Nonprofit Finance
The short answer is yes. The slightly longer answer is: yes, and they should. The name “nonprofit” creates a fundamental misunderstanding that has caused real damage to the sector for decades. People hear “nonprofit” and assume these organizations are supposed to break even every year, spend every dollar they receive, and operate on razor-thin margins with no financial cushion.
That’s not what the law requires. It’s not what the IRS expects. And it’s not how financially healthy organizations operate.
Here’s what the term actually means, what the legal restrictions really are, and why the most effective nonprofits in the country deliberately generate surplus revenue.
The term “nonprofit” describes one thing and one thing only: the organization does not distribute profits to owners or shareholders. That’s it. There are no owners. There are no shareholders. There are no dividends. Any surplus revenue stays inside the organization and gets reinvested into the mission.
A nonprofit can charge fees for services. It can sell products. It can earn investment returns. It can accumulate savings. It can build an endowment. It can generate millions of dollars more than it spends in a given year. All of this is perfectly legal and, in many cases, a sign of strong organizational health.
Consider that US nonprofits collectively generate $3.7 trillion in annual revenue and spend about $3.5 trillion. That $200 billion gap isn’t a scandal — it’s the sector building financial stability, investing in future capacity, and maintaining reserves against economic uncertainty.
The IRS doesn’t care whether a 501(c)(3) organization generates surplus revenue. It cares about two things:
That’s the entire framework. You can make as much money as you want. You can save as much money as you want. You just can’t give it to individuals as profit. Everything must be reinvested into the mission.
There’s a persistent and harmful belief in the nonprofit sector that organizations should spend every dollar they receive, that low overhead is inherently virtuous, and that having money in the bank means you’re not doing enough good. This mindset, sometimes called the “nonprofit starvation cycle,” has been thoroughly debunked by researchers and practitioners.
Here’s why generating surplus revenue is not just acceptable but essential:
Most financial experts and nonprofit governance organizations recommend maintaining operating reserves equal to 3–6 months of annual operating expenses. This provides a financial cushion against revenue disruptions, unexpected costs, and seasonal cash flow gaps.
| Annual Budget | Recommended Reserve | Months of Coverage |
|---|---|---|
| Under $500K | $125K – $250K | 3–6 months |
| $500K – $2M | $250K – $1M | 3–6 months |
| $2M – $10M | $500K – $5M | 3–6 months |
| $10M+ | $2.5M – $5M+ | 3–6 months |
Some organizations maintain significantly larger reserves — particularly those with endowments, capital plans, or revenue models subject to high volatility (such as organizations dependent on a few large government contracts). This is acceptable as long as the board has a documented reserve policy with a clear rationale.
The key point: having reserves is a sign of good management, not hoarding. A nonprofit board that deliberately builds financial stability is fulfilling its fiduciary responsibility, not violating it.
While nonprofits are generally exempt from federal income tax, there is one important exception: Unrelated Business Income Tax (UBIT). This applies to income from business activities that are not “substantially related” to the organization’s exempt purpose.
The three-part test for UBIT is straightforward:
If all three answers are yes, the income is subject to UBIT at the standard corporate rate of 21%. Organizations with more than $1,000 in unrelated business income must file IRS Form 990-T.
| Activity | UBIT Applies? | Reason |
|---|---|---|
| Museum gift shop (mission-related items) | No | Related to educational purpose |
| Hospital cafeteria for patients/visitors | No | Convenient for exempt function |
| University bookstore selling textbooks | No | Related to educational purpose |
| Nonprofit renting unused office space | Yes | Not related to exempt purpose |
| Charity selling branded merchandise online | Likely yes | Unless items are educational in nature |
| Investment dividends and interest | No | Passive income exclusion |
| Volunteer-run thrift store | No | Volunteer labor exclusion |
UBIT isn’t something to fear — it’s something to manage. Many nonprofits have legitimate unrelated business income and simply pay the tax on it. The existence of UBIT doesn’t threaten tax-exempt status unless unrelated business activities become the organization’s primary activity, which would raise broader exempt-purpose questions.
While making a profit is perfectly legal, certain financial behaviors can jeopardize a nonprofit’s tax-exempt status or trigger IRS penalties:
The bottom line: making money isn’t the problem. What you do with it and how you govern the organization around it — those are what the IRS watches.
Our database of 1.65 million nonprofit organizations includes revenue data, employee counts, and contact information across all 50 states — useful for researchers, B2B teams, and anyone working with the nonprofit market.
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