Nonprofit organizations play an important part in society. They promote charitable, educational, religious or other good deeds. Nonprofits generate income and use it for these exempt purposes.

A nonprofit business doesn't have to be incorporated. Still it's usually a good idea to do so. Incorporation gives the business certain benefits, like property tax exemptions and special mailing rates at the post office.

Forming a non-profit organization is complicated. It requires a lot of paperwork and compliance with a lot of different laws. These include federal tax laws and state and local laws. This is true for incorporated or unincorporated organizations. So, if you're considering forming a nonprofit, thoroughly research all of these laws. You could also get help from an experienced business law attorney.

Incorporate or Not?

Forming a non-profit corporation has many benefits. Some of the biggest advantages are:

  • Qualifying for government and private foundation grants and other funds
  • Receiving exemptions from federal, state and local taxes
  • Qualifying for individual or corporate contributions or donations, which are tax deductible by the donor
  • Protection from personal liability for the corporation's debts and other obligations for directors, officers and employees

There are some exceptions to limited personal liability. If you personally guarantee a debt or commit fraud you may be responsible personally for it.

There are some disadvantages to incorporating as well, such as:

  • You'll have to pay taxes on profits from activities that aren't related to your exempt purpose
  • You can't pay any of the corporation's earnings to its members
  • Tax exempt status requires you to transfer all the corporate assets to another non-profit corporation if you wind up

Incorporating a Nonprofit Organization

The exact incorporation process varies from state to state, but generally involves:

  • Filing documents with your state's corporation commission or secretary of state. This is your "articles of incorporation" or "corporate charter," depending on the state. These state the corporation's name, the directors who'll run the corporation, and the name of the corporation's "registered agent." The registered agent is designated to receive important documents, like legal and tax documents, for the corporation
  • Drafting "corporate by-laws," which state how you'll run the corporation and who can vote on decisions. Most states have language to use to protect board members and others from personal liability
  • Applying for tax-exempt status.  File your application under IRC § 501(c)(3) with the Internal Revenue Service (IRS). You may have to apply for tax exempt status with your state as well. Many states automatically grant your state tax exemption based on IRS exemption. Be sure to check the laws in your state, or else your non-profit corporation might be liable for state taxes

There are two other important things to keep in mind when applying for tax exempt status.

The organization has to fit within one of the 5 types of organizations specified in IRC § 501, that is, it must:

  • have a charitable purpose
  • have a literary purpose
  • qualify as a religious group
  • qualify as an educational organization, or
  • be a scientific organization

Also, to get the federal tax exemption, your organization must have an employer identification number (EIN). The EIN is used to identify the organization. In addition, your organization might need a state identification number. Be sure to check your state's tax laws.

Guarding Your Nonprofit Tax Status

You have to follow the rules to keep your tax status. The IRS (and/or your state's tax authority) can take away your organization's tax-exempt status if you don't. Make sure you:

  • Keep detailed records on your sources of income
  • Keep separate and pay taxes on income from activities unrelated to the corporation's nonprofit purpose
  • Keep careful records of corporate meetings
  • Document and store any correspondence with the IRS
  • Don't distribute any of the corporate income to board members or any one else connected with the organization. Salaries can be paid to employees and board members. They must be reasonable and comparable to salaries paid in for-profit organizations similar to your nonprofit

Questions for Your Attorney

  • How much will it cost to form a non-profit corporation?
  • Are money donations the only thing tax-deductible, or can companies donate their services to my non-profit and take a deduction?
  • Does my non-profit organization have to have more than one person on the board of directors?