How Does a Nonprofit Make Money?

A nonprofit makes money the same ways anything else does: it is given money, it earns money, and it is paid under contracts. What distinguishes it is not how money comes in but what may happen to it once it is there.

Nonprofits may charge for services, run a surplus, hold reserves, invest, and pay competitive salaries. The prohibition is on distributing net earnings to directors, officers or other insiders. That is the whole of it.

The six revenue types

The fourth row surprises people. Across the sector as a whole, fees for services and goods are the largest revenue source, not donations. That figure is dominated by hospitals and universities, which is exactly why sector averages are a poor guide to what your own mix should be.

Charitable giving, and where it comes from

Americans gave $617.20 billion in 2025. Individuals gave $394.20 billion of it, 63.9%. Foundations gave 19.0%, bequests 10.1% and corporations 7.1%.

The practical implication for a small organization: individuals are roughly three quarters of all giving once bequests are counted, and corporate giving is 7%. Fundraising effort is frequently allocated in close to the opposite proportion.

Can a nonprofit charge for what it does

Yes, and many should. A theatre sells tickets, a nursery charges fees, a training organization charges for courses, a museum charges admission. None of that threatens exempt status where the activity furthers the exempt purpose.

Earned revenue has a quality donations lack: it is unrestricted, it recurs, and it does not require anyone to be asked. Organizations that can charge and choose not to, on the grounds that charging feels wrong, are often choosing dependence on grants instead.

Where charging would exclude the people you exist to serve, the usual answer is a sliding scale or free places funded by donations, not free provision to everyone including those who could pay.

The limit: unrelated business income

Exemption does not make all income untaxed. Income from a trade or business regularly carried on, that is not substantially related to your exempt purpose, may be unrelated business taxable income and reported on Form 990-T.

Several exclusions apply, including activities carried out substantially by volunteers and sales of donated merchandise. If any meaningful share of your income looks like ordinary commerce, raise it with your accountant rather than assuming exemption covers it.

Note also that a large unrelated business relative to your exempt activity is a different and more serious question than the tax. It can put exemption itself at risk.

Where the money goes

Salaries, rent, insurance, programmes, technology, accounting and reserves. A nonprofit pays for the same things any organization pays for, and paying reasonable compensation for real work is not inurement.

What is prohibited is distributing net earnings to insiders. In practice that means: no dividends, no owner draws, no compensation above a reasonable amount for the role, and no arrangements routing charitable money to directors, officers or their families on terms better than arm’s length.

Surplus is not only permitted, it is necessary. An organization that spends exactly what it receives has no reserves, cannot absorb a late grant, and cannot invest in anything. Building an operating reserve is a deliberate act, budgeted as a line, not whatever happens to be left in December.

Government funding behaves differently

Public money is often called a grant and behaves more like a contract, and treating the two the same is how a growth opportunity becomes a cash crisis.

Most government funding is paid in arrears against expenditure already incurred, sometimes months later. That means you fund the work from your own cash first. An organization without reserves cannot safely accept a large reimbursement-based award, however good the programme is.

The compliance obligations are also substantial: allowable cost rules, procurement requirements, record retention and detailed reporting. Above a threshold of federal spending in a year you must have a Single Audit, which is more demanding and more expensive than an ordinary audit.

One thing organizations routinely lose money on: indirect costs. Federal awards recognise them, and a de minimis rate is available to organizations without a negotiated rate. Claiming nothing because nobody explained this is a real and avoidable loss.

Diversification, and the concentration risk

The single most useful question about a nonprofit’s finances is not how much it raises but how much comes from its largest source.

If one funder provides more than about a third of your income, their non-renewal is an existential event rather than a setback. That is true whether the source is a foundation, a government contract, or one very generous individual, and organizations rarely notice the exposure until it materialises.

Diversifying is slow and it is the work that protects everything else. The practical route for most small organizations is individual giving, because it is the only source with no eligibility criteria, no application cycle and no renewal decision made by somebody else.

It also compounds. A monthly donor recruited this year is still giving in three years, which is not true of a project grant.

A realistic first-year mix

Organizations that plan year one around grants usually spend it waiting. Grants fund the year after next; individual giving funds now.

Questions people ask

Can a nonprofit make a profit?

Yes, and a well-run one should. The restriction is on distribution, not on generating a surplus.

