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 of forming a for-profit corporation.
1) Choose a Name
Creating the perfect moniker for your nonprofit is the first step to your success. It’s nearly as important as your nonprofit’s concept itself. You’ll need to create a name that is both unique and compliant with legal requirements.
No matter which state you incorporate in, your nonprofit’s name cannot be the same as a name that’s been claimed by another entity, and it also cannot be too similar to any names already in use.
2) Designate a Registered Agent
Nonprofits should also appoint a registered agent for the organization, an important role that ensures the state always has a reliable point of contact for your nonprofit corporation. You will need to include the name and address of your registered agent (or registered agent service) on your Articles of Incorporation document.
3) Prepare and File the Articles of Incorporation
For one, the Articles of Incorporation are the documents that officially form the organization, and the version for nonprofits is fairly similar to the version for 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).
4) Draft Your Nonprofit Bylaws
A nonprofit’s bylaws may be the most important document your nonprofit corporation will have. Bylaws are legally required, and they outline many organizational policies of your nonprofit. Some nonprofits choose to make their bylaws public as a display of transparency, but this isn’t a requirement. The information you’ll need for this document includes some basic info about your nonprofit, including its statement of purpose, directors and officers, fiscal year schedule, meeting schedules, the process for adding or subtracting board members, dissolution process, and more.
5) Obtain an EIN
The next step is to acquire a federal tax ID number (often referred to as an EIN or employer identification number) from the Internal Revenue Service. This is similar to a Social Security number for an individual, as the EIN is a nine-digit number that’s used to identify your organization for taxation purposes. An EIN can help your nonprofit accomplish many important tasks, including opening bank accounts, hiring employees, and more.
6) Hold an Initial Meeting With Your Board of Directors
The first meeting of your new board of directors will set the tone for all future nonprofit endeavors. You’ll need to discuss key features of your nonprofit, such as bylaws, setting up your stock and shareholder agreements, and appointing officers to manage the daily operational affairs.
7) Register for Taxes or File for 501(c)(3) Status
If your nonprofit is not tax-exempt, taxes are a vital part of operating a compliant organization, and you’ll need to register for taxes on both the state and federal levels. For example, most nonprofit corporations will need to pay federal and state corporate income taxes — Wyoming and South Dakota are the only states without that type of tax.
Other taxes, such as employment taxes or industry-specific taxes, may also be required. Taxation can be complicated, so you may want to consult with a tax professional or an accountant if you have any questions.
The other option is to file for 501(c)(3) status. This is the process of applying for tax exemption, and it can be a rather arduous process. The application requires extensive details about your organization, and you’ll need to complete it with care. For more information, check out our full-length article on this topic.
8) Set Up the Nonprofit’s Financial Infrastructure
Next, you’ll need to open a bank account for your organization and set up your accounting system. The bank account is simple enough — all you need to do is bring your EIN to the bank of your choice and tell them you’d like to set up an account for your nonprofit corporation.
Once the account is set up, make sure to use it exclusively for your organization’s expenses and income. Commingling your nonprofit’s assets with your personal assets is a highly dangerous practice that makes your nonprofit corporation susceptible to lawsuits, administrative dissolution, and more.
As for your accounting system, the easiest solution is to get accounting software like QuickBooks for your organization. This allows you to keep track of all your business income and expenses in one convenient place, making tax time (and legal compliance) a breeze.
9) Maintain Business Records
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.
You’ll also need to maintain detailed minutes of your directors’ and shareholders’ meetings, file annual reports, and more as part of the nonprofit corporation maintenance process.
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.
Income taxes
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) organization 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 income taxes only, not other tax types.
Other taxes
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.
Pros of a Nonprofit Corporation
There are several noteworthy advantages to incorporating a nonprofit. There are seven key benefits, which we’ll discuss in detail here.
Limited personal liability
One of the primary reasons so many nonprofits choose to incorporate is for the personal asset protection offered by the corporate veil. Essentially, this means that if your nonprofit is sued or defaults on a debt, your personal assets cannot be taken as payment.
It’s tempting to think that a nonprofit does not need a corporate veil as much as an LLC or a for-profit corporation, but that’s far from true. Even nonprofits can get loans and thus run the risk of not making payments, and lawsuits due to common liability issues are always a risk no matter what type of organization you’re operating.
Incorporating does not eliminate those risks, but it does protect your personal belongings. The last thing you want is to lose your personal bank accounts, car, or house for an error committed by your nonprofit.
Eligibility for tax exemption
Let’s be clear: no nonprofit is automatically exempt from taxes. You must complete an application for exemption with the IRS in order to get an exemption from federal taxes. Then, you’d likely need to complete a similar application for exemption from state taxes. Only after those applications are accepted will your nonprofit be exempt from taxes.
