Federal law also requires nonprofits to make their three most recent 990 reports, as well as their application for tax exemption and supporting documents, available for public inspection. State and local laws in your area may require additional disclosures. Posting your 990 reports and other required documents on the web is an acceptable way to meet disclosure requirements.
Although nonprofit employees have no dollar limit on the amount of compensation they can earn, the IRS does have the authority to penalize individuals (and organizations) who receive (or pay) excessive compensation. Whether the IRS considers benefits “excessive” depends on the situation. For instance, a staff member earning $100,000 annually from an organization with a budget of $125,000 may need to worry, but someone earning $100,000 from a nonprofit with a $5 million budget probably doesn’t.
An employee who’s found to be receiving excessive compensation may be required to return a portion of his compensation and to pay an excise tax, and, in dire cases, the nonprofit organization may lose its tax-exempt status. Chapter 5 offers more information on excessive compensation.
So when setting your nonprofit’s executive director’s salary, make sure the amount of compensation is justified by salary surveys of similar organizations. Also factor in the local cost of living, the size of the nonprofit’s budget, and the type of services being provided. Community foundations and nonprofit consulting firms can offer salary guidelines to aid in the compensation decision. Also, many states have a statewide nonprofit organization that collects information about and provides information to other nonprofits.
Looking at the Many Varieties of Nonprofits
The words nonprofit and charity go together in most people’s minds, but remember that not all nonprofits are charitable organizations. The most common examples are business and trade associations, social welfare organizations, labor organizations, political advocacy groups, fraternal societies, and social clubs. Although these nonprofits enjoy exemption from corporate income taxes, people who donate to them can’t claim a tax deduction for their contributions.
Most nonprofits, charitable or not, are incorporated organizations that are formed under the laws of the state in which they’re created. Some nonprofits have other legal structures, such as associations or trusts, but these are in the minority. The IRS grants tax-exempt status to a nonprofit after reviewing its stated purpose. (See Chapter 4 for information about incorporating and applying for a tax exemption.) Nonprofit types are identified by the section of the IRS code under which they qualify for tax-exempt status.
In this section, we provide an overview of the types of nonprofit organizations and some of the rules and regulations that you’ll be subject to if you decide to incorporate and seek tax-exempt status from the IRS. You may discover, for example, that your idea will have a better chance for success if you create a social-welfare organization – a 501(c)(4) – or a for-profit business.
Identifying nonprofits by their numbers
Nonprofit organizations can be formed under the IRS code for many reasons other than charitable ones. To give you a taste of the variety of these organizations, the following list summarizes various classes of nonprofit organizations:
❯❯ 501(c)(3): These organizations are formed for educational, scientific, literary, charitable, or religious pursuits and also to test for public safety and to prevent cruelty to children and animals. Nonprofits in this category may be classified as public charities or private foundations; the source of support for the organization usually determines the classification. Foundations are subject to additional rules and reporting requirements. This book focuses on 501(c)(3) organizations that are classified as public charities. Contributions to these organizations are tax deductible for their donors. Public charities may engage in limited lobbying. More information about lobbying can be found in the following section.
❯❯ 501(c)(4): These organizations are known as social-welfare organizations because they’re formed for the improvement of general welfare and the common good of the people. Advocacy groups tend to fall into this category because organizations with this classification are allowed more leeway to lobby legislators as a part of their mission to improve the general welfare. Contributions to these organizations aren’t deductible for the donor.
❯❯ 501(c)(5): Labor unions and agriculture and horticulture organizations formed to improve conditions for workers are in this category. These groups also may lobby for legislation.
❯❯ 501(c)(6): Business and trade associations that provide services to their members and work toward the betterment of business conditions are placed in this classification. This category includes chambers of commerce and real estate boards, for example. Again, lobbying for legislation is allowed.
❯❯ 501(c)(7): This section covers social clubs formed for recreation and pleasure. Country clubs and organizations formed around a hobby come under this classification. These organizations must be funded primarily by memberships and dues.
❯❯ 501(c)(9): This type of nonprofit is an employees’ beneficiary association that’s created to pay insurance benefits to members and their dependents. It must be voluntary, members must have a common bond through employment or a labor union, and in most cases, it must meet nondiscrimination requirements.
Several other 501(c) – type organizations are so specialized in nature that we won’t go into them here. One of our favorites is the 501(c)(13), which covers cemetery companies.
Political action committees (PACs) and parties have their own special classification, too. They’re recognized under IRS code section 527 and are organized for the purpose of electing persons to office. They have special reporting requirements and aren’t required to be incorporated. Donations to these organizations are not tax-deductible and the names of their donors must be disclosed.
Rules and regulations to add to your file
Entire volumes have been written about IRS regulations and laws pertaining to nonprofits. But don’t worry – we just want to give you an overview of some facts that may help you decide whether starting a 501(c)(3) nonprofit organization is your best choice.