Many entrepreneurs wonder how to profit from a nonprofit organization, a type of corporation that must support a literary, scientific, educational, or charitable purpose and not exist primarily to make money. However, most federal and state tax laws allow these organizations to earn more money than they spend, as long as they are organized and operated under regulations. This means that nonprofit organizations can make an income, which may or may not be taxable depending on the income-producing activities in question.

Profiting From Related Activities

Most tax-exempt nonprofit organizations survive by raising money that is used to cover salaries, operational costs, and other expenses. These profits are not taxable as long as they are earned through activities associated with the organization's charitable purpose.

For example, a nonprofit organized to fundraise for the local public library could sell donated books or charge admission for talks by famous authors. Because these activities support the library's mission, they are allowed under federal tax-exemption guidelines. The resulting income can be used for salaries and library operating expenses, but may not be distributed to directors, officers, or other library stakeholders.

Profiting From Unrelated Activities

When tax-exempt nonprofits earn money through activities that are unrelated to their mission, these profits are subject to federal and state corporate income tax. In most cases, the first $1,000 in unrelated profit is not taxed.

With the library example, if the library became involved in the business of buying and selling rare and out-of-print books to collectors, this activity, though profitable, would not be considered supportive of the library's mission. This means the earnings must be reported to the IRS and will be taxed at the corporate level.

If unrelated business activities are excessive, the IRS may revoke the organization's nonprofit status. Businesses can avoid reconsideration of their 501(c)(3) status by making sure unrelated activities do not produce more income than created by related activities, take up significant staff time, or require additional staff.

Understanding Unrelated vs. Related Activities

The IRS has established certain activities as tax-exempt for nonprofits, even if they are not strictly mission driven. These include:

  • Distribution of small donor incentives valued at less than $5, such as pens or stickers
  • Member or donor mailing list exchanges and rentals
  • Sales of donated merchandise
  • Activities that directly benefit officers, patients, employees, members, or students
  • Activities that are primarily conducted by volunteers

Challenges of Starting a Nonprofit Organization

Like traditional companies, nonprofit organizations need a viable business plan to succeed financially, despite the fact that they are not profit-driven. If you're thinking about starting a nonprofit, consider the following:

  • You'll need to dedicate a portion of your budget to marketing and sales in order to drive engagement and donations.
  • It can take up to two years to achieve nonprofit 501(c)(3) status, while a for-profit limited liability company (LLC) can be up and running in less than a month.
  • The filing fee for a nonprofit is $850 compared to less than $100 for the typical LLC.
  • Investors may be scarce because of the low return on investment.
  • Shares cannot be sold on the stock exchanges.
  • Operating expenses must remain low, which means talent and facilities may be difficult to come by.
  • Managing volunteers carries specific challenges.
  • The public tends to be critical of your expenses and results, which must be disclosed.
  • Some worthy causes are less marketable than others, even those backed by reputable organizations.
  • Even major nonprofit organizations spend as much as 90 percent of the total operating budget on fundraising efforts.

Hybrid Organizations

Many newer companies are founded to support both nonprofit and for-profit aims. These hybrid organizations include the low-profit LLC and the benefit corporation. The former structure, sometimes called an L3C, must generate minimal income and have a charitable purpose. This entity may help you attract donations from private foundations.

When deciding what type of organization you want to form, consider the following:

  • How you want to improve the community and the world
  • How you want to impact others
  • Who will directly and indirectly benefit from your organization's success
  • How success will be defined and measured

If you need help with figuring out how to profit from a nonprofit organization, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.