Wounded Warrior Project. Habitat for Humanity. The Humane Society.
What do all these have in common? They’re nonprofits. Perhaps you’ve even made a donation to their causes.
Many charitable groups elect to incorporate and become nonprofit corporations, but charities are just one type of nonprofit corporation.
In this guide, we’ll cover several important considerations about nonprofits, including what a nonprofit corporation is, how taxation works as a nonprofit, and whether you should incorporate your nonprofit.
What a Nonprofit Corporation Is:
Technically speaking, a nonprofit is any business which is not organized for private commercial gain.
Instead, it is a business organized for the benefit of a group, such as the general public, or a specific section of the population. But “nonprofit” does not imply that the business cannot make any profit — a nonprofit corporation can make a profit on its goods and services.
The primary difference between a nonprofit corporation and a business (for-profit) corporation is what happens with those profits. In a business corporation, the profits are distributed to the directors and shareholders for their personal gain, but in a nonprofit corporation, all profits are immediately applied to the pursuit of the nonprofit’s goal or cause. They cannot go to the directors.
That said, a nonprofit can pay a reasonable salary to its employees to compensate for services to the organization, which draws a distinction between a “wage” and a “distribution of profits.”
For example: you’ve probably seen commercials for St. Jude’s Children’s Hospital. They research childhood cancer and provide top-tier cancer treatments to kids, all at no charge to the patients’ families. They rely on donations from people all across the country to operate, but doctors and nurses have to be hired to work there. St. Jude compensates these professionals for their hard work and expertise. They might not earn as much as they would at another hospital, but they do earn competitive wages for their roles.
Similarly, a religious group can pay its leaders for their work. This way, there can be full-time pastors and priests. The distinction is that of personal gain. The nonprofit corporation’s members do not get personal commercial gain from the church treasury, and the directors of St. Jude do not get profits from the hospital.
Charities are the most common type of nonprofit, but other types include religious groups, education groups, literary associations, and more. Even country clubs can be considered nonprofits if they exist exclusively for the benefit of their members and not the directors.
Forming a Nonprofit Corporation
The process to form a nonprofit corporation is somewhat similar to the process for forming a profit corporation.
For one, the articles of incorporation is the document that officially forms the organization, and the version for nonprofits is fairly similar to the version for-profit corporations. If you want to apply to be a tax-exempt nonprofit, you’ll need to pay attention to the IRS’s language for tax exemption in the “purpose” section of your articles, as this can help you acquire 501(c)(3) status (more on this in a moment).
Nonprofits should also appoint a registered agent for the business, obtain an EIN if they’ll have employees, apply for business bank accounts, and more. The nonprofit also needs directors — some states require you to have at least three initial directors, but some require only one.
Nonprofits are legally required to keep their financial records available for public scrutiny. This keeps the organization’s activities transparent — after all, donors want and deserve to know how their money is being used. Because of this, it’s important to keep your business finances completely separate from your personal funds.
Like a profit corporation, nonprofits are comprised of members, but nonprofit members are not shareholders, and they do not receive dividends. Despite that, a nonprofit should establish bylaws to govern and protect the rights and privileges of each member.
Taxation as a Nonprofit
One of the primary reasons to incorporate as a nonprofit (as opposed to remaining as an unincorporated organization) is that it’s easier to get tax breaks. This applies to income taxes, sales taxes, and other taxes, but not all nonprofits get the same tax cuts. There are also different tax exemptions on both the federal and state levels.
Nonprofits are not automatically exempt from income taxes. To get the exemption, the first step is to apply for a federal designation as a 501(c)(3) by filing IRS Form 1023.
Filling it out for the first time requires a fair amount of time because this is a long and detailed document, but it will be worth the investment. If your application is accepted, the IRS will issue you a certificate of tax-exempt status within 3-5 months.
Not all nonprofits are eligible for 501(c)(3) status, which exempts you from federal income taxes. It usually applies to charities, religious organizations, education groups, and similar groups.
Each state also has the right to grant or deny exemption from its own income taxes. You’ll need to contact your state’s tax department to learn how to apply. Some states have their own exemption application, while others accept the IRS’s designation, provided you supply a copy of their certificate of exemption for your nonprofit.
Nonprofits that do not qualify for the exemption will still be subject to income taxes. Please note that these exemptions apply to the income taxes only, not other tax types.
Some states also supply nonprofits with exemptions from other tax types, the most common of which are exemptions from sales and property taxes. Of course, listing the exemptions provided by all 50 states would make this guide extremely long!
Instead, we recommend that you consult your state’s Department of Revenue (or similar state agency) to get more information on state-specific exemptions for your nonprofit.
Should I Bother Incorporating?
You don’t have to be a nonprofit corporation in order to operate as a charitable organization, but incorporating does have its advantages.
For one, incorporating gives you increased access to public and private grants and donations, and since donations to nonprofits are usually tax-exempt, your nonprofit will be more attractive to potential donors. (Note: Many states require you to register your nonprofit if you will solicit donations from the general public).
Incorporating also improves your professional image. The state regulates the entities it incorporates, so the public can have greater confidence that it is interacting with a compliant, established nonprofit.
Last but not least, incorporation also provides you with limited personal liability. As a nonprofit corporation, your personal assets will usually be protected if the nonprofit is sued or cannot pay its debts. Even though incorporating takes some time and a little money, these advantages make it well worth consideration.
Even though nonprofit corporations do not exist for personal gain, they play an important role in our society. Running one allows you to help further a cause you believe in.