Nonprofit Status: Everything You Need to Know
Nonprofit status is a status provided by either the state or federal government that classifies an organization as a specific type.8 min read
Nonprofit status is a status provided by either the state or federal government that classifies an organization as a specific type that is beneficial or charitable to individuals or communities.
Nonprofits and tax-exempt entities each have benefits and disadvantages. There are also certain regulations that need to be followed when one of these organizations is created or formed.
Organizations, whether they are for profit, nonprofit, or a charity, must also know these regulations and how they need to be followed.
While it is sometimes difficult to locate the information that you need, especially since legal information is not always readily available, everyone must follow the laws of the country. This means that you should understand what it means to legally create a nonprofit and retain nonprofit status under the regulations set up by your state and federal governments.
Some of the Questions that Most Community Groups will Face Are:
As a business, organization, or community group, you likely have a variety of questions regarding nonprofit status. A few of the most common include:
- What kind of community groups can be formed?
- My organization is considered a nonprofit, isn’t it?
- Since we are a nonprofit, this means we can have a tax-exempt status, right?
Are Nonprofit and Tax-Exempt Statuses the Same?
The first thing you may want to know is whether or not tax-exempt and nonprofit mean the same thing. While they are extremely similar, they really do not.
They are not the same thing based on who actually grants the status to the organization. Nonprofit organizations are entities that are granted status through state government. On the other hand, tax-exempt businesses or groups are offered the status through the federal government and the tax governing body, the IRS. In this case, the tax-exempt status allows your organization to become a 501(c)(3). You may be familiar with the term 501(c)(3) and how it refers to charities.
While nonprofits and tax-exempt entities are different, all tax-exempt organizations are nonprofits. In fact, you need to work with your state government to garner nonprofit status first. In a very basic sense, a nonprofit is any business or group where the individuals who directly control it do not see a direct profit from the organization’s activities.
You may know this already, since it is common to switch between the terms nonprofit and not-for-profit. If you want a tax-exempt entity, then you need to work with the state in which you live to arrange for a nonprofit status first.
Federal Tax-Exempt Status
An organization that is tax exempt is one that does not pay federal taxes. These entities are outlined directly in the tax codes of the United States. This means there are some strict guidelines when it comes to offering a community group a tax exemption.
While this is true, there are over two dozen provisions in the code that describe organizations that fall under the tax-exempt status. Since there are so many exemptions, it should be easy for you to find at least a single one that applies directly to your nonprofit.
The different exemptions do need to be reviewed carefully so an appropriate one is chosen for your business. This may require the expertise of a legal professional, especially since the tax code is confusing.
Once you are given nonprofit status and have applied for the tax exemption, you will be contacted directly by the IRS. Do not be concerned if a letter states that your application is processing or pending. This is normal.
After the IRS has reviewed your paperwork and has decided whether or not your organization falls into one of the tax code categories, you will receive a letter of determination. The letter will outline whether or not your organizations is tax exempt, and if not, why the determination was made.
There are some certain cases where you do not need to file paperwork asking for a tax exemption. This involves automatic exemption and something called fiscal conduit or fiscal sponsorship.
Three nonprofit organization types are recognized by the federal government:
- Unincorporated business
Most businesses commonly choose to become corporations when becoming a nonprofit. This is also something that is done when a community organization wants to be a not-for-profit, since a corporation does benefit from protections under that law in regard to financial liabilities.
The protections allow only the organization to be sued if an individual believes that the business has injured them in some way. You and the other members cannot be held responsible, under the law, for wrongs of the corporation.
While you can enjoy the liability protections, they do vary depending on your state. Check with your legal professional to gain a better understanding of your liability. If you are interested in an unincorporated business, then you should know that it works much the same as a corporation with the same basic business structures and processes.
Trusts are very different and an organization must be a specific type to fall under the trust category.
Since there is a great deal of legal and business information that you should understand before starting one of the three types of nonprofits, it is wise to look over information carefully either online or in person with a lawyer. You should know that there is the option of beginning your nonprofit without all of the legal hassles. You can simply wait to complete paperwork and ask your state for the status at a later date when you are ready.
