As this report illustrates, the nonprofit and charitable sector represents a significant, highly diverse component of the U.S. economy. Currently, there are a number of policy issues that could affect, either directly or indirectly, the structure and functioning of nonprofit and charitable organizations. President Barack Obama has turned toward the nonprofit sector while seeking solutions to social problems via the Social Innovation Fund. The recent economic downturn increased the demand for many of the goods and services provided by charitable organizations, while simultaneously placing the same organizations under increased financial constraints. The treatment of nonprofits in health care reform has also been a major issue, as the tax code cannot provide the same incentives to nonprofits (nonprofit health care providers and nonprofit employers providing insurance) that are available to for-profit organizations. Finally, the tax treatment of nonprofits and their contributors raises issues of efficiency, equity, and fairness. To assist policymakers in evaluating reforms that will potentially affect nonprofit and charitable organizations, this report provides a broad overview of the charitable sector. Such context and background information will help policymakers determine if the government's current relationship with the nonprofit and charitable sector is efficient, or if there are policy changes that could lead to a better use of resources. This report begins by defining the nonprofit and charitable sector. It is especially important to understand the distinction between nonprofit and charitable organizations. While the term nonprofit tends to be used loosely in the literature, nonprofit here is used to identify the broad array of organizations with federal tax-exempt status. Charitable organizations are defined as organizations with 501(c)(3) public charity status, and are a subcategory of the broader nonprofit sector. The second section provides an overview of the charitable sector, focusing specifically on employment within the sector, as well as revenue and assets of charitable organizations. The charitable sector's role in the broader economy is evaluated by comparing the charitable sector to other major industrial sectors. Third, the finances of charitable organizations are explored. Specifically, various revenue sources, both government and nongovernment, are examined. The amount of revenue coming from private contributions, government grants and transfers, private payments, and investment income is identified. The differences in revenue sources across charitable sectors are also analyzed. Finally, the impact of the economic downturn on revenue for charitable organizations is briefly addressed. The fourth section reviews the relationship between the charitable sector and government. To evaluate the relationship between the charitable sector and the federal government, the economic rationale for subsidizing charities is presented. After presenting the theoretical underpinnings for interaction between charities and government, direct evidence on the cost of the relationship as it presently exists is discussed. Finally, the report concludes with policy considerations and options. The policy options are framed by examining policy issues deemed important by nonprofit and charitable organizations. The possibility of increasing support through grants and subsidies, introducing an oversight agency within the federal government, and revising the rules on itemized deductions for charitable organization are explored. This report analyzes data relating to the nonprofit and charitable sectors. For purposes of this report, the term "nonprofit sector" is generally intended to include all organizations with federal tax-exempt status. The term "charitable sector" is used to refer to one type of tax-exempt organization, specifically those organizations with 501(c)(3) public charity status. The Internal Revenue Code (IRC) describes approximately 30 types of tax-exempt organizations. Examples include charitable organizations, social welfare organizations, labor unions, trade associations, fraternal societies, and political organizations. The largest category, and the primary focus of this report, are the organizations described in Internal Revenue Code (IRC) Section 501(c)(3). Organizations eligible for 501(c)(3) status include charities, religious organizations, hospitals, and educational institutions. The entire universe of these organizations is commonly referred to as "charitable organizations." Every 501(c)(3) organization is classified as either a "public charity" or "private foundation." Public charities have broad public support and tend to provide charitable services directly to the intended beneficiaries. Private foundations often are tightly controlled, receive significant portions of their funds from a small number of donors or a single source, and make grants to other organizations rather than directly carry out charitable activities. 