How Do Nonprofits Make Money? What to Know

When we hear “nonprofit,” we often think of charitable nonprofits: organizations that operate “exclusively for religious, charitable, scientific, testing for public safety, literary, educational or other specified purposes,” according to the U.S. Internal Revenue Service (IRS).

Nonprofit organizations do not operate to generate a profit, so how do they generate income?

Essentially, not-for-profit organizations make money in many of the same ways that traditional for-profit businesses do, but they also hold fundraising events to raise money from benevolent donors or members. Like a business, they pay operating expenses, employee salaries, and other typical business costs.

The main difference between nonprofits and traditional businesses is that nonprofit organizations use the funding they earn or receive to support their mission rather than to generate a profit or pay stockholders.

Do Nonprofits Make Money at All?

Nonprofits operate like other businesses and need a flow of income to pay operational expenses. They also use the funding to support their mission, which is often a charitable endeavor. They may save money by having mostly volunteer staff and by paying employees a lower amount than they would make in the business world.

For-profit companies generate revenue by selling goods and services. Some nonprofits do this as well; however, they also make money through:

• Donations
• Fundraising drives
• Grants
• Sponsorships

How Can Nonprofits Pay Employees?

To maintain nonprofit status, organizations cannot legally use their revenue to benefit private interests. Instead, nonprofits must use their income to support their mission rather than fill the pockets of executives and stockholders.

Since organizations need people to operate, they can use the money they earn from various revenue streams to pay employees. The chief officers and employees can receive what the IRS defines as “reasonable compensation.” Salaries exceeding the “reasonable” rate can result in a loss of tax exemption and nonprofit status.

It is important to note that nonprofits have founders, boards, and chief officers, but not owners. An individual can receive credit for establishing the organization but does not have complete control over its operations or finances.

Generally, an executive director runs the organization while answering to a board of directors. Most nonprofits have a board of directors whose members volunteer their services.

Nonprofit salaries should be in line with other similar organizations. For example, if one organization pays employees annual salaries that greatly exceed those of a similar organization, the IRS may flag it.

Additional Compensation for Staff Members

Nonprofits do offer additional benefits for staff members as part of their compensation packages. These include traditional benefits like dental, life, and health insurance. Some even offer tuition reimbursement, extra vacation days, and sabbaticals.

Additionally, nonprofits aim to create a pleasant work environment that makes staff feel valued and appreciated. Many workers join nonprofits to do meaningful work rather than attain higher salaries. Many consider doing good for the community while making a livable wage as fair compensation.

What Are Nonprofit Organizations?

While most people think of a nonprofit organization as it relates to charitable giving, this is not always the case.

The Financial Definition: Tax-Exempt Status

Unlike for-profit corporations, the goal of a nonprofit organization’s budget is to generate enough revenue to cover annual costs and break even.

Meanwhile, for-profit companies focus on making a profit and often have shareholders to answer to.

What happens if a nonprofit organization earns a profit?

While the goal of the nonprofit sector is to generate enough revenue to pursue mission-related activities, they can still incur a profit. What makes them different from for-profit corporations is what they do with that surplus income.

A nonprofit uses the surplus earned income and reinvests it into the organization to further the mission or give charitable donations.

By investing profits into its mission, a nonprofit becomes federally recognized by the IRS as a 501(C)(3) organization, earning them tax-exempt status.

Organizations can also use profits to create a reserve fund to protect themselves in cases of emergencies. However, these funds in an emergency account cannot go to employees or other individuals. Otherwise, the organization risks IRS penalties.

The Philanthropic Definition

Nonprofits make money to fund their missions and better their communities. In non-financial terms, a nonprofit comprises like-minded people with similar charitable goals.

While some of these people are paid employees, many are volunteers. Nonprofits rely heavily on volunteers to operate. Although a nonprofit has some skeletal staff, it generally cannot afford to hire a large staff without violating IRS nonprofit salary regulations.

