Key Takeaways:

  • Nonprofit corporations are separate legal entities that focus on charitable, educational, or other non-commercial purposes, differing from C corporations in purpose, taxation, and operation.
  • Formation of a nonprofit involves steps like registering with the state, adopting bylaws, and applying for tax-exempt status under IRS Section 501(c).
  • Nonprofit corporations share similarities with C corporations, including limited liability and the ability to generate profits, though profits are reinvested in the mission rather than distributed as dividends.
  • Tax-exempt nonprofits have unique benefits, including exemption from federal and state taxes and eligibility for grants and donations, but they face restrictions in political lobbying and campaign activities.
  • Incorporating a nonprofit provides credibility, liability protection, and tax advantages, but involves compliance with strict regulations and reporting requirements.

Is a nonprofit corporation a C corporation? No, a nonprofit corporation is not a C corporation. Nonprofit corporations are regulated under Section 501(c) of the Internal Revenue Code. Unlike C corporations, the purpose of nonprofit corporations is not to make profits for the owners. Instead, nonprofits are formed for charitable, literary, scientific, religious, and other activities. Some nonprofit corporations have  IRS tax-exempt status.

How to Form a Nonprofit Corporation

The process of forming a nonprofit corporation differs from state to state, but it is generally similar to the formation of a traditional corporation. The formation of nonprofits typically involves the following steps:

  • Name Reservation
    The owners of the corporation reserve a name with the state's secretary of state. The name should be unique compared to the names of other corporations in the state.
  • Filing a Certificate of Incorporation
    The Certificate of Incorporation, called the Articles of Incorporation in some states, documents basic facts about the nonprofit.
  • Appointing a Board of Directors
    The board of directors gives oversight to the nonprofit.
  • Adopting Bylaws
    The new board must hold a meeting to adopt bylaws and appoint officers of the corporation.
  • Registering with the State and Federal Governments
    The nonprofit can now apply for local permits and a federal tax ID.
  • Applying for Tax-Exempt Status
    After registration with the state, the nonprofit can apply for tax-exempt status. This is achieved by filing the IRS Package 1023 or Form 1023-EZ depending on the size of the corporation. 

Key Considerations Before Starting a Nonprofit Corporation

  • Mission Clarity: Clearly define the nonprofit's mission and objectives to ensure they align with IRS 501(c) requirements.
  • Funding Strategy: Determine how the nonprofit will be funded, considering grants, donations, membership fees, or program revenues.
  • Governance Structure: Establish a board of directors with diverse skills to provide oversight and strategic direction.
  • State-Specific Regulations: Research state-specific requirements for incorporation, permits, and ongoing compliance.

Types of Nonprofit Corporations

There are dozens of classes of nonprofits under Section 501(c) of the Internal Revenue Code. Not all these classes are eligible for tax-exempt status. Only organizations that file under 501(c)(3) can get tax-free donations.  You can find details about nonprofit classifications and tax implications in the IRS Publication 557.

All organizations that have 501(c) designation file Form 990 with the IRS. You can see Form 990 of any nonprofit by contacting either the IRS or the nonprofit or by searching the online corporation database of the state where the organization was incorporated. 

Advantages and Disadvantages of Nonprofit Corporations

Advantages:

  1. Tax Benefits: Nonprofits with 501(c)(3) status are exempt from federal income taxes and may also be exempt from state taxes. Donors can deduct contributions from their taxes.
  2. Liability Protection: Nonprofits provide limited liability protection to directors and officers, shielding personal assets from lawsuits or debts incurred by the organization.
  3. Grant Eligibility: Many foundations and government programs provide grants only to nonprofit organizations.
  4. Credibility and Public Trust: Incorporating as a nonprofit signals legitimacy, fostering trust among donors, volunteers, and the community.

Disadvantages:

  1. Complex Formation Process: Establishing a nonprofit involves multiple steps, including creating bylaws, filing Articles of Incorporation, and securing 501(c) status.
  2. Ongoing Compliance: Nonprofits must comply with annual reporting requirements, maintain tax-exempt status, and adhere to strict operational rules.
  3. Limited Activities: Nonprofits face restrictions on political activities and lobbying, depending on their classification.
  4. Operational Costs: Although nonprofits are tax-exempt, they may still face high operational and compliance costs.

