Non Profit Entity FAQs
What is a nonprofit corporation?
Like any corporation, a nonprofit corporation is a limited liability entity managed, typically, by a board of directors and officers elected by that board. What makes a nonprofit corporation different is that no part of the corporation’s income may be distributed to members, directors, or officers. Members may derive benefits from the nonprofit corporation (e.g. trade organizations, HOAs, social clubs), but they do not receive dividends like stockholders. While a nonprofit can, in fact, make profit, those profits cannot generate income or equity for individuals. They must be reinvested in the corporation, exchanged for goods or services at fair value, or distributed by some other appropriate means, such as charitable grants.
That is the 30,000-foot view. The rules for how a nonprofit corporation must manage its income and assets depend on what tax-exempt status is conferred upon it by the IRS.
But isn’t a nonprofit corporation a tax-exempt entity?
Not in and of itself. A D.C., Maryland, or Virginia nonprofit organization—whether a corporation or an unincorporated association—is not automatically exempt from federal or state taxes. To become exempt, the organization must meet certain requirements and apply with the IRS and local jurisdictions.
There are many different types of tax-exempt entities, but the focus of our nonprofit practice at Quinn, Racusin & Gazzola is the type of charitable or public benefit corporation commonly referred to as a “501(c)(3)”, a name derived from the section of the Internal Revenue Code governing that most-valuable type of federal tax exemption. 501(c)(3)s are organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, educational, or another less common purpose enumerated by statute. They exist to serve the public benefit and not for individual benefit.
What makes the 501(C)(3) status the preferred exemption for charities?
Donations to a 501(c)(3) can be deductible from income. Whether or not a taxpayer can deduct a donation depends on the taxpayer’s facts and circumstances. Unfortunately, since Congress passed tax reform laws in 2017, fewer individual taxpayers have a tax incentive to make charitable contributions. Still, 501(c)(3) status remains highly valuable for public fundraising.
How is a nonprofit corporation created?
A nonprofit corporation is created by filing articles of incorporation with the secretary of state (or the District Secretary in D.C.). A nonprofit corporation may be created for any lawful purpose, and that purpose must be stated in its articles of incorporation. For a corporation that wants to apply for 501(c)(3) status, the purpose in the articles must be worded with intention. A nonprofit attorney knows how to frame a purpose statement to garner IRS approval. It is a good idea to consult an attorney before filing the articles, even though the process of filing is simple enough for the lay person to navigate.
What comes after incorporation?
After incorporation, the corporation’s board of directors must hold an organizational meeting where it elects officers, adopts corporate bylaws, and lays the basic groundwork for effective operation. How to accomplish all of this depends on the jurisdiction of incorporation. The board should draft and adopt resolutions giving its president (or someone) authority to take certain necessary steps – hiring accountants, opening bank accounts, negotiating with potential vendors, etc.
What are bylaws? Is that all my nonprofit needs?
The bylaws are rules governing the board of directors and officers. Bylaws constitute the bare minimum for operating a corporation and are often supplemented by other corporate policies at the request/demand of partnering organizations or other regulatory authorities. For example, before granting 501(c)(3) status, the IRS will probably want to see a Conflict-of-Interest Policy so it knows that a structure is in place to prevent corporate self-dealing. A grantor might require that the corporation adopt a Nondiscrimination Policy or, if the program is educational, a Non-Fraternization Policy. The bylaws are just a policymaking starting point and are structured to satisfy state corporate law.
Some of the most substantial and important articles in the bylaws describe the role of the directors and each officer of the corporation. How many directors should sit on the board and how often should the corporation hold director elections? How can the corporation remove a director who breaks policy or fails to perform required duties? Should board meetings be held in zoom or in person? The answers to these questions belong in the corporate bylaws.
Can one person be the sole director and officer of a nonprofit corporation?
Not in D.C., Virginia, or Maryland. In all three jurisdictions, a nonprofit corporation must have at least three directors. The essential officer positions are president, secretary, and treasurer. The president and treasurer roles should be vested in separate individuals, but one person can combine other officer hats.
Can a nonprofit corporation pay a salary to its officers, directors, and/or employees?
Yes. Any corporation may pay reasonable compensation for services rendered to the corporation. What passes for reasonable compensation is a matter of state law. When establishing director/officer fees for the first time, or hiring a director or officer (or a family member thereof) as an employee or contractor of the corporation, the nonprofit should consult an attorney to make sure that the arrangement is not only fair to the corporation but demonstrably so.
I’m filing articles of incorporation for a nonprofit corporation, and I must decide whether the corporation will have members. What is a member?
Many nonprofits use the term “member” synonymously with “supporter” or “donor.” Separate from this fundraising use, however, membership is a term of art in tax law. Members of a nonprofit corporation are like shareholders of a for-profit corporation in that both members and shareholders may have significant rights with respect to internal corporate governance. Unlike shareholders, however, members of a nonprofit corporation are not owners and are not issued stock.
