Most people are familiar with the terms nonprofits, not-for-profits, and for-profits—but do you know how each type of organization operates? While their differences may seem straightforward, each structure has distinct governance, revenue generation, and profit usage requirements.
Below, we break down the three organizational structures, exploring their operational, legal, and financial differences to help you determine which is right for your small business.
What is a nonprofit organization?
A nonprofit organization has a legally approved purpose or social cause beyond profit generation. Its income is not dispersed to any shareholders but is instead invested back into the organization. These IRS tax-exempt organizations include many hospitals, universities, national charities, and foundations.
“Nonprofits are typically overseen by a board of directors with fiduciary responsibilities to the mission and donors,” said Ezra Helfand, CEO and Executive Director of the nonprofit Wellspring Center for Prevention. “[A nonprofit’s] success is measured by impact and effectiveness in achieving [its] mission and the number of people impacted.”
Notable nonprofit examples include National Geographic, the Alzheimer’s Association, Big Brothers Big Sisters of America, the American Red Cross, and PBS.
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.
“Nonprofits rely on donations, grants, and fundraising, while for-profits generate their revenue through the sale of goods and services,” Helfand explained. “If nonprofits realize surplus income at the end of their fiscal year, they… usually will reinvest them into the organization’s mission.”
The IRS grants nonprofits 501(c)(3) status, meaning that an individual or business that donates to a nonprofit can deduct qualified donations from their tax return. The nonprofit, likewise, typically pays no taxes on any money received through fundraising, provided the funds are acquired through activities related to its mission.
[Read more: 9 Things to Consider When Starting a Nonprofit]
What is a not-for-profit organization?
While the terms sound similar, not-for-profit organizations (NFPOs) and nonprofits are distinct in how each operates. A significant difference is their purpose and who they serve.
“NFPOs—like nonprofits but usually smaller—serve members rather than a broad public mission,” Helfand said, who cited organizations like hobby clubs as an example.
Some other well-known types of NFPOs include parent-teacher associations, homeowners associations, and social organizations like college sororities and fraternities.
Because of this member-driven focus, NFPOs have fewer governance and public disclosure requirements, providing greater operational flexibility. However, they may be subject to more local, state, and federal tax obligations than nonprofit organizations.
“It is possible for NFPOs to receive some tax benefits, but [they] often don’t qualify for full tax exemption,” Helfand noted.
Despite these differences, NFPOs are similar to nonprofit organizations in that they may qualify for tax-exempt status under various sections of the IRS’s 501(c) tax code. For NFPOs, this typically includes 501(c)(6) for business leagues and 501(c)(7) for social and recreational clubs. Some may also receive property or sales tax exemptions, though eligibility depends on the organization’s classification and state laws.
Additionally, NFPOs generate revenue through external channels, including grants, donations, and membership dues, just like nonprofits. They must also reinvest surplus profits into the organization rather than distribute them.
What is a for-profit organization?
True to its name, a for-profit company is an organization that exists to earn a profit. Helfand explained that these entities can earn revenue through sales or services, secure investments, or raise capital through loans or equity. They have fewer public disclosure requirements and no legal obligations dictating how they must use their profit. Instead, they can disperse earnings among the owners, shareholders, and employees or spend them however they choose.
“For-profits answer to owners, shareholders, or private investors,” Helfand said. “[They] evaluate success based on financial performance and growth.”
For-profit organizations are readily available, encompassing everything from airlines to restaurants to manufacturers and service providers. Even your favorite clothing brand or streaming platform is likely a for-profit organization.
Popular for-profit organizations span all industries and sectors, including brands like Apple, the NFL, Hulu, Chewy, Google, Uber, and Sephora.
[Read more: Can a For-Profit Business Add a Nonprofit Arm?]
Choosing the proper business structure depends on your goals, business experience, target audience, and desired tax advantages.
Can you change your legal entity?
Whether you decide to start a nonprofit, NFPO, or for-profit, the initial steps to creating your organization are the same. Start by filing for a business entity in the state in which you wish to run your operations. Depending on your intended status, your business entity might be a corporation, LLC, sole proprietorship, or partnership.
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.