A nonprofit that spends exactly what it receives has no reserves, cannot absorb a grant that arrives late, and cannot invest in anything. Surplus retained in the organization and applied to the mission is entirely proper, and building an operating reserve is a deliberate act rather than an accident.

What is prohibited is inurement: distributing net earnings to directors, officers or other insiders. Paying reasonable compensation for real work is not inurement.

Can a nonprofit charge for its services?

Yes, and across the sector fees for services are the largest single revenue source, larger than donations.

Theatres sell tickets, schools charge tuition, clinics bill for care, training organizations charge for courses. Where the activity furthers the exempt purpose, charging for it does not threaten exemption.

Earned revenue has qualities donations lack. It is unrestricted, it recurs, and it does not require anyone to be asked for it.

Where a fee would exclude the people you exist to serve, the normal answer is a sliding scale or funded free places, rather than free provision to everyone including those who can pay.

What percentage of nonprofit income comes from donations?

Across the whole sector, a minority. Fees for services and goods, including tuition, hospital charges and government payments per unit of service, are the largest source.

That figure is dominated by hospitals and universities, so it describes the sector rather than your organization. The picture inverts as organizations get smaller: an all-volunteer neighbourhood group may be funded entirely by donations.

The useful comparison is not the sector average but organizations of your size in your field, and their Form 990s are public. Pull three from ProPublica Nonprofit Explorer and you will learn more than any national figure will tell you.

Do nonprofits pay taxes?

Recognised 501(c)(3) organizations do not pay federal income tax on income related to their exempt purpose. They do pay other taxes.

Payroll taxes apply to employees, though many 501(c)(3) organizations are exempt from federal unemployment tax and may have options on state unemployment.

Income from an unrelated trade or business regularly carried on may be taxable and reported on Form 990-T, even though the organization remains exempt.

State and local taxes are separate. Federal exemption does not grant exemption from state income tax, sales tax or property tax; each is applied for through your state, and property tax exemption in particular is often decided locally.

How do nonprofits pay their staff?

The same way any employer does. Salaries or wages, payroll taxes withheld and remitted, W-2s in January.

Compensation must be reasonable for the role, which is determined by comparison rather than by feel. For senior staff, the sensible process is to review comparability data from similar organizations, have the disinterested directors approve it, and record both in the minutes.

Paying above a reasonable amount risks excess benefit consequences that can fall on the individual and on the managers who approved it. The full Form 990 discloses compensation of the highest paid people, so the figures are public.

Treating staff as contractors to avoid payroll obligations is a classification problem, not a saving, and it is one the IRS and state agencies actively examine.

What is unrelated business income?

Income from a trade or business regularly carried on that is not substantially related to your exempt purpose. It is reported on Form 990-T and may be taxable even though the organization remains exempt.

The three tests are all required: it must be a trade or business, carried on regularly, and not substantially related to the exempt purpose. Occasional activity generally fails the second test.

Important exclusions apply, including activity carried out substantially by unpaid volunteers, and sales of merchandise received as donations, which is why volunteer-run thrift stores typically fall outside it.

The tax is the smaller issue. An unrelated business that becomes large relative to your exempt activity can put exemption itself at risk.

Can a nonprofit have investments?

Yes. Holding reserves in interest-bearing accounts or investing an endowment is normal and prudent, and public charities pay no excise tax on the income.

Private foundations are treated differently: they pay an excise tax on net investment income and must distribute broadly 5% of assets annually.

Boards should adopt a written investment policy setting out objectives, risk tolerance, liquidity requirements and who may act. Directors' duty of care applies to investment decisions, and most states have adopted prudent investment standards for charitable funds.

For a small organization the practical question is simpler: reserves should be somewhere safe and accessible, since their purpose is to be available in a bad month.

How much money should a nonprofit keep in reserve?

Three months of operating expenses is the figure most commonly cited as a floor, and most small organizations hold considerably less.

Reserves are not built by having a good year. They are built by putting a reserve contribution in the budget as an expense line, funding it monthly, and treating it as unavailable. An organization planning to save whatever is left at year end saves nothing, because there is never anything left.

Holding reserves is not hoarding and does not conflict with charitable purpose. An organization that cannot survive one late payment is not in a position to serve anyone reliably.

Note the distinction that matters: reserves must be unrestricted. A large balance made up mostly of restricted grant money is not a reserve.

This is reference information, not legal or tax advice. Rules vary by state and change over time. For a decision that carries real consequences, check the current text at irs.gov or your state registry, and talk to a nonprofit attorney or CPA.