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Since non-profits are established with a specific promise to return the profits into the organization and to not pass them along to any officer, director or employee of the organization, some financial transactions are bound to raise a red flag or be a cause for a non-profit to lose access to federal grants, community donations, and tax exemption. These transactions fall into two categories.
Private Benefit/ Inurement
While directors and staff employed by a non-profit have a right to a reasonable salary, anything beyond what is considered reasonable, even if it’s not a monetary compensation, is considered to be an inappropriate and illegal appropriation of non-profit funds. This category includes the crime of embezzlement.
Unrelated Business Income
A non-profit could stand to lose its 501(c)(3) tax-exempt status if it has too much income generated from activities or trade that are regularly carried on and are unrelated to the exempt function of the organization.
If your business plan includes regularly carried on trade or business from which you would like to retain a profit, you can consider structuring your business as a social enterprise rather than a non-profit. California recently introduced two “hybrid” corporate forms for social enterprises: flexible purpose corporations and benefit corporations. The Startup Garage has helped several social enterprises begin their businesses – please look through The Startup Garage’s web site for more information on beginning a social enterprise.