Different types of business structures have different implications for your business.
There are several key differences between these three business entities, from profits that stem from doing good in the community to paychecks that come from fundraising. — Getty Images/SDI Productions

When you’re starting a business, it’s likely you’ll hear the phrases “nonprofit” and “not-for-profit” thrown around. It’s also easy to assume these two terms mean the same thing. However, nonprofits and not-for-profits are business structures with different tax implications, governance and functions. Both of these entities contrast with for-profit organizations. Here are the ins and outs of what all these terms mean so you can figure out which structure is right for your new venture.

[Read more: Getting Ready to Launch? How to Choose the Right Business Structure]

What is a nonprofit organization?

A nonprofit organization is one that qualifies for tax-exempt status by the IRS because its mission and purpose are to further a social cause and provide a public benefit. Nonprofit organizations include hospitals, universities, national charities and foundations.

[Read more: Education, Partnerships and Community Are Essential to Nonprofit Success]

To qualify as a nonprofit, your business must serve the public good in some way. Nonprofits do not distribute profit to anything other than furthering the advancement of the organization. As such, you will be required to make your financial and operating information public so that donors can see how their contributions are being used. An individual or business that makes a donation to a nonprofit is allowed to deduct their donation from their tax return. The nonprofit, likewise, pays no taxes on any money received through fundraising.

What is a not-for-profit organization?

Similar to a nonprofit, a not-for-profit organization (NFPO) is one that does not earn profit for its owners. All money earned through pursuing business activities or through donations goes right back into running the organization.

However, not-for-profits are not required to operate for the benefit of the public good. A not-for-profit can simply serve the goals of its members. A good example is a sports club; the purpose of the club is to exist for its members’ enjoyment. These organizations must apply for tax-exempt status from the IRS, including exemptions from sales tax and property taxes. That also means that money donated by an individual to an NFPO cannot be deducted on that person’s tax return.

To qualify as a nonprofit, your business must serve the public good in some way.

Nonprofit vs not-for-profit organizations

There are three key differences between a nonprofit and a not-for-profit:

  • Nonprofits are formed explicitly to benefit the public good; not-for-profits exist to fulfill an owner’s organizational objectives.
  • Nonprofits can have a separate legal entity; not-for-profits cannot have a separate legal entity.
  • Nonprofits run like a business and try to earn a profit, which does not support any single member; not-for-profits are considered “recreational organizations” that do not operate with the business goal of earning revenue.
  • Nonprofits may have employees who are paid, but their paychecks do not come through fundraising; not-for-profits are run by volunteers.

Nonprofits are granted 501(c)(3) status by the IRS. NFPOs are also governed by IRS tax code section 501(c), but depending on their purpose they could fall under a different section, like section 501(c)(7).

What is a for-profit organization?

A for-profit organization is one that operates with the goal of making money. Most businesses are for-profits that serve their customers by selling a product or service. The business owner earns an income from the for-profit and may also pay shareholders and investors from the profits.

Whether you decided to start a for-profit, not-for-profit or nonprofit, the first steps for creating your entity are the same. Start by filing for a business entity in the state in which you wish to run your operations. Your business entity might be a corporation, LLC, sole proprietorship or partnership. All of these entities can operate as for-profit, nonprofit or not-for-profit organizations.

Once the entity has been formed, you will apply for an Employer Identification Number (EIN) with the IRS. It’s during this step that you will select your tax-exempt status using Form 1024 if you wish to run as a nonprofit.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published March 30, 2020