Aside from identifying your niche, forming your strategy, and knowing your target market, deciding on your legal entity is also an important part of establishing your business. Even if you are running as a small business, determining it will also have an effect on your finances.
Difference between Nonprofit vs. Not-for-Profit Types of Organizations
There are three main types of legal entities, namely: for-profit, nonprofit and not-for-profit. Technically, the first one can be clearly identified as one that is built to produce finances. However, the other two may be confusing since it is indeed difficult to identify the differences between the two.
To start with, if you’ve researched the process of forming a nonprofit organization, you’ve definitely noticed a few buzzwords. The industry is commonly referred to as “nonprofit,” while the term “not for profit” is sometimes used instead.
Which is a nonprofit organization and which one is a not-for-profit? Is there a meaningful distinction between these two terms? Which one do you think is the best term that defines your company?
However, as we go through, you’ll surely identify the distinctions between the two to help you decide (if you are still in the process of identifying) and describe. We shall compare the concepts “nonprofit” and “not for profit”, discuss the benefits and drawbacks of officially operating as a nonprofit organization, and be introduced to a few tools that can aid you during the registration process.
Before we continue, it’s a must to remember and understand that this post was written for companies located in the United States.
If you are not situated in the United States, you should study the laws, regulations, terminologies, and policies governing corporations in your home country. Furthermore, these concepts are still helpful too as you understand the basics.
Read on to learn the difference between nonprofit and not-for-profit companies and how such categories apply to yours!
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Definition and Scope of Nonprofit Organization
A nonprofit organization is one whose tax has been exempted by the Internal Revenue Service due to its objective and purpose of advocating a social cause and offering a public benefit. Institutions such as clinics, schools, social work, trusts, and the like are all examples of nonprofit organizations.
To register as a nonprofit organization, your company must contribute to the greater good in some way. Non – profit organizations do not generate earnings for any reason other than the growth of the organization.
Simply put, you will be required to make financial and operational information about your company available to the public so that contributors may have access to how their donations are being used.
Another important concept to note is that a person or business that donates to a nonprofit organization may deduct the donation from a tax return. Therefore, a nonprofit organization does not pay taxes out of any funds raised through fundraising.
Defining Not-For-Profit Organization (NFPO)
A not-for-profit organization (NFPO), like that of a nonprofit, is something that does not produce profit for its shareholders. All funds generated through business operations or donations are spent in the operations of the company.
However, not-for-profit organizations are not obligated to operate for the public good. A not-for-profit organization might exist solely to serve the interests of its members. A good example of a not-for-profit organization is a sports club, wherein the club’s mission is to provide fun for its members.
These organizations must apply to the IRS for tax-exempt status, which includes sales and property tax exemptions. This also means that someone’s contribution to a not-for-profit organization cannot be deducted from the individual’s tax return.
Main Distinctions of Nonprofit Vs Not-For-Profit Organizations
To strike the differences between a nonprofit and a not-for-profit organization, here are the main distinctions to take note of:
As nonprofit organizations aim to advance the betterment of others, not-for-profit organizations exist to accomplish private owner’s corporate reasons.
Whereas nonprofit organizations can form legal entities, not-for-profit organizations cannot do such.
Nonprofit organizations, though they still look for ways to generate revenues, do not support their members. On the other hand, not-for-profits organizations are regarded as recreational organizations and revenue is not their main priority.
While nonprofit organizations may still earn a profit as a source of their employees’ salaries, not-for-profit organizations are run by volunteers
The Other Side: For-profit Organizations
A for-profit organization is one that exists purely for the sake of profit. The majority of businesses are for-profit entities that serve their consumers through the sale of a product or service. The business owner gets money from the for-profit venture and may also distribute rewards to shareholders and investors.
Whether you choose to form a for-profit, not-for-profit, or nonprofit organization, the initial steps are the same. Begin by forming a business entity in the state in which you desire to conduct business.
Your business may be organized as a corporation, limited liability company, single proprietorship, or partnership. All of these organizations might be for-profit, nonprofit, or not-for-profit.
After the organization is constituted, you will apply to the IRS for an Employer Identification Number (EIN). If you desire to operate as a nonprofit, this is the step at which you will pick your tax-exempt status using Form 1024.
How to Change a Legal Entity to Another
Certain companies begin as one sort of legal entity before changing to another. This is achievable, even though it varies in difficulty based on the scope of the groups involved.
Changing from Nonprofit to For-Profit
There are several reasons why you would want to switch from a nonprofit to a for-profit organization. Perhaps you assume that by forming a for-profit organization, you will have easier access to loans or other forms of funding. Or perhaps you choose to operate outside of the nonprofit sector’s regulatory framework.
However, once you’ve carefully studied this option and obtained consensus from all shareholders, you must tell the IRS by submitting a “statement of nonprofit conversion” to the IRS. This statement will include the following:
- The reason for the nonprofit’s closure;
- A certified copy of the liquidation plan;
- The organization’s fair market value; and
- A list of all asset receivers if assets are distributed.
Moreover, you will need to visit your state officials to submit any forms required by your area.
Changing from For-Profit to Nonprofit
Switching a for-profit organization to a nonprofit organization is more complicated, as the IRS aims to prevent businesses from changing to nonprofits to avoid paying taxes. It is achievable, though, through a process similar to that of organizing a charity from start.
While you may retain the for-profit organization’s name for your nonprofit, a nonprofit organization requires you to use the money you raise for purposes other than distribution to shareholders or business owners, and it must also support the nonprofit’s mission and goals.
Beginning the process of converting to a nonprofit organization needs planning ahead of registering the nonprofit with the state in which it operates.
Among other things, this process entails developing a mission statement, establishing bylaws, and filing articles of incorporation with the Secretary of State.
It is at the articles of incorporation stage that you must notify the Secretary of State that you intend to retain the same name as your existing for-profit organization.
Identifying the Best Legal Identity
Finally, the legal entity that is best for your firm is determined by your objectives. This is strengthened by academicians and entrepreneurs at Harvard Business Review. Generally. It’s safe to say that each type of legal entity has its fair share of advantages and disadvantages.
Another important thing to consider when forming a legal company for your business, there is no one-size-fits-all solution.
However, the good news is that when your business expands, you may easily change your entity. You can start with consulting an expert who can assist you in selecting an entity that maximizes your tax deductions while still accomplishing your primary objective.
As an entrepreneur, one aims to make an impact on your organization as well as on the people around you such as your employees or volunteers. To do such, a team needs to innovate not just in terms of generating revenue but also in identifying the organization’s structure.
For more insights on how to build and run an organization efficiently, check out more of our articles on this blog.
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