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A nonprofit is created for charitable, educational or other purposes – these cannot benefit the owners directly. This allows nonprofits to operate tax-free. Nonprofits are named for the Internal Revenue Code section they fall under. 501(c) is the most common. This is further broken down into sub classes. For instance, a 501(c) (19) would refer to an organization of current or past members of the armed forces.
A nonprofit has the same initial paperwork that a corporation has, with one difference. Nonprofits have a mission statement that clearly defines the organization. The purpose of the nonprofit must be laid out clearly. The IRS recognizes 26 different sub-classes of nonprofits. Going beyond the scope of the mission can mean loss of tax-exempt status.
Starting a nonprofit means doing a name search and registering with the Secretary of State and the IRS. Deciding where to incorporate, choosing directors, and creating articles of incorporation are added tasks. Tax-exempt status is not automatic and can be denied. Application for tax-exempt status has to be made with both Federal and State authorities.
Non profits operate tax-free. They can make profits (referred to as ‘surpluses’) but all money above operating costs must be used to further the goals of the nonprofit. Surplus cannot be paid to the stakeholders. They can accept donations and grants. The tax benefits can flow through to donors who contribute money or time. Wages may be paid to employees at standard rates.
Approval is both at the State and Federal (IRS) level. Five purposes are recognized: Charitable, Religious, Scientific, Educational and Literary. There may be some overlap. Obtaining tax-exempt status from the IRS will usually make State approval easier.
Even though a nonprofit is tax free, regular filings with the IRS are required. These are used to monitor the organization. Because loss of status has so many tax consequences, great care must be taken to keep records current and accurate.
A corporate shield exists for nonprofits. Suits may arise and the assets of the nonprofit may be attacked. However, as long as the legal structure remains correct, stakeholders are immune from individual liability.
Most legal issues revolve around loss of tax-exempt status by misuse of the nonprofit – either through inappropriate gain or improper distribution of surpluses. A successful challenge to nonprofit status will remove the protection and allow liability to transfer to individuals in the organization.
Nonprofits can own assets and generate income (usually in the form of donations or grants) and they can take out loans. There is no ownership to sell in the sense of investments, but assets can be used as collateral.
Dissolving a nonprofit is complicated. Nonprofits cannot be sold in the traditional sense. All assets must be transferred to another nonprofit or put toward the purpose of the organization. No funds can be directly distributed to the owners.