For-Profit vs. Nonprofit: The Main Differences

Aside from financial structures, the various key differences between for-profit and nonprofit organizations include:

• Nonprofits use fund accounting systems, while for-profit companies use traditional accounting.
• Nonprofits focus on doing good for the community, while for-profits prioritize growing revenue and profit margins.
• Nonprofits are tax-exempt, whereas for-profits are not.

So How Do Non-Profits Make Money?

Nonprofit income is crucial for pursuing its mission. If the nonprofit corporation does not operate like traditional for-profit businesses, how does it bring in income?

Nonprofit charities have many different income streams to help them raise funds. Below are the most common ways they generate revenue.

Partnerships and Sponsorships

One way nonprofit organizations earn money is by establishing partnerships or sponsorships with other organizations or for-profit companies. For example, a nonprofit may partner with a local business which sponsors an event.

Nonprofit organizations can also raise money by marketing through sponsorships with trade shows, journals, and conferences.

Are PARTNERSHIPS taxable?

Nonprofits attain tax-exempt status by reinvesting profits into the cause. According to the IRS, partnerships with nonprofit organizations are taxable because the relationship creates an excess benefit to the for-profit sponsor or Unrelated Business Income (UBI).

Unrelated income differs from traditional nonprofit funding because it does not serve the nonprofit organization’s mission. Instead, organizations use it for advertising purposes, which means it is taxable.

To summarize, related business income for an organization is revenue that directly supports its mission. Conversely, unrelated business income comes from unrelated activities, such as advertising, making it taxable.

Grants

Grants are a distinctive way for a nonprofit to earn money. They generally come from a major donor looking to fund a mission that shares similar interests.

What Are Grants?

Grants are funding given to one organization from another for a certain purpose. Grantors often fund organizations that have similar charitable interests, ensuring that their donations go towards a cause they support.

Since grantors often donate large sums of money, they have specific regulations for grant recipients. Likewise, corporate donors will have different guidelines depending on the available grant and potential recipient. Understanding these guidelines before applying for a grant is essential to receiving the desired funding.

Types of Grants

Nonprofits can apply for grants from different organizations, such as:

• Public charities
• Government entities
• Private foundations
• Family foundations
• Community foundations

Whether for community or government grants, nonprofits must keep a record of their spending to prove they use the grant money for mission-specific purposes. If grantors discover misuse of grant funding, they could cancel it and report the nonprofit’s income to the IRS.

How to Search for Grants

One of the best ways to find grant funding is by doing your due diligence and researching different grants. Since grantors want to fund charitable nonprofits with similar interests, it’s important to apply for the right grant.

For example, a nonprofit focusing on community efforts could apply for grants from community foundations or public charities. Meanwhile, environmentally focused organizations could apply for various government-funded grants.

How to Apply for Nonprofit Grants

When applying for a grant, a nonprofit must understand and follow the necessary guidelines. In addition, they must follow the application instructions and submit compliant proposals.

To increase the chances of receiving grant funding, the nonprofit must argue why they deserve the funds and explain their shared interests with the potential donor.

Making a Profit From Activities

As we briefly mentioned above, nonprofit organizations have two types of activities: related and unrelated.

Related Business Income

Related business income comes from activities directly related to the mission of the nonprofit. For example, related activities could include fundraisers, donations, and other funding sources.

Due to the nature of related activities, they are tax-exempt.

Unrelated Business Income

Unrelated activities do not directly contribute to the cause and are subject to Unrelated Business Income tax. An example of this is a nonprofit sponsorship by a local magazine.

Since the magazine is advertising the organization, it could gain a financial benefit. Additionally, the advertising does not directly benefit nonprofit purposes. As such, unrelated business activities are void of tax exemptions.

The same applies if a nonprofit advertises for a sponsor. In this case, the nonprofit receives money for the ad, but since the sponsor also has a financial gain, it is an unrelated activity.

Fundraising Activities and Events

Fundraising is one of the most common income streams for a nonprofit. Nonprofits use fundraisers to collect donations and connect with the surrounding community.

Types of Fundraising Events

A nonprofit can make money by hosting various types of fundraisers.

For example, a silent auction is a great way to encourage individual donors to donate to the cause. During a silent auction, individual donors contribute items for the nonprofit to sell. These items can range from small items like bags to big-ticket items like vacation getaways.

