Nonprofit Corporation vs 501(c)(3)
Learn How to Start a Nonprofit Corporation
Creating a nonprofit corporation allows organizations to focus on their mission-driven goals without the pressure of profit-making, provides potential tax benefits, offers personal liability protection for directors and members, and establishes public trust through transparency and accountability.
Corp formation starts at $0 + state fees and only takes 5-10 minutes
Editor’s note: At this time, ZenBusiness does not help with nonprofit business formations.
It’s not terribly difficult to form a nonprofit corporation, as long as you have the right paperwork and your business has the appropriate aims.
Essentially, a nonprofit corporation is a business that’s incorporated at the state level and recognized as tax-exempt by the IRS. This is usually because the organization focuses on something that benefits an area of society without focusing on profit. Benefits could be educational, scientific, or humanitarian — but there are many other areas of focus that would qualify.
Incorporating a nonprofit is very similar to incorporating a for-profit corporation, and you’ll have many of the same protections a for-profit has. You’ll also have to keep meticulous records of all your paperwork and financial records and do regular checks to make sure you’re in compliance with the state and in good standing. Although a nonprofit corporation requires more formalities than a limited liability company (LLC), it offers many of the same protections that a standard for-profit corporation does.
The following will give you a breakdown of how to form a nonprofit corporation.
Nonprofit Corporations vs. Nonprofit Associations and Nonprofit Organizations
There are a few key differences between corporations, associations, and organizations.
- Nonprofit Corporations: These are primarily focused on a specific mission, usually of benefit to the wider community. They can only be formed by filing at the state level and usually apply for 501(c)(3) status from the IRS; however, they are not required to register with the IRS.
- Associations: These provide benefits to their members (often as business leagues), not to the wider community. They can be incorporated at the state level, but they usually apply for either 501(c)(4) or 501(c)(6) status from the IRS; however, the status they apply for depends on what IRS classification they fall under.
- Organizations: This is a much broader category that includes corporations and associations, among others. An organization can be unincorporated, or it can be arranged as an LLC (with major restrictions — in general, a nonprofit LLC’s members must be nonprofits themselves or part of the state to be eligible). Without formal registration, however, most nonprofit organizations are considered partnerships at the state level.
Nonprofit Corporations vs. Unincorporated Nonprofits
While it’s often simpler to not incorporate your nonprofit, incorporation offers major benefits:
- It protects board members from personal liability. This means that the only assets on the line are those owned by the business, not the personal property of each board member. While there are a few exceptions, mostly relating to the duty to conduct operations in the nonprofit’s best interest and avoiding illegal or irresponsible acts, board members and founders can’t be pursued in the courts.
- Incorporation provides significant tax benefits on income. That’s not to say that all net income is untaxed; profit has to be substantially related to the nonprofit’s mission, otherwise, it may be subject to an unrelated business income tax. Nonprofit associations and nonprofit organizations, on the other hand, are taxed as partnerships.
- Tax advantages. Incorporated nonprofits that have 501(c)(3) status are exempt from federal income taxes, as well as other types of taxes a for-profit would have to pay.
Unincorporated nonprofits cannot usually offer these benefits.
Other Benefits
It’s a lot easier to apply for grants and public funding if you’re set up as a nonprofit corporation. Many government agencies and foundations restrict grants to registered charities, and donations to 501(c)(3) charities are usually tax-deductible for those making them. These donations don’t have to be monetary donations; they can be anything from donations of artwork or goods to real estate. Different rules apply in different instances, so those looking to donate major capital assets should consult a tax attorney. IRS Publication 526 is usually a good starting point, although it’s quite a big read.
In addition, a nonprofit corporation can enter into agreements as an entity. This differs from an unincorporated nonprofit, where the individual partners must enter into agreements. The ability to enter into agreements as an entity is related to the liability shield benefit mentioned above.
