Non-Profit Corporations: An Overview
A “regular” corporation is a legal entity formed by its incorporators to do business, generate income, and be legally responsible for its own actions separate and distinct from those of its owners. As time passed, people decided that this same structure could be used to gather funds together to do charitable or other work generally beneficial to society. Laws were passed to make this workable, and today these are what are called non-profit corporations. Unlike regular corporations, non-profit corporations are creatures of federal and state law because they must meet certain criteria to get favorable tax treatment, without which they are of little practical use.
A non-profit corporation is just as it sounds—it’s a company that cannot generate a profit. It cannot issue stock, and there are no dividends or profits distributed to its owners. However, its directors, officers, and employees can make a salary, and the money generated can be used to operate the business and fund the beneficial purpose for which it was founded.
Like a regular corporation, investors in a non-profit company generally limit their liability to the amount they invested. Further, like an S Corporation (as described further on this site), its tax treatment hinges on obtaining certain governmental approvals from its beginning. Forming a non-profit corporation does not allow it automatically to be tax exempt. It must file papers with the IRS and the state it is incorporated in to be deemed tax exempt—and at that point it is exempt from any corporate income taxes from activities related to the company’s purpose. Without this approval, the corporation would not be allowed to accept grants, and the donations to it may not be deductible on the donors’ federal and state tax returns. Finally, unlike other types of corporations, to form a non-profit corporation most states require that there be at least three directors before approval will be given.
Typically non-profit corporations are found to be public charities that solicit donations broadly from the public, or private foundations that receive grants and donations from a group of donors. Regardless, the governing authorities look to determine whether the corporation is acting for some public purpose and monitor that it at all times is acting consistent with this beneficial purpose, rather than seeking to profit from its works.
For this reason, non-profit corporations must attempt to limit their activities to their non-profit purpose or they risk having the IRS revoke their tax exempt status—and even impose further taxes or fees against the corporation. Other limits apply as well, for example while they can make profits from unrelated purposes, such as advising, those must be kept to a minimum. They are limited in their political activities and cannot contribute to political campaigns and generally cannot be involved in political lobbying. Most importantly, as noted above, a nonprofit corporation cannot have the purpose of financially benefiting its officers or directors, other than payment of reasonable salaries. Finally, when a nonprofit corporation dissolves, its assets must be distributed to another tax-exempt group because, again, it cannot profit itself or any individual.
In effect forming a non-profit corporation is to form a corporation that enjoys certain tax advantages because it acts in a certain way that is deemed to be beneficial to society. It does not profit anyone individually, generally does not engage in politics, and it sticks to the purpose for which it was founded. If it is created in the right way, and acts consistent with these themes, the IRS and state government allow it to take grants and donations, and keep its special status. If it does not, it risks losing its status. For these reasons, people thinking of forming a non-profit corporation must think through the purpose of the company well, and have it created and operated in the proper way.