Difference Between a Nonprofits and Charities: Comprehensive Guide

The terms “nonprofit” and “charity” are often used interchangeably, but in the legal and operational world, they represent distinct entities. Understanding the difference between these two types of organizations is crucial for anyone looking to start a mission-driven venture or contribute to one. Nonprofits and charities may both serve the public interest, but their structures, funding sources, and legal responsibilities vary significantly.

This guide delves into the distinctions between nonprofits and charities, clarifying their legal definitions, tax status, funding mechanisms, and operational differences. Whether you’re a prospective founder, donor, or board member, this comprehensive overview will equip you with the knowledge to navigate the nonprofit sector effectively.

What Is a Nonprofit?

A nonprofit organization is a legal entity that operates for a collective, public, or social benefit rather than for the purpose of generating profit. Nonprofits can include a wide range of organizations, such as educational institutions, trade associations, professional societies, hospitals, and even certain political organizations.

The primary goal of a nonprofit is to serve a public or mutual benefit without distributing profits to members, directors, or officers.

In the U.S., nonprofits are commonly formed as corporations and governed by state laws. While they may generate revenue, any surplus must be reinvested into the organization’s mission rather than being distributed to shareholders or members.

Nonprofits operate in various sectors, including:

• Healthcare: Nonprofits like hospitals and health clinics provide essential services to communities, often for little to no cost to the patients.
• Education: Schools, universities, and educational foundations frequently operate as nonprofit organizations.
• Advocacy Groups: Many environmental, political, and social advocacy organizations are established as nonprofits.

A nonprofit organization does not automatically qualify for charitable tax-exempt status, which leads us to the next section—understanding what a charity is.

What Is a Charity?

A charity is a type of nonprofit organization that is specifically focused on charitable activities, which usually include helping those in need, advancing education, or supporting religious, scientific, or literary causes. Charities are eligible to apply for 501(c)(3) status under the Internal Revenue Code in the U.S., which allows them to receive tax-deductible donations and qualify for other tax exemptions.

The key characteristic of a charity is its emphasis on providing public benefit, typically through donations, volunteer work, or offering services to underserved populations. Charitable organizations often include:

• Human Services Charities: Organizations like food banks, homeless shelters, and disaster relief groups fall under this category.
• Educational Charities: Scholarships, tutoring programs, and institutions that promote education can be considered charitable.
• Religious Organizations: Churches, mosques, synagogues, and religious charities that provide aid and spiritual services to communities also qualify as charitable organizations.

Charities are required to ensure their operations align with the public interest to maintain their tax-exempt status, making it critical that they meet specific legal and regulatory requirements.

Legal Definitions of Nonprofits vs. Charities

Nonprofit Legal Definition

In the U.S., a nonprofit organization is defined as an entity that is organized for purposes other than generating profit. Nonprofits are typically registered as corporations under state law and can range from social clubs and homeowner associations to educational and health organizations. Nonprofits are not required to obtain tax-exempt status, but many do apply for it under different sections of the Internal Revenue Code, such as 501(c)(4) for social welfare organizations or 501(c)(6) for business leagues.

The legal structure of a nonprofit typically includes a board of directors responsible for governance, and any income or surplus must be used to further the organization’s purpose rather than be distributed to members.

Charity Legal Definition

A charity, on the other hand, is specifically defined as an organization that engages in charitable activities. In the U.S., most charities seek 501(c)(3) status, which is the section of the Internal Revenue Code that grants tax exemption to organizations whose purposes include religious, educational, scientific, and charitable endeavors.

To qualify as a charity under 501(c)(3), the organization must meet several criteria:

• Operate for the public good
• Not engage in political campaigning or lobbying as a substantial part of its activities
• Ensure that no part of the organization’s income benefits private individuals

Charities must adhere to strict IRS regulations, especially concerning how funds are raised, managed, and distributed.

Tax Status and Exemptions

Tax Status for Nonprofits

Nonprofits may or may not be tax-exempt. A nonprofit organization can apply for tax-exempt status under various sections of the U.S. Internal Revenue Code, depending on its mission and activities. For instance, a 501(c)(4) organization focuses on promoting social welfare but is not eligible to receive tax-deductible donations.

Other types of tax-exempt nonprofits include:

• 501(c)(5): Labor and agricultural organizations
• 501(c)(6): Business leagues, chambers of commerce, and professional associations

These types of nonprofits are still exempt from federal income tax but are subject to different rules compared to charities under 501(c)(3).

