A nonprofit corporation is a corporation formed to carry out a charitable,
educational, religious, literary or scientific purpose. A nonprofit can
raise funds by receiving public and private grant money and donations from
individuals and companies. Certain federal, state, and local income, property
and sales tax exemptions are available to nonprofit corporations. The federal
and state governments do not generally tax nonprofit corporations on money
they make that is related to their nonprofit purpose, because of the benefits
they contribute to society. The most common federal tax exemption for nonprofits
comes from Section 501(c)(3) of the Internal Revenue Code, which is why
nonprofits are sometimes called 501(c)(3) corporations. Tax exempt nonprofit
organizations offer donors an individual deduction for contributions.
(Private donors can claim personal federal income tax deductions of up
to 50% of adjusted gross income for donations made to 501 (c) (3) organizations.)
FORMATION
Forming a nonprofit corporation is much like creating a regular corporation,
except that nonprofits have to take the extra steps of applying for tax-exempt
status with the IRS and their state tax division. The basic steps to follow
include:
- Obtain nonprofit materials from your state's corporate
filing office. This packet should include sample or fill-in-the blank articles
of incorporation and your state's nonprofit corporation laws. It should
also contain a filing fee schedule, as well as forms and instructions for
checking the availability of your proposed business name. The articles
of incorporation will contain the name of your corporation, the corporation's
address, a "registered agent" (a person who agrees to receive legal papers
on behalf of the corporation), and sometimes the names of the corporation's
directors.
- Choose an available business name that meets the requirements
of state law. State requirements vary, but generally, the name of your
nonprofit cannot be the same as the name of another corporation on file
with the corporations division, the name must end with a corporate designator,
such as "Corporation," "Incorporated," "Limited," or "Corp.," "Inc." or
"Ltd.", and the name cannot contain certain words prohibited by the state,
such as Bank, Cooperative, Federal, National, United States or Reserve.
Also, you must make sure your name won't violate a trademark owned by another
company (in your state or out of state). To do this, you'll need to conduct
a trademark search. You aren't usually required to file or reserve the
name with your state. Once you file your articles of incorporation, your
nonprofit's name will be automatically registered.
- File formal paperwork, usually called "articles of incorporation,"
and pay a small filing fee (typically $30 or $40).
- Apply for your federal and state tax exemptions. The
IRS requires you to submit a copy of your filed articles with your application.
To apply for your exemption, you must complete IRS Form 8718, User Fee
for Exempt Organization Determination Letter Request, and IRS Package 1023,
Application for Recognition of Exemption. For instructions on filling out
these forms, read IRS Publication 557, Tax-Exempt Status for Your Organization.
After the IRS reviews your application, it will send you a letter indicating
that it has approved your nonprofit status, or it might ask you for more
information about your organization. The IRS can also deny your application
outright.
A few states require you to complete a separate application to get a
state tax exemption. In other states, as long as you file nonprofit articles
of incorporation and obtain your federal 501(c)(3) tax-exempt status, your
state tax exemption will be automatically granted. In still others, to
get your state exemption you must send in a copy of the IRS determination
letter that granted your federal exemption.
- Create corporate "bylaws," which set out the operating
rules for your nonprofit corporation, including procedures for holding
meetings, making major business decisions, voting rights and other important
guidelines.
- Appoint the initial directors. Directors, who meet and
make decisions collectively as the board of directors, have the authority
(and responsibility) to manage and run the nonprofit corporation. Many
states allow nonprofits to have just one director, but other states require
at least three. Some states require the directors to be chosen before filing
the articles of incorporation because you must list their names in the
document.
- Hold the first meeting of the board of directors. Before you
start doing business, you must elect a board of directors and hold an initial
meeting of the board. Typically, the bylaws are adopted by the corporation's
directors at their first board meeting. The directors also will elect
officers -- state law usually requires a president, secretary and treasurer,
and sometimes a vice president as well. Then, the directors should authorize
the newly elected officers to take actions necessary to start the business
of the nonprofit, such as setting up bank accounts and admitting members.
