Nonprofit corporations, by definition, exist not to make money but to fulfill one of the purposes recognized by federal law: charitable, educational, religious, scientific or literary activities. Under federal tax law and state corporate statutes, however, as long as a nonprofit corporation is organized and operated for a recognized nonprofit purpose, it can take in more money than it expends in conducting its activities. In other words, it can make a profit.
Making a Profit From Related Activities
Let's take as an example a group called Friends of the Library Inc. It's a 501(c)(3) nonprofit (that means it has a federal tax exemption) organized to encourage literary appreciation in the community and to raise money for the support and improvement of the public library. It can make a profit from its lecture series featuring famous authors and from its annual sale of donated books.
Because these activities are educational, they do not jeopardize the group's tax-exempt status. It may use its tax-free profits for its own operating expenses (including salaries for officers and staff) or for the benefit of the library. What it cannot do is distribute any of the profits for the benefit of officers, directors or employees connected with Friends of the Library - as dividends, for example.
Unrelated Business Activities
Nonprofits can also make money in ways that aren't related to their nonprofit purposes. Such unrelated business income is permissible and often essential to the survival of nonprofit organizations. But it is subject to taxation, under state and federal corporate tax rules.
It's best not to let unrelated business activities reach the point where the group starts to look like a regular commercial business. Unrelated business activities shouldn't absorb a substantial amount of staff time, require additional paid staff or volunteers to run them, or produce much more income than your exempt-purpose activities and services generate.
For example, say that many thousands of books are donated to Friends of the Library for its annual book sale, one of its major fund raising events. Although the sale is always highly successful, thousands of books are left over, and Friends decides to sell the more valuable ones by advertising in the rare and out-of-print books classified sections in various magazines.
The response is overwhelming, and soon there are six employees cataloging books. In addition, Friends begins a business buying books from other dealers and reselling them to the public. Such a situation could attract attention from the IRS and prompt it to reconsider Friends' 501(c)(3) tax-exempt status.
Finally, although it's not typical for the average group, a nonprofit corporation may make money from " passive" sources such as rents, royalties, interest and investments. This income is non-taxable in some cases.
Copyright 1999 Nolo.com, Inc.