Another thing to note: you can achieve tax exemption as either an incorporated and unincorporated entity, but it’s usually much easier as an incorporated organization. This is because a nonprofit corporation faces much higher regulation and oversight standards from the state. Your incorporation documents also include sections where you can use language necessary for tax exemption.
We highly encourage you to read more about the IRS’s exemption policies.
Grant eligibility
Being incorporated (plus getting 501(c)(3) tax exemption) greatly increases your opportunities to get grants. Incorporating adds prestige to your nonprofit, which improves your chances of earning the grants you apply for. In addition, some grants are available to nonprofit corporations only.
Grants can go a long way in furthering your nonprofit’s cause — unlike a loan, you won’t need to pay back the money. You’ll be expected to use it wisely, of course, but grants give you sums of cash to work with (and potentially large ones).
It’s important to note that only 501(c)(3) organizations are eligible for grants, so forming a nonprofit corporation is just the first of several steps toward receiving grants.
Employee benefits
Incorporated nonprofits can offer benefits to their employees, a privilege that is not available to nonprofit associations. This includes health insurance, pensions, and other benefits. These incentives can serve as a helpful draw for new employees, too.
Many times, nonprofit employees are highly motivated individuals who are just as dedicated to your cause as you are. They understand that working for a nonprofit organization isn’t a money-making venture. That said, you can offer your own gesture of thanks by offering benefits to your employees.
Ease of fundraising
Nonprofit corporations — due to their regulated status — are perceived as more trustworthy than their unincorporated equivalents. As a result, potential donors are more likely to give their funds to you if you’re incorporated, making fundraising easier.
In addition, if you also hold tax-exempt status, then donations to your nonprofit will not be taxed. This provides additional incentive to donate because donors appreciate the opportunity to make a tax write-off, however large or small.
Perpetual existence
When you incorporate your nonprofit, ownership of the organization becomes a group venture. Even if the original owners die or leave the corporation, it will persist.
As a leader of a nonprofit, the last thing you want is for all the hard work you put into the cause to fizzle out when you retire or pass away. As a corporation, this won’t happen. Instead, you’ll pass your share of ownership on to a successor, and the cause continues.
Nonprofit associations do not have this guarantee, as it can be far more complicated to transfer ownership of the nonprofit without the formal structure of a corporation.
Formal structure
The act of incorporating brings a new structure into your nonprofit: directors on your board make key decisions, and officers manage the daily affairs. Unincorporated nonprofits do not have this clear-cut structure (although they should have some structure in place).
If this structure sounds like more of a hassle than a benefit, keep in mind the perpetual existence we just mentioned. This structure facilitates the transfer of ownership. When one director leaves, another takes his or her place — the nonprofit doesn’t collapse.
Similarly, this committee-type structure can facilitate the flow of decisions in your nonprofit. Group decision-making (while more time-consuming) builds accountability, transparency, and effectiveness. If your directors work as a team, they can accomplish far more good than they could separately. The nonprofit corporation’s structure empowers them to accomplish that.
Cons of a Nonprofit Corporation
Despite its benefits, a nonprofit corporation does have its pros and cons. We’ll discuss seven of those disadvantages here.
Costs
Operating as a nonprofit corporation requires both time and money.
The fees can prove especially problematic for some nonprofits. For one, each state charges a fee to incorporate, which usually isn’t too expensive, but if you’re just starting out, your budget might be strained.
And this doesn’t even cover the fees to apply for tax exemption, which can range from $250-850. These fees are more substantial and much more likely to cause budget issues.
Lengthy wait times for exemption status
The application for 501(c)(3) status, IRS Form 1023, is not only costly — it’s also quite time-consuming. Filling nearly 30 pages, the application can take a long time to complete (especially if it’s your first time).
But the wait isn’t over once you’ve sent in the application. Depending on the time of year, the number of applications, and the accuracy of your application, it can take anywhere from three to five months for the IRS to process your application.
Unfortunately, there is no way to speed up this process. The only way you can help yourself is to ensure your application is completely correct because if it isn’t, you’d need to correct the problem and then start the process over again.
“Nonprofit” does not equal tax exemption
If the only reason you want to incorporate is to gain tax exemption, be aware that not all nonprofits are eligible. The exempt status goes to certain groups, including some nonprofit hospitals, education groups, charities, and religious organizations.
If you’re exempt, the IRS will award you the tax-exempt status, but if your nonprofit does not qualify — for example, if your business is a country club incorporated as a nonprofit — you’ll still need to pay taxes.
Directors and officers do not receive profits
In a normal corporation, the directors and officers get a cut of the profits, but that is not allowed in a nonprofit corporation. After all, nonprofits are organized for the benefit of a large group, not the individual members of the board.
