What is a Nonprofit Corporation?

A nonprofit corporation is an organization incorporated legally under state law whose basic purpose is to exclusively benefit a group or society, commonly for charitable, educational, or religious reasons, instead of providing financial benefit to any of the corporation’s members or other outside individuals.

Nonprofit corporations are formed at the state level in much the same way as regular profit corporations. Some types of nonprofits are eligible to obtain federal tax exempt status, which is granted or denied to a nonprofit by the IRS at the federal level. In most (but not all) cases, this requires submitting an application to the IRS.

Some types of nonprofits, such as some churches, can automatically be exempt. Depending on your state, your nonprofit corporation may be required to obtain federal tax-exempt status through the IRS first before becoming eligible to apply for tax exemptions at the state level.

Incorporating a nonprofit organization provides personal liability protection for its members, and makes it easier to gain tax exempt status from the IRS. Nonprofit corporations don’t issue stock or distribute dividends to its members, and raise funds in ways other than selling stock.

 

Nonprofit Corporation vs. For-profit Corporation

There’s a considerable difference between both the purpose and organization of nonprofit corporations and for-profit corporations.

At the most basic level, nonprofit corporations put all their profits back into the business to further their stated purpose of benefiting a society (as with charities) or a particular group with shared goals (as with mutual benefit nonprofits). A nonprofit corporation can bring in a surplus, but cannot distribute any of that surplus to any private person or group. No stocks or dividends are distributed either, since no single person or group can own a nonprofit corporation.

In comparison, for-profit corporations put their profits towards the enrichment of owners and shareholders. The ambition of a for-profit corporation is to maximize its profits. A for-profit corporation can raise funds from private investors or groups, and provide a return on investment (or an ROI).

  • Are All Nonprofits Corporations?
    No. It’s important to note that not all nonprofits are corporations. Other possible organizational structures include unincorporated associations, LLCs, and trusts.

 

Advantages of Incorporating Your Nonprofit

  • Federal income tax-exempt status is easier for an incorporated nonprofit organization to gain. Many nonprofits are public or private charitable organizations, which commonly seek 501(c)(3) status by filing an application with the IRS. Note that not every nonprofit has to apply in order to obtain tax-exempt status. Many churches, for example, are recognized automatically and are not required to file an application for 501(c)(3) status.
  • Limited liability protection offered for nonprofit corporations is just as strong as any other corporation. All the members of your nonprofit corporation are typically protected from personal liability and won’t be responsible for the debts of the business, with the exceptions of members involved in things like fraudulent activity within the business.
  • Credibility gained by incorporating your nonprofit can have a big impact on the success of getting donations and grants. Donors are more likely to give to an incorporated nonprofit organization than an informal group of people with a nonprofit purpose.
  • Public and private grants are more accessible to incorporated nonprofits, especially after they’ve acquired 501(c)(3) status for their organization. The donations made to a 501(c)(3) nonprofit are tax-deductible for the person donating.

 

Disadvantages of Incorporating Your Nonprofit

  • Time and money will need to be poured into the upkeep of your nonprofit corporation. Months of devotion and prep work are usually needed to get your nonprofit corporation up and running. It’s important to be aware that the paperwork and costs will be heavier than with other nonprofit structures, but will usually be worth it for the cause.
  • Director and officer classification rules can get complicated. Classifications for these job positions generally include volunteers, employees, or contractors. Government agencies conduct special tests to ensure nonprofit corporations are classifying their directors and officers correctly. Although most directors are classified as volunteers and most officers are classified as employees, you’ll have to understand and follow the guidelines on their job duties to ensure they don’t get reclassified, causing potential tax-related issues.
  • Public access to a nonprofit’s information is a legal requirement of tax-exempt nonprofits. The Form 990 annual return, Form 1023 tax-exempt application, and supporting documents such as state financial forms are legally obligated for nonprofit corporations to have available at all times, or by request. The public can access a nonprofit’s information through the IRS, the nonprofit itself, the Secretary of State or Attorney General, or through online directories.
  • Compliance obligations and formalities are more rigid (and abundant) for nonprofit corporations than for informal nonprofits, such as unincorporated associations or trusts. It’s important to understand the higher level of maintenance involved to ensure you have the means to manage a nonprofit corporation.

