A nonprofit is created for charitable, educational or other purposes – these cannot benefit the owners directly. This allows nonprofits to operate tax-free. Nonprofits are named for the Internal Revenue Code section they fall under. 501(c) is the most common. This is further broken down into sub classes. For instance, a 501(c)(19) would refer to an organization of current or past members of the armed forces.

Starting a NonProfit

A nonprofit has the same initial paperwork that a corporation has, with one difference. Nonprofits have a mission statement that clearly defines the organization. The purpose of the nonprofit must be laid out clearly. The IRS recognizes 26 different sub-classes of nonprofits. Going beyond the scope of the mission can mean loss of tax-exempt status.

Starting a nonprofit means doing a name search and registering with the Secretary of State and the IRS. Deciding where to incorporate, choosing directors, and creating articles of incorporation are added tasks. Tax-exempt status is not automatic and can be denied. Application for tax-exempt status has to be made with both Federal and State authorities.

NonProfit Taxes

Nonprofits operate tax-free. They can make profits (referred to as ‘surpluses’) but all money above operating costs must be used to further the goals of the nonprofit. Surplus cannot be paid to the stakeholders. They can accept donations and grants. The tax benefits can flow through to donors who contribute money or time. Wages may be paid to employees at standard rates.

Approval is both at the State and Federal (IRS) level. Five purposes are recognized:

  1. Charitable
  2. Religious
  3. Scientific
  4. Educational
  5. Literary

There may be some overlap. Obtaining tax-exempt status from the IRS will usually make State approval easier.

Even though a nonprofit is tax free, regular filings with the IRS are required. These are used to monitor the organization. Because loss of status has so many tax consequences, great care must be taken to keep records current and accurate.

NonProfit Liability

A corporate shield exists for nonprofits. Suits may arise and the assets of the nonprofit may be attacked. However, as long as the legal structure remains correct, stakeholders are immune from individual liability.

Most legal issues revolve around loss of tax-exempt status by misuse of the nonprofit – either through inappropriate gain or improper distribution of surpluses. A successful challenge to nonprofit status will remove the protection and allow liability to transfer to individuals in the organization.

NonProfit Credit and Financing

Nonprofits can own assets and generate income (usually in the form of donations or grants) and they can take out loans. There is no ownership to sell in the sense of investments, but assets can be used as collateral.

Dissolving a nonprofit is complicated. Nonprofits cannot be sold in the traditional sense. All assets must be transferred to another nonprofit or put toward the purpose of the organization. No funds can be directly distributed to the owners.

Generally, a nonprofit corporation is an organization that exists for charitable, educational, religious, literary or scientific purposes.

Incorporating in Nonprofit Articles of Incorporation

The first step toward forming a nonprofit corporation is to file articles of incorporation with the appropriate state office. In most states, this is the office of the Secretary of State.

The Articles of Incorporation for a nonprofit corporation must contain certain language as mandated by the Internal revenue Service if it intends to qualify for Federal tax exempt status.

Nonprofit Corporation with Tax-Exempt Status of 501(c)(3)

Under Section 501(c)(3) of the Internal Revenue Code, a nonprofit corporation may be exempt from taxation and may be eligible to receive tax-deductible donations from its contributors.

Restrictions and challenges:

  • Cannot pay dividends
  • Upon dissolution, corporate assets must generally be distributed to another qualified non-profit group.
  • Complex filing requirements exist at both the State and Federal level to establish and maintain tax-exempt status.
  • Prohibited from engaging in certain activities.

A common reason for forming a nonprofit corporation may be:

  • Charitable
  • Eductional
  • Religious
  • Literary
  • Scientific
  • Public Safety

The IRS defines exempt purposes as “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.”

The term “charitable” is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.

How to Form a Nonprofit Corporation

To form a nonprofit corporation:

  • File nonprofit articles of incorporation (or a certificate of incorporation) with the appropriate state agency, along with payment of the required fee.
  • File a separate application for 501(c)(3) tax-exempt status with the Internal Revenue Service.

We can assist you in this daunting process.

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