Hopefully, if you’re working as a nonprofit, you’re already aware of this, but if you want to take a cut of the profits, you’re better off forming a for-profit business corporation. You can still pursue your goals of helping others with a for-profit corporation, while also taking home some profit.
If your directors are caught making a profit off your nonprofit, then you would face a wide variety of penalties, which could even include losing your tax-exempt status. In short, just keep in mind that any profits earned by a nonprofit corporation must be invested back into the corporation’s cause.
Extensive paperwork requirements
If you detest paperwork, then being incorporated is likely not for you. Nonprofit corporations must keep detailed records, including financial records, copies of your bylaws, your charitable registration permits, your tax-exempt certificate status letter, and much more.
And then there are the forms you’ll be expected to file each year. For example, you’ll need to file annual reports with your state. If you’re also tax-exempt, you won’t file a tax return per se: you’ll file IRS Form 990. This serves as a report of your income, even though you’re not taxed on it.
If you fail to file these forms, you could lose your tax-exempt status. You’d also compromise your organization’s good standing, and your reputation might even be harder to restore than your tax-exempt status.
Tedious process to apply for grants
Grants make your mission possible, so you’ll want to obtain as many as you can, and being incorporated makes it possible to apply for a wide variety of them. That said, getting grants can be a tedious process.
For one, you’ll need to search the grants you’re eligible for. You can learn a fair amount about grants with Grants.gov. Your state may also have a nonprofit association that helps you find grants and other funding.
Then, of course, you’ll need to actually complete the process of applying. As you can imagine, this can take a lot of time. You obviously won’t receive every grant you apply for, so you’ll likely need to complete the process several times.
Public scrutiny
Part of your role as a nonprofit corporation includes keeping your activities visible to the public. You are legally required to provide copies of your vital business records to anyone who wants them, and the public can also access your annual reports.
This accessibility of your records helps promote transparency and keeps you accountable for your use of the funds you receive from donors. However, some nonprofit corporations find that the same public which donates to their cause also criticizes their decisions. Most businesses face criticism, but nonprofit corporations seem to encounter more.
Unincorporated nonprofits are still expected to keep their donors informed, but not to the same extent as a corporation.
Hiring an Incorporation Service
Does this process sound like a hassle? Would you rather pay someone else to incorporate your nonprofit while you focus on actually growing your business?
Fortunately, there are plenty of reputable incorporation services out there that can provide professional assistance for a mere fraction of a lawyer’s fees.
There are dozens of different companies that offer incorporation services these days, and it can be difficult to discern which of them is your best option. That’s why we put together our comprehensive guide to the top-rated incorporation services available online. We encourage all of our readers to check out that guide and choose the right company for your specific situation.
When Is the Best Time to Incorporate Your Nonprofit?
If you’re decided that incorporating your nonprofit is the right move, the next question is when you should do it. As we’ve mentioned, the incorporation process can be a hassle, and it can also take quite a bit of time. That said, we think you should form your corporation before you execute your first transaction with your nonprofit.
Why? The explanation all comes back to the personal asset protection afforded by the corporation. If you start your business as an unincorporated nonprofit to “ease into” nonprofit ownership, you will be entirely liable on a personal level for every transaction you execute. That’s because informal entities do not provide any limited liability protections.
If you incorporate your nonprofit before you perform your first transaction, everything your nonprofit does will be protected by the corporate veil (as long as you form and maintain your corporation properly). This protection is absolutely vital for just about any business type, so you should incorporate yours as soon as you’re 100% certain about your nonprofit model.
The Real Cost of Incorporating Your Nonprofit
Another of the most common questions we hear from nonprofit owners is how much it actually costs to incorporate. There are often additional expenses involved with the incorporation process, other than the fee you pay the state for your formation document filing. It’s important to note that, much like each state charges its own rates for incorporations, the additional costs can vary from state to state (and industry to industry, in some cases) as well.
Let’s quickly break down some of the other potential costs. One that isn’t usually required is a name reservation fee, which is required by law in Alabama but is optional elsewhere. In most states, a name reservation only has a nominal fee — in many, this will only cost you $10-20.
Another variable that can add expenses is whether you choose to use an incorporation service or not, as most of these companies charge their own service fees in addition to the state’s formation fee. Similarly, whether you want a registered agent service will also affect your new nonprofit corporation’s bottom line. If you opt for assistance from an attorney instead, your expenses will obviously grow.
Then, there’s the issue of initial and annual reports. Initial reports aren’t required in very many states, but they’re a highly important part of the incorporation process in states that do require them. As for annual reports, most states require them from nonprofit corporations, and the costs can vary widely. Some states only charge $5-10, while some don’t charge for annual reports at all. On the other hand, New York charges up to $1,500, depending on your nonprofit’s net worth.
