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Non-profit incorporation

Starting a nonprofit is a bit complicated. Let us help.

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  • What is a nonprofit organization?

    There is not an official definition of "nonprofit organization." Most experts say that a nonprofit organization is a group of people who come together to support a specific cause or to advocate a shared viewpoint.

    When asked what a nonprofit organization is, we usually think of the most familiar types: organizations dedicated to charity, education, religion, promoting the arts and humanities, and protecting the environment. However, many people are surprised to learn that other types of nonprofits exist. Some examples are veterans' clubs, volunteer fire departments, social clubs, chambers of commerce, and labor unions.

    Nonprofit organizations can be very small, such as a local music appreciation club that also raises money for scholarships for students studying music, or they can be very large and employ thousands of people, like a hospital.

    Nonprofit organizations can look like businesses and charge for services, such as museums or universities, or they can give all or most of their services away for free, such as a food bank or disaster aid organization.

    Nonprofits can make their services open to the public, such as a local civic organization. Alternatively, they may restrict their services to members, such as labor unions or professional football leagues.

    What links these seemingly different types of organizations into the category of "nonprofit organization"? The answer is that state and federal law treats these organizations differently from ordinary, for-profit businesses. These laws restrict how nonprofit organizations may operate, place special responsibilities on the people who manage the organizations, and limit how the organization uses its money and property.

    While nonprofit organizations come in many shapes and sizes, at the core of each organization is a group of people working to benefit society and not for personal financial gain.

  • How does a nonprofit work?

    A nonprofit forms and operates very similarly to a for-profit business. In most cases, a nonprofit starts when an individual registers the nonprofit with the state. There are several options, but most nonprofits register as nonprofit corporations (also called non-stock organizations in some states).

    Once registered with the state, the nonprofit becomes a legal entity. It can own property, buy and sell items, open a bank account, enter into contracts, and much more.

    The next step is to appoint one or more individuals to manage the nonprofit. One or more individuals form a board of directors or a board of trustees. The board is legally responsible for the nonprofit's activities, even those assigned to employees or volunteers. The board adopts bylaws which are a set of rules for how the board will make decisions and use the nonprofit's assets.

    Once the nonprofit has humans to run it, the nonprofit must earn income and use its income to provide services. Most nonprofits begin with no money except what was donated by the individuals who started the nonprofit. The nonprofit board is responsible for finding money to keep the nonprofit operating. Money can come from various sources, such as donations, membership, fees charged for services, and fundraising events.

    As the nonprofit begins to grow and earn income, the nonprofit will follow many of the same business practices as a for-profit business. It will hire employees and contractors. It must follow the same employment laws. The nonprofit must file a tax return each year. While many nonprofits are exempt from paying state and federal income tax, not all are. In addition, many nonprofits must pay sales tax, franchise tax, and real estate tax just like a for-profit business does.

    To summarize, a nonprofit begins and operates much like a for-profit business does. However, instead of existing to earn a profit for the benefit of owners and investors, the nonprofit exists to earn income to provide beneficial services to society.

  • What are the advantages of starting a nonprofit?

    Nonprofits are usually intended to serve the community and its members. Since they are expected to benefit communities, the government offers tax advantages to help maximize the services they can offer. Many nonprofit founders may say that the "feel goods" are a benefit from starting a nonprofit, but there are tangible advantages as well. Major benefits include the following:

    • Limited liability protection - Directors, officers, and members usually are not held personally liable for the organization's debts and activities. Incorporating your nonprofit can help protect your assets.
    • Tax-exempt status - Nonprofits can apply for both federal, state, and local tax-exempt status, allowing them to devote a larger proportion of their resources to achieving their goals.
    • Access to grants - Some nonprofits are eligible to receive public and private grants or government funding.
    • Tax-deductible donations - Donors can make tax-deductible donations to most nonprofit corporations.
    • Lower rates on many goods and services - For example, many nonprofits are eligible for reduced postage rates—approximately 40% lower than the regular rate for commercial mailers.
    • Perpetuity - Nonprofits can survive their founders.
    • Possible state tax advantages - In addition to all these benefits, nonprofit organizations also benefit from many state specific tax advantages.

    With Rocket Lawyer, you can create, store, and customize all the legal forms for your nonprofit. Become a member and form your nonprofit with our free incorporation service, and enjoy the many benefits of a nonprofit organization.

  • Who owns a nonprofit?

    No one. This answer surprises many people. How can a nonprofit not have an owner? To answer that, we have to look at who owns the assets.

    All nonprofit assets are held in trust and may only be used to carry out the nonprofit's purposes. A group of directors or trustees oversees the management of the nonprofit. They are the guardians of the nonprofit's assets and are responsible for ensuring that the nonprofit uses its assets appropriately. The directors or trustees do not own the nonprofit or its assets.

    Since a nonprofit's assets are held in trust, the assets cannot be sold to an individual or a for-profit business. In addition, the profit earned by the nonprofit must be used to carry out the nonprofit's purposes. While a for-profit business often pays out its profits as a dividend to its investors, a nonprofit cannot do that.

    When a nonprofit wants to stop operating, it cannot simply close its doors and divide the remaining assets among the board of directors. Instead, the nonprofit must donate its assets to another nonprofit that serves a similar purpose. It must donate the assets because no one owns the assets. State and federal laws require that the assets go to a nonprofit organization with a similar purpose.

  • How do nonprofit organizations make money?