501(c)(3) organizations are presumed to be private foundations unless they qualify for public charity status based on support and control tests. A primary source for some of the data contained in this report is Form 990, which is the annual information return that must be filed with the IRS by most tax-exempt organizations. Form 990 collects information about the organization's finances, assets, and activities. For tax year 2009, public charities with gross receipts of at least $500,000 or total assets of at least $1.25 million must file the regular Form 990, while public charities with gross receipts between $25,000 and $500,000 and total assets of less than $1.25 million may file the Form 990-EZ. Public charities whose gross receipts normally do not exceed $25,000 file the Form 990-N ("e-Postcard"), which only requires basic identifying information such as the names and addresses of the organization and a principal officer. Private foundations file using the Form 990-PF. Churches and other qualifying religious organizations are exempt from the annual information-reporting requirements. In addition to the information return, there are other situations when tax-exempt organizations must file a tax return. For example, tax-exempt organizations are subject to tax on income from business activities unrelated to their exempt purpose. Organizations subject to this tax, known as the unrelated business income tax (UBIT), must file a tax return using the Form 990-T. Additionally, tax-exempt organizations must generally pay the same employment taxes (i.e., withhold income and payroll taxes of their employees) as for-profit employers and file the applicable returns. Finally, an organization's activities might require it to file other returns, such as an excise tax return. Table 1 presents information on the number of nonprofit and charitable organizations as of July, 2009. Of the 1.5 million registered nonprofit organizations, nearly 64% are public charities. Nearly 8% are private foundations, while 29% are other types of nonprofits. Only 52% of registered charities file Form 990. Non-filers include qualifying religious organizations, small organizations, and organizations that may no longer exist but have not been removed from the IRS Business Master File (BMF). Very little information is available regarding non-filing organizations. Measuring employment in the nonprofit and charitable sector is not an easy task. There is no government agency that regularly collects systematic employment data on the nonprofit sector. There are two major studies that have attempted to measure employment in the nonprofit and charitable sector in recent years. Their results are presented in Table 2 and Table 3 below. The first is employment in the nonprofit sector. In 2005, the estimated total employment in the nonprofit sector was 12.9 million. The second is employment in the charitable sector. The estimated number of paid workers employed by charities in 2004 was 9.4 million. At the end of 2004, there were 132.5 million employees nationwide. Nearly 10% of America's workforce works in the nonprofit sector, with more than 7% of the workforce employed by charities. Table 2 provides estimates of nonprofit employment by industry. More than half of nonprofit employment (approximately 54%) is involved in health care and social assistance. In 1998, nearly 23% of nonprofit employees were involved in other services. This proportion fell by 2005 to just over 21%. In both 1998 and 2005, approximately 18% of nonprofit employees provided educational services. Arts, entertainment, and recreation was the fourth largest category, with nearly 4% of all nonprofit employment within this category. Between 1998 and 2005, employment in the nonprofit sector grew by an estimated 16.4%. Overall, nationwide growth in employment was approximately 6.2%. While the utilities; transportation and warehousing; accommodation and food services; and professional, scientific, and technical services sectors experienced the most growth between 1998 and 2005, each of these four sectors still represents less than 1% (1.3% for the professional, scientific, and technical services) of total nonprofit employment. The first and third largest sectors in terms of nonprofit employment—health care and social assistance and education services, respectively—experienced increases in employment that exceeded employment increases for the nonprofit sector as a whole. The second employment estimate is that of the number of persons employed by the charitable sector. Table 3 presents 2004 estimates of employment by charities across various sectors. Generally, the estimates of employment in the charitable sector are consistent with estimates for total employment by nonprofits. Since charities are a subset of nonprofits, it is expected that there would be fewer persons employed by charities as compared to nonprofits. Figure 1 depicts regional variation with respect to the percentage of the workforce employed by the charitable sector. In relative terms, the northeast tends to see a larger proportion of its workforce employed by the charitable sector. The District of Columbia has the largest proportion of workers employed by the charitable sector, with 16.3%. In Rhode Island, 13.6% of workers are employed by a charitable organization. New York ranks third when ranking states by employment in the charitable sector, with 13.3%. Relative to other parts of the country, fewer persons are employed by the charitable sector in the south. In addition to paid workers, volunteer workers make up a significant portion of the labor involved in providing charitable goods and services. In 2004, there were an additional 4.7 million full-time equivalent (FTE) volunteer workers employed by charitable institutions. Figure 2 depicts FTE volunteers as a percentage of total employment in each state. While states in the northeast tend to have a larger proportion of workers employed in the charitable sector, a similar pattern does not appear for volunteers as a share of total employment.