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Business Formation

Learn about nonprofit organizations, a common business formation.

Nonprofit organizations serve the public interest or are charitable in nature. [©Jupiter Images, 2009]
©Jupiter Images, 2009
Nonprofit organizations serve the public interest or are charitable in nature.

One common business formation is the nonprofit organization. Unlike for-profit corporations, nonprofit organizations are not formed for the purpose of making money; they generally serve the public interest or are charitable in nature. Nonprofit status confers many benefits upon an organization, including exemption from income taxes. However, nonprofit status also has limitations, such as a ban on significant lobbying activity.

Benefits to Nonprofit Business Formation

The United States Department of Agriculture explains that there are many benefits to starting a nonprofit organization, including the following:

  • Nonprofit organizations can receive government grants.
  • Nonprofit organizations qualify to receive charitable contributions.
  • Nonprofit organizations are exempt from paying income taxes.
  • Nonprofit status is an essential step toward implementing community-wide development plans.

The Virginia Department of Business Assistance adds that nonprofit organizations also qualify for limited liability protections.

Nonprofit organizations are formed under different state laws than those for profit corporations. Generally speaking, the nonprofit organization must have one of the following purposes:

  • Religious
  • Charitable
  • Educational
  • Literary
  • Scientific

Nonprofit organization status is sought by groups working in many different areas, including:

  • Childcare centers
  • Homeless shelters
  • Community health care clinics and hospitals
  • Museums
  • Religious organizations
  • Arts groups
  • Conservation-related organizations
  • Schools

How Nonprofit Organizations Work

Most nonprofit organizations are run by a board of directors, sometimes called trustees. These directors or trustees set the nonprofit's policy but usually are not on the payroll. Officers run the organization on a daily basis and often receive salaries.

Nonprofit organizations are expected to follow many of the common business practices of for-profit corporations, such as maintaining records, compiling minutes of board meetings and keeping separate bank accounts. Nonprofit corporations cannot contribute money to political campaigns and can only engage in limited lobbying activities.

How to Start a Nonprofit Organization

According to the Office of the New Mexico Attorney General, forming a nonprofit organization (sometimes called a charitable organization) can be complicated. Such organizations must be able to prove that they have a charitable purpose. Those wishing to start a nonprofit organization usually follow these steps:

  • Choose a name and set goals. The organization's name must not already be in use by another incorporated organization. The organization's goals should be clear. Like-minded citizens should be brought together to form the organization.
  • Gather necessary materials. The Secretary of State's office, or a similar department in a state government, may provide necessary materials for starting the nonprofit organization. These materials usually include the articles of incorporation form, the state's nonprofit laws, a list of filing fees and instructions for required activities after incorporation.
  • Review Internal Revenue Service (IRS) rules on tax-exempt status for nonprofit organizations.
  • Write and file the articles of incorporation with the Secretary of State's office or other applicable state department. As they can be difficult to amend, many nonprofit organizations keep their articles of incorporation as general as is allowed. Certain language should be inserted into the articles of incorporation for tax purposes. Such language deals with the organization's charitable purposes, its earnings and its dissolution. Many people trying to start nonprofit organizations hire an attorney to assist them with this part of the business formation process.
  • Write down bylaws. Typically, bylaws deal with issues such as those who will be on the board of directors, the organization's policies, its fiscal management practices and so on. Basically, the bylaws spell out specific organizational details.
  • After incorporation, the nonprofit organization needs to file for tax-exempt status with the IRS. In determining tax-exempt status, the IRS considers such factors as legislative activities and the amount of money spent on lobbying. Organizations cannot spend a substantial part of their time promoting a political agenda or trying to influence legislation and still receive tax-exempt status.
  • After receiving tax-exempt status, a nonprofit organization must file other IRS tax forms, such as a 990 form. These forms are required for nonprofit organizations with gross receipts exceeding $25,000.

Tax-Exempt Status

Tax-exempt status allows a nonprofit organization exemption from having to pay state and federal income taxes after business formation. The most common federal tax exemption for nonprofit organizations derives from Section 501 c(3) of the Internal Revenue Code. Thus, many people refer to nonprofit groups as 501 c(3) corporations. The organizations do not have to pay taxes on income from activities that are related to the nonprofit purpose of the organization. Also, those who donate money to the nonprofit can then deduct their contributions. This makes it easier for nonprofit organizations to engage in successful fundraising.

IRS codes define 25 categories of nonprofit organizations. In many cases, to qualify for one of these categories, the income or profit cannot be distributable to members, directors or officers of the nonprofit. A nonprofit organization also needs to get an employer identification number (EIN) from the IRS. The EIN number allows the nonprofit organization to open bank accounts, file employee taxes and undergo other nonprofit related fiscal activities.

The IRS provides many detailed reports that answer people's questions about filing for tax-exempt status.

Personal Liability Protection

Directors, officers and members of nonprofits do not have personal liability for the debts and other obligations of the nonprofit organization. Limited liability makes sure that people who obtain judgments against a nonprofit organization cannot go after the personal property owned by those who work for or manage the nonprofit business.

Some exceptions to the limited liability protections exist for those who work for nonprofit organizations. For example, a person can still be held liable if he or she personally and directly injures someone, personally guarantees bank loans, fails to deposit or file taxes, intentionally defrauds or causes harm, or mingles nonprofit and personal funds.

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