The Nonprofit FAQ
| Can a nonprofit be a business? |
| Someone wrote in usnonprofit-l: You don't "establish a business as non-profit". If you are a business, you are not non-profit as defined under the Internal Revenue Code. Putnam Barber (pbarber@eskimo.com) replied: It's easy to get tangled up in word games here, but I'd like to weigh in on the other side of this debate and say that (1) it seems to me there are lots of "nonprofit businesses" and (2) there's nothing wrong with it. Organizing a nonprofit involved agreeing to certain standards (defined by the state in which you incorporate and, if you choose to apply for tax-exempt status, by the section of the Internal Revenue Code you choose to rely upon). These laws don't exclude business-like activities. In fact, most of the time they expect it. What they deal with is the ownership of the corporation, what will be done with any available surplus funds (or other assets), and a few details of how it will do its work. There's no question that these matters are subtle, and that the language used by lawyers, accountants and tax-agents is "specialized". But I can't find any reason to conclude that there is something "wrong" (in the sense of against the law) about a nonprofit organization +making+ a profit. The laws are designed to ensure two things: that the activities of the organization are "exempt in character" (and if they're not, that "unrelated business income taxes" are properly paid); and that any surplus is used to extend the corporation's efforts directed toward its public-benefit purposes (and not, in other words, distributed to its owners or directors). Generally, it's the federal law that you're dealing with when you consider income and income-taxes. And the state law that sets the terms for incorporation and defines the rights and limitations on "owners" (if they're allowed at all) or directors. If your state allows substantial tax or other benefits to "nonprofit corporations", then it may also have laws that set strong standards for the sorts of things nonprofits can do that qualify for such benefits. These provisions vary widely among states and experience gained in one may be totally useless in another. A close look is well worth the time in a library. In April 1996 there was this further exchange on this topic: Bill Scott (Bill_Scott@mindlink.bc.ca) wrote: In case you haven't noticed, business donations are down; government funding is being cut; there is more competition for donations and other handouts. If NPOs are to survive and hopefully flourish, what other options are available to them? I believe NPOs must investigate all of their revenue generating options. To ignore exploring business options -- regardless of who you are competing with -- is just bad business." And Putnam Barber commented: Nonprofits enjoy "privileges and exemptions" not available to for-profit businesses. (It is also true that for-profit businesses have operating advantages -- most prominently related to various methods of raising capital -- not available to nonprofits. But that is another story) The issue here is when and how might it be legitimate for a nonprofit to take advantage of those privileges and exemptions (most prominently, not paying some forms of taxes) to help make a go of a revenue-generating activity that is in direct competition with the services offered by for-profit businesses. Of course, IMHO, any organization that pays all the taxes (and other charges) that a for-profit business pays should feel no internal anxieties over entering the field -- competition is a powerful economic force for the benefit of consumers (though again there are nuances that shouldn't divert us now). If it is a well-known nonprofit and if it depends on community support for other parts of its activities, there may be "external" anxieties related to making sure that its status as a full-fledged taxpayer is fully understood and completely believed -- otherwise it may find the "profits" from its business lines are eaten up by lost support for its charitable lines. The subtle and complicated questions come into play when the business in question is not going to pay all the taxes, make all the charitable donations, pay equivalent wages, etc etc etc, and will still compete with for-profit businesses. There may be cases where this is justified -- and even a good idea (not always the same thing). But thinking it through carefully is not only necessary from a business point of view but essential to the ethical standing of the field. There is a virtue to the exhortation that nonprofits should be "more businesslike." But not if we slip over the line and start thinking that nonprofit organizations are "nothing but" a special kind of business. The option of organizing a nonprofit is made available in order to allow groups of people to implement their vision of the public good independently. When no "public good" is at stake, the nonprofit form is inappropriate -- perhaps even being abused. A more technical discussion occurred in 1998. Someone asked in ARNOVA-L: SCENARIO: The Executive Director of a new nonprofit (paperwork submitted, grant writing beginning) has the opportunity to buy a for-profit Cafe. She wants to tie both entities together - allowing a portion of the profits to be paid to the investors (she is one of them) and a large portion goes back to support her agency. QUESTIONS:
And Richard Sansing (richard.sansing@YALE.EDU) replied on April 29: For a primer on the use of affiliated subsidiaries by nonprofits, I recommend the following. Tenenbaum, Jeffrey S. 1996. "Subsidiaries & related foundations: Maximizing the returns & minimizing the risks to your association." The Exempt Organization Tax Review 14 (July):105-114. Carl Milofsky (milofsky@BUCKNELL.EDU) added: The arrangement also is not so unfamiliar among nonprofits as we heard a month or two ago when there was discussion here of for profit subsidiaries of nonprofits. That's all been worked out in the law, beginning with New York University's acquisition of Mueller's Spaghetti. The principle is that businesses that compete with other tax paying businesses are usually going to have to be taxed (even if they are nonprofit in intent.) If the business can be conceived as a subsidiary of the nonprofit, then the business as an entity would pay taxes on its profit and if the nonprofit were an owner and received a return on investment from the business, the nonprofit would probably have to pay taxes on those proceeds (right lawyer/accountant friends?) To which Richard Sansing replied: No. The for-profit corporation with a tax-exempt owner is often referred to as a "feeder organization" (IRC Section 502). The feeder organization is subject to the corporate income tax; dividends paid to the tax-exempt owner are not taxed a second time (under the general rule that endowment income is tax-exempt). Note that certain payments that would ordinarily not be taxable to a nonprofit (e.g. interest or rent) are taxed as unrelated business income if paid by a controlled for-profit organization (IRC Section 513(b)(13)). (Control means 50%+ ownership in this context.) Note further that a charitable contribution from the for-profit to the non-profit are really dividends, so no deduction will be available at the corporate level [Rev. Rul. 68-296]. (Note: the revenue ruling was in the context of a 100% owned subsidiary, but contributions in the context of for-profit with multiple owners raises questions regarding fiduciary responsibilities to the for-profit owners). If the cafe is operated in certain ways (substantially all work done by volunteers, IRC Section 513(a)(1)) or for use by employees and patrons of the exempt organization (akin to a cafeteria in a nonprofit museum) then the income would not be taxable (Rev. Rul. 74-399). Carl Milofsky and Richard Samsing had this further exchange: Milofsky: I suppose the nonprofit could even be a subsidiary of the business (acting like a corporate foundation or some such.) Samsing: Yes, but that would not change the tax results. The nonprofit nature of the owner does not shield the taxable nature of the for-profit subsidiary. Reposted, with additions and corrections, August 1, 1998 -- PB |