Taxes are another variable for nonprofit corporations. Remember that not all nonprofits are tax-exempt, so if your nonprofit isn’t a qualified charity, you’ll need to plan for taxes. Different states have different nonprofit tax rates, and some also assess other fees, like franchise taxes.
Frequently Asked Questions
How long does it take to incorporate a nonprofit corporation?
The answer to this question varies considerably based on your state of formation. There are some states that have online incorporation portals where you can form a nonprofit corporation immediately. Meanwhile, some states require you to mail in paper forms that can take a matter of weeks. Additionally, many states offer some sort of expedited service that can dramatically speed up your formation process. For more details, ask your incorporation service or your state’s Secretary of State office. In general, nonprofit incorporation can often take a bit longer than business incorporation or an LLC formation.
Should I use an online incorporation service, hire an attorney, or form my own nonprofit corporation?
All three of these options have their own advantages and disadvantages, depending on your priorities. Forming your own nonprofit corporation will always be the cheapest option, although it doesn’t involve any professional assistance. On the other end of the spectrum, hiring an attorney can be prohibitively expensive for many nonprofits, although the expert advice you’ll get can make it worthwhile. Finally, an online incorporation service splits the difference, providing professional help while charging a fraction of an attorney’s fees.
What types of bonus features can I expect if I use an incorporation service?
This all depends on which company you choose to form your nonprofit corporation, and which of its formation packages you opt for. In general, it’s common to see these companies include perks and features like registered agent service, operating agreements, annual report service, binders embossed with your nonprofit’s name, and more.
Can I form a nonprofit corporation with a limited lifespan?
Yes, when you incorporate your nonprofit, you will have the option to designate a perpetual lifespan or a specified dissolution date.
Can I form a nonprofit corporation by myself? Or do I need co-owners?
Although the vast majority of nonprofit corporations have multiple owners or shareholders, you are welcome to form a one-person corporation in many states if you’d like to.
Do I need to hold regular meetings for my nonprofit corporation?
Nonprofit corporations have strict requirements to hold shareholder and board of directors’ meetings on a regular basis, and also to take detailed minutes from those meetings.
What state should I form my nonprofit corporation in?
This is a bit of a tough question, as different states have different pros and cons for nonprofit incorporations. For the most part, people tend to form nonprofit corporations in their home states, and this is typically our recommendation as well. However, there are a few states with distinct advantages that we should briefly discuss. Delaware is a popular option for nonprofit incorporations for several reasons. This state allows for a one-person board of directors, which is why many smaller New York nonprofits incorporate in Delaware (New York requires at least three directors). Delaware also does not have nonprofit statutes, which means there are far fewer restrictions on nonprofit corporations here than in many other states. Arizona has become an increasingly popular state for nonprofit corporations as well. Arizona has some of the lowest incorporation and maintenance fees in the nation, with very few regulations on nonprofits as well. Meanwhile, if your nonprofit is not a tax-exempt entity, you might want to look at Nevada, which is a state with no corporate income taxes and loose nonprofit regulations.
How does limited liability protection work?
The limited liability protections afforded by a nonprofit corporation are often referred to as the “corporate veil.” This veil provides a layer of separation between your organization’s assets and your personal assets, preventing creditors from pursuing your house, car, personal bank accounts, and more while suing your nonprofit. Thanks to the corporate veil, only your organization’s assets are at risk in a lawsuit. However, if you fail to form or maintain your nonprofit corporation in compliance with state laws, your corporate veil could be “pierced” and you will lose your limited liability protection.
What do I need to do after I form my nonprofit corporation?
The maintenance required for a nonprofit corporation can be rather extensive, especially if your nonprofit has tax-exempt status. Most states require nonprofit corporations to file annual reports and pay the associated fees. Many states also require state tax board filings. And, if your nonprofit is tax-exempt, you’ll also need to file your Form 990 with the IRS every year.
Aspects to Consider Before Forming a Nonprofit Corporation
You don’t have to be a nonprofit corporation in order to operate as a charitable organization, but incorporating does have its advantages. Before we wrap things up, let’s take a look at a few things you should keep in mind when deciding if a nonprofit corporation is the right entity for your organization.
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.
Conclusion
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. Still, keep in mind that incorporating is far from the only way you can support a good cause with your nonprofit organization, and for-profit corporations can also help shape our society for the better while also providing more financial incentives for you and your co-owners.
If you’re seeking personal asset protection and you want to apply for 501(c)(3) charitable tax-exempt status, then a nonprofit corporation could very well be the perfect entity type for your new organization.