Tax Status for Charities

Charities that qualify under 501(c)(3) are considered tax-exempt at both the federal and state levels. Additionally, donations made to these charities are typically tax-deductible for the donors.

Charities must file an annual report (Form 990) with the IRS, disclosing their income, expenses, and activities to ensure they are operating within their tax-exempt purpose. Failure to comply with IRS requirements could lead to the revocation of tax-exempt status.

Key Takeaway: All charities are nonprofits, but not all nonprofits are charities. The distinction lies in their tax status and the types of activities they undertake.

Funding Sources for Nonprofits and Charities

The way nonprofits and charities generate revenue can also differ. Nonprofits often rely on a mix of funding sources, while charities tend to focus more heavily on donations and grants.

Nonprofit Funding Sources

Nonprofits can have a diverse range of revenue streams, including:

• Membership Fees: Many nonprofit organizations, such as professional associations or social clubs, generate income from membership dues.
• Service Fees: Nonprofits like hospitals or educational institutions may charge for services rendered, though they reinvest the income into their operations.
• Grants: Nonprofits often apply for governmental or private foundation grants to fund specific programs or initiatives.

Charity Funding Sources

Charities, on the other hand, are more likely to rely heavily on:

• Donations: Individual and corporate donations are the lifeblood of many charities, especially those with 501(c)(3) status.
• Fundraising Events: Charities frequently host events like auctions, galas, or walkathons to raise money for their causes.
• Grants: Many charities also apply for grants from private foundations or government programs that support their charitable mission.

Charitable Contributions and Deductibility

One of the main differences between nonprofits and charities lies in how donations are treated for tax purposes.

Nonprofit Contributions

Nonprofit organizations that do not have 501(c)(3) status can still receive contributions, but these donations are typically not tax-deductible for the donor. Nonprofits without charitable status often rely on other income sources, like membership dues or service fees, rather than donations.

Charity Contributions

Charities with 501(c)(3) status enjoy a significant advantage when it comes to fundraising: donations made to them are tax-deductible for the donor. This is a powerful incentive for individuals and businesses to contribute to charities. However, charities must provide donors with appropriate documentation for tax purposes, such as receipts for large donations.

Operational Differences Between Nonprofits and Charities

While both nonprofits and charities are mission-driven, their operations and governance structures can vary.

Governance

Nonprofits typically have a board of directors that oversees the organization’s activities, ensuring that the mission is being fulfilled. Nonprofits can be large organizations with multiple layers of governance, or they can be smaller and less formal in structure.

Charities, however, are often required to have a more formal governance structure, especially if they are 501(c)(3) organizations. This typically includes a board of directors, bylaws, and strict rules on conflict of interest to ensure that funds are used for public benefit.

Public Accountability

Charities must adhere to higher levels of public accountability. They are required to file Form 990 with the IRS annually, which details their finances, operations, and governance. These documents are publicly available, which helps maintain transparency and trust with donors.

Nonprofits that do not have 501(c)(3) status may not be subject to the same level of scrutiny, although they still have to maintain good governance practices.

Benefits of Forming a Nonprofit vs. Charity

Choosing between forming a nonprofit or a charity depends largely on the goals of the organization.

Benefits of Forming a Nonprofit

• Flexibility: Nonprofits have more flexibility in their operations and funding mechanisms. For example, they can engage in a broader range of activities like advocacy or trade association work.
• Broader Purpose: Nonprofits aren’t restricted to charitable purposes. They can exist to serve a membership base or support professional industries.

Benefits of Forming a Charity

• Tax Deductibility: Charities offer tax deductions for donors, which can be a powerful incentive for fundraising.
• Public Trust: Charities often enjoy a higher level of public trust and support due to their mission-driven focus and tax-exempt status.

Examples of Nonprofits That Are Not Charities

Not all nonprofits operate as charities. Some examples include:

• Trade Associations: Organizations like the American Medical Association (AMA) exist to support professionals within an industry, but they don’t qualify as charities.
• Social Clubs: Many social clubs, such as country clubs or recreational groups, are nonprofits that focus on providing services to their members.
• Political Action Committees (PACs): These organizations may operate as nonprofits but are not considered charitable and cannot qualify for 501(c)(3) status.

FAQs

Conclusion

While both nonprofits and charities serve the public good, their operational structures, tax treatment, and funding sources differ significantly. Understanding these distinctions is crucial for anyone looking to form or contribute to a mission-driven organization.

Nonprofits offer broader flexibility in purpose, while charities enjoy significant tax benefits and public trust. When considering which type of entity to establish, it’s essential to weigh the operational goals, funding needs, and compliance obligations that each structure entails.