    Nonprofit organizations cannot survive on volunteer work alone. Instead, nonprofits must earn income somehow so they can provide services. Nonprofits can make money in a variety of ways.

    Some common ways to raise money are:

    • Donations, gifts, and grants.
    • Membership dues.
    • Income from selling products or services.
    • Investment income such as from endowment funds and restricted accounts.
    • Licensing intellectual property, such as trademarks, copyrights, and patents.
    • Commercial co-venture agreements (where a for-profit business promotes a nonprofit and donates a portion of the sales proceeds to the nonprofit).
    • Fundraising events.
    • Raffles, bingo, and other games of chance.

    Many people mistakenly believe that a nonprofit cannot "make a profit." This is not true. While a nonprofit cannot have a commercial purpose—meaning that it cannot exist to make money—a nonprofit can earn income and make a profit. However, all profit must be used for the nonprofit's purposes.

  • What is the difference between nonprofit and for-profit?

    There are several important differences between nonprofit and for-profit entities.

    Ownership: No one owns a nonprofit. Instead, a group of individuals oversees and manages the nonprofit. However, no one owns any of the nonprofit's assets. In contrast, people or businesses own a for-profit. The for-profit owners also own the business's assets.

    Governance: The individuals managing nonprofits and for-profits act in the best interest of the organization. However, a nonprofit is held to some additional standards. For example, individuals with decision-making authority must be careful to avoid conflicts of interest and, when they occur, follow certain practices to ensure a fair decision is made. Further, individuals with decision-making authority have a legal obligation to act in the best interest of the nonprofit even if the decision may not be in the best interest of the individual or his or her family members.

    Assets: A nonprofit organization is an organization that reinvests its profit back into its charitable purposes. It is not permitted to distribute the profits to its directors, managers, and members. However, a nonprofit may use its operating income to pay for reasonable expenses, such as rent, employee wages, insurance, supplies, equipment, and advertising. By contrast, a for-profit business exists to generate profit for its owners and may lawfully distribute its profit to its owners.

    Taxes: Most, but not all nonprofits, are exempt from most state and federal income taxes. Depending on state law, nonprofits may also be exempt from paying sales tax, real estate tax, occupancy tax, and franchise tax. However, like a for-profit business, all nonprofits must pay payroll taxes, local business occupation taxes, state unemployment taxes. All nonprofits must pay unrelated business income tax.

    Dissolution: Every nonprofit and for-profit eventually comes to the end. Often this is due to the lack of interest by volunteers or the public, the lack of money, or the nonprofit accomplished its purpose. Since a nonprofit is not owned by anyone, when it wants to stop operating, it must distribute its assets to another nonprofit. In contrast, a for-profit will distribute its assets to its owners. In addition, many states require a nonprofit to notify the state Attorney General before dissolving the nonprofit and distributing the assets to another nonprofit.

  • Can the founder of a nonprofit receive a salary?

    Yes. A nonprofit may pay a reasonable salary to anyone who provides services to the organization.

    A nonprofit may pay employees, contractors, and suppliers for the services provided. The founder may receive a salary if the founder provides services and the services are reasonably necessary for the nonprofit to operate. The salary or payment must be reasonable as compared to other nonprofits in similar industries, of similar size, and in similar locations.

    For example, a small art museum in a mid-sized city should not look at the salary of household name art museums in major metropolitan areas. Instead, it should review the salaries of similar museums in similarly-sized cities.

    So, yes, a founder may receive a salary for services provided. However, a founder may not receive a salary or any other payment simply because the founder started the nonprofit or donated money to start the nonprofit.

  • Can board members of a nonprofit be paid?

    Yes, but the IRS discourages it. According to IRS Treasury Regulation 53.4958-6, 'charities should generally not compensate persons for service on the board of directors except to reimburse direct expenses of such service.'

    However, nonprofits may reimburse board members for reasonable expenses incurred while serving on the board. For example, a nonprofit may reimburse board members for necessary and reasonable travel or for purchasing items to be used by the nonprofit.

    In addition, the IRS does not prohibit nonprofits from paying board members. The IRS publishes guidance for those that choose to do so. Nonprofits that pay their directors usually do so because the nonprofit has significant assets to manage and needs the specialized expertise and time commitments of their directors.

    However, before paying board members, a nonprofit must consider some factors. First, most nonprofits simply do not have extra income to afford to pay board members. Second, community and donor perceptions are important. Paying more than a nominal 'honorarium' can result in negative feedback from the community and donors. Third, some states, such as California, limit how many board members may be paid.

    Finally, paying board members can create a conflict of interest. This means a board member may be less likely to challenge a bad decision because the board member wants to stay on the board and continue to receive payment.

  • Can family members be on a nonprofit board?

    Yes, with limitations. No law bans family members from serving on the board of directors of the same nonprofit. In fact, some types of nonprofits, such as family foundations, will naturally have members of the same family serve on the board.

    However, many states, such as California and Indiana, require a certain percentage of the board of directors to be 'disinterested' or 'unrelated.' Family members are, by definition, 'related' and do not meet these criteria. Therefore, a board of directors may include some family members but must also include individuals who are not related.

    How many family members may a nonprofit board have? The IRS regularly advises, through Revenue Rulings and court cases, that at least 51% of the board members should be unrelated to each other. The reason is that when board members are related to each other, they may be unconsciously influenced by family interests and make decisions that benefit a family member to the detriment of the nonprofit.

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