My radio program piece I posted last week generated some good discussion in the comments. In this post I would like to follow up by providing some background to the discussion that nonprofit organizations are not fully deserving of the aura they they receive. The following is a synopsis of the Nonprofit Structure training I give for AmeriCorps*VISTA members; you can also watch the 40 minute training.

Most people have heard of what I will, for the rest of this article, call nonprofit organizations, nonprofits, or the nonprofit sector. There are many terms though that people use:

  • Non-profit (with a hypehen)

  • Not-for-Profit

  • Charity (or Charitable Organization)

  • Agency

  • NGO (Non-Governmental Organization)

  • Social Change Agency

  • Mission-Based Organization

  • Community Benefit Organization

  • Philanthropic Agency

  • Voluntary Sector

  • Third Sector (the first two being the Public and Private Sector)

Regardless of what you call a nonprofit, it’s really only but two elements:

  1. A Corporation: an incorporated entity that provides limited liability for its agents and its actions

  2. Tax Exemption: generated (program income) and contributed (donations) revenue are not subject to taxation

These two foundational pieces are explicitly regulated by the government: state governments determine the rules under which an entity may incorporate; the Federal Government—Congress, the Courts and especially the IRS—determine why a corporation may be tax-exempt. Important point:

By allowing certain corporations to be tax-exempt, the government, in effect, provides an indirect subsidy of about 25% of their income.

(This frame is not my own idea, but was first presented to me by Michael Davidson of Governance Matters from this post on board governance)

Why would the government provide such a subsidy? The rules for tax-exempt organizations are laid out in the 501(c) tax statute, but Nonprofit Organizations, as we think of them, lie specifically within the 501(c)3 statute. This statute lays out exempt purposes for charitable, religious, educational, and scientific purposes (as well as some very specific ones, like international sports competitions). Charitable is defined in the generally accepted legal sense as relief of the poor or distressed, lessening burdens, eliminating prejudice and discrimination and other things.

In actuality, the purposes for which a nonprofit organization can organize are near in-exhaustible. As Norman Silber argues in A Corporate Form of Freedom, court cases during the 1950s and 1960s (especially NAACP v. Patterson and Association for the Preservation of Freedom of Choice v. The Secretary of New York State) eroded Discretionary Conception—the legal framework under which the formative purpose of a corporation could be contested. These court decisions created a near entitlement to organize for any purported social purpose upon the grounds of liberty and the 1st Amendment.

Because of these decisions, it’s perhaps more important to look at the few reason for which a nonprofit may not incorporate, or actions an incorporated Nonprofit may not take. Here they are:

  1. May not attempt to influence legislation as a substantial part of its activities and it may not participate in any campaign activity for or against political candidates.

  2. None of its earnings may inure to (i.e. there is no equity to be owned), or activities benefit any private shareholder or individual.

Number 2 on that list is a pretty self-evident, but Number 1 is the prime reason that nonprofit organizations are beggared in their ability to effectively change society for the better. The context and effect of this fundamental rule though will have to be left to another post.