Minutes of the meeting should be created and filed in the corporate records
book.
- Obtain licenses and permits that may be required for
your corporation. A local business license (sometimes called your "tax
registration certificate") may be required for your activities, and if
you sell anything to consumers, you'll need a sales tax permit.
MANAGEMENT
Like any corporation, a nonprofit has a board of directors to make important
policy decisions, officers (president, treasurer and secretary) to oversee
and manage the day-to-day operations of the organization, and possibly
employees to do the work. Unlike regular corporations, however, nonprofit
corporations do not have shareholders or owners. Nonprofits are owned by
no one person or group of persons and cannot be sold.
The members, directors and officers of the corporation are generally
prohibited from profiting at the expense of the corporation. The assets,
income or profits may generally be distributed to such people only as compensation
for services, as a distribution of assets upon dissolution of the corporation,
as payment of dividends to members as provided for in special instances
in articles of incorporation, or when profit derived from sales to members
is rebated to members in proportion to fees paid by members.
Every nonprofit corporation must be organized upon a stock or nonstock
basis. Some states do not allow for the formation of a stock-issuing nonprofit
corporation. Every nonstock corporation is generally organized as either
a directorship corporation or a membership corporation, although hybrid
forms are sometimes possible. In a directorship corporation, the directors
elect their own successors. The corporation may or may not have members,
but if it does, such members have no voting power, leaving the decision
making up to the directors. In a membership corporation, the members have
the exclusive right to elect directors, amend articles and bylaws and vote
on a merger or dissolution of the corporation.
All nonprofit corporations must keep proper corporate records to preserve
directors' limited personal liability and protect the organization's tax-exempt
status. These records should include minutes of directors' and members'
meetings and document important corporate decisions.
A corporate records book is usually used to record minutes and also
contain a copy of your articles of incorporation, bylaws and tax exemption
determination letters from the IRS and your state tax agency, if applicable.
Nonprofit corporations must record any financial transactions in a double-entry
bookkeeping system and keep other financial records in order to file an
annual corporate tax return.
Under IRS rules, a nonprofit cannot make political lobbying a
substantial part of its total activities, and a nonprofit must make sure
that its activities don't personally benefit its directors, officers or
members. Nonprofit corporations must abide by the following restrictions
to retain their tax-exempt status:
- Nonprofit corporations with a 501(c)(3) tax exemption
cannot participate in or contribute money to political campaigns. If they
do, the IRS can revoke their nonprofit status, and can assess a special
excise tax against the organization and its managers.
- Nonprofit corporations can engage in only limited
lobbying activities. Tax-exempt 501(c)(3) nonprofits that influence legislation
to any "substantial degree" face the loss of their nonprofit status. However,
for tax-exempt nonprofits that want to participate in lobbying, the IRS
simply sets a limit on the money they can spend on political activities.
- Nonprofit corporations must not distribute profits
to members, officers or directors. A nonprofit corporation cannot be organized
to financially benefit its members, officers or directors. However, reasonable
salaries and expense reimbursements are permitted.
- Nonprofit corporations must pay taxes on income
from "unrelated activities." The IRS requires nonprofits to pay corporate
income taxes on such unrelated income over $1,000, whether or not the group
uses that money to fund its tax-exempt activities.
- Nonprofit corporations cannot make substantial
profits from unrelated activities. If a nonprofit spends too much time
on unrelated activities, or if the unrelated activities generate "substantial"
income, the group's nonprofit status may be jeopardized.
- When a nonprofit corporation dissolves, its assets
must be distributed to another tax-exempt group. Since tax-exempt organizations
and their assets cannot be owned, they can never be sold.
DURATION
Nonprofits are not actually owned by anyone and therefore cannot be
sold. If the directors of a nonprofit corporation decide to dissolve it,
they must pay off all debts and obligations of the nonprofit and distribute
all of its assets to another tax-exempt nonprofit corporation.
LIABILITY
Forming a nonprofit corporation generally protects the directors, officers
and members of the nonprofit from personal liability for the corporation's
debts and other obligations. Only the assets of the corporation may be
used to pay off debts and other liabilities. This protection from having
personal assets available to pay off debts or judgments is called "limited
liability".
