Should You Structure Your Business as a Nonprofit?

Unlike a for-profit business, a nonprofit corporation may be eligible for certain benefits, such as sales, property, and income tax exemptions at the state level. The IRS points out that while most federal tax-exempt organizations are nonprofit organizations, organizing as a nonprofit at the state level doesn't automatically grant you an exemption from federal income tax.

Another major difference between a profit and nonprofit business deals with the treatment of the profits. With a for-profit business, the owners and shareholders generally receive the profits. With a nonprofit, any money that's left after the organization has paid its bills is put back into the organization. Some types of nonprofits can receive contributions that are tax deductible to the individual who contributes to the organization. Keep in mind that nonprofits are generally organized to provide some benefit to the public.
Nonprofits are incorporated under the laws of the state in which they're established. To receive federal tax-exempt status, the organization must apply with the IRS. First, you must have an Employer Identification Number (EIN) and then apply for recognition of exemption by filing Form 1023 (Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code) or Form 1024 (Application for Recognition of Exemption under Section 501(a)) with the necessary filing fee. Both forms are available online.

The IRS identifies the different types of nonprofit organizations by the tax code by which they qualify for exempt status. One of the most common forms is 501(c)(3), which identifies organizations that are set up to do charitable, educational, scientific, religious, and literary work. This includes a wide range of organizations, from continuing education centers to outpatient clinics and hospitals.

The IRS also mandates that there are certain activities that tax-exempt organizations can’t engage in if they want to keep their exempt status. For example, a section 50l(c)(3) organization cannot intervene in political campaigns.

Remember, nonprofits still have to pay employment taxes, but in some states, they may be exempt from paying sales tax. Check with your state to make sure you understand how nonprofit status is treated in your area. In addition, nonprofits may be hit with unrelated business income tax. This is regular income from a trade or business that's not substantially related to the charitable purpose. Any exempt organization under Section 501(a) or Section 529(a) must file Form 990-T (Exempt Organization Business Income Tax Return) if the organization has gross income of $1,000 or more from an unrelated business, and pay tax on the income.

If your nonprofit has revenues of more than $25,000 a year, you must file an annual report (Form 990) with the IRS. Form 990-EZ is a shortened version of Form 990 and is designed for use by small exempt organizations with incomes of less than $1 million.

Form 990 asks you to provide information on the organization’s income, expenses, and staff salaries. You may also have to comply with a similar state requirement. The IRS report must be made available for public review. If you use the calendar year as your accounting period, you have to file Form 990 by May 15.

For more information on IRS tax-exempt status, download IRS Publication 557 (Tax-Exempt Status for Your Organization).

Even after you settle on a business structure, remember that the circumstances that make one type of business organization favorable are always subject to changes in the laws. It makes sense to reassess your form of business from time to time to make sure you're using the one that provides the most benefits.