Blog

Virtually every nonprofit needs to generate revenue to fulfill its mission. Most generate their income through donations and membership fees, but many also charge for program services or even product sales. Generating revenue through any or all of these means does not put a nonprofit’s legal status at risk.

What matters is what nonprofits do with any money left over after operating expenses. In a compliant nonprofit, excess revenue must be reinvested into the organization’s mission, not distributed as profit to founders, directors, or stakeholders.

Does Paying Large Salaries to Executives Count as Profiting from a Nonprofit?

One of the most common points of confusion is how nonprofit executives can earn six- or seven-figure salaries. People often ask, “How can it be a nonprofit if the director is making a million dollars a year?”

Nonprofits are allowed to pay staff competitive wages for the work performed. The IRS does not cap nonprofit salaries, but it requires that compensation be fair and appropriate for the role, based on:

• The individual’s qualifications and experience
• The complexity and scope of the job
• Salaries paid for similar positions at comparable organizations
• Cost of living and market rates in the area

A $1 million salary may raise eyebrows, but if the organization is multi-state or international, managing hundreds of employees and millions in donations, a seven-figure salary may be appropriate. However, nonprofit salaries are subject to oversight and rules that for-profit businesses don’t have to worry about. Nonprofit boards must ensure internal compliance with compensation rules to avoid issues that could compromise their status.

Can Founders and Nonprofit Board Members Game the System by Overpaying Themselves?

Inflating the salary of executives or board members or funneling excess profits into a disguised form of personal gain can trigger IRS penalties. This is known as an excess benefit transaction, a form of private inurement, and it's strictly prohibited for 501(c)(3) organizations.

If the IRS determines that an insider (such as a board member or executive) received unreasonable compensation:

• The organization can face excise taxes
• The individual may be personally liable for repaying the excess
• Repeated or willful violations can lead to revocation of tax-exempt status

To protect themselves, nonprofits should:

• Use third-party compensation studies or Form 990 comparisons
• Have independent board members approve compensation packages
• Document the review and approval process clearly in meeting minutes

What About Lavish Spending on Donor Perks?

Some nonprofits face criticism for spending more on fundraising and donor cultivation than on their actual mission. High-end galas, retreats, or travel perks may be legal if they support fundraising efforts, but they can raise serious ethical and reputational concerns if mission-related spending is minimal by comparison.

The IRS does not prohibit fundraising expenses, but nonprofits must ensure that spending is reasonable, documented, and ultimately in service of the organization’s exempt purpose. Excessive spending on donor perks can invite public backlash, watchdog scrutiny, or even jeopardize donor trust.

Watch Out for Unrelated Business Income

Problems can arise when nonprofits engage in activities unrelated to their core mission, especially if those activities resemble commercial business operations. This type of revenue is known as unrelated business income (UBI).

For example, a youth sports nonprofit that sells concessions at games is likely fine. But if that same organization starts operating a full-time coffee shop open to the public with no programmatic tie-in, the IRS may classify the earnings as UBI.

If an activity meets the UBI criteria, the nonprofit may owe unrelated business income tax (UBIT) on the net earnings from that activity. This doesn’t necessarily jeopardize tax-exempt status, but it does create reporting and tax obligations.

Even if a nonprofit earns unrelated business income and pays taxes on it, it still cannot distribute the remaining profit to individuals like an owner or shareholder.

How Much Unrelated Revenue Is Too Much?

There is no set dollar threshold for what counts as “substantial,” but some tax professionals use a rough benchmark of 15% to 20% of total revenue. However, each case is evaluated individually, and how the revenue is earned and used can matter just as much as the percentage.

Best Practices for Earning Revenue Legally and Justifying Expenses

• Ensure that revenue-generating activities clearly support the mission
• Avoid excessive unrelated business income or operate it through a separate taxable subsidiary
• Document all board approvals for contracts, compensation, or new business ventures
• Pay staff and insiders reasonable compensation based on market standards
• Reinvest all net revenue into programming, operations, or reserves

Thorough Documentation and Experienced Legal Review from an Unaffiliated Third-Party Can Help

Working with reputable outside nonprofit general counsel for legal audits and risk assessments can demonstrate that a nonprofit’s revenue-generating activities and spending are being reviewed by an unbiased party that’s focused on compliance.

Atlanta nonprofits can call the Law Office of Cameron Hawkins at 678-921-4225 for a consultation and more information.