Nonprofit Corporations Text Size:

Non-profit ("nonprofit" or "not-for-profit") organizations are usually created for things like certain educational, charitable or religious purposes. The idea here is for the business to make money, which in turn is given over to the educational, charitable or religious cause for which it was formed.

A non-profit business doesn't have to be incorporated, but it's usually a good idea because incorporation gives the business certain benefits, like property tax exemptions and special mailing rates at the post office.

Forming a non-profit organization, regardless of whether its incorporated or not, requires the filing of a lot of paperwork and compliance with a lot of different laws, like federal tax laws and state and local laws. So, if you're considering forming a non-profit business, it's critical that you thoroughly research all of these laws, or seek the help of an experienced business law attorney.

Incorporate or Not?

Forming a non-profit corporation has several benefits, but some of the biggest advantages are:

• The business is eligible for government and private foundation grants and other funds
• The business can receive exemptions from federal, state and local taxes
• Companies and individuals can make contributions or donations to the business, which are tax deductible by the donor
• The corporation's directors, officers and members are shielded from personal liability for the corporation's debts and other obligations, which is called "limited liability"

There are, however, some exceptions to when a non-profit corporation's officer or director can be personally liable, such as when he or she personally guarantees a debt that is in default or commits fraud.

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 non-profit corporate purpose
• You can't pay any of the corporation's earnings to its members
• Because of the tax exempt status, when you end the corporation you'll have to transfer all the corporate assets to another non-profit corporation

Incorporating a Non-profit Organization

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

• Filing certain papers with the corporate division of your state's government, usually the Secretary of State, which are usually called "articles of incorporation" or maybe a "corporate charter," depending on the state. These documents contain information about the corporation, such as it's name, the persons who will serve as the board of directors, that is, who'll run the corporation and the name of the corporation's "registered agent" (the person who will receive important documents, like legal and tax documents, on behalf of the corporation).
• Drafting "corporate by-laws," which lay out how you'll run the corporation and who will have voting status to make decisions. Most states have laws that specify exactly what language should be used to protect board members and others from personal liability.
• Applying for tax-exempt status, first by filing your application under IRC § 501(c)(3) with the Internal Revenue Service (IRS). In some states, you have to apply for tax exempt status with your state as well, but in other states, if the IRS grants your exemption, your state will automatically grant you an exemption from state tax. 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
• In order to get the federal tax exemption, your organization must have an employer identification number (EIN), which is used to identify the organization. In addition, your organization might need a state identification number, so be sure to check your state's tax laws.

Guarding Your Non-profit Tax Status

The IRS (and/or your state's tax authority) can take away your organization's tax-exempt status if you don't follow some rules. To safeguard your status, make sure you:

• Keep detailed records on the sources of any income
• Carefully separate and pay taxes on any income that comes from activities that are not related to the corporation's non-profit 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, but salaries can be paid to employees and board members so long as they are reasonable and equal to that paid to such persons in for-profit organizations that are similar to your non-profit

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?

Sherrie Bennett is the former director and staff attorney at the University of Washington Student Legal Services in Seattle.

Related Resources on lawyers.com^sm

Related Web Links