Fact checked for accuracy by Billie Anne Grigg, a bookkeeper and Mastery Level Certified Profit First Professional.
If you’re interested in starting a charitable organization, you’re most likely wondering whether it makes sense to operate as a nonprofit corporation or not.
Some charitable organizations will find that the corporate structure makes perfect sense. For others, the disadvantages might outweigh the advantages.
The best way to navigate the decision-making process around this issue is to learn all the pros and cons. From there, you and your board can make a final decision on whether it makes sense to structure the organization as a nonprofit corporation.
Benefits of Forming a Nonprofit Corporation
There are eleven specific advantages to forming a nonprofit corporation. Take these pros back to your board and engage in meaningful conversation about them.
Limited Liability Status
Your assets can receive protection from lawsuits that occur due to actions taken by yourself or other employees on behalf of the nonprofit corporation. Don’t take this benefit lightly. Some people don’t think limited liability is as crucial with nonprofits.
However, your nonprofit might take out loans, for instance. If the corporation defaults, then you’ll have some protection against anyone taking your personal assets.
Additionally, you and all officers should consider what happens if anyone makes a legal mistake while operating the nonprofit. If you experience such unfortunate situations, the limited liability feature can mean all the difference when protecting your home or retirement funds.
Tax Exemption Eligibility
For-profit corporations can’t gain tax-exempt status. However, nonprofit organizations typically enjoy this privilege. It allows a nonprofit corporation to save money because it doesn’t have to pay taxes.
Compared to state tax-exempt status, it’s usually easier for a nonprofit organization to become federally tax-exempt. Federal tax-exemption applications are easier to complete and typically don’t require as much information.
Corporations do not automatically end when the founders die. They are entities in their own right.
Why is perpetual existence a good thing? It’s beneficial because it means that donors can contribute to a nonprofit corporation knowing that their gift will still do good for others long after they are gone.
Nonprofit corporations have an easier time raising funds than other types of organizations. This is because many people choose to give their money according to the IRS tax-deductible status of a nonprofit corporation.
Having a nonprofit designation on your organization’s documents allows the public to see that you do good work and are worthy of their support. For example, if you put in an application for funding from a foundation, then it may get accepted more easily.
Separate Legal Entity
Corporations are separate legal entities from their owners and employees. It can enter into contracts and purchase assets to further its goals.
For example, a nonprofit may sign a contract to rent out space for an office. Because the corporation is a legal entity, it’s held personally liable for the debt if the lease agreement ends early. A nonprofit corporation can also sue or get sued.
Nonprofit corporations don’t pay federal income taxes. Instead, they pay a second layer of taxation through the tax returns filed by the owners or employees of the corporation who receive a portion of the profits as compensation.
Professional Registered Agent
Nonprofits formed as corporations must appoint a registered agent. This provides them with a contact person who receives all vital mail and service of process documents.
Like an officer, a professional registered agent remains responsible for knowing what needs to be filed with the state and getting it together on time.
State regulations hold the nonprofit corporation accountable to ensure it meets its legal obligations. A registered agent helps keep track of this entire process.
Access to Grants and Loans
Nonprofit corporations have an easier time gaining access to government grants and loans. Many foundations and governmental agencies seek to help nonprofit organizations with funding, knowing that their goals are more extensive than just making a profit.
For example, if you are a nonprofit trying to start up an after-school program for disadvantaged youth, you can apply for grants specifically intended for this purpose.
Additionally, 501(c)(3) organizations (which is the best-known designation for nonprofit corporations) can apply for loans through public or private sources. For example, they can arrange a loan with banks or other financial institutions.
People are more comfortable donating money to a nonprofit corporation because they know their donation goes toward making a difference. This also helps your organization attract donors and volunteers who want to see the positive effect of their time and investment.
For example, if you are trying to create a fundraiser event for your organization, you’re more likely to have people pay into the fundraiser if they know their money will go towards helping others.
Nonprofit corporations pay less in taxes than other types of organizations. As a result, they can provide more benefits to their employees and invest more in them, helping attract and retain talented individuals who want to contribute to mission-driven work.
Some nonprofits offer their employees child-care benefits, pensions, or health care coverage. Also, because the organization doesn’t have to pay the high cost of being a for-profit company, they can offer higher salaries.
A nonprofit corporation can also cross-promote with other organizations that share its mission. For example, if a nonprofit corporation runs a museum, it can also invite other nonprofits to rent an office or exhibit space in its building.
Additionally, because there are so many nonprofits out there, it’s sometimes easier to find people who want to volunteer with your organization. For example, you may have more success finding volunteers for an after-school program if you can tell them that you’re associated with a museum that has an after-school program.
Disadvantages of Forming a Nonprofit Corporation
As you and your board consider the advantages to nonprofit corporations, you need to weigh the following eight disadvantages to help the final decision.
Being a nonprofit corporation means that you’ll have to comply with state regulations and tax filings. You must set up the management structure of the organization in a way that complies with these rules. In other words, there is a greater risk for mismanagement of funds if things aren’t done properly.
For example, if your board doesn’t meet periodically and record its meetings correctly, then you could lose your nonprofit status.
Officers and Directors Don’t Receive Profits
As a nonprofit corporation, you have to reinvest any profits back into the organization. This means that officers and directors don’t receive salaries. They often take a lower wage as a volunteer instead.
For example, if your executive director was working for another company during their day job and then they suddenly joined your nonprofit, it’s probably difficult for them to give up their salary and take a lower position.
Nonprofit corporations lose a degree of privacy because they have to disclose all their financial information. The organization is subject to public scrutiny.
Suppose your nonprofit corporation donates to an organization that some members of the community are against. In that case, they could demand more transparency on how you choose which organizations to donate to.
Costs and Expenses
Nonprofit organizations spend up to 30 percent of their revenue on operating costs. As such, you won’t be able to donate as much money to other causes unless you raise more money through fundraising.
Political Campaigning or Lobbying Isn’t Allowed
Nonprofit corporations can’t campaign or lobby politically. If your organization does engage in these activities, then you could lose your nonprofit status.
For example, suppose the organization’s executive director didn’t know that it was illegal for their nonprofit to financially support a specific candidate. In that case, they could get charged with a crime.
Ongoing Compliance and Paperwork
Being a nonprofit corporation means that you have to file paperwork and pay various fees. The organization has to follow state bylaws and regulations, leading to increased running costs or fines if they aren’t followed correctly.
Long Waits to Receive Exemption Status
When you apply for nonprofit status, the application may take anywhere between one to six months. Each state has different standards and paperwork required for exemption status, so it’s essential to understand what you need before applying.
The application process with the IRS can take three months to a year, and this time frame could go longer if you request an advance ruling.
To avoid complications during the exemption ruling process, you must file your paperwork correctly and pay any relevant fees on time.
The Process to Apply for Grants Is Tedious
Nonprofit corporations have to follow strict guidelines when applying for grants. If you don’t know the policies of a specific grant program, then your grant application could get rejected or delayed.
The Last Word
It’s time to weigh the pros and cons of starting a nonprofit corporation. Think it through with your other team members. Have a meeting to discuss everything you’ve learned, and then take the action that best fits your situation. If you think forming a nonprofit corporation is the right move for you, head over to our recommendations for the best non-profit formation service to help you get started.
Filed under: Advice Columns