When forming a nonprofit corporation, you must determine whether the corporation will have members, and if so, who will govern the corporation—the members, a board of directors, or both. The implications of misapplying this term in creating a nonprofit corporation can prove significant when the time comes to apply for tax-exempt status. If you are unsure, consult a nonprofit attorney.
What if my corporation distributes profits to its members?
You are describing what is commonly referred to as a cooperative, which may not receive tax exempt status and will not receive 501(c)(3) status from the IRS.
So how do I form a “501(c)(3)” corporation?
Again, the designation “501(c)(3)” refers to a specific federal tax provision only. First, you must create a nonprofit corporation as explained above. Then you must make the IRS aware of the corporation’s existence by applying for a tax ID number, which the IRS calls an Employer Identification Number (EIN). Once those two steps are complete, the nonprofit will be able to apply for 501(c)(3) status by filing a Form 1023 with the IRS.
I don’t know how much money we will be able to raise in the first few years? Should I use the 1023-EZ form because it is cheaper and faster?
Not necessarily. The 1023-EZ can save time and money for some organizations, but certain grantors might not contribute to a 501(c)(3) that filed a 1023-EZ because it means the IRS scrutinized the applicant less thoroughly.
If our 1023 is approved, when will the 501(c)(3) become effective?
Tax exempt status will be retroactive to the date that the articles of incorporation were filed, as long as the Form 1023 was filed within 27 months of incorporation.
Can a nonprofit corporation engage in politics?
There are state-level restrictions on political contributions and activity by nonprofit corporations. However, the IRS may also revoke an organization’s tax-exempt status for substantial engagement in politics, including campaigning, generating “propaganda”, or making attempts to influence legislation (lobbying). Getting involved in policy and politics is a sensitive matter for any nonprofit corporation and counsel should be constantly involved to ensure compliance with state and federal law. There are many pitfalls to avoid when nonprofits choose to dabble in politics.
Who has authority to investigate the activities of a nonprofit corporation?
Unlike some countries, such as the UK, the United States does not have a centralized regulatory authority for nonprofit corporations other than the IRS, which has a limited mandate. In the U.S., the state(s) where the nonprofit operates supervise(s) the operation of nonprofit corporations, primarily to protect donors. Unsurprisingly, the level of regulation can vary dramatically from state to state.
What if my nonprofit operates abroad?
Nonprofits operating outside of the United States must follow laws designed to prevent the spread of corruption abroad — most importantly the Foreign Corrupt Practices Act — and adopt policies to prevent the corporation’s funding from enriching a person or entity on a sanctions list. This is serious business. Always consult an attorney before setting up a program outside of the U.S.
What is a 990?
A 990 is a tax return that an active 501(c)(3) must file with the IRS every year. It contains information about the corporation’s activities over the past fiscal year and shows revenues, expenditures, and assets. A 990 is a valuable resource for donors to vet the effectiveness of a charity because they show how much of the organization’s revenue goes toward programs and how much goes toward overhead.
Smaller nonprofits may be able to file a short form 990-EZ or even the one-page 990-N. As of 2021, all 990s must be electronically filed. To file your organization’s 990, talk to an IRS approved e-file vendor or a professional tax preparation firm like Quinn, Racusin & Gazzola.
How do I obtain a 990?
The IRS provides information about how to obtain copies of Forms 990, exemption applications, and related tax filings on its Form 990 Resources and Tools page.
Who keeps the books and records of a nonprofit corporation?
Normally the secretary of the board of directors. The organization’s 990 should state where the books are kept. Inspection rights concerning these records are governed by state law.
Do I need a business license?
Probably if you plan on fundraising. Charitable solicitation is regulated by the states, even if the solicitation is passive (e.g., website link) or quasi-passive (social media). Fundraising has a compliance cost and should be undertaken with the assistance of counsel.
What if my nonprofit operates across the DMV?
A nonprofit corporation can only be formed in one state. However, let us assume that your nonprofit is incorporated in D.C. For it to do business in Arlington and Rockville as well, the nonprofit corporation should register as a foreign corporation in Virginia and Maryland. The nonprofit may even incur penalties by doing business in those other cities before filing the appropriate paperwork.
Registering as a foreign corporation does not automatically establish the right to fundraise in that state or operate programs for a fee. A business license and/or charity registration might also be required.
What is an unincorporated nonprofit association?
An unincorporated nonprofit association is an unincorporated organization consisting of three or more members joined by mutual consent for a common nonprofit purpose. Unlike nonprofit corporations, unincorporated nonprofit associations do not file articles of incorporation with the secretary of state.
An unincorporated nonprofit association should incorporate before applying for tax exempt status. It just makes the application process easier.
What is a private foundation?
A private foundation is a public benefit organization that is not supported by the public. Often a private foundation will be formed to confer tax benefits on an individual, a family, or a for-profit organization. If a 501(c)(3) cannot demonstrate its broader public support when filing the 1023 and afterward (in the annual 990s), the IRS might give it private foundation status. This will negatively impact the organization’s ability to raise funds from the public.
If you have non-profit legal entity related questions, request a consultation with one of our Washington DC non-profit attornies today.