“Nonprofits can apply for tax-exempt status, which means that they don’t pay federal income taxes, but they must follow very strict regulations,” Helfand explained. “For-profits are subject to corporate taxes but have fewer restrictions on financial activities.”
Some organizations start as one type of legal entity and later decide to convert to another. This is possible, but it can be a little complicated depending on the types of entities involved.
From nonprofit to for-profit
While uncommon, nonprofits requiring additional funding or more autonomy can dissolve their status and transition to for-profit by following the below steps:
- Analyze your finances: Review your tax returns with a trusted advisor to ensure that your income potential will be worth the additional yearly taxes your business will incur.
- Give notification of intent: Meet with your board of directors to vote on the status change, then disperse a notification of intent to employees and stakeholders.
- Inform the IRS: Explain your reasoning for dissolving your nonprofit by drafting a statement of nonprofit conversion for the IRS.
- Change your status at the state level: Request the necessary paperwork for a status change from your attorney general.
- Notify key parties: Communicate the change to employees, members, and relevant stakeholders.
- Submit your final tax return: File your final tax return within five months and 15 days of terminating your nonprofit status, indicating your new termination status.
From for-profit to nonprofit
Converting from a for-profit to a nonprofit organization is possible by following these steps:
- Confirm your 501(c)(3) eligibility: Following the Internal Revenue Code Section 501(c)(3), determine whether your organization can obtain tax-exempt status.
- Incorporate your business: If you haven’t already, you should convert to incorporation to obtain nonprofit status. This protects stakeholders from personal liability.
- Submit Form 1023: Apply for 501(c)(3) tax-exempt status using Form 1023; all paperwork should reflect valid information. Approved organizations will receive a determination letter from the IRS.
- Register with the state: Depending on your operating state, you may need to register your nonprofit at the local level to qualify for state tax exemptions.
Is it easier to manage a nonprofit or for-profit?
Managing a for-profit business can be easier than managing a nonprofit. For-profit organizations have fewer regulations and more control over how they use their funds. In contrast, nonprofits have fund restrictions and must comply with stringent reporting guidelines, which can vary based on the stakeholders involved, such as donors and regulatory agencies. These restrictions can lead to unstable revenue streams, making it challenging to support long-term programs.
“A unique challenge for any nonprofit organization is funding stability since they often rely on grants, donations, [and] fundraising—revenue flows which can be very unpredictable,” Helfand said. “For instance, if a major grant is not renewed, the organization may struggle to sustain its services and staff.”
In addition to continually meeting IRS criteria and compliance requirements, nonprofit organizations must also manage paperwork and reporting for their programs, campaigns, and grant opportunities. They must adhere to the budget set by the nonprofit’s board of directors, meet its specific requirements, and address its concerns.
Despite these challenges, Helfand notes that passionate change-makers willing to work hard will find nonprofit leadership rewarding.
“Nonprofit work can be challenging, but with resilience, adaptability, a very strong staff to back you up, and a clear focus on impact, a leader can create meaningful and lasting change,” Helfand highlighted.
[Read more: Loan Types for Nonprofit Businesses]
Which legal entity is best for your business?
Choosing the proper business structure depends on your goals, business experience, target audience, and desired tax advantages.
“If the primary goal is social impact or addressing a public need without seeking personal profit, a nonprofit may be the best choice,” Helfand said. “If the goal is financial gain and growth, a for-profit structure is more suitable.”
Both nonprofit and NFPO structures offer tax benefits, though nonprofits must meet stricter qualifications. Both can fundraise, accept donations and membership dues, and earn from selling refurbished goods. However, NFPO contributions support more focused missions or specific communities, not the public.
“Some experience working in and for traditional businesses could prove beneficial [for nonprofit leaders], but one must develop and sustain a passion for a specific cause,” Helfand said. “[They] need to have … experience in strategic planning, financial management, and strong leadership. They need to … build diverse revenue streams, develop and invest in relationships with donors and stakeholders, and surround [themselves] with a team that shares the nonprofit’s vision.”
A for-profit business is more appropriate if you want to make money and grow your wealth without restriction. With this structure, you can obtain funding from external sources, sell products or services for profit, and potentially become publicly traded.
Emily Heaslip contributed to this article.
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