Is Overhead the Enemy? Reevaluating the Concern of Internal Expenses in Tax Exempt Organizations

By: Myles A. Roth

In 2022, Americans gave $499 billion to charity.[1] The largest source was from individuals, who donated $319 billion, or 64% of total charitable giving.[2] This giving was provided to countless tax-exempt entities with a majority going to religious, human services, education, and health charities.[3] As competition for donations grows, donors have looked for methods to make sure their money is being put to its best use. One major factor many donors consider is the amount of overhead in a public charity. Overhead is generally defined as the sum of an organization’s management, general, and fundraising expenses.[4] A nonprofit organization has three specific categories of costs: program, management and general, and fundraising.[5] The management and general costs are combined with fundraising expenditures and form a charity’s overhead.[6]

Many groups and services use overhead costs or ratios to grade charities.[7] And in turn, these services are used by the public to determine what charities will receive their donations. One list of the “best and worst charities” discusses overhead, and states high-ranked charities often spend 75% or more on program costs, which indicates that “your money goes to causes you want to support.”[8] This common theme is spread across popular media, with warnings against donating to groups who spend highly on executives or internal expenses like advertising.[9] There is clearly a need to research a nonprofit, but fixating on overhead is increasingly seen as a misplaced concern.

 In 2013, Dan Pallotta discussed this in a popular TED Talk.[10] He examines the pressures of nonprofits and notes their employees face a mutually exclusive choice of doing well for themselves or doing good for the world.[11] He then suggests that allowing nonprofits to expand their overhead costs will not only benefit hiring and employee retention, but will also improve the organization’s ability to impact their charitable purpose.[12] Recently, some charities have attempted to combat these concerns regarding overhead. Charity: water, uses a highly publicized model where a group of wealthy donors fund the organization’s overhead, allowing for individual donations to fully be used for program costs.[13] But this model still appears self-defeating. Critics argue that when Charity: water advertises its efficiency by removing overhead costs, it relies on the flawed public perception that overhead is inherently non-efficient.[14] To best support their mission, nonprofits need talented employees and strong internal systems that fall under management costs. The most successful charities and nonprofits are therefore not automatically the ones with the lowest overhead.

To improve the general understanding of what make a charity successful, an emphasis should be placed on expanding education about nonprofits. For instance, the classic misconception is that a nonprofit cannot legally make a profit. But just like any other business, a charitable nonprofit can (and should) aim to make money. The IRS simply states that the net earnings of the organization cannot inure, or give to the benefit of, a private shareholder or individual.[15] There are also strong requirements that a nonprofit must follow to receive its coveted tax-exempt status. This includes a condition that the organization must be organized and operated solely for one or more permissible exempt purposes.[16] Then there are the public reporting obligations. These disclosures are a great source of information that individuals should take the time to research. With some exceptions, tax exempt organizations submit a Form 990 to the IRS, which provides information about the nonprofit’s activities for the past year.[17] These forms are available on the IRS’s website, within third-party charity information sites, and often directly on the charity’s website.

With this additional knowledge and information, public scrutiny should transition towards a nonprofit’s accountability, rather than its overhead. Potential donors should be wary of groups who choose to provide limited disclosures or cannot accurately account for their expenditures.[18] When using an independent charity evaluation group, the public must also understand the metrics of how the charities are reviewed, and what emphasis the group places on overhead. Instead of relying purely on overhead ratios, a better alternative is to choose an evaluation model that emphasizes charitable accountability and transparency.[19] The focus should be placed on disclosures and actual results—to ensure that the charity or nonprofit is doing precisely what a donor wants it to do. While operational efficiency is a key part of the equation, requiring that nonprofits adhere to strict overhead limits does more harm than good.

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[1] Charitable Giving Statistics, Nat’l Philanthropic Tr. (2024), https://www.nptrust.org/philanthropic-resources/charitable-giving-statistics/.

[2] Id.

[3] Id.

[4] (Mis)Understanding Overhead, Nat’l Council of Nonprofits, https://www.councilofnonprofits.org/running-nonprofit/administration-and-financial-management/misunderstanding-overhead.

[5] Id.

[6] Id.

[7] See Our Charity Rating Process, Charity Watch, https://www.charitywatch.org/our-charity-rating-process (last visited Mar. 15, 2023).

[8] Penelope Wang, Best and Worst Charities for Your Donations, Consumer Reps. (Nov. 22, 2019), https://www.consumerreports.org/money/charities/best-charities-for-your-donations-a4066579102/.

[9] See e.g., Will Potter, The WORST charities in America? These are the organizations giving over 90 PERCENT of donations to their fatcat executives – while ignoring their causes, Daily Mail (June 25, 2023), https://www.dailymail.co.uk/news/article-12219603/The-WORST-charities-America-organizations-giving-CEOs-millions-ignoring-causes.html.

[10] Dan Pallotta, The way we think about charity is dead wrong, TED (Mar. 2013), https://www.ted.com/talks/dan_pallotta_the_way_we_think_about_charity_is_dead_wrong.

[11] Id.

[12] Id.

[13] See David Gelles, A Charity Accepts Uber Stock as Donations. Then Uses It to Pay Staff Bonuses. Is That O.K.?, N.Y. Times (Apr. 11, 2019), https://www.nytimes.com/2019/04/11/business/charity-water-employees-payment.html.

[14] Id.

[15] I.R.C. § 501(c)(3).

[16] Alicia Alvarez & Paul R. Tremblay, Introduction to Transactional Lawyering Practice 424 (2021); see 6 C.F.R. § 1.501(c)(3)-1.

[17] See About Form 990, Return of Organization Exempt from Income Tax, Internal Revenue Serv. (2024), https://www.irs.gov/forms-pubs/about-form-990;

[18] For information about the types of 990 Filings, see Form 990 Series Which Forms Do Exempt Organizations File Filing Phase In, Internal Revenue Serv. (2024), https://www.irs.gov/charities-non-profits/form-990-series-which-forms-do-exempt-organizations-file-filing-phase-in.

[19] Stop Using Overhead Ratios to Evaluate Nonprofits, Giving Compass, https://givingcompass.org/article/why-donors-need-to-stop-using-overhead-ratios-to-evaluate-nonprofits.