In a few situations, people involved with a nonprofit corporation
can be held personally liable for its debts. A director or officer of a
nonprofit corporation can be held personally liable if she:
- personally and directly injures someone
- personally guarantees a bank loan or a business
debt on which the corporation defaults
- fails to deposit taxes or file any necessary tax
returns
- does something intentionally fraudulent, illegal
or clearly wrong-headed that causes harm, or
- co-mingles nonprofit and personal funds.
To safeguard against some of these exceptions, insurance is available
to protect volunteer directors, who may be reluctant to serve without it.
TAXATION
IRC 501 (c) (3) nonprofit corporations must be organized for religious,
charitable, educational, scientific or literary purposes for the benefit
of the public. To obtain full tax benefits, the organization must
also qualify as a public charity. There are three ways to qualify as a
public charity:
1. Automatic Public Charity. The following organizations
are recognized as as public charities by the IRS:
- Traditional churches, without
regard to any particular religion.
- Schools, providing education
for public benefit.
- Hospitals and Medical Research Organizations, which provide on-site medical care (excludes convalescent homes).
- Public Safety Organizations,
which administer public safety testing.
- Government Organizations
which support colleges or universities.
- Support Organizations set up solely to support one of the organizations above.
2. Publicly Supported Organizations. To qualify, the organization
must rely on broad-based support individual members of the community or
various public and private sources, rather than funding from a few private
sources.
3. Meeting the Support Test. To qualify as a public charity
under the Support Test, an organization must meet BOTH of the following
two requirements:
1. The organization must normally receive more than 1/3rd of total support
each tax year as Qualified Public Support. Qualified Public Support is
support from any of the following sources;
- gifts, grants, contributions or membership fees
- gross receipts from activities related to the exempt purpose of the nonprofit
2. The organization must normally not receive more than 1/3rd of its annual support
from unrelated trades or businesses, or gross investment income. Taxes
on business income are deducted before the 1/3rd amount is calculated.
Tax-exempt nonprofits often make money as a result of their activities
and use it to cover expenses. As long as a nonprofit's activities are associated
with the nonprofit's purpose, any profit made from them isn't taxable.
Sometimes nonprofits make money in ways that aren't related to their nonprofit
purposes. While nonprofits can usually earn unrelated business income without
jeopardizing their nonprofit status, they have to pay corporate income
taxes on it, under both state and federal corporate tax rules. Generally,
tax is imposed on any amount above the first $1,000 of unrelated income.
Some activities will not be taxed, even if they aren't related to the
nonprofit's purpose, including:
- activities in which nearly all the work is done
by volunteers
- activities carried on primarily for the benefit
of members, students, patients, officers or employees
- sales of merchandise that has been mostly donated
to the nonprofit
- the rental or exchange of mailing lists of donors
or members, and
- the distribution of items worth less than $5 as
incentives for donating money
ADVANTAGES
Profits are exempt from corporate taxation.
A nonprofit is permitted to raise funds by receiving public and private
grant money and donations from individuals and companies.
Allows for tax-deductible contributions by donors to nonprofit corporations.
Directors, officers and members have protection from personal liability
for the corporation's debts and liabilities.
Profits can be retained and used to pay reasonable salaries.
Some incidental benefits include:
- Special postage rates. Nonprofits can apply for
and receive a mailing permit that gives them a special reduced nonprofit
rate for mailings. This is especially helpful for organizations that will
do a lot of solicitation by mail.
- Property tax exemptions. In addition to an exemption
from income taxes, nonprofits are usually exempt from paying property taxes
on real estate and other property.This property tax exemption is called
a "welfare exemption."
- State sales tax exemptions. Some states offer
exemptions from state sales tax to qualified nonprofits.
DISADVANTAGES
Cannot distribute profits to members, employees or participants.
Increased corporate formalities; periodic filings with state and federal
agencies, mandatory corporate meetings, more rigorous bookkeeping requirements.
Must file the federal tax exemption application.
