The Difference in Incorporation & Nonprofit

by Elizabeth Rayne
Donations are not tax-deductible unless the nonprofit has 501(c)(3) status.

Donations are not tax-deductible unless the nonprofit has 501(c)(3) status.

Image Source/Photodisc/Getty Images

If you and a group of friends want to get together for a charitable purpose, like cleaning up your neighborhood park or handing out blankets to the homeless, you can do so without jumping through the hoops of becoming an incorporated nonprofit. If your activities expand, you want to raise money or get more people involved, you may find some benefits in officially incorporating the organization, or eventually filing for 501(c)(3) status with the Internal Revenue Service.

Forming an Unincorporated Nonprofit

Generally speaking, a nonprofit is any organization that was not formed for the purpose of making a profit, but instead to further a particular purpose or mission. However, a nonprofit is allowed to make a profit in carrying out its mission, so long as the profit is not passed on to the people who control it. An unincorporated nonprofit is simply one that has not filed paperwork with the state to form a nonprofit corporation, LLC, or any official legal entity. In other words, if a group of people get together for a reason other than to make money, without filing any paperwork, the group may be considered an unincorporated nonprofit.

Incorporating a Nonprofit

Most nonprofit organizations incorporate, which means the organization becomes a corporation at the state level. Each state has different requirements for nonprofit corporations. Generally speaking, the nonprofit must file articles of incorporation with the state. The state may specify that the nonprofit must have a minimum number of people on its board of directors or must have bylaws, which provide the internal rules for how the nonprofit will run. In addition, state law will likely specify that, in order to qualify as a nonprofit corporation, it cannot use its profits to benefit the directors or officers, but instead profits must further the purpose of the organization.

Pros and Cons of Incorporation

Some nonprofits, particularly small enterprises with little fundraising activity, decide to remain unincorporated nonprofits. The organization may not meet the state's requirements for a nonprofit corporation or the organizers may not want to deal with the burdens of forming a board of directors, drafting bylaws or making annual reports. However, without incorporation, it may be more difficult to fundraise, largely because many foundations will only give grants or other support to incorporated nonprofits. In addition, incorporation generally shields the owners from personal liability, meaning that if the nonprofit is sued, the owners will not be personally responsible for the debt.

Filing for 501(c)(3) Status

A nonprofit organization may, but is not required to, file for 501(c)(3) status with the IRS. This tax designation allows the nonprofit to avoid business income tax, and any donations made to a 501(c)(3) are also tax deductible for the donor. Other benefits may come with 501(c)(3) status, such as state tax exemption, more grant opportunities and reduced postal rates. Unincorporated nonprofits are not precluded from applying for 501(c)(3), but generally incorporated organizations are more likely to be approved by the IRS.