What Is A Nonprofit
There’s an important distinction between for-profit and nonprofit organizations, although it may not be what you expect. A nonprofit organization can generate profits, but differs from a for-profit organization in what it can do with those profits.
For-profit organizations aim to generate profits for their owners or shareholders, while nonprofit organizations do not have owners in the traditional sense and are not allowed to distribute profits to individuals. Instead, nonprofit organizations are required to reinvest their profits into furthering their mission or “program activities.” This concept is sometimes referred to as the “nondistribution constraint.”
The distribution of profits to owners is permitted in for-profit entities, but not in nonprofit. The distribution of any profits by a nonprofit entity is a form of private inurement. This is the improper use of an organization’s earnings for the benefit of individuals associated with the organization, rather than for the organization’s stated mission or activities. Nonprofit organizations are prohibited from engaging in private inurement, while for-profit organizations often do so as part of their business model.
Although the term not-for-profit organization is sometimes used instead of nonprofit organization, as a matter of law, the terms are not synonymous. People use the two terms interchangeably in good faith, but the proper legal term is nonprofit organization.
“Nonprofit” is the proper legal term and refers to entities organized for purposes other than making a profit, such as charitable, educational, religious, or scientific purposes. These organizations are exempt from paying taxes on their income and may also be eligible to receive tax-deductible donations.
On the other hand, “not-for-profit” is more appropriately used to describe an activity or endeavor that is not pursued with a business or commercial motive. For example, expenses incurred for a not-for-profit activity are typically not deductible as business expenses for tax purposes because they are considered more akin to personal hobbies rather than business pursuits.
Understanding the distinction between profit at the entity level and profit at the ownership level is crucial to differentiating these terms. Nonprofit organizations may generate revenue, but any surplus funds must be reinvested into the organization’s mission rather than distributed to shareholders or owners. In contrast, not-for-profit activities are generally undertaken without the expectation of financial gain, akin to personal hobbies or pursuits.
Overall, while the terms “not-for-profit” and “nonprofit” are often used interchangeably in everyday language, it’s important to recognize the legal and technical differences, particularly in the context of taxation and regulatory compliance.
We hope this helps clarify the distinction between for-profit and nonprofit organizations and sheds light on the underlying principles governing their operations and use of profits.