An unincorporated club, church or other group is an “unincorporated association”. All members of an unincorporated association are personally liable for any obligations incurred in connection with its activities. This risk should compel any reasonable person to insist that their unincorporated association be incorporated as a nonprofit corporation.
A nonprofit organization is not prohibited from engaging in profit making activities. It is prohibited from passing any profit to the individuals who control the entity, either during its existence or at its termination. A nonprofit organization may pay reasonable salaries to and reimburse expenses incurred by its officers, employees and others who provide a service for it.
The most common form of nonprofit organization is a nonprofit corporation. The nonprofit corporation will be organized under the law of the state where its operation is located. Creation of a nonprofit corporation does not qualify the entity as a tax exempt organization for purposes of federal income tax.
To qualify as a tax exempt entity, a nonprofit corporation will generally qualify as a public charity under Section 501(c)(3) of the U.S. Internal Revenue Code (hereafter “I.R.C.”). To qualify, the entity must be formed and operated for a charitable purpose that is for the benefit of some significant segment of society, and must be publicly supported, receiving funds from governmental entities or from multiple private donors.
Qualification as a tax exempt entity is evidenced by a “determination letter” from the I.R.S. that should be filed with the permanent records of the corporation. It will be frequently necessary to provide a copy in order to establish the status of the nonprofit corporation as a tax exempt organization under I.R.C. Section 501(c)(3).
Qualification of the entity as a tax exempt organization under I.R.C. Section 501(c)(3) will exempt the organization from federal corporate income tax, and will allow donations to the organization to be qualified as charitable donations that are deductible to the donor under I.R.C. Section 170.
Nonprofit Corporation: Limited Liability:
A nonprofit corporation is exposed to liability for its own debts and obligations, including income tax, sales tax and other taxes, violation of charitable solicitation laws, and lawsuits common to any business: wrongful termination of employment, employment discrimination, personal injury and breach of contract. Directors, officers and members of a nonprofit corporation enjoy limited liability for the obligation of the organization, including any unlawful acts of other directors, officers, employees or members.
This limitation on liability does not protect a director, officer, employee or member from personal liability for their own wrongful conduct. It is also possible that personal liability may be imposed on directors, officers, employees or members of an entity under the doctrine of “piercing the corporate veil” if the formal structure of the corporation is not observed, or the corporation is “thinly capitalized”.
Formation of a Nonprofit Corporation:
The existence of corporate status is commenced by the filing of Articles of Incorporation, usually with the Secretary of State. In addition to the more typical provisions pertaining to corporate governance, in order to qualify as a tax exempt entity under I.R.C. Section 501(c)(3), the Articles of Incorporation must contain language stating the purpose of the nonprofit corporation, and the ultimate distribution of the assets of the nonprofit corporation upon dissolution of the corporation to qualifying nonprofit organizations.
Following the filing of the Articles of Incorporation, the directors named in the initial Articles of Incorporation should hold an organization meeting at which the initial officers of the corporation will be elected, the initial Bylaws of the corporation will be adopted, and other items of business will be transacted as may be necessary to authorize the corporation to conduct its business. The Bylaws are the internal rules and procedures for the operation of the corporation. They are generally much more detailed than the general principles of corporate existence as stated in the Articles of Incorporation.
Officers of the nonprofit corporation should institute and maintain a system of permanent corporate records that can be conveniently handed over to succeeding officers. These records should include the current Articles of Incorporation and Bylaws, membership records, correct and adequate records of accounts and finances, names and addresses of directors and officers, and minutes of the proceedings of any meetings of members, directors or minutes maintained by committees of the Board.
Details with respect to the governance of a nonprofit corporation are stated in the specific Articles of Incorporation and Bylaws of the nonprofit corporation. Reference should always be made to these documents to be certain that appropriate procedures are being followed so that the business of the nonprofit corporation may be lawfully authorized.
In general, the management of all corporate affairs is vested in the Board of Directors. The directors make major strategic and financial decisions for the corporation (such as the election of officers, the adoption of a fiscal budget and authorization of expenditures), and ensure compliance with relevant legal and accounting requirements.
Officers are generally elected by the Board of Directors or the members of the organization. Officers oversee day-to-day operations of the corporation. The officers usually consist of a president, vice-president, secretary and treasurer.
The nonprofit corporation may also employ employees or other contract personnel who execute the decisions made by the directors or officers.
Initial Tax Filings:
A nonprofit corporation will need an Employer Identification Number (“EIN”) issued by the Internal Revenue Service. The application may be submitted at the IRS website or by mailing or faxing Form SS-4 to the IRS. The EIN is issued immediately. The issuance of the EIN does not constitute qualification of the nonprofit corporation as a tax exempt entity for the purposes of I.R.C. Section 501(c)(3).
A nonprofit corporation may also be required to file with state and local taxing authorities.
Application for 501(c)(3) Tax Exemption:
A nonprofit organization that has been established as a public charity with a 501(c)(3) purpose does not need to apply for federal tax exemption if its gross receipts are normally less than $5000.00 per taxable year (or a total of $15,000.00 in its first three tax years). But if that threshold is exceeded, the application for tax exempt status must be filed within 90 days of the end of the fiscal year.
Ordinarily, it is preferable to secure the tax exempt status retroactive to the date of incorporation so that any income is exempt from tax, and any donations are tax deductible to the donor. To secure retroactivity, the Form 1023 must be filed within 15 months from the date of incorporation. If the entity has not completed a tax year of at least eight months at the time of application, an advance ruling must be requested. In that case the IRS will issue an advance ruling if it believes that the information submitted will qualify the nonprofit organization for tax exempt status. After five years, the IRS will review the nonprofit corporation’s annual information returns to evaluate whether the nonprofit corporation has been operating according to the requirements set forth in I.R.C. Section 501(c)(3). If so, the IRS will issue its determination letter.
If the entity has completed a tax year of at least eight months at the time of application, a definitive ruling may be requested.
Registration with State Charitable Solicitations Department:
If the nonprofit corporation intends to solicit donations from the public, it will likely need to be registered with the state department that oversees charitable solicitations.
Federal Tax Treatment:
A nonprofit corporation that is qualified as tax exempt under I.R.C. Section 501(c)(3) is exempt from federal corporate income tax. However, this exemption does not apply to unrelated business taxable income that is generated from regular trade or business activities that are not substantially related to the nonprofit organization’s exempt purpose. Such income is reportable to the IRS on Form 990T.
A tax exempt organization must file an annual tax return with the IRS unless its gross receipts are normally $25,000.00 or less. Organizations with gross receipts below $100,000.00 and with total assets of less than $250,000.00 can file the return on Form 990EZ. Other organizations must file the return on Form 990.