Similarities Between Nonprofit Corporations and C Corporations

Nonprofit corporations and C corporation have a number of similarities, such as the following:

  • Limited Liability Protection
    These protect the shareholders from liability arising from the corporation.
  • Formation
    Both nonprofit corporations and traditional C corporations are formed at the state level. The initial stages of the formation of nonprofit corporations and C corporations are virtually identical.
  • Profit Generation
    Contrary to popular belief, many nonprofits actually make profits like C corporations. Profits of nonprofits are not given out to the owners but are used to further the goals of the corporation.
  • Taxes
    Some nonprofits pay taxes to the federal and state governments just like C corporations. Never make the mistake of thinking that your nonprofit corporation automatically has tax-exempt status. Even tax-exempt nonprofits may pay taxes on some of their income. A good tax lawyer can help you to understand the tax implications of the different non-profit classifications.
  • Employee Benefits
    There are some tax benefits for nonprofit corporation employees that are not available to C corporation employees. Such benefits may include group life insurance and medical insurance.

Nonprofit vs. Not-for-Profit Corporations

While often used interchangeably, nonprofit and not-for-profit corporations have key distinctions:

  • Purpose: Nonprofits typically focus on broader charitable or educational missions, while not-for-profits often serve members, such as a sports club.
  • Tax Exemption: Most nonprofits are tax-exempt under 501(c), while not-for-profits may or may not qualify for tax-exempt status.
  • Profit Usage: Nonprofits reinvest all profits into their mission, whereas not-for-profits might use surplus funds for members' benefits.

Differences Between Nonprofit Corporations and Traditional C Corporations

  • Shareholder Benefits 
    Unlike C corporations, nonprofit corporations do not give out dividends to their owners. Any profits the corporation may make are used to pursue the organization's non-business goals. During the dissolution of 501(c)(3) nonprofits, the proceeds will go to another nonprofit and not to the owners of the corporation.
  • Taxes
    Tax-exempt nonprofits are exempt from a number of taxes that C corporations are required to pay. Nonprofits may be exempt from corporate tax, among other taxes. Nonprofits are usually exempt from state sales tax, and they may also qualify to apply for certain grants.
  • Filing 
    There are unique filing requirements that apply to nonprofits and not to C corporations. These requirements may exist both at the federal and state levels. At the federal level, nonprofits need to file specifically under Section 501(c) of the Internal Revenue Code.
  • Political Activities
    Some classes of nonprofits are prohibited from participating in activities like lobbying and political campaigns. Many C corporations participate in such activities.
  • Contributions
    Contributions from donors to 501(c)(3) nonprofit corporations can be written off for taxes, but investment in a C corporation may be taxed.

While nonprofit corporations are not C corporations, they share a number of similarities with C corporations. Both types of corporations have a similar initial formation process, and both give liability protection to the owners. Differences between nonprofit corporations and C corporations include filing requirements and tax treatment.

How Nonprofit Corporations are Taxed

Nonprofit corporations that qualify under Section 501(c) enjoy significant tax advantages, but they are subject to specific rules:

  • Tax-Exempt Income: Income derived from the organization’s mission-related activities is typically tax-exempt.
  • Unrelated Business Income (UBI): Revenue from activities not directly related to the nonprofit’s mission may be subject to corporate income tax.
  • State Tax Exemptions: Many states offer additional tax exemptions, such as sales tax exemptions, to qualifying nonprofits.
  • Filing Requirements: Nonprofits must file Form 990 annually with the IRS to maintain their tax-exempt status. Failure to comply may lead to penalties or revocation of tax-exempt status.

Frequently Asked Questions

  1. What type of corporation is a nonprofit?
    1. A nonprofit corporation is a legal entity focused on charitable, educational, or other public-benefit purposes. It differs from C corporations in purpose and tax treatment.
  2. Are all nonprofits tax-exempt?
    1. No, only nonprofits that apply for and are granted 501(c) status by the IRS are tax-exempt. Others may still be subject to taxes.
  3. Can a nonprofit corporation generate revenue?
    1. Yes, nonprofits can generate revenue, but the profits must be reinvested in the organization’s mission rather than distributed as dividends.
  4. What restrictions apply to nonprofit corporations?
    1. Nonprofits face restrictions on political lobbying and must strictly adhere to their stated purpose to maintain tax-exempt status.
  5. How can UpCounsel help with nonprofit formation?
    1. UpCounsel connects you with experienced attorneys to guide you through the formation, compliance, and operation of a nonprofit corporation.

If you need help with your nonprofit corporation, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.