Nonprofit Tax-Exempt Status and Articles of Incorporation

Nonprofits benefit from incorporation in different ways than for-profit businesses. While for-profit companies take advantage of tax savings and asset protection when they incorporate, nonprofits gain even more benefits from a tax standpoint.

Incorporating a nonprofit organization has several advantages, but the corporation must meet particular requirements to fulfill the IRS’s definition of nonprofit. In particular, the nonprofit must meet certain specifications when it comes to drafting its articles of incorporation. Unfortunately, many state forms do not have the correct language to meet the