If you operate a charitable organization, then you’ve probably wondered about whether or not you should become a nonprofit corporation.
For many charitable causes or nonprofit groups, becoming a corporation is a valuable opportunity, but for others, it causes problems.
Fortunately, we can help make your decision a little easier. We’ve compiled a guide to both the advantages and disadvantages of forming a nonprofit corporation. Armed with this knowledge, you’ll be able to choose whether this business type is right for your organization.
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Advantages of a Nonprofit Corporation
There are several noteworthy advantages to incorporating a nonprofit. There are seven key benefits, which we’ll discuss in detail here.
Limited personal liability
One of the primary reasons so many nonprofits choose to incorporate is for the personal asset protection offered by the corporate veil. Essentially, this means that if your nonprofit is sued or defaults on a debt, your personal assets cannot be taken as payment.
It’s tempting to think that a nonprofit does not need a corporate veil as much as an LLC or a for-profit corporation, but that’s far from true. Even nonprofits can get loans and thus run the risk of not making payments, and lawsuits due to common liability issues are always a risk no matter what type of organization you’re operating.
Incorporating does not eliminate those risks, but it does protect your personal belongings. The last thing you want is to lose your personal bank accounts, car, or house for an error committed by your nonprofit.
Eligibility for tax exemption
Let’s be clear: no nonprofit is automatically exempt from taxes. You must complete an application for exemption with the IRS in order to get an exemption from federal taxes. Then, you’d likely need to complete a similar application for exemption from state taxes. Only after those applications are accepted will your nonprofit be exempt from taxes.
Another thing to note: you can achieve tax exemption as either an incorporated and unincorporated entity, but it’s usually much easier as an incorporated organization. This is because a nonprofit corporation faces much higher regulation and oversight standards from the state. Your incorporation documents also include sections where you can use language necessary for tax exemption.
We highly encourage you to read more about the IRS’s exemption policies.
Being incorporated (plus getting 501(c)(3) tax exemption) greatly increases your opportunities to get grants. Incorporating adds prestige to your nonprofit, which improves your chances of earning the grants you apply for. In addition, some grants are available to nonprofit corporations only.
Grants can go a long way in furthering your nonprofit’s cause — unlike a loan, you won’t need to pay back the money. You’ll be expected to use it wisely, of course, but grants give you sums of cash to work with (and potentially large ones).
It’s important to note that only 501(c)(3) organizations are eligible for grants, so forming a nonprofit corporation is just the first step toward receiving grants.
Incorporated nonprofits can offer benefits to their employees, a privilege which is not available to nonprofit associations. This includes health insurance, pensions, and other benefits. These incentives can serve as a helpful draw for new employees, too.
Many times, nonprofit employees are highly motivated individuals who are just as dedicated to your cause as you are. They understand that working for a nonprofit organization isn’t a money-making venture. That said, you can offer your own gesture of thanks by offering benefits to your employees.
Ease of fundraising
Nonprofit corporations — due to their regulated status — are perceived as more trustworthy than their unincorporated equivalents. As a result, making fundraising easier, potential donors are more likely to give their funds to you if you’re incorporated.
In addition, if you also hold tax-exempt status, then donations to your nonprofit will not be taxed. This provides additional incentive to donate, because donors appreciate the opportunity to make a tax write-off, however large or small.
When you incorporate your nonprofit, ownership of the organization becomes a group venture. Even if the original owners die or leave the corporation, it will persist.
As a leader of a nonprofit, the last thing you want is for all the hard work you put into the cause to fizzle out when you retire or pass away. As a corporation, this won’t happen. Instead, you’ll pass your share of ownership on to a successor, and the cause continues.
Nonprofit associations do not have this guarantee, as it can be far more complicated to transfer ownership of the nonprofit without the formal structure of a corporation.
The act of incorporating brings a new structure into your nonprofit: directors on your board make key decisions, and officers manage the daily affairs. Unincorporated nonprofits do not have this clear-cut structure (although they should have some structure in place).
If this structure sounds like more of a hassle than a benefit, keep in mind the perpetual existence we just mentioned. This structure facilitates the transfer of ownership. When one director leaves, another takes his or her place — the nonprofit doesn’t collapse.
Similarly, this committee-type structure can facilitate the flow of decisions in your nonprofit. Group decision-making (while more time-consuming) builds accountability, transparency, and effectiveness. If your directors work as a team, they can accomplish far more good than they could separately. The nonprofit corporation’s structure empowers them to accomplish that.
