition for employees with the public and private sector is another problem that nonprofit organizations inevitably face, particularly for management positions. There are reports of major talent shortages in the nonprofit sector today regarding newly graduated workers, and NPOs have for too long relegated hiring to a secondary priority, which could be why they find themselves in the position many do. While many established NPOs are well-funded and comparative to their public sector competitors, many more are independent and must be creative with which incentives they use to attract and maintain vibrant personalities. The initial interest for many is the remuneration package, though many who have been questioned after leaving an NPO have reported that it was stressful work environments and implacable work that drove them away.
Public- and private-sector employment has, for the most part, been able to offer more to their employees than most nonprofit agencies throughout history. Either in the form of higher wages, more comprehensive benefit packages, or less tedious work, the public and private sectors have enjoyed an advantage over NPOs in attracting employees. Traditionally, the NPO has attracted mission-driven individuals who want to assist their chosen cause. Compounding the issue is that some NPOs do not operate in a manner similar to most businesses, or only seasonally. This leads many young and driven employees to forego NPOs in favor of more stable employment. Today, however, nonprofit organizations are adopting methods used by their competitors and finding new means to retain their employees and attract the best of the newly minted workforce.
It has been mentioned that most nonprofits will never be able to match the pay of the private sector and therefore should focus their attention on benefits packages, incentives and implementing pleasurable work environments. A good environment is ranked higher than salary and pressure of work. NPOs are encouraged to pay as much as they are able and offer a low-stress work environment that the employee can associate him or herself positively with. Other incentives that should be implemented are generous vacation allowances or flexible work hours.
Front building of the Bill & Melinda Gates Foundation in Seattle
In the United States, two of the wealthiest nonprofit organizations are the Bill and Melinda Gates Foundation, which has an endowment of US$38 billion, and the Howard Hughes Medical Institute originally funded by Hughes Aircraft prior to divestiture, which has an endowment of approximately $14.8 billion. Outside the United States, another large NPO is the British Wellcome Trust, which is a ‘charity’ by British usage. See: List of wealthiest foundations. Note that this assessment excludes universities, at least a few of which have assets in the tens of billions of dollars. For example; List of U.S. colleges and universities by endowment.
Measuring an NPO by its monetary size has obvious limitations, as the power and significance of NPOs are defined by more qualitative measurements such as effectiveness at performing charitable missions.
Some NPOs that are particularly well known, often for the charitable or social nature of their activities performed over a long period, include Amnesty International, Oxfam, Rotary International, Kiwanis International, Carnegie Corporation of New York, Nourishing USA, DEMIRA Deutsche Minenräumer (German Mine Clearers), FIDH International Federation for Human Rights, Goodwill Industries, United Way, ACORN (now defunct), Habitat for Humanity, Teach For America, the Red Cross and Red Crescent organizations, UNESCO, IEEE, INCOSE, World Wide Fund for Nature, Heifer International, Translators Without Borders and SOS Children’s Villages.
However, there are also millions of smaller NPOs that provide social services and relief efforts to people throughout the world. There are more than 1.6 million NPOs in the United States alone, and millions more informal, community-based entities, which Frumkin and others consider part of the nonprofit sector.
There are also examples, for instance in Ireland of NGO umbrella organizations bringing about a degree of self-regulation in the NGO sector.
Many NPOs often use the .org or .us (or the CCTLD of their respective country) or .edu top-level domain (TLD) when selecting a domain name to differentiate themselves from more commercial entities, which typically use the .com space.
In the traditional domain noted in RFC 1591, .org is for ‘organizations that didn’t fit anywhere else’ in the naming system, which implies that it is the proper category for non-commercial organizations if they are not governmental, educational, or one of the other types with a specific TLD. It is not designated specifically for charitable organizations or any specific organizational or tax-law status, however; it encompasses anything that is not classifiable as another category. Currently, no restrictions are enforced on registration of .com or .org, so one can find organizations of all sorts in either of these domains, as well as other top-level domains including newer, more specific ones which may apply to particular sorts of organization including .museum for museums and .coop for cooperatives. Organizations might also register by the appropriate country code top-level domain for their country.
Instead of being defined by ‘non’ words, some organizations are suggesting new, positive-sounding terminology to describe the sector. The term ‘civil society organization’ (CSO) has been used by a growing number of organizations, including the Center for the Study of Global Governance. The term ‘citizen sector organization’ (CSO) has also been advocated to describe the sector – as one of citizens, for citizens – by organizations including Ashoka: Innovators for the Public. Advocates argue that these terms describe the sector in its own terms, without relying on terminology used for the government or business sectors. However, use of terminology by a nonprofit of self-descriptive language that is not legally compliant risks confusing the public about nonprofit abilities, capabilities and limitations.
In some Spanish-language jurisdictions, nonprofit organizations are called ‘civil associations’.