Starting a New Nonprofit? Better Know These Rules and Guidelines
Nonprofit organizations are created to serve a specific social purpose. Here are some of the permissible and forbidden activities and practices that NPs must follow in order to maintain their tax-exempt status and comply with legal and ethical standards.
By Ben Delaney
© 2023 ImmersivEdge Advisors. All rights reserved.
Image generated by AI.
Unlike conventional businesses, nonprofit organizations (NPs) are created to serve a specific social purpose, rather than to generate profits for their owners or shareholders. In exchange for this societal benefit, NPs are often granted special tax-exempt status by state and federal governments. In return for this valuable concession, there are specific permissible and forbidden activities and practices that NPs must follow in order to maintain their tax-exempt status and comply with legal and ethical standards.
NPs in the United States must comply with federal and state laws governing their operations, including reporting requirements, financial disclosures, Board conduct, political activities, private inurement, and accounting standards. Keep in mind that that individual states may have additional or different rules that nonprofits must follow. These rules typically apply to fundraising and reporting of activities.
This list is not comprehensive, and when you start your nonprofit be sure to consult with a local attorney who is experienced in nonprofit law in the state(s) in which you will be forming the corporation and operating.
Violations of these laws can result in loss of tax-exempt status, fines, and other penalties.
Permissible activities for NPOs:
Mission-Driven Activities: Nonprofit organizations must focus on achieving their stated mission and serving their target community. Any activities or practices that support the mission are generally permissible. For example, a nonprofit dedicated to reducing homelessness could engage in activities such as providing housing, running a food bank, and offering job training for the homeless.
Fundraising: Nonprofits rely on donations and grants to fund their activities, and fundraising is a permissible activity as long as it is done in an ethical and legal manner. NPOs must disclose their fundraising activities, including how donations are used, to donors and the public.
For-profit business: Many people are surprised to learn that nonprofits can engage in profit-making businesses. Called social enterprises, these businesses must be directly aligned with the nonprofit’s mission and other activities. One of the best-known examples of this is Goodwill Industries, which operates thrift stores to earn money. That income is used to help support workforce development programs, childcare programs, digital connectivity, and other charitable activities. Other social enterprises refurbish computers, train adults in needed skills, run bakeries and restaurants, and operate schools and even colleges. The bottom line for the IRS is that in order to avoid tax liability, any earned income must be directly related to the activities of the nonprofit.
Advocacy: NPs can engage in advocacy activities to promote their mission and bring about social change. This can include lobbying for specific legislation or policy changes, conducting research to inform public opinion, or engaging in public education campaigns.
Collaboration and Partnership: Nonprofit organizations are allowed to collaborate with other organizations to achieve their mission. This can include forming partnerships with corporations, government agencies, and other nonprofit organizations. Collaboration can help to leverage resources, increase impact, and reduce duplication of efforts.
Fiscal Responsibility: Nonprofit organizations are expected to practice good fiscal responsibility by maintaining accurate financial records, using funds for their intended purpose, and avoiding conflicts of interest. They are also required to file annual reports with the Internal Revenue Service (IRS) and to make their financial statements available to the public.
Forbidden activities for NPOs:
Activities outside of Mission: Nonprofits cannot engage in activities that are outside of their mission. For example, a nonprofit focused on environmental conservation cannot engage in activities that promote unsustainable practices.
Discrimination: Nonprofit organizations are prohibited from engaging in discriminatory practices based on race, ethnicity, gender, religion, or other protected categories. This can include discriminatory hiring practices or denying services or benefits to certain groups.
Compensation for employees: Nonprofits are allowed to pay reasonable compensation to their employees. This is often necessary to attract and retain qualified staff.
Excessive Financial Benefit or Private Inurement to Insiders: Nonprofits cannot provide excessive financial benefit to insiders, such as board members, officers, or key employees. This can include providing excessive compensation to directors, officers, or employees, or engaging in transactions with related parties that are not at arm's length.
Unrelated Business Income: Nonprofit organizations are discouraged from engaging in business activities that are not related to their charitable purpose. Operating a commercial enterprise or investing in a for-profit business is not illegal, but if considered unrelated income, that revenue will be taxed at normal rates.
Political Campaign Intervention: Nonprofit organizations are prohibited from engaging in partisan political activity or supporting or opposing candidates for public office. This can include making campaign contributions, endorsing candidates, or distributing campaign literature.
Excessive Lobbying: Nonprofit organizations are subject to limits on their lobbying activities and expenditures. They are required to disclose their lobbying activities and expenditures and may be subject to excise taxes if they exceed certain thresholds.
Paying taxes: many people are surprised that nonprofits must pay some taxes. Tax-exempt status applies only to income taxes. Other taxes, including payroll taxes, sales tax, property taxes, and vehicle taxes must be paid by a NP, just as they are by any other business.
Nonprofit organizations play a vital role in our communities by addressing critical social needs. However, they must also adhere to strict ethical and legal standards to maintain public trust and credibility. By engaging in permissible activities and avoiding forbidden practices, NPOs can fulfill their mission and create positive change in their communities.
ImmersivEdge Advisors has experience in all aspects of nonprofit and social enterprise formation and operations. We’re ready to help when you need it. Contact us at 510 419-0800 or by clicking here.
More Info:
Internal Revenue Service (IRS): Tax Information for Charities & Other Non-Profits. https://www.irs.gov/charities-non-profits
National Council of Nonprofits. (n.d.). Nonprofit Lobbying: Yes, You Can! https://www.councilofnonprofits.org/everyday-advocacy
National Council of Nonprofits. (2017). Conflicts of Interest. https://www.councilofnonprofits.org/running-nonprofit/ethics-accountability/ethics-and-accountability-nonprofits
Board Effect (2021) Private Inurement and Excessive Benefits. https://www.boardeffect.com/blog/private-inurement/
Alliance for Justice, Bolder Advocacy Program (2012) The Rules of the Game: A Guide to Election-Related Activities for 501(c)(3)s. https://bolderadvocacy.org/wp-content/uploads/2012/01/Rules-of-the-Game.pdf