Forming a Nonprofit Corporation at the State Level
The process of forming a nonprofit corporation always happens at the state level. That’s because each state has slightly different rules for incorporation, and registering businesses is not a federal task. The process varies from state to state, but it generally looks something like this:
Choose a name
No matter what state you incorporate in, you’ll need to choose a name for your nonprofit. The general rules are that the name may:
- Not be misleading
- Have limitations on certain words (often financial words such as bank, trust, and credit as well as profession-based words such as doctor, engineer, or chartered)
- Have to include a suffix (Corp., Inc., etc.)
- Not be profane or obscene
- Not be materially similar to another business registered in the state
Each state is slightly different, especially with what it defines as “materially similar.”
No matter what state you’re incorporating in, you often have the option of reserving a name until you’re ready to incorporate. While this isn’t strictly necessary, it’s a useful way to ensure your preferred name is available when you need it. Our name reservation service can hold your name for as long as permitted by the state so that it’s there when you’re ready to start the incorporation process.
You also need to think about your nonprofit’s website address. Ideally, it should be easy to remember, different from any other website out there, and representative of your business. You may consider your nonprofit’s name, its initials, or what it does. When you’re ready to register your website, use the ZenBusiness domain registration service.
Choose the directors
The directors of a nonprofit provide oversight for the nonprofit. Typically, they help set the overall strategy and focus of it and ensure that the executive roles (CEO, CTO, CFO, and so on) are aligned. They set bylaws, vote in officers (president, secretary, and treasurer), and set policies to avoid conflicts of interest. In their role as a board member, they generally must be volunteers, although they can be reimbursed for expenses (travel, accommodation, etc.).
The minimum number of directors is three in most states. In the following 16 states, the minimum is one:
- Arizona
- California
- Colorado
- Delaware
- Georgia
- Iowa
- Kansas
- Maryland
- Massachusetts
- Mississippi
- Nebraska
- North Carolina
- Oklahoma
- Pennsylvania
- Virginia
- Washington
In New Hampshire, the minimum is five. To qualify for 501(c)(3) status, the IRS recommends that all nonprofit corporations name three directors who are not related. This is something that those in one director states should look at before incorporating.
While the board can be completely separate from management (chief executive officer and so on), in many small nonprofits, board members also serve as part of the management team. In addition, directors must be over 18.
Choose a registered agent
Every corporation, including a nonprofit corporation, must appoint a registered agent when the business is formed. This registered agent becomes the main contact between the business and the Secretary of State (or whichever agency oversees business formation) for each state. A registered agent for a nonprofit receives correspondence from the state’s business entity formation agency and important legal notices, such as service of process for lawsuits.
As a result, a registered agent must:
- Have a physical address within the state of incorporation
- Be available during normal business hours
You can act as your own registered agent if you wish, although you would need to be available at the address registered during normal working hours. This can be a major disadvantage, particularly for those who wish to get involved in projects outside the office. Instead, use ZenBusiness’s registered agent service today to find a reliable registered agent in your state.
File Articles of Incorporation
The Articles of Incorporation is the filing that makes your nonprofit official under state law. They may be called Certificates of Incorporation or Articles of Association in some states, but they mostly follow similar formats:
- Name of the corporation
- Name and address of the registered agent
- Corporate structure (usually a nonprofit corporation)
- Names and addresses of the board of directors
- How long the corporation will last for (in perpetuity is usually the default option)
- Name, address, and signature of the incorporator
A lot of states ask for the purpose of the corporation; however, this purpose can be wide-ranging, so you can often be as vague as you like. This can be beneficial if you need to pivot your nonprofit to focus on a different mission at a later date.
The vast majority of states have a specific form that you need to fill in that covers these requirements, although Nebraska is a notable exception.
