A 501(c)(3) nonprofit can spend money on anything that genuinely advances its charitable, educational, religious, or scientific mission, including reasonable salaries, program costs, fundraising, and limited lobbying. The allowable expenses for nonprofit organizations are bounded on three sides: no personal enrichment of insiders, no campaign activity, and no spending that primarily serves private interests instead of the public. Staying inside those lines depends less on what you buy than on how you categorize, document, and report each dollar.
The Three Expense Categories Every Nonprofit Must Use
Form 990 requires every filing organization to sort its spending into three functional columns in Part IX: program services, management and general, and fundraising. The IRS reviews the allocation, and donors and grant makers use the ratios to judge efficiency.1Internal Revenue Service. Instructions for Form 990 Return of Organization Exempt From Income Tax
Program services are the direct costs of doing the mission work. For a food bank, that means the warehouse lease, delivery fuel, and the salaries of staff who sort and distribute food. Management and general covers overhead that keeps the organization running without directly delivering services: executive compensation, accounting fees, board meeting costs, general office rent, and insurance. Fundraising covers everything spent on soliciting donations, writing grants, and running fundraising events.
When a staff member’s time splits across categories, the salary has to split with it. Dumping the whole paycheck into the program column because the employee spends most of their time on programs is a common error the IRS looks for.1Internal Revenue Service. Instructions for Form 990 Return of Organization Exempt From Income Tax
Compensation and Benefits
Salaries, bonuses, and benefits for employees, officers, and board members are all allowable, but the amount has to be reasonable. Reasonable means comparable to what similar organizations in similar locations pay for similar work. Compensation that crosses into excessive territory becomes an “excess benefit transaction” under Section 4958, and the person who received it owes an initial excise tax of 25% of the excess amount. If they don’t repay it within the correction period, a second tax of 200% applies, and any manager who knowingly approved the payment owes 10%, capped at $20,000 per transaction.2Office of the Law Revision Counsel. 26 USC 4958 – Taxes on Excess Benefit Transactions
How to Lock In a Presumption of Reasonableness
A board can build itself a “rebuttable presumption of reasonableness” that shifts the burden to the IRS if compensation is later questioned. Three steps are required, and skipping any one loses the presumption entirely:3eCFR. 26 CFR 53.4958-6 – Rebuttable Presumption That a Transaction Is Not an Excess Benefit Transaction
- The compensation is approved in advance by a board or committee of people with no financial interest in the outcome.
- That body relies on comparable data: compensation surveys, peer job postings, or written competing offers.
- The decision, the data reviewed, and the reasoning are documented at the time of the meeting. Writing the minutes months later does not count.
Fundraising Costs
The costs of raising money are legitimate expenses as long as they sit in the fundraising column. Event costs, printing and postage for solicitations, professional fundraiser fees, and the fundraising portion of staff salaries all qualify.
Dual-purpose activities cause most of the trouble. A mailing that combines educational content with a donation ask can only have its costs split between program and fundraising if all three joint-cost criteria are met: the activity genuinely serves a program or management purpose, the audience is chosen for its need for the content rather than its likelihood of giving, and the content includes a call to action beyond donating. Miss any one criterion and the entire cost has to go into fundraising.
Lobbying Is Allowed. Campaigning Is Not.
