Nonprofit Corporations


How is a nonprofit corporation formed?

A nonprofit corporation is formed by filing Articles of Incorporation with the Secretary of State (or equivalent agency) in the formation state. The Articles must contain certain provisions describing the type of nonprofit and whether it will be seeking tax-exempt status. There are often state requirements to register with the Attorney General or other official in the state.

Can one person fill all positions in a nonprofit corporation?

No. Most states restrict the same person from being the president and also the secretary or chief financial officer. It is also a common requirement to have at least 3 directors.

Are there any restrictions on who may be a director?

Nonprofit corporation laws have strict regulations on directors because they are often the main governing body of the organization. There are commonly restrictions against, or limitations on, so-called “interested persons” from serving on a board or comprising a majority of a board. An interested person is one who is already being compensated by the corporation in some other capacity or has a certain close family relationship with someone being compensated.

Is a director prohibited from having any business relationship with the corporation?

There is not usually a blanket prohibition against a director having a business relationship with the corporation, but there are often requirements and procedures that must be followed to ensure that all such transactions are disclosed and determined to be fair and reasonable to the corporation to prevent any “self-dealing” by a director.

What is a 501(c)(3) organization?

This is a common type of nonprofit that qualifies for tax-exempt status. The numbers refer to the Internal Revenue Code. An organization falling under this section will have one of the following purposes:

  • Religious
  • Charitable
  • Scientific
  • Literary
  • Educational
  • Testing for Public Safety
  • Prevention of Cruelty to Children or Animals

What is considered an “educational purpose?”

While any organized school will be generally fall into this category, a school is not required. Educational activities may include lectures, panel discussions, forums, and radio and television programs to list a few. The educational purpose is found in providing instruction or training to individuals to improve or develop their capabilities.

What is considered a “charitable purpose?”

A charitable purpose is one that is beneficial to the public interest and includes a broad range of purposes, including:

  • Relief of the poor or underprivileged;
  • Advancement of education or science;
  • Elimination of prejudice and discrimination;
  • Defense of human and civil rights;
  • Combating community deterioration and juvenile delinquency.

What are the requirements to receive tax-exemption as a religious organization?

The IRS applies two basis tests:

  1. Are the particular religious beliefs of the organization truly and sincerely held?
  2. Are the practices and rituals associated with the religious beliefs illegal or contrary to clearly defined public policy?

What’s the difference between a “private foundation” and a “public charity”?

Every 501(c)(3) tax-exempt organization is either classified as a private foundation or a public charity. A public charity must fall within one of six categories:

  • Church or association of churches;
  • Educational organization such as a school;
  • Hospital or associated facility;
  • Certain endowment funds;
  • A government unit; and
  • A publicly supported organization.

The significance of this classification is that private foundations have additional restrictions on investments and other use of funds, accumulation of earnings and certain taxes that may be imposed, as well as restrictions on the activities of the principals of the organization that do not apply to public charities.

What is considered a “publicly supported organization” to be classified as a public charity?

The IRS has two tests. The one-third support test is satisfied if the nonprofit normally receives at least one-third of its total financial support from government units or contributions from the general public.
The facts and circumstances test allows for just ten percent of total financial support from government units or the general public as long if the IRS determines that the organization has, or seeks, broad public support based on a review of the representative nature of the persons comprising the board of directors, the facilities it provides for the public or services it offers and how widespread the scope of such facilities or services is, and the nature of its membership.

Is a nonprofit corporation permitted to engage in political activities?

There are no restrictions against engaging in political activities merely by being a nonprofit corporation. However, if the nonprofit will seek tax-exempt status, it will be restricted from engaging in any political activities, such as participating in any political campaign or attempting to influence legislation. A violation of this restriction risks voiding the tax-exempt status.

Can the principals of a nonprofit corporation receive any profits?

No. A nonprofit corporation may not be organized or operated for the personal benefit or private shareholders or individuals, or for the benefit of personal interests, such as the creator’s family, or other private interests or organizations controlled by the creator. All profits must be for the benefit of the nonprofit group or interest.

What happens to the assets of a nonprofit organization when it ends?

The Articles of Organization of a nonprofit corporation that will seek tax-exempt status must state that upon dissolution all assets will be distributed to a nonprofit organization with an exempt purpose or to a federal, state, or local government for a public purpose. They may not be distributed to any private individual or non-exempt group.

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