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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.)
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:
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:
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.
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:
To safeguard against some of these exceptions, insurance is available to protect volunteer directors, who may be reluctant to serve without it.
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:
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;
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:
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:
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.