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501
(c) (3) Nonprofit
Corporations
General Definition:
A corporation exempt from the federal corporate income tax under Section 501 (c) (3) of the Internal
Revenue Code.
IRC 501 (c) (3) Nonprofit Corporations must be organized for religious, charitable,
educational, scientific or literary purposes for the benefit of the public.
To obtain full tax benefits, the organization must also qualify as a
public charity. There are three ways to qualify as a public
charity:
- Automatic
Public Charity. The following organizations are
recognized as as public charities by the IRS:
- Churches, without regard to
any particular religion, so long as they are organized under a
traditional structure.
- Schools, providing education
for public benefit.
- Hospitals and Medical Research
Organizations, which provide on-site medical care (excludes convalescent
homes).
- Public Safety Organizations,
which administer public safety testing.
- Government
Organizations which support Colleges or Universities.
- Support Organizations
set up solely to support one of the organizations above.
- Publicly
Supported Organizations. To qualify, the organization
must rely on broad-based support from individual members of the community
or various public and private sources. Publicly Supported
Organizations cannot rely on funding from a few private
sources.
- Meeting the
Support Test. To qualify as a public charity under
the Support Test, an organization must meet BOTH of the following two
requirements:
- The organization must normally
receive more than 1/3rd of total support each tax year as
Qualified Public Support. Qualified Public Support is
support from any of the following sources;
- gifts, grants, contributions or
membership fees
- gross receipts from activities
related to the exempt purpose of the nonprofit
- In
addition, the organization must normally not receive more than
1/3rd of its annual support from unrelated trades or businesses,
or gross investment income. Taxes on business income are
deducted before the 1/3rd amount is calculated.
| major
benefits |
major
drawbacks |
| Profits
are exempt from corporate taxation
Allows for tax-deductible contributions by donors to nonprofit
Profits can be retained
and used to pay reasonable salaries
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Cannot distribute profits to members, employees
or participants
Increased corporate formalities; periodic filings with state and
federal agencies, mandatory corporate meetings, more rigorous bookkeeping
requirements
Must file the federal tax exemption application |
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Limiting Personal Liability:
Like other types of corporations, a nonprofit protects
members, directors and employee from exposure to the liabilities, debts and obligations incurred by their
business.
Exceptions to liability protection:
- A corporation takes out a loan, and someone within the
corporation personally guarantees the loan. However, it is very uncommon
for a non-profit director to have to sign personally on a loan.
- State and federal governments can hold the corporate
employee who is responsible for reporting and paying corporate taxes personally
liable for unpaid taxes or penalties that come as a result of not paying
taxes. Since a 501 (c)(3) nonprofit should not have to pay taxes, this
sort of personal liability should not be a problem. However, personal
liability for unpaid taxes may come into play if the nonprofit maintains a
"for profit" arm. Normally, the party burdened with personal liability is the corporate Treasurer.
- Members of a nonprofit corporation can be found
personally liable for breach of duty that they owe to the corporation.
Directors and officers have a "duty of
care" to act responsibly when performing corporate duties. Generally, if
directors and officers attend meetings and carry out their responsibilities
designated to them in the corporate bylaws, they will not be found in breach of
their duty of care.
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terminology |
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name
for owners:
Participants or Members
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name
for ownership Interest:
N/A
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document
that creates the entity:
Articles of Incorporation
Certificate of Incorporation
Charter of Incorporation
Articles of Association
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document
that determines
operating procedure:
Nonprofit Bylaws
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- Organization as a tax exempt nonprofit corporation is a common requirement
for obtaining grant funds from government agencies and private foundations.
- Certain federal, state, and local income, property and sales tax exemptions
are available to nonprofit corporations.
- Tax exempt nonprofit organizations offer donors
an individual deduction for contributions. (Private donors can claim personal federal income tax deductions of
up to 50% of adjusted gross income for donations made to 501 (c) (3)
organizations.)
Ancillary Benefits:
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Nonprofits can qualify for employment incentive programs where salaries of
certain employees are paid largely through state and federal government
funds.
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Nonprofits receive
lower postal rates on 3rd class bulk mailing.
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Many publications offer cheaper classified advertising rates to nonprofit
organizations.
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Stores often give lower membership rates to nonprofit employees.
Directors:
The board of directors act as representatives of the members. They
make the important policy decisions of the company and elect the officers.
Most states require nonprofit corporations to have at least two directors.
Officers:
The officers manage the day to day operations of the corporation.
Generally, the first three officers elected in a nonprofit corporation are the President,
Treasurer and Secretary.
Members:
Members may or may not pay dues to the organization. They participate in
the overall management of the organization and typically vote to select
directors.
Meetings:
Generally, Nonprofit Corporations must hold annual meetings of the board of
directors. Corporate bylaws may be drafted to
allow members and/or directors to attend annual meetings by
proxy.
State
Reports: Most states require Nonprofit Corporation to file annual (in some states
biannual) reports with the state, updating the status of directors, officers,
participants, and/or the corporation in general.
Most states require one of the following words, or an abbreviation thereof,
to be included in the name of a Nonprofit Corporation:
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names
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abbreviations
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Corporation
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Corp.
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Incorporated
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Inc.
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Limited
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Ltd.
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As long as a corporation is organized for a nonprofit purpose, it can
generate more money than it expends. Tax-free profits can be used for reasonable salaries of officers, directors
and employees or to further advance the cause of the organization
Furthermore, nonprofits can collect passive income (from rents, royalties, interest etc.)
without taxation in many cases.
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operational
rules and restrictions |
- Payment of profits (in any form) to directors, officers, members or staff
is prohibited
- Income from sources unrelated to the tax exempt purpose of the group must
not be substantial
- The assets of the group must be dedicated to tax exempt purposes (when the
group dissolves, the remaining assets must be distributed to another tax exempt
organization)
- Profits made from activities not included in the
nonprofit purpose are
likely subject to federal income taxation
- A nonprofit organization cannot participate in political campaigns for or against
candidates for public office
In a nonprofit, principals of the corporation
may serve as employees. Employees are entitled to many of the same fringe
benefits available to employees of a C
Corporation.
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Startup Legal, Inc.
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