The IRS treats lobbying and campaign activity very differently, and mixing them up is one of the fastest ways to lose exempt status.4Office of the Law Revision Counsel. 26 USC 501 – Exemption From Tax on Corporations, Certain Trusts, Etc
Lobbying, meaning attempts to influence legislation, is allowed within limits. By default, lobbying cannot become a “substantial part” of the organization’s overall activities, but the IRS has never defined a specific percentage, so the standard is unpredictable. Public charities (except churches and private foundations) can elect the Section 501(h) expenditure test instead, which replaces the vague standard with concrete dollar limits calculated on a sliding scale of the organization’s exempt-purpose spending, capped at $1,000,000 in lobbying regardless of size. Within the total, grassroots lobbying aimed at the general public is limited to 25% of the overall lobbying allowance.5Office of the Law Revision Counsel. 26 USC 4911 – Tax on Excess Expenditures to Influence Legislation
Campaign activity is a different matter. A 501(c)(3) cannot endorse candidates, contribute to campaigns, or distribute materials favoring or opposing anyone running for public office. No amount is permissible, and violations can trigger immediate revocation of tax-exempt status.4Office of the Law Revision Counsel. 26 USC 501 – Exemption From Tax on Corporations, Certain Trusts, Etc
Reimbursing Employees and Volunteers
Out-of-pocket expenses that staff and volunteers pay on behalf of the organization are reimbursable, but only an IRS-approved accountable plan keeps those reimbursements from being treated as taxable wages. Without a plan in place, every reimbursement has to be reported as compensation and run through payroll taxes.6Internal Revenue Service. Publication 463 – Travel, Gift, and Car Expenses
A qualifying plan has to meet three conditions:
- Business connection. The expense has to relate to organizational activities. Personal costs never qualify, no matter how carefully documented.
- Adequate accounting. Receipts and documentation have to come in within a reasonable time. The IRS safe harbor is 60 days after the expense. Documentary evidence is required for any lodging and for any other single expense of $75 or more.
- Return of excess. If an advance exceeded the actual expense, the recipient has to return the difference. The safe harbor for return is 120 days.
Nonprofits that operate without a written plan often discover the problem at audit, when years of reimbursements get reclassified as unreported compensation.
Unrelated Business Income and Its Deductions
Income from a trade or business that isn’t substantially related to the exempt purpose, like a museum gift shop selling unrelated merchandise or a university licensing its logo, is subject to unrelated business income tax. Expenses directly connected to earning that income are deductible against it, which can reduce or eliminate the tax bill.7Office of the Law Revision Counsel. 26 USC 512 – Unrelated Business Taxable Income When facilities or personnel serve both exempt and business purposes, the allocation has to be reasonable: direct costs are fully deductible, and variable and fixed costs get split based on actual use. Income earned “on nonprofit property” is not automatically exempt, and clean records are what separate a legitimate deduction from a disallowed one.
Extra Rules for Federal Grant Money
Federal award dollars come with a second rulebook, the Uniform Guidance at 2 CFR Part 200, and it is often stricter than the general standards above. To charge any cost to a federal award, the cost has to be necessary and reasonable, allocable to that specific award based on the benefit it provides, consistent with how the organization treats similar costs elsewhere, and adequately documented.8eCFR. 2 CFR Part 200 Subpart E – Cost Principles
Certain costs are flatly unallowable on federal awards regardless of how reasonable they might be, including alcoholic beverages, entertainment, fines and penalties, and lobbying.9eCFR. 2 CFR 200.403 – Factors Affecting Allowability of Costs Those expenses may be legal to pay with unrestricted funds, but they cannot touch grant money. Violations can force a nonprofit to return funds or lose future eligibility.
Prohibited Spending: Private Inurement and Private Benefit
Two related rules limit who can benefit from a nonprofit’s spending, and the IRS enforces them separately.
Private inurement applies to insiders: founders, officers, board members, and anyone with significant influence over the organization. No part of the organization’s earnings can flow to their personal benefit.4Office of the Law Revision Counsel. 26 USC 501 – Exemption From Tax on Corporations, Certain Trusts, Etc Paying an officer’s personal credit card, covering a board member’s vacation, or letting a founder use organizational property for personal purposes all qualify. The prohibition is absolute, and a single clear instance can cost the organization its exemption.
Private benefit is broader. It covers any private individual, insider or not, who receives more than an incidental benefit from the organization’s operations.10Internal Revenue Service. Inurement/Private Benefit – Charitable Organizations A job training program that routes all its graduates to a single company owned by a board member’s spouse raises private benefit concerns even if no insider is directly paid.
The working rule for any expenditure is this: it should be defensible as serving the public mission first. When a payment also happens to benefit someone personally, especially someone with influence, the organization carries the burden of showing the public benefit was primary and the private benefit incidental.