Non-Profit Vs. Incorporation

by Wayne Thomas

When we think of corporations, the image that comes to mind is usually a for-profit venture. However, nonprofits can also benefit from incorporation, particularly if the organization is interested in pursuing federal tax exempt status. Yet, the formalities of being incorporated under state law may not be desirable for all organizations operating in the public interest. Smaller nonprofits that receive limited contributions may choose to remain an unincorporated association. Knowing the benefits and drawbacks to incorporation can help you decide whether it makes sense to pursue a corporate structure for your nonprofit.

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Nonprofit Corporations vs. Unincorporated Associations

When a nonprofit is formed, organizers can choose to either pursue corporate status or remain unincorporated. If the nonprofit does not incorporate, it is referred to as an unincorporated association. Determining whether or not to incorporate is an important decision and several factors should be considered. The unincorporated association's primary benefit is that this entity avoids the bulk of reporting, registration and organizational requirements of a nonprofit. This informality can be advantageous, particularly if the organization is small and does not plan on receiving large financial contributions. For example, a music club that does not plan on having a lot of personnel and does not bring in enough income to benefit from tax-exempt status, may choose to remain an unincorporated association to avoid the corporate requirement of holding meetings and voting.

Personal Liability

Another important distinction between an unincorporated association and a corporation is with regard to personal liability for the actions of the organization, such as breach of contract. A corporation is considered an independent legal entity and, as such, its members and the board of directors enjoy limited liability. However, some states have created similar protections for unincorporated associations by legislation. In Texas, for example, members are no longer held personally responsible for the organization's breach of contract or tortious acts merely because they are members.

Incorporating Under State Law

A nonprofit is formed under state law and its articles of incorporation must be filed with the Secretary of State, registrar or similar regulatory agency in the state where it will be doing business. Nonprofits seeking federal tax exempt status must include a statement describing the charitable purpose of the organization in the articles of incorporation. In addition, the nonprofit will need to draft corporate bylaws. The bylaws will spell out the organization's internal procedure and rules of operation.

Overview of Tax-Exempt Status

Federal 501(c)(3) tax-exempt status can be favorable to a nonprofit organization, allowing it to be exempt from federal income taxes if it meets certain guidelines. To pursue this status, a nonprofit must file Form 1023 with the Internal Revenue Service and request the public charity classification. The application requires that the organization have an Employer Identification Number and pay the appropriate filing fee.