A nonprofit generally refers to an organization that qualifies for special tax status under section 501(c)(3) of the U.S. tax code. The key difference between a for-profit and a nonprofit is that one is organized to make money for its owners and the other is not. A nonprofit is meant to serve a charitable, educational, scientific or literary purpose. This distinction in purpose between the two types of organizations is what drives most of the other differences between nonprofits and for-profits.
Like traditional for-profit companies, a nonprofit is required to adopt a formal organizationa structure and Employer Identification Number (EIN). A nonprofit may choose to organize as a corporation, trust, or unincorporated association. But an organization that wants to operate as a nonprofit must obtain additional approval from the IRS. A potential nonprofit must submit a completed Form 1023 and registration fee by the end of the 15th month after it was created to qualify with the IRS. If the organization qualifies, the IRS will issue it a determination letter that will recognize the organization’s exempt status.
A for-profit’s income is taxed in some fashion when it is earned. If the entity is a corporation, the business pays the tax. If the entity is a partnership or limited liability company, the business owners pay tax on their share of the business's income for the year. Nonprofit organizations are generally exempt from paying any tax on their income.
Most donations received by a nonprofit are tax-deductible for the donor. This means that any money the donor gives to nonprofits can be used to offset his taxable income. The government allows donors to deduct their contributions to nonprofits to encourage charitable giving. If a taxpayer pays cash to a for-profit business, it is generally not deductible.
Distributions to Shareholders
For-profit businesses are able to distribute their accumulated earnings to their owners. In corporations these payments are known as dividends, in partnerships they are known as distributions. Nonprofits cannot distribute their excess assets to the individuals that created them; all assets that the nonprofits own must be used to achieve their charitable purpose. If a nonprofit enters into a transaction with someone who has substantial influence over the organization, such as its CEO, and the deal results in the person receiving a greater economic value than what he gave up, the person may be charged an excise tax as penalty.
John Cromwell specializes in financial, legal and small business issues. Cromwell holds a bachelor's and master's degree in accounting, as well as a Juris Doctor. He is currently a co-founder of two businesses.