Deciding whether to operate your company as a for-profit or non-profit is a big decision. You have to decide whether your focus will be on helping others or helping yourself. While you can do both in many situations, there are advantages to creating a company that is specifically designated as a non-profit, including the fact that non-profit businesses are exempt from federal, state, and local taxes. However, you have to balance those advantages with the realization that you may need to be paid differently as an owner of this type of company.
Following are some factors to consider when deciding between a non-profit or for-profit business entity for your business.
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What makes a business “non-profit”?
Non-profit businesses are just as they sound—the profits from this company will be provided back to the community, rather than given to executives or the business’s owners. Some of the most common examples of non-profit businesses include national charities, hospitals, foundations, and universities.
Non-profit businesses must also meet some other stringent requirements. These requirements are necessary to ensure that for-profit companies do not abuse the significant tax benefits that non-profit businesses receive in the United States. For example, non-profit businesses are required to make their financial and operating information public. This type of transparency allows donors to see how their money is being used.
A non-profit business is commonly referred to as a 501(c)(3) organization, which refers to the federal tax code that exempts these organizations from federal income taxes. This designation is important because it also allows donors to deduct contributions to your business on their income taxes.
Additional benefits of forming a non-profit organization include things like:
- Limited liability protection for directors, officers, and members.
- Access to certain public and private grants.
- Low postage rates.
Donors are much more likely to provide donations if they can deduct them from their income taxes, making this type of structure very appealing for those whose goal is to serve their community or provide another social good.
What is the difference between a “non-profit” and a “not-for-profit” business?
Keep in mind that a non-profit and a not-for-profit business are not the same thing. While both do not permit owners to take profits, the focus on serving the public is not quite the same. A not-for-profit company is not required to serve the public as a whole. Instead, it is designed to serve the goals of its members, rather than the public good.
A common example of a not-for-profit business is a sports club. This type of business enjoys some of the same tax exemptions, but donations are not tax-deductible.
What are the major differences between a for-profit and non-profit business?
How profits are used is likely the biggest difference between for-profit and non-profit businesses. However, there are other significant distinctions, as well.
Investors in a for-profit company are very different from those who provide funds for a non-profit entity. Investors who provide money to for-profit companies expect a return on their investment. In contrast, those who provide money to non-profit businesses either do it out of the goodness of their heart or because they want a tax deduction for their donation.
It can be much harder to attract investors in a non-profit business in some circumstances, as those investors have to expect that they will get very little in return for their investment.
Ownership, Employees, and Leadership
Non-profit businesses often function because volunteers want to help out with the cause of the company. However, they can still have employees as well. Most rely heavily on volunteers or part-time staff members.
In contrast, a for-profit entity generally will not rely on volunteers at all. Instead, they may have a highly paid staff and leadership team to run the company.
Expenses and Transparency
There is arguably some additional pressure on non-profit organizations to use their money wisely because their books and records are on display for donors. While both entities want to make more money than their total expenses, there is some increased scrutiny for non-profits who must tell donors exactly how their money was used. This level of transparency simply does not apply to most for-profit businesses.
How do you start a non-profit business?
Creating a non-profit business is very similar to starting a corporation. You will create a business plan, name your company, and create articles of incorporation. Learn more about forming a non-profit business.
Which entity Is best for your business?
The goal of a non-profit company is very different compared to a for-profit business. Choosing the right entity will depend on your overall goals for the company. While non-profit corporations have significant tax advantages and other financial benefits, only you can decide how you want to use the business’s profits.
If you have questions about business entities and which option is right for you, ask a lawyer about which choice is right for your specific situation. An attorney can walk you through the pros and cons of each option and help you form whichever entity you choose.
This article contains general legal information and does not contain legal advice. Rocket Lawyer is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.