Before You Incorporate as a Nonprofit – Pros & Cons

Not every nonprofit needs to incorporate and apply for 501(c)(3) status from the IRS. To help you decide, we’ve compiled a list of advantages to nonprofit incorporation and some important drawbacks.

Benefit #1: No Taxes

As a nonprofit corporation, your organization is eligible for state and federal exemptions from corporate income taxes plus certain other taxes. Federal corporate tax rates can run as high as 34% while state corporate taxes can take a bite as well. If you expect to earn substantial amounts of money from your services, exhibits, product sales, or performances, you’ll likely want to seek an exemption. A tax-exempt nonprofit will also save on local taxes such as levied by your state, and county.

Benefit #2: Ability To Receive Public And Private Donations

As a 501(c)(3) nonprofit corporation you will be able to receive grants and donations. Tax-exempt government foundations such as the National Endowment for the Arts or Humanities and private foundations such as the United Way or the Ford Foundation are required to give funds only to 501(c)(3) organizations.

Individual donors to your nonprofit corporation can claim personal federal income tax deductions for their donations, and bequests will be exempt from federal estate taxes.

Benefit #3: Protection From Personal Liability

Shielding members of your organization from personal liability is key among the benefits of nonprofit incorporation. Board members, officers, and employees of your organization will be protected from liability for corporate debts or liabilities such as unpaid organizational debts or lawsuits against the organization. Creditors can go after only your corporate assets, not the personal assets of the people who manage, work for, or volunteer for your organization.

Benefit #4: Organizational Perpetuity

A corporation is a legal entity separate from individuals who manage it or organize it. It is this separate legal existence that affords the protection from liability, but it also means that the organization becomes immortal in a way. The nonprofit corporation continues to exist beyond the lifetime or involvement of the people who began it or who have managed it. The fact that the organization continues in this way is attractive to donors who want to fund a cause over the long term.

Benefit #5: Employee Benefits

Being a corporation opens the door for employee benefits such as group life insurance, health insurance, a pension plan, etc. These benefits are not available to the workers in unincorporated organizations.

Benefit #6: Corporate Structure

Forming a nonprofit corporation is not simple but the documents required do force the group to be clear about its mission, think through its operating rules, and develop procedures for decision making. This is especially important for a nonprofit whose board members may come with diverse interests and viewpoints. Clear-cut delegation of authority and specific operating rules embodied in the articles of incorporation and the bylaws will make running the organization easier and less divisive.

Other Benefits

Miscellaneous benefits include exemptions from county real and personal property taxes; lower postal rates on third-class bulk mailing; cheaper advertising rates; the ability to air free radio and television public service announcements (PSAs), and many others depending on the activities your organization engages in.

Disadvantages

Disadvantages include a lot of paperwork; costs such as hiring a lawyer to prepare your papers; and time and energy to comply with regulatory demands and to grow your organization.

There will be restrictions too, such as no pay for your directors, no political campaigning or lobbying, and when your organization folds, its assets must be given to another nonprofit.

But if the benefits of becoming a nonprofit corporation make sense and outweigh the disadvantages, you may be ready to move ahead.

Nonprofit Incorporation – an Overview

Nonprofit Incorporation Begins at the State Level

Before you can apply to the IRS for tax-exempt status, your organization must first become a corporation. Incorporation will protect board members and other individuals in your organization from being held personally liable in case of a lawsuit.

Nonprofit incorporation is very similar to creating a regular corporation except that a nonprofit must take the extra steps of applying for tax-exempt status with the state in which it incorporates and with the IRS.

Nonprofit incorporation usually involves these steps:

  • Choose a name that is legally available in your state.
  • File your “articles of incorporation,” and pay a filing fee.
  • Apply for federal and state tax exemptions.
  • Create bylaws that will dictate how the corporation is run.
  • Appoint an initial board of directors.
  • Hold the first meeting of the board of directors.
  • Apply for any licenses or permits that your corporation will need to operate in your state and local municipality.

Your state’s corporate filing division is usually part of the secretary of state’s office. You can also look up your state office through the National Association of State Charity Officials (NASCO). You can request a packet of nonprofit materials from that office which will include sample articles of incorporation, the state’s laws on nonprofit corporations, and instructions on how to find an available business name.

