- How It's Taxed
A nonprofit corporation is a corporation that is formed and operated for a recognized nonprofit purpose identified by state corporation law and federal and state tax statutes. These generally fall into public purposes, religious purposes or the advancement of the interests of a limited group of persons sharing a common interest.
Nonprofit corporations share many of the attributes of regular for-profit business corporations. They are a separate legal entity providing their directors, officers and members with limited liability. They may sue or be sued, incur debts and obligations, acquire and hold property, and engage, generally, in any lawful activity. They may even engage in profit-making activities unrelated to their nonprofit purpose, though the income from such activities is subject to taxation and certain rules. There are no shareholders in a nonprofit corporation and for that reason it is also referred to as a non-stock corporation.
There are several types of nonprofit corporations: mutual benefit corporations, public benefit corporations, and religious corporations.
Mutual Benefit Corporations
A mutual benefit nonprofit corporation is formed primarily for the benefit of its members or persons engaging in a particular business or activity, rather than for broader public purposes. It therefore serves a smaller group of people since its business or activities tend to be of a limited nature. In a sense, it is a “catch-all” category as it includes nonprofit corporations that do not meet the requirements of public benefit or religious nonprofit corporations.
Any nonprofit corporation that is not considered either a Public Benefit or Religious Corporation is a Mutual Benefit corporation. Mutual benefit corporations typically include trade associations, automobile clubs, social groups, homeowners associations, etc.
Public Benefit Corporations
Public Benefit Corporations are formed for a public or charitable purpose rather than the more limited purposes of either the mutual benefit of members or the furtherance of religion.
Most Public Benefit Corporations are organized for scientific, literary or educational purposes that benefit the public.
Religious Corporations are formed primarily or solely for religious purposes. They are regulated by the nonprofit religious corporation laws of the states. However, because of the need to respect the separation of church and state, there is much less regulation of Religious Corporations than other types of nonprofit corporations. Thus, great latitude is afforded this type of nonprofit corporation in the establishment and transfer of membership interests, the structure of the management of the corporation and the regulation of management decisions.
A Religious Corporation need not be a formal church. Religious purposes could include any group organized to promote the study or practice of religion. In fact, it need not involve a group at all. One person may form and operate a religious corporation for any purpose intended to promote religion.
Note that nonprofit corporations are not automatically tax-exempt.
Nonprofit corporations are subject to federal income tax as well as state income and franchise taxes unless they qualify for tax-exempt status. Applications must be filed with the IRS and often with a state to receive tax-exempt status. There are a number of provisions in the Internal Revenue Code (IRC) setting forth the types of nonprofits that qualify for tax-exempt status
Where a group doesn’t have a profit motive and doesn’t seek or qualify for tax-exempt status, it may still want the personal liability protection of a corporation. A nonprofit corporation is an appropriate choice in this situation. The classic example is a homeowners association.
More commonly, however, a group seeks to do good by providing a specific service for charitable reasons or to provide services or products in certain categories that are recognized as benefitting the public and therefore qualify for tax-exempt treatment.
The IRC lists literary, scientific, educational, or religious purposes as the categories of services or products that may qualify for tax-exempt treatment. These are commonly known as 501(c)(3) nonprofits. Their tax-exempt status facilitates fund-raising activities because they are recognized as meeting the requirements for such status and donations are therefore tax-deductible. Many corporations contribute primarily or exclusively to 501(c)(3) or other tax-exempt nonprofit corporations.
There is no requirement that a nonprofit corporation have members. If members are provided for, they may be legal (voting) members or non-voting members. The bylaws of the corporation describe the requirements for becoming a member and related matters such as the application process, any dues requirement, meetings and voting procedures, and removal or termination of membership.
If there are no voting members, all policy decisions are made by the board of directors.
The directors set major policy of the corporation but, in this capacity, do not operate the business on a daily basis. Directors may have regularly scheduled meetings to approve or authorize actions by the officers or call special meetings for this purpose. A nonprofit corporation generally cannot have just a single director.
As with a regular business corporation, most states allow dispensing with formal meetings of directors and preparing written minutes authorizing or approving actions that are signed by the directors. No notices of meetings or actual meetings or formal votes are required.
Nonprofit corporation laws usually contain strict requirements and restrictions for any transactions between a director and the corporation where a director would be compensated or profit from the transaction other than any reasonable compensation for acting as a director.
Every state requires at least a president and secretary and most every state requires a treasurer or chief financial officer as well. While one person may fill more than one office position as in a business corporation, a single person generally cannot fill every office in a nonprofit corporation.
As in a business corporation, the principal officers run the corporation on a day to day basis. They are responsible for the hiring and firing and supervision of employees and other responsibilities of running the business, all in accordance with any parameters set by the board of directors. Officers are usually appointed by the board, not elected, as serve until they resign, die, or are removed by the board.
How It’s Taxed
Unless it applies for and is granted tax-exempt status at both the federal and state levels, a nonprofit corporation pays taxes on its income at regular corporation tax rates. Every nonprofit corporation that is not tax-exempt remains a C Corporation because it doesn’t meet the requirements for an S Corporation tax classification.
Most nonprofit corporations apply for tax-exempt status. A detailed application form must be completed and sent to the IRS with a required filing fee. Note that the IRS no longer issues advance letters giving temporary tax-exempt status. If an application is properly completed, it will take about 90 to 120 days for approval if all requirements for tax-exempt status are met.
To receive tax-exempt status, nonprofit corporations are subject to specific restrictions. A nonprofit corporation may not be organized for the financial benefit of a particular person or group of persons, such as the directors, officers or members, or other persons related to these individuals. It may pay reasonable salaries to directors, officers, employees, or agents for services rendered to the corporation in connection with its nonprofit purpose. It may not distribute gains or profits to its members while it is in existence, nor may it distribute its assets to members when it is terminated or dissolved (with the exception of Mutual Benefit Nonprofit Corporations). It may not engage in many political activities without voiding its tax-exempt status.
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:
- 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:
- Are the particular religious beliefs of the organization truly and sincerely held?
- 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.