How Much Can a Non-Profit Legally Spend on Overhead?

By John Green

Until recently, nonprofit organizations were not subject to specific limits on the amount they could spend on salaries, fundraising and other overhead expenses. However, overhead expenditures by nonprofits exempt from federal income tax may come under scrutiny by the Internal Revenue Service, and new legal restrictions on overhead spending are also being put in place by some state governments.

The Nondistribution Constraint

As Yale Law School Professor Henry Hansmann observes in "The Ownership of Enterprise," nonprofit organizations are subject to the nondistribution constraint, which is a legal prohibition on distributing net profits to insiders. For example, charities can be subject to financial penalties and even lose their federal tax exempt status, if they pay salaries that the IRS determines to be excessive.

New York's Limit on State Funding

As nonprofit lawyer Bruce Hopkins observes in "The Law of Fundraising," the U.S. Supreme Court has struck down several attempts to limit nonprofit fundraising expenditures. However, in 2012, Governor Andrew Cuomo of New York, placed specific limits on overhead expenses for nonprofits receiving state grant funding: total overhead expenditures cannot exceed 25 percent of state grant support to a nonprofit, with no more than $199,000 going to an executive's salary.

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The Oregon Law

In recent years, several state legislatures have also tried to pass new restrictions on nonprofit overhead, and in 2013, the Oregon legislature enacted a specific limit on overhead expenditures. As of January 1, 2014, a charity that does not spend at least 30 percent of its expenditures on its charitable programs can be stripped of its eligibility to receive donations exempt from Oregon's state income tax.

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Rules & Regulations for Non Profit Foundations

Nonprofit foundations that meet certain requirements are eligible for special tax treatment by the IRS under Section 501(c)(3) of the Internal Revenue Code. Donors to such organizations enjoy tax benefits as well. Most nonprofit organizations must apply for 510(c)(3) status before taking advantage of its benefits. Under certain circumstances, however, the IRS may revoke a nonprofit foundation's status.

IRS and Laws Prohibiting Nonprofits From Political Activity

Federal tax laws prohibit nonprofit organizations from engaging in partisan political activity. Tax-exempt organizations may run afoul of the Internal Revenue Service if those groups take part in political campaigns for or against a candidate for public office. Nonprofits that violate IRS guidelines and U.S. laws prohibiting nonprofits from partisan political activity risk losing their tax-exempt status and may also incur tax penalties.

501(c)(3) Auxiliary Restrictions

A 501(c)(3) auxiliary organization is an independent legal entity organized to support a parent organization that is organized as a 501(c)(3), such as a church, university, hospital or other charity. With some exceptions, a 501(c)(3) auxiliary must follow the same restrictions as its parent organization. These restrictions include rules about the organization's purpose, activities and profit distributions.

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