Nonprofit corporations, also called “not-for-profits,” are businesses organized for a purpose other than to gain profits. Unlike the name implies, nonprofits are allowed to earn a profit. However, instead of disbursing profits to shareholders by paying dividends, they must reinvest any profits into the corporation. Generally, they aim to create some benefit or service to the general public or specific public groups. Most nonprofits take the form of charitable, educational, religious, literary, or scientific organizations.
Nonprofits also do not pay federal or state taxes on the income they earn while carrying out their missions. The IRS and state tax agencies believe that the benefits nonprofits bring to the public entitle nonprofits to this tax exemption, which is most commonly section 501(c)(3) of the IRC.
Nonprofits are formed by incorporating under state law in a process similar to that of normal for-profit corporations. Incorporation offers many advantages, including personal liability protection for the directors and officers. Furthermore, nonprofits may continue in existence in perpetuity. This allows the business to continue to pursue its objectives long after the founding members are gone.
While nonprofit corporations may be controlled by voting members (discussed below), most are controlled by the board of directors. With this structure, the initial board members are elected at the first corporate meeting, and additional and replacement board members are elected by the board itself. This is what is known as a “self-perpetuating board” because there is no need for separate voting members to continually elect the board members.
The main responsibilities of a board of directors are to make certain high-level company decisions and establish major corporate policies. In practice this means that they look out for large risks threatening the nonprofit’s mission as well as the overall viability of the business. Specific tasks for accomplishing this typically include finding and placing talented executives in key roles, setting executive compensation, monitoring the corporation’s performance, auditing financials, setting goals, and dissolving the corporation if need be. In a nutshell, the board must do its best to safeguard and serve the interests of the corporation and its mission.
The board may be comprised of outside members, executive officers, and key management personnel. The size and exact composition of the board of directors will depend on the company’s needs and circumstances. The focus should be on finding a good balance of external members and internal managers in order to effectively represent the interests of the business itself, the management, and the public.
When nonprofits take the form of democratic, member-driven organizations or associations, they often choose to use voting members to elect their boards. In this way, the members have the ultimate say over who is setting the major corporate goals and policies. Common examples of organizations that frequently use voting members include social clubs, unions and trade associations, chambers of commerce, professional associations, and churches.
Members have specific rights under state law and the corporation’s governing documents, namely the articles of incorporation and corporate bylaws. However, keep in mind that there may be additional corporate formalities that voting membership nonprofits must follow. For instance, all meetings of voting members must be properly noticed and documented in the same manner as board meetings.
The board of directors elects the corporate officers. At a minimum, officers include a president or chief executive officer (CEO), a secretary, and a treasurer. State law determines which officers are required to serve in nonprofits and which are optional.
Officers have a duty to always act in the best interests of the nonprofit within the scope of their responsibilities. For this reason, it is not uncommon to see larger companies with tens or even hundreds of officers. At the top of the pyramid is the CEO who is accountable to the board of directors for the overall performance of the business.
The treasurer, or chief financial officer (CFO), is responsible under state law for keeping accurate financials that comply with all applicable laws and regulations. The secretary must maintain all corporate records, including board meeting minutes and corporate resolutions, corporate bylaws, licenses and permits, major contracts, tax and other governmental filings, and stock transactions.
Optional officer positions include other upper management roles that report to the CEO, including a chief operating officer (COO), a chief information officer (CIO), a chief sales officer (CSO), and senior vice presidents.
The most obvious difference between nonprofit and for-profit corporations is that nonprofits are prohibited from operating for a profit. What this means in practice is that corporate income may not go to any individuals beyond the reasonable salaries paid to employees. Therefore, there may be no shareholders profiting from the nonprofit’s operations. Income earned must stay in corporate accounts and only be spent on business expenses. All employee salaries must be “reasonable” within the industry and under the business’s circumstances. If salaries are too large, then the corporation may lose its status as a nonprofit.
Other notable differences include the following:
The income for normal for-profit C corporations is taxed twice in what is known as “double taxation.” A C corporation pays taxes on the company’s income at the entity level, and then is taxed again at the personal level on income that goes to shareholders and employees as salaries.
On the other hand, nonprofit corporations that maintain their status receive a number of tax benefits. Most importantly, they are exempt from paying federal income taxes to the IRS. They also typically do not have to pay state income taxes, but this may vary a little depending on the state.
Another potential tax advantage comes in the form of tax-exempt financing. There are often a number of federal and state laws available to nonprofits that help them obtain cheaper financing. Investors that offer this financing do not have to pay income tax on income received from the nonprofit’s interest payments, so the savings typically get passed on to nonprofits as lower interest payments.