The nonprofit can use the proceeds from the silent auction to fund its charitable efforts.

Other types of fundraisers can include T-shirt sales, bake sales, and hosting events for the community, like fall festivals, to raise money.

What to Consider When Planning an Event for a Non Profit Organization

Planning an event is a fun and exciting way to make money while engaging with the local community. As with any event, fundraisers require careful planning and consideration.

One of the most important things to consider is the budget. Hosting an event comes with additional costs, such as rentals, merchandise, venues, etc. Planning for these costs and budgeting accordingly can help ensure that the nonprofit incurs positive revenue.

In addition, nonprofits should always document donations and money received. To maintain nonprofit status, organizations must keep a detailed record of their income and spending to prove that the money goes towards the mission rather than private interests. Failing to file the proper IRS documents could risk an organization’s tax exemption status.

Individual Contributions

Most nonprofits make money by having multiple individual donors. These donors can make various types of contributions to benefit the nonprofit, such as:

• Online contributions: Many organizations have a donation page on their website where individuals can donate money via credit card payment.
• Planned gifts: Planned gifts are often large and come from wills or trusts. A donor promises a certain financial amount to the organization and pays out upon their death or on a specific later date.
• Event donations: Donations from events fall into the same category as fundraiser contributions.
• Stocks: Some individual donors will gift stocks to the organization rather than cash or physical items.
• In-kind contributions: Instead of cash, some donors will give in-kind contributions, which are physical donations like furniture or anything other than money. Nonprofits must record these donations according to their estimated value for IRS purposes.

Earned Income

Earned income is self-generated revenue. Nonprofit organizations can create earned income by selling merchandise, charging service fees, renting venues, and maintaining membership fees.

Some examples include:

• An organization establishes a membership program for local community members who want to participate in the mission. It charges a membership program fee to fund its mission.
• Charitable nonprofits sell shoes or T-shirts and use the proceeds to pay staff and fund charitable efforts.
• A nonprofit holds community classes and charges a fee for its provided service.

An essential thing to remember about earned income is that it must directly contribute to the nonprofit’s mission to maintain its tax-exempt status.

Do Nonprofits Pay Taxes?

By registering as a 501(C)(3) organization, nonprofits can avoid tax obligations. The only exception to this is unrelated business income.

Being a 501(C)(3) organization means you can make money without paying traditional income tax. However, the IRS has specific guidelines that nonprofits must follow to maintain this status.

For example, nonprofits can remain tax-exempt by doing the following:

• They must provide written receipts for all donor gifts exceeding $250.
• They must pay the required taxes on unrelated business income.
• They must complete the annual tax return to report gross receipts and show how they spent funding.
• They should maintain records of compensation agreements and show that they pay employees reasonable compensation for mission-related purposes and in no way benefit private interests.
• They must avoid involvement in political campaigns.
• They must understand and abide by lobbying restrictions and regulations for nonprofits.

If an organization violates any of these, it risks losing tax-exempt status. In addition, it would be responsible for paying taxes on all past contributions. Therefore, carefully abiding by IRS nonprofit regulations is essential to maintain 501(C)(3) status and avoid expensive penalties.

Why Become a Nonprofit Instead of a Traditional For-Profit Business?

Making money while doing good in the community is a great reason to establish or join a nonprofit. However, philanthropic efforts are not the only benefit of becoming a nonprofit.

Nonprofits are exempt from paying federal taxes, which means that more money goes toward the organizational mission. As such, they can sell merchandise, offer services, and generate revenue without paying taxes. However, following the IRS regulations mentioned above is vital to avoid penalties. A nonprofit cannot raise money if it benefits private interests.

Nonprofits also have the unique ability to apply for grants from the government or private foundations. Grants are one of the most significant ways nonprofits make money, and they often contribute to a large portion of an organization’s annual revenue.

Nonprofits make money like any other business. However, they use this revenue to do good for the community and support their missions. Joining a nonprofit as a volunteer or staff member is a great way to give back while enjoying numerous unique benefits.