Disadvantages of a Nonprofit Corporation
Despite its benefits, a nonprofit corporation does have its pros and cons. We’ll discuss seven of those disadvantages here.
Operating as a nonprofit corporation requires both time and money.
The fees can prove especially problematic for some nonprofits. For one, each state charges a fee to incorporate, which usually isn’t too expensive, but if you’re just starting out, your budget might be strained.
And this doesn’t even cover the fees to apply for tax exemption, which can range from $250-850. These fees are more substantial and much more likely to cause budget issues.
Lengthy wait times for exemption status
The application for 501(c)(3) status, IRS Form 1023, is not only costly — it’s also quite time-consuming. Filling nearly 30 pages, the application can take a long time to complete (especially if it’s your first time).
But the wait isn’t over once you’ve sent in the application. Depending on the time of year, the number of applications, and the accuracy of your application, it can take anywhere from three to five months for the IRS to process your application.
Unfortunately, there is no way to speed up this process. The only way you can help yourself is to ensure your application is completely correct, because if it isn’t, you’d need to correct the problem and then start the process over again.
“Nonprofit” does not equal tax exemption
If the only reason you want to incorporate is to gain tax exemption, be aware that not all nonprofits are eligible. The exempt status goes to certain groups, including some nonprofit hospitals, education groups, charities, and religious organizations.
If you’re exempt, the IRS will award you the tax-exempt status, but if your nonprofit does not qualify — for example, if your business is a country club incorporated as a nonprofit — you’ll still need to pay taxes.
Directors and officers do not receive profits
In a normal corporation, the directors and officers get a cut of the profits, but that is not allowed in a nonprofit corporation. After all, nonprofits are organized for the benefit of a large group, not the individual members of the board.
Hopefully, if you’re working as a nonprofit, you’re already aware of this, but if you want to take a cut of the profits, you’re better off forming a for-profit business corporation. You can still pursue your goals of helping others with a for-profit corporation, while also taking home some profit.
If your directors are caught making a profit off your nonprofit, then you would face a wide variety of penalties, which could even include losing your tax-exempt status. In short, just keep in mind that any profits earned by a nonprofit corporation must be invested back into the corporation’s cause.
Extensive paperwork requirements
If you detest paperwork, then being incorporated is likely not for you. Nonprofit corporations must keep detailed records, including financial records, copies of your bylaws, your charitable registration permits, your tax-exempt certificate status letter, and much more.
And then there’s the forms you’ll be expected to file each year. For example, you’ll need to file annual reports with your state. If you’re also tax-exempt, you won’t file a tax return per se: you’ll file IRS Form 990. This serves as a report of your income, even though you’re not taxed on it.
If you fail to file these forms, you could lose your tax-exempt status. You’d also compromise your organization’s good standing, and your reputation might even be harder to restore than your tax-exempt status.
Tedious process to apply for grants
Grants make your mission possible, so you’ll want to obtain as many as you can, and being incorporated makes it possible to apply for a wide variety of them. That said, getting the grants can be a tedious process.
For one, you’ll need to search the grants you’re eligible for. You can learn a fair amount about grants with Grants.gov. Your state may also have a nonprofit association that helps you find grants and other funding.
Then, of course, you’ll need to actually complete the process of applying. As you can imagine, this can take a lot of time. You obviously won’t receive every grant you apply for, so you’ll likely need to complete the process several times.
Part of your role as a nonprofit corporation includes keeping your activities visible to the public. You are legally required to provide copies of your vital business records to anyone who wants them, and the public can also access your annual reports.
This accessibility of your records helps promote transparency and keeps you accountable for your use of the funds you receive from donors. However, some nonprofit corporations find that the same public which donates to their cause also criticizes their decisions. Most businesses face criticism, but nonprofit corporations seem to encounter more.
Unincorporated nonprofits are still expected to keep their donors informed, but not to the same extent as a corporation.
When you choose to incorporate your nonprofit, you expose your organization to several new advantages that you couldn’t gain otherwise, but as you’ve seen, there are drawbacks as well.
For the most part, we still think that the nonprofit corporation is the best entity type for charitable organizations and other not-for-profit businesses, but it’s important to understand that it’s not a perfect structure by any means.