Furthermore, the ability to receive tax-deductible donations makes it easier for nonprofits to find financing. Nonprofits may also be eligible for exemptions from various local and state taxes (including sales taxes), and many nonprofits may receive large discounts on postage rates from the United States Postal Service.
Forming a nonprofit corporation is almost identical to forming a for-profit corporation. You begin by filing the articles of incorporation with the appropriate division in the state in which you wish to incorporate (see our FAQ "In which state should I incorporate?").
Once complete, you will apply for federal and state tax exemptions. Section 501(c)(3) of the Internal Revenue Code (IRC) is the primary exemption you will need to obtain. Also check with your state’s tax division for any state exemptions that may be available to nonprofits. This is the main difference between forming nonprofit and for-profit corporations and is often the most time-consuming part of the process.
The next step requires drafting your corporate bylaws, which will specify the major rules and procedures used to determine how the corporation will be run. This includes details on the annual members’ meeting, voting rights, the board of directors, corporate officers, and dissolution procedures.
The final step is to hold the first members’ meeting to elect the board of directors, formally start operations, and pass any initial resolutions. Note that depending on your industry, as well as state and local requirements, you may need to also obtain specific licenses and permits before starting operations.
Once you have figured out in which state you want to incorporate, you will need to file the articles of incorporation (see below). During the incorporation process, it is recommended that you review your state’s nonprofit requirements. This is important information to know even if you are using an online service to help you incorporate. Ultimately, the nonprofit is responsible for making sure it stays in compliance with any local, state, and federal laws. If you plan to operate in a highly-regulated industry, it is usually advisable to consult an experienced attorney.
When using an online service, such as LegalNature, to incorporate, simply provide the relevant information when prompted. The service will then handle the rest of the work—filling out the forms, submitting them, and sending you a confirmation and any additional instructions or information needed to proceed once you are approved by the state.
The registered agent is the person responsible for receiving service of process for the corporation. All corporations must have a registered agent available during regular business hours in their state of incorporation to receive court summons and other legal notices.
You can choose to either act as your own registered agent or hire a third-party service to act on the nonprofit’s behalf. Each option has its pros and cons; for example, being your own registered agent is less expensive, whereas a typical third-party service costs between $150 and $300 per year. The downside of not using a service is that you could be served with lawsuits in the presence of employees and customers, which may be damaging to your reputation.
Expedited filing is an option many states offer for nonprofits wishing to incorporate on a more condensed timeline. While the processing time varies from state to state, expedited filing typically takes one to three days. There is an additional fee associated, but this may be well worth paying if your business needs to get to market fast.
To receive your corporate status and all the rights, privileges, and obligations that come with it under state law, you will need to file your articles of incorporation with the appropriate state division, usually the Secretary of State’s Office. The articles will include, at a minimum, the name of the corporation, the principal place of business, a statement of the primary purpose of the organization, the name and address of the registered agent, the nonprofit’s duration of existence (either a fixed date or perpetual), and the names and addresses of the initial members or incorporators.
Note that most states allow businesses to provide a statement of purpose in very general terms, such as “to engage in any and all business permitted by law.” However, nonprofits need to state one or more of the exempt purposes approved under section 501(c)(3) of the IRC: "religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competitions (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals." Failing to do so may result in a denial when you apply for tax-exempt status with the IRS.
Think of bylaws as an internal rulebook for the organization’s key decision-makers. They specify the nonprofit’s corporate governance procedures, including how the board of directors and any committee members will be selected, when and how annual meetings will be conducted, and how to deal with conflicts of interest between the company and its decision-makers.
Although federal tax law does not require nonprofits to maintain corporate bylaws or to include any specific language, most states require nonprofits to maintain updated bylaws, and it is generally advisable to do so even if not mandated by state law.
State nonprofit law commonly includes provisions on corporate governance. These operate as default, or “gap-filler,” rules for nonprofits to abide by when their own bylaws are silent on a particular matter. Your bylaws are allowed to depart from state law by creating alternate procedures, so long as those procedures are not specifically deemed illegal under state law. You should make a habit of always updating your bylaws with any new corporate governance rules you may be using. This will ensure that there is always a single document containing all relevant operating rules and procedures whenever anyone has questions.
The first official order of business will be to hold an organizational meeting to pass the standard resolutions necessary to formally begin operations. The meeting minutes are simply official records of the items discussed and resolutions passed at such meetings. Corporations must maintain meeting minutes of all board meetings in their corporate records.
Once the meeting is officially called into session and the necessary introductory formalities are taken, the members will agree to adopt the articles of incorporation, bylaws, and any other documents necessary at that time. Next, the members will appoint the corporate officers named in the bylaws, agree on the dates of the fiscal year, authorize the pursuit of any outstanding tax exemptions, and adopt a corporate seal, if desired.
Contact us here.