After you have filed all the paper work for nonprofit incorporation in your state, and received a copy of your articles of incorporation, you can move on to submitting your application to the IRS for your federal nonprofit status as a 501(c)(3) organization. It is best to file within 27 months after the date of your incorporation.

The forms you must complete for the IRS include

  • IRS Form 818, User Fee for Exempt Organization Determination Letter Request
  • IRS Package 1023, Application for Recognition of Exemption.

IRS publication 557, Tax-Exempt Status for Your Organization, provides instructions on filling out these forms. You can get all of the forms and Publication 557 by calling 800-TAX-Form, or they can be downloaded from the IRS website, www.irs.gov.

The IRS will review your application and send you a letter indicating that it has approved your nonprofit status. Or, the IRS might ask you for more information. It can also deny your application. If that happens, don’t give up; contact a lawyer who specializes in nonprofits.

You may need to apply to your state for tax-exempt status as well. Some states require a separate application to get a state tax exemption; some states are satisfied with your federal tax-exempt status; and in others, you will need to send a copy of your IRS determination letter. To find out what your state requires, contact your state tax agency.

Apply for a solicitation license from your city. Check to see if your city requires you to have such a license before you can solicit funds.

How To Incorporate as a Nonprofit: A Check List

Once you decide to incorporate as nonprofit organization and to apply for tax-exempt status, there are a number of steps that you must take. This list can serve as a blueprint and as a reminder of what needs to be done and in what order.

Time Required: Varies

Here’s How:

  1. Draft a mission statement. It should describe the charitable purpose of your organization
  2. Recruit board members. Your state will require a certain number of board members if you incorporate as a nonprofit. If you do not plan to incorporate, or if it is too early in the process to do that, pull together an informal advisory group to guide you.
  3. Hire a lawyer. A lawyer can help you file your articles of incorporation; help you apply to the IRS for tax-exempt status; and, eventually, review your organization’s personnel policies.
  4. Open a bank account. Choose a bank that has experience with new, small nonprofits.
  5. Find an accountant to set up a basic bookkeeping system.
  6. Get an insurance agent. You may need liability insurance, property insurance, and advice about staff issues such as worker’s compensation, health and life insurance benefits, and more.
  7. Write articles of incorporation. Your Secretary of State’s office may provide a template for articles of incorporation. The articles provide a legal description of your organization and assign power to the board. Submit them to your board for approval. You will need these in order to incorporate in your state as a nonprofit.
  8. Draft bylaws and get board approval. Bylaws specify how the organization will be run and how the board will operate.
  9. File for incorporation with your state. The secretary of state’s office can provide you with your state’s specific requirements. The IRS maintains links to state websites where you can find the appropriate office.
  10. Apply to the IRS for federal tax-exempt status. The IRS provides information at its Tax Information for Charities & Other Non-Profits.
  11. Apply for state tax exemption, if necessary.
  12. Find out what laws govern charitable solicitations in your state. You will need to fulfill all requirements before you start to raise funds for your nonprofit.
  13. Get a mail permit from your local post office. This will get you a discount on bulk mailings.
  14. Get a federal employer identification number (EIN). You will need this to hire employees, withhold income taxes and FICA. You must apply for your EIN with the IRS before submitting your application to the IRS for your federal nonprofit status as a 501(c)(3) corporation.
  15. Find out about unemployment insurance requirements from your state.

Tips:

  1. Don’t forget to create a name for your nonprofit, a task that is more involved than you might think.
  2. Many states supply materials such as templates for your articles of incorporation. These forms may be online and you may even be able to file them online. Check your secretary of state’s office website which you can probably get to through the main site of your state. You may also send a letter to your Secretary of State requesting that information on incorporating as a nonprofit be sent to you.
  3. Most state websites provide a link to the state’s nonprofit corporation laws. You will want to look at these and know how to reference them as you prepare your incorporation paperwork.

Fritz, Joanne. “Guide to Nonprofit Charitable Orgs”
About. June 11, 2010. June 14, 2010.