Groups that are recognized as having 501(c)(3) status and don't need to file include:
- Religious organizations, churches, and any type of organization directly affiliated with a church
- Businesses that fall under a group exemption, like an organization that falls under a parent company with an established status
- Any group that is not an individual foundation that receives less than $5,000 in a given year. Citizens working together to enact local governmental change in their city is an example of this.
While a certain organization may already be recognized automatically as a 501(c)(3) and therefore be tax exempt, it can file for the official status with the IRS. This is ideal so that there is paperwork stating the exemption.
Groups that are fiscal conduits are ones that are started as incorporated entities that provide the financial backing and also services like accounting and other business tasks for an organization.
Many nonprofits start out as fiscal conduits, so this might be the right choice for your group.
While federal tax exemptions allow for exemptions from all federal taxes, a state one is a bit different and may mean that your group does not need to pay property, income, or sales tax. In some cases, you may be able to benefit from all of these exemptions.
For Nonprofit Status:
If you are an individual who desires to act on behalf of the group and be the person in charge who is directly named as the contact of the organization, then you should establish a nonprofit that is an incorporated one.
This type of organization is beneficial in many ways, like a reduction in your postal rates and the possibility that your group can go on and thrive as a recognized organization. If it does, then you may be able to get a federal tax exemption.
For Federal Tax-Exempt Status:
As outlined already, one of the greatest benefits of a federal tax exemption is that your entity will not need to pay federal taxes. There is also the benefit that individuals donating money can garner a tax exemption as well. You have the ability to file for and receive grant money. With the exemption, you can fill out applications and garner the money directly.
The federal exemptions also allow for some business and organizational freedoms that you may not have experienced before. For example, your will not need agents or other officers or fiscal members to control the financial aspects of the organization. Even if these people have been helpful, understanding, and professional, they add an extra expense and headache to an organization’s practices.
Disadvantages of Applying for Nonprofit or Tax-Exempt Statuses
Applying for official nonprofit and tax-exempt statuses can be helpful, but there are some disadvantages to doing so.
If you decide to go the incorporated business route, then there are some things that may be confusing to you. In essence, you will need to deal with complex business matters that you are unfamiliar with. If your group is a volunteer-based one, then you may not have the resources to assist you. You may spend a great deal of time filling out paperwork and speaking with professionals about the regulations and intricacies of tax exemptions. You will need to invest money and time in the process.
If your organization is just starting out, you may not require the tax exemptions right away. In other words, you may not be dealing with enough donations and gifts for it to assist you properly. You also may not be able to involve your group in certain activities if it has the status. For example, you may not be able to lobby or advocate for certain groups of people.
You should understand that tax exemptions do not mean that you do not need to pay taxes at all. You will need to do so if your organization participates in any activities that are outside the realm of the tax-exempt activities.
How to Know if You Should Apply
After assessing the advantages and disadvantages of applying for these statuses, you might decide that they are the right steps for your organization. But here’s how you tell for sure.
You should make sure that your group is acknowledged in your community as one that is helpful and charitable to the city or state where you live. Also, take into account whether you have won awards or assisted your own town or city in some way that is recognizable.
You want all of the individuals involved in the organization to commit their time and energy to the organization for the present and the future. If members are not interested in continuing, then you should make sure that you have enough leaders to move forward.
You should be trying to garner grant money soon or selling items or services that will make being a nonprofit or tax-exempt organization beneficial.
How to Know if You Shouldn’t Apply
You have not decided whether or not your organization will go on into the future. You do not have a need for a great deal of money through grants or you will not be offering products or services. You do not have the time or the money to invest in the process right now and you think that you will at some point in the future.
Keep in mind that if you decide to wait, an exemption status can be applied to your organization retroactively. This means that you can enjoy tax exemptions even if you are not in a rush to start filling out paperwork.
If you need assistance with forming a nonprofit or with working out whether federal tax exemption status is right for you, then post a job on the UpCounsel marketplace. We accept only the best and top lawyers in the country to assist our clients, and our legal professionals have, on average, 14 years of experience.