Non-Profit Series: 1. What is a Non-Profit Organization?

Written by Sagan L. Carman-Downer

Have you and a group of your peers started or considered starting a non-profit organization? It can be difficult when starting out to decide whether creating a formal non-profit entity is necessary in your situation. And if it is necessary, figuring out the next steps you need to take can be overwhelming. This article will start a mini-series discussing non-profit organizations and answering some common questions.

First, it is important to understand what a non-profit organization is and what differentiates it from a traditional business entity. The main distinction is that a non-profit’s goal or purpose is not to generate a profit for its shareholders. That is not to say, though, that a non-profit will not generate money. The difference lies in how that money is distributed. Non-profit organizations utilize that money to further one or more charitable purposes recognized by their state, while traditional business entities typically distribute their profit among the business’s owners.

Next, it is worth noting that the requirements for recognizing a non-profit for purposes of state law are not identical to those for federal law. Non-profit entities are creatures of state law. Thus, the requirements you must meet to establish a formal non-profit will depend on the state in which you are located. The main question the state will examine is the purpose for which the organization is formed. There are numerous purposes that state law typically recognizes as charitable. These purposes will be addressed in a later article. For now, it is enough to understand that what is charitable will depend on your state’s laws.

While this may come as a surprise to some, an organization that is considered a non-profit for purposes of state law, is not necessarily a non-profit for purposes of federal law. In fact, federal law does not expressly recognize “non-profit organizations.” Instead, federal law provides that certain organizations, meeting specific requirements, are exempt from paying federal income tax. Thus, you may sometimes hear non-profits referred to as “tax-exempt organizations” in reference to federal law.

In sum, a non-profit is an organization formed and operated for some charitable purpose that is recognized by state law. If that non-profit meets certain federal requirements, it may be a tax-exempt organization, meaning it does not have to pay federal income tax. While many of the state and federal requirements are the same or similar, they are not always identical, so it is possible that a non-profit organization recognized by a state would still be required to pay federal income tax.