 

How do I Start a Nonprofit Corporation?

Nonprofit corporations are formed at the state level by filing a document usually referred to as the nonprofit Articles of Incorporation to the Secretary of State. This document spells out detailed information about the nonprofit as required by the state law. This document is short but can be complex. If your nonprofit is a charity and intends to seek 501(c)(3) status from the IRS, keep in mind that your Articles of Incorporation must include specific tax-exempt language and provisions required by the IRS.

Incorporating your nonprofit can usually be taken care of online, and at a lower cost than forming other entities. Starting a nonprofit corporation is a comparable process to starting a for-profit corporation. Once your nonprofit Articles of Incorporation are approved, this begins the nonprofit corporation’s existence under state law.

Since the act of incorporating creates a legal entity under state law, the organization is enabled certain powers, such as being treated as a corporation under law and enter into business dealings, form contracts, and own property as any other individual or for-profit corporation may do.

Generally, most states require the nonprofit Articles of Incorporation to contain, at a minimum, information about the following:

  • Nonprofit Corporation Name*
  • Business Address
  • Name and Address of the Registered Agent
  • Name and Address of Incorporator(s)
  • Name and Address of at least 3 Director(s) or Officer(s)
  • Detailed Purpose Statement
  • Nature of the Nonprofit Corporation
  • Duration of the Nonprofit Corporation
  • Membership

*Must include a name ending such as “corporation,” “incorporated,” “company,” “foundation,” or its abbreviations. Some states do not impose name ending requirements, however.

 

How to Obtain Federal Tax Exempt Status Under 501(c)(3)?

If your nonprofit is a charity and intends to seek 501(c)(3) tax-exempt status, then the next step after incorporating your nonprofit organization is to obtain the 501(c)(3) federal tax exempt status. A 501(c)(3) designated organization must operate exclusively for a charitable, literary, scientific, religious or educational purpose, or for testing for public safety, fostering national or international amateur sports, or prevention of cruelty for children or animals.

Some nonprofit charities don’t need to apply for recognition from the IRS, including churches classified as synagogues, temples, and mosques. Not all nonprofits can qualify as 501(c)(3) organizations, and some smaller nonprofit charities don’t intend to gain 501(c)(3) status at all, usually due to the administrative costs involved.

The 501(c)(3) designation refers to a specific tax category in the Internal Revenue Code, and is intended for public and private charitable organizations. Obtaining this status can be done by submitting Form 1023 directly to the IRS. Eligible nonprofits can submit the faster and less expensive Form 1023-EZ if the nonprofit’s gross receipts in a taxable year aren’t more than $5,000. It costs $600 to submit Form 1023 and $275 to submit Form 1023-EZ.

The 501(c)(3) status exempts a nonprofit organization from paying federal income taxes. At the state level, a 501(c)(3) nonprofit can apply for exemptions on property and sales taxes. Federally exempt nonprofits often also have unrelated business income tax, referred to as UBIT, and are required to pay taxes on income from activities unrelated to the nonprofit mission.

To obtain a 501(c)(3) tax exempt status for your nonprofit corporation, submit Form 1023 Application for Recognition of Exemption to the IRS. It’s important to understand the level of complexity that is the lengthy process of filling out a potentially 28-page long form to obtain this federal tax-exempt status. The IRS requires a high level of detail, and you must use specific tax-exempt language.

 

The IRS provides a list of requirements in order to earn 501(c)(3) status. Below are some examples of those requirements:

  • Your organization must be incorporated as a nonprofit corporation
  • Your organization must obtain an employer identification number
  • Your organization must include a full description of its proposed activities
  • Your organization must operate exclusively for a charitable, literary, scientific, religious or educational purpose, or for testing for public safety, fostering national or international amateur sports, or prevention of cruelty for children or animals.
  • Your organization may not be operated for the private interests or financial benefit of any private shareholder or individual
  • Your organization must not participate in any campaign activity

After obtaining this status, there’s a list of annual requirements and general guidelines to follow in order to keep exempt status. For example, the nonprofit will need to maintain financial bookkeeping and records of the nonprofit’s activities, submit annual informational tax returns, and keep certain financial documents available to the public.

When you’re ready to incorporate your nonprofit, Active Filings is here to help you through the process.