Nonprofit Basics

Becoming a nonprofit corporation requires some paperwork–and some money–but for many groups, it’s worth it. The Commonwealth of Massachusetts allows businesses to form nonprofit corporation status, also known as not-for-profit corporations. The main reason people form these corporations are to get tax-exempt status under the Internal Revenue Code (Section 501(c)(3)). If a corporation is tax-exempt, not only is it free from paying taxes on its income, but also people and organizations that contribute to the nonprofit corporation can take a tax deduction for their contributions. Because many nonprofit organizations rely heavily on grants from public agencies and private foundations to fund their operations, attaining 501(c)(3) status is critical to success.

Tax-exempt status isn’t the only benefit available to a nonprofit corporation. An organization that plans to do some heavy mailing may be attracted by the cheaper postal rates.
To apply for federal nonprofit tax status, you need to get the IRS Package 1023 exemption application. This is a lengthy and technical application with many references to the federal tax code. Most nonprofit organizers need help in addition to the IRS instructions that accompany the form. Generally, you must meet the following conditions to qualify for a 501(c)(3) IRS tax exemption:

• The assets of your nonprofit must be irrevocably dedicated to charitable, educational, religious or similar purposes. If your 501(c)(3) nonprofit dissolves, any assets it owns must be transferred to another 501(c)(3) organization. (You don’t have to name the specific organization that will receive your assets–a broad dedication clause will do.)
• Your organization cannot campaign for or against candidates for public office, and political lobbying activity is restricted.
• If your nonprofit makes a profit from activities unrelated to its exempt-purposes activities, it must pay taxes on the profit (but up to $1,000 of unrelated income can be earned tax free).
What kinds of groups should consider becoming nonprofit corporations? Here’s a partial list:
• child care centers
• shelters for the homeless
• community health care clinics
• museums
• hospitals
• churches, synagogues, mosques and other places of worship
• schools
• performing arts groups
• conservation groups.

Most nonprofit corporations are run by a board of directors or trustees who are actively involved in the work of the corporation. Officers and employees (some of whom may also serve on the board) carry out the day-to-day business of the corporation and receive salaries. Because both profit and nonprofit corporations can take a tax deduction for the reasonable salaries of their employees, there may not be too much difference in the operation of the two types of corporations.
Keep in mind that if you put assets into a nonprofit corporation, you give up any ownership or proprietary interest in those assets. They must be irrevocably dedicated to the specified nonprofit purposes. If you want to get out of the business, you can’t just sell it and pocket the cash. The nonprofit corporation goes on; if it ends, any remaining assets must go to another nonprofit.

It’s a myth that you can’t make a profit from your 501(c)(3) nonprofit. Nonprofit corporations, by definition, exist not to make money but to fulfill one of the purposes recognized by federal law: charitable, educational, religious, scientific or literary activities. Under federal tax law and state corporate statutes, however, as long as a nonprofit corporation is organized and operated for a recognized nonprofit purpose, it can take in more money than it expends in conducting its activities. In other words, it can make a profit.

Here are four circumstances that may make it worth your while to incorporate.

1. You want to solicit tax-deductible contributions.
If your organization becomes a tax-exempt nonprofit corporation, donors can deduct their gifts to your group on their federal and state tax income returns.
Let’s say your group, Project Green, wants to sponsor monthly cleanup drives to pick up and haul away trash left along the local streets. You’ve enlisted a sufficient number of enthusiastic volunteers, but you need funds to rent a truck, buy gas and pay for volunteers’ meals. You know many in your local community would be willing to chip in and help fund your effort, but only if your group were a recognized public charity eligible to receive tax-deductible contributions. You decide to incorporate as a nonprofit corporation and apply for tax-exempt status to accomplish this objective.
2. Your association makes a taxable profit from its activities.
If your group will show a profit from its activities, incorporating as a nonprofit can yield a great benefit: You won’t have to pay income tax on the money you make.
3. You want to apply for public or private grant money.
Sorry, but without being recognized as a tax-exempt nonprofit by the IRS, your group is unlikely to qualify for grants.
4. Your members want some protection from legal liability.

If your group might be the target of a lawsuit, incorporation can provide welcome peace of mind. Nonprofit corporations can still be sued–but their individual members and directors are generally protected from personal liability. That’s not true of an unincorporated association. In addition, reasonably priced insurance is available to protect volunteer directors, who may be reluctant to serve without it.