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Practice Definitions  | Non-Profit Corporations

Non-Profit Corporations

Non-Profit Corporation - A legal structure authorized by state law allowing people to come together to either benefit members of an organization (a club, or mutual benefit society) or for some public purpose (such as a hospital, environmental organization or literary society). Nonprofit corporations, despite the name, can make a profit, but the business cannot be designed primarily for profit-making purposes, and the profits must be used for the benefit of the organization or purpose the corporation was created to help. When a nonprofit corporation dissolves, any remaining assets must be distributed to another nonprofit, not to board members. As with for-profit corporations, directors of nonprofit corporations are normally shielded from personal liability for the organization's debts. Some nonprofit corporations qualify for a federal tax exemption under ? 501(c)(3) of the Internal Revenue Code, with the result that contributions to the nonprofit are tax deductible by their donors.

All sorts of groups, from artists and musicians to people active in education, health, and community services wish to operate as nonprofit (or not-for-profit) corporations. Often the reason for doing this is simple -- nonprofit status is usually a requirement for obtaining funds from government agencies and private foundations. Obtaining grants, however, is not the only reason to incorporate. Here, we discuss two additional important benefits of forming a nonprofit -- tax-exempt status and personal liability protection. We then introduce you to some of the basic rules for setting up and running your nonprofit corporation.

Tax-Exempt Status

In addition to qualifying for public and private grant money, most nonprofit groups seek nonprofit corporate status to obtain exemptions from federal and state income taxes. The most common federal tax exemption for nonprofits comes from Section 501(c)(3) of the Internal Revenue Code, which is why nonprofits are sometimes called 501(c)(3) corporations.

If your group obtains tax-exempt status, not only is it free from paying taxes on all income from activities related to its nonprofit purpose, but people and organizations that donate to the nonprofit can take a tax deduction for their contributions.

Protection From Personal Liability

Forming a nonprofit corporation normally protects the directors, officers and members of the nonprofit from personal liability for the corporation's debts and other obligations. Called "limited liability," this shield ensures that anyone who obtains a judgment against the nonprofit can reach only the assets of the corporation, not the bank accounts, houses, or other property owned by the individuals who manage, work for, or participate in the business.

As an example, consider a nonprofit symphony that is sued by a visitor who falls through a poorly maintained railing on a staircase. The court finds in favor of the visitor and issues a judgment against the nonprofit for an amount greater than the nonprofit's insurance coverage. The amount of the judgment is a debt of the corporation, but the directors, officers and members are not personally responsible for paying it. By contrast, if an unincorporated association of musicians owned the premises, the principals of the unincorporated group could be required to pay the judgment amount out of their own pockets.

Who Should Consider Becoming a Nonprofit Corporation?

The types of groups that typically seek nonprofit status vary widely. Here's a partial list of associations that may be eligible:

  • child care centers
  • shelters for the homeless
  • community healthcare clinics
  • museums
  • hospitals
  • churches, synagogues, mosques and other places of worship
  • schools
  • performing arts groups
  • conservation groups
If your group isn't on this list, it doesn't necessarily mean you won't qualify for tax-exempt status. As long as your group's activity is charitable, educational, literary, religious, or scientific, you should be able to get a tax exemption.

Forming a Nonprofit Corporation

Forming a nonprofit corporation is very similar to forming a regular corporation: You must file "articles of incorporation" with the corporations division (usually part of the Secretary of State's office) of your state government. But unlike regular corporations, you must also complete federal and state applications for tax exemptions.

After filing this initial paperwork, you will create "corporate bylaws," which lay out the operating rules for your nonprofit. Finally, you elect the initial directors of your nonprofit and hold an organizational meeting of the board.

Running a Nonprofit Corporation

Most nonprofit corporations are run by a board of directors -- called "trustees" in some states. The directors set policy for the nonprofit and are usually actively involved in the work of the corporation. Officers (who may also serve on the board) carry out the day-to-day business of the corporation and sometimes receive salaries. Depending on its structure, a nonprofit may or may not have formal members with voting rights. If the nonprofit does not create a formal membership structure, the only people who participate in the management of the nonprofit are the directors and officers.

Nonprofit corporations must observe most of the same formalities as regular corporations. These include keeping good corporate records, holding and preparing minutes of directors' (and possibly members') meetings and maintaining a separate bank account.

Unlike regular corporations, a nonprofit corporation cannot distribute any profits to its members, contribute money to political campaigns or engage in lobbying activity, except in very limited circumstances.

Ending a Nonprofit Corporation

Nonprofits are not actually owned by anyone and therefore cannot be sold. If the directors of a nonprofit corporation decide to dissolve it, they must pay off all debts and obligations of the nonprofit and distribute all of its assets to another tax-exempt nonprofit corporation.

Nonprofit Corporations Frequently Asked Questions

What is a nonprofit corporation?

A nonprofit corporation is a corporation formed to carry out a charitable, educational, educational, religious, literary or scientific purpose. A nonprofit corporation doesn't pay federal or state income taxes on profits it makes from activities in which it engages to carry out its objectives. This is because the IRS and state tax agencies believe that the benefits the public derives from these organizations' activities entitle them to a special tax-exempt status.

The most common federal tax exemption for nonprofits comes from Section 501(c)(3) of the Internal Revenue Code, which is why nonprofits are sometimes called 501(c)(3) corporations.

What are the benefits of forming a nonprofit corporation?

Nonprofit corporations enjoy an exemption from corporate income taxes on profits from activities that are related to their organizational purpose. Also, a nonprofit is permitted to raise funds by receiving public and private grant money and donations from individuals and companies. (And the tax laws encourage people and businesses to donate money and property by allowing donors to deduct their contributions on their own tax returns.) Finally, structuring an organization as a nonprofit corporation protects its directors, officers and members from personal liability for the corporation's debts and liabilities.

How do I form a nonprofit corporation?

There are several steps you must take to create a nonprofit corporation. The first is filing a short document, usually called "articles of incorporation," with the corporations division of your state government. To do this, you'll have to pay a filing fee of $30 or so. Articles of incorporation contain:

  • The name of your corporation
  • The corporation's address
  • A "registered agent" (a person who agrees to receive legal papers on behalf of the corporation), and sometimes
  • the names of the corporation's directors.
After you file your articles, you must apply for state and federal income tax exemptions (the most common federal tax exemption comes from Section 501(c)(3) of the Internal Revenue Code), which require you to complete a fairly lengthy set of forms. You must also write "corporate bylaws," a document that sets out the rules that govern your corporation, including procedures for making major business decisions, voting rights and other important guidelines. Finally, before you start doing business, you must elect a board of directors and hold an initial meeting of the board.

Is it difficult to run a nonprofit corporation?

Although operating a nonprofit corporation requires some attention to detail, as long as you understand and follow some basic rules, you'll be fine. The first rule is to hold required meetings of directors and members and to keep minutes of these meetings in a corporate records book.

The IRS also has a thing or two to say about what a nonprofit can and cannot do. For instance, a nonprofit cannot make political lobbying (influencing legislation) a substantial part of its total activities, and a nonprofit must make sure that its activities don't personally benefit its directors, officers or members.
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