Apologies in advance if this is a General Question, but I figured it might be debatable:
Say a guy I know asks me to try a cookie, and I tell him it’s the most delicious I’ve ever tasted. “Secret recipe,” he says with a chuckle; “I figure I can hire a baker, and write him a paycheck every week, and hire a salesman, and write him a paycheck every week — and, with a good manager keeping an eye on things, I figure tons of cash will come in: so much that I could even donate a little money to the local homeless shelter or something, while still pocketing a fortune as the 100% owner of the business!”
He adds that maybe he’ll hire a manager, and write him a check every week — or maybe he’ll just be the manager, and write himself a check every week. And I reply, with a chuckle of my own, that the more he pays himself as a manager, the less he’ll pocket as the owner.
He thinks about that for a moment, and then his eyes go wide. “Wait a minute,” he says; “I just got a great idea: I’ll pay a fortune to the manager, and pocket nothing as an owner! That way, I can throw around terms like ‘nonprofit’ or ‘not-for-profit’ or whatever, and probably rack up more sales and bring in more money as a result!” He starts scribbling a mathematical formula or something, and then triumphantly declares that he’s got a heck of a sales pitch: that, after paying the employees and otherwise covering expenses, every dollar goes to charity!
Is he correct? Never mind whether it’s moral; is that legal?
Wouldn’t work in the US without fraudulent tax filings. You have to jump through a few hoops with the IRS to get 501c3 status (there are other kinds of non-profits, like churches and foundations, but they tend to be more restrictive).
So, if you could get away with lying about what you are doing that meets the definition of a nonprofit, yeah you could do it. Just “throwing the term around” won’t cut it. And if you’re caught, you’ll get in trouble.
But even more than that, legitimate non-profits can run into problems as well if they try to compensate executives too highly. So creating a non-profit, collecting a million bucks for children, giving the children 100k and paying yourself the rest as the CEO is almost certainly going to get you audited and shut down.
The IRS flags returns that show that compensation is high compared to your actual philanthropic use or if you spend a lot of money on fundraising but not so much on actual charity (so no, raising money just to throw big parties to raise more money isn’t a real charity either).
Much obliged. But it’s the specifics that I’m curious about: you say the problem is compensation being “high”, or spending “a lot” of money on the fundraising efforts compared to the actual charity — but does it get more particular than, as you put it, “too highly?”
Up to 2015 the National Football League (NFL) was a 501(c) non profit entity. Lots of people making big bucks there, but somehow not getting into trouble.
I worked for a Public TV station for a time. I sold advertising for their monthly magazine, which was a profitable venture. I was surprised to find out that non-profits can run profit-making businesses on the side, as long as the proceeds support the greater organization.
If you have a business, but you don’t make any money at it, that doesn’t make you a “non-profit organization.” You have to be registered as such, and you have to prove it. There are rules, and there are watchdog organizations like Charity Navigator and Give dot org that will call you on it if you’re suspected of anything unethical. That isn’t to say that nefarious things never happen, however.
It’s almost certainly a case-by-case situation. Typically it would have to do with fair market value of the good or service. If your work as CEO (of, say, the NFL to use @corudstr’s example) is actually worth what you’re are being paid then it could be just fine.
I’m not a tax expert, but I did spend a few hours with an IRS investigator when our 501(c)3 PTO got audited due to a red flag on a tax return (too much revenue spent on fundraising).
A common guideline is that management expense (including fundraising) must not exceed 20%-30% of the total budget. Thus leaving 70%-80% that needs to be spent on the charitable non-profit function.
If you spend more than 30% on management salaries, benefits, or fundraising costs, that’s a red flag that will get the IRS scrutinizing your so-called ‘non-profit’. And often the Charities division of your state Attorney General office, too.
Since the original question has been answered, let me head off the next logical question:
Let’s say a legitimate 501(c)(3) organization (for our purposes, let’s say it’s an animal welfare group) stumbles across the greatest cookie recipe of all time, and starts selling them to supplement their revenue. They make money hand over fist, everyone gets huge raises, they sell them in every grocery store in the tri-state area, etc. What then?
Well, the IRS cracks down on them and makes them pay taxes on Unrelated Business Income. Making and selling cookies has nothing to do with taking care of animals,
But that sort of comes back to my question: it seems like they could, legitimately, argue that they’re making and selling cookies to bring in more money, which in turn lets them take care of more animals because they can now spend considerably more money than they did last year — and they’re also paying their employees considerably more than they did last year.
I mean, there already is a prominent example of a nonprofit organization for which selling cookies is a big chunk of their income. Although the Girl Scouts probably claim that selling cookies is related to their charitable purpose, because it teaches girls entrepreneurial skills.
It’s sort of like charities that claim as part of their purpose “helping veterans find jobs”, and then a big chunk of their money goes towards payroll, because they’re themselves employing veterans.
Another example; Newman’s Own, the food company started by Paul Newman and A.E. Hotchner. All of the after-tax profits go to a non-profit foundation; over $600 million in charitable contributions since 1982. Note that in the case of Paul Newman, he started with a salad dressing rather than a cookie.
No - the income from cookies is Unrelated Business Income. There is nothing about making and selling cookies that has anything to do with animal welfare, and you certainly will not convince the IRS there is - it’s the very definition of “Unrelated Business Income”. Just because the money is diverted to animal welfare doesn’t make the generation of it irrelevant.
Sure. They just have to pay corporate income taxes on it.
Also, employees of non-profits pay income taxes just like everyone else. It’s not like being part of a non-profit somehow makes you immune from a W2.
I just want to comment that one of the first things they told us in business school is that one of the major failings of small business owners is an inability or unwillingness to fairly compensate themselves for their own time.
Meaning that if someone’s got a restaurant and is putting in 100 hours a week on it and not paying themselves a salary, they’re skewing their numbers and underselling their own labor. The recommendation was to actually pay yourself a salary and be aware of how much you’re working; many small businesses are not actually profitable, except for the owners and their families working uncompensated or for sub-minimum wages, even with the owner’s share of the “profits”.
Put differently, they’d be better off overall financially just having a job somewhere rather than grinding at that small business.
True… it was more of a cautionary tale for newly-minted MBA graduates to be aware of if they got bit by the entrepreneurial bug than anything else, as well as a quick introduction to the idea that profit isn’t always profit, if you’re not accounting for everything.