Create the corporation’s bylaws
The bylaws of the nonprofit act as the internal manual for how the nonprofit operates. You should consider adding:
- How the nonprofit corporation is governed
- How often it holds board meetings
- How board members and officers are elected/appointed
- How voting works and what constitutes a quorum (the latter is sometimes determined by state law)
- The number of directors you need
- Rules on conflicts of interest (required for 501(c)(3) status)
- How bylaws can be amended
The bylaws, the conflict-of-interest document, and the confirmation of the officers are completed at the first meeting of the board of directors. In addition, you need to set up a corporate binder or another form of recordkeeping (such as using the cloud) to store and report major business documents, such as minutes from board meetings and annual reports. This is vital to maintaining both federal and state tax exemptions and other legal protections.
Get a tax ID number
Federal taxes are assessed and collected by the IRS, so you need to get a federal tax ID. This is formally called an Employer Identification Number or EIN. You can apply online, via fax, by email, or by telephone, and you’ll need a taxpayer identification number, such as a Social Security Number or Individual Taxpayer Identification Number (ITIN). For anything other than online filing, you need to fill in Form SS-4. If you want someone to take this task off your shoulders, you can use the ZenBusiness EIN service to obtain one on your behalf.
Filing for Tax-Exempt Status
It’s now time for the part that separates nonprofits from for-profits: 501(c)(3) status.
As stated above, to apply for this status, you have to fall into a category that the IRS deems acceptable for a nonprofit: charitable, scientific, testing for public safety, literary, educational, fostering of national or international amateur sports, and prevention of cruelty to animals and children. The term charitable is broad, as it can encompass numerous activities.
Despite its name, a nonprofit corporation can make a profit from various activities, but that profit has to be funneled into its mission. As a result, your business cannot distribute excess capital to its management or board of directors (such as through a dividend). In addition, the IRS allows employees to be paid — including the management team — but the payments must be “reasonable.”
The next step is to file Form 1023 or Form 1023-EZ. To file the latter, you must:
- Be eligible for 501(c)(3) status
- Have yearly gross receipts of $50,000 or less
- Have total assets of less than $250,000
Otherwise, you would file the standard Form 1023.
This must be filed within 27 months of the approval by the state of the nonprofit’s Articles of Incorporation. The form itself must include a statement on the governing structure, the purpose, and the planned program of your nonprofit.
Once you have found this form, you must file an annual information return each year (some exceptions apply, normally involving 501(c)(3) religious organizations) to the IRS (usually Form 990, although smaller organizations may be eligible to file Form 990-EZ or Form 990-NV).
Compliance
Finally, you want to make sure that you maintain your nonprofit corporation’s good standing by staying compliant with all state and federal laws. This means paying any taxes you may owe (yes, on some occasions a nonprofit must pay taxes), obtaining and maintaining all necessary licenses and permits, keeping proper records, and filing state-mandated notices like annual or biennial reports. State laws can vary widely, so make sure you check what your particular state requires.
Ready to start your nonprofit business?
At ZenBusiness, we’re proud to support small businesses through a variety of different tools and services. Whether you need a registered agent service, want to reserve a business name, or are looking to register a domain, our goal is to help you stay on the road to success. Although we don’t assist with nonprofit formations at this time, this guide provides a general overview of the requirements you need to meet when incorporating a nonprofit.
Nonprofit Corporation FAQs
-
A nonprofit corporation is one that’s been incorporated in a state. The term nonprofit organization applies to a much wider range of nonprofits, including unincorporated nonprofits.
-
A nonprofit corporation doesn’t fall under the S or C corporation tax categories. They’re a separate entity.
-
You can form a nonprofit as an LLC provided that the entity that’s creating the nonprofit is also a nonprofit. In practice, this does not apply to individuals.
-
Nonprofit corporations are exempt from specific taxes provided they apply for 501(c)(3) status. However, they are not exempt from all taxes.
-
The management team and employees can be paid in a nonprofit corporation, but they must be paid a “reasonable” wage for their work.
Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
NonProfit Resources
Form a Nonprofit In These States
Ready to Start a Corporation?
