Intro
Whether you’re new to the world of non-profit organizations (NPO) or a seasoned professional, you are bound to have some unanswered questions crop up occasionally. With NPOs in particular, these questions are related to non-profit accounting and taxes. Why? Because the structure and classification of your organization can impact several processes, such as financial reporting, tax compliance, operational procedures, and more.
Familiarizing yourself with the different types of non-profit organizations will help you better understand what you legally can and cannot do, informing your day-to-day decision-making. Understanding the difference between a non-profit and a not-for-profit is essential to help you maintain compliance.
This article will help you distinguish between a non-profit, not-for-profit (NFPO), and for-profit organization. It will also introduce you to the five most common types of non-profit organizations to help determine which category your organization falls into.
The Basics: What is a Non-Profit Organization?
A non-profit is any organization or foundation that primarily supports, advocates, and creates significant benefits for people, society, and the environment. Unlike a for-profit business, it does not profit by selling its products and services.
Non-profit organizations rely on funding from several sources, such as organization members, donors, grants, and income earned from investments or selling products and services. These funds are highly regulated and can only be used to support the organization’s mission, to serve beneficiary needs, or as donations to other non-profit organizations. As a result of this financial model, there are significant differences between for-profit versus non-profit accounting standards.
There are also a few characteristics that set non-profits apart from not-for-profit organizations. While non-profit organizations serve the wider public, not-for-profit organizations serve a particular group, charity, or cause. NPOs and not-for-profits are regulated differently under the Internal Revenue Service’s (IRS) 501(c) code. The most crucial distinction that NPO tax consulting experts can help you keep track of is that although both organization types are tax-exempt, NFPOs cannot deduct donations and dues from their taxable income.
The Top 5 Types of Non-Profit Organizations
Understanding the different types of non-profit organizations is vital for your NPO finance and tax processes. Under the 501(c) Internal Revenue Code, 29 different types of non-profit organizations exist. Depending on their purpose, these organizations are characterized under different tax sections and have different tax-exemption rules that they must follow.
According to Statista, the top 5 most common types of non-profit organizations are:
Religious, charitable, or related organizations, social welfare organizations, business leagues, social and recreational clubs, and labor and agriculture organizations. Let’s further explore these different types of non-profit organizations and what they mean for your NPO financial reporting and tax compliance needs.
1. 501(c)(3): Religious, Charitable or Educational Organizations
Organizations categorized under this section are established to serve a religious, charitable, scientific, educational, or literary purpose. Such organizations include schools, churches, elderly care homes, and girls and boys clubs. These organizations are tax-exempt and are not required to file tax returns with the IRS. Donations made to these organizations are tax-deductible, often encouraging more significant contributions from donors.
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2. 501(c)(4): Social Welfare Organizations and Local Associations
These organizations have been established to impact social welfare positively. They must benefit a community instead of employees, corporations, or other private groups. Non-profits in this category can participate in limited political activity and lobbying if it contributes to their mission. Local businesses, homeowners associations, civic associations, and volunteer fire departments fall into this category. Contributions to these organizations are not tax-deductible.
3. 501(c)(5): Labor and Agricultural Organizations
Non-profit organizations associated with improving labor conditions and quality of life for factory and agricultural workers, cultivating land, or raising livestock are categorized under this tax code section. Examples include agricultural associations, horticulture groups, labor unions, and farmers’ associations. NPO financial reporting for these organizations must prove that all income earned is used to improve worker conditions, product quality, and operational efficiency. These organizations must also contribute to practices promoting food security and sustainability.
4. 501(c)(6): Business Leagues, Chambers of Commerce, Trade Boards
This section consists of organizations that strive to support professionals and businesses in a particular industry or region. Chambers of commerce, real estate boards, and trade and professional associations are some organizations that fall into this category as long as they are supported by membership dues and income related to their primary purpose. Some lobbying associations can also be categorized under section 501(c)(6) but face additional tax-related barriers that NPO tax consulting experts can efficiently help them overcome.
5. 501(c)(7): Social and Recreational Clubs
Organizations that provide social and recreational support to a particular group receive tax-exempt status under this section of the IRS tax code. Such organizations include fraternities, alumni associations, athletic leagues, and social clubs. The profits these organizations earn through membership fees and concessions must only be used to provide social and recreational opportunities to their members.
Getting Started on Your NPO Journey
Now that you know the different types of non-profit organizations, you are ready to start your NPO journey. It’s time to map out an organizational structure, iron out your operational processes, and assemble your dream team. Working with experts specializing in NPO finance and accounting can also help clear any doubts about financial management specific to your organization’s needs. Consider outsourcing some of your accounting and tax processes to streamline your NPO’s accounting practices.
Final Thoughts
The first step to establishing yourself in the non-profit world is clearly understanding the various types of NPOs. Since these categories are directly linked to tax compliance and NPO financial reporting, knowing where your organization fits is vital for operational efficiency and financial management. With this knowledge, you can take the next step in your non-profit journey.
Want to know more about non-profit accounting and tax consulting? In addition to HR, benefits, recruiting, and payroll through its PeopleOps, Escalon’s Essential Business Services include FinOps (CFO services, taxes, bookkeeping, and accounting) and Risk (business insurance). Talk to an expert today.
This material has been prepared for informational purposes only. Escalon and its affiliates are not providing tax, legal, or accounting advice in this article. If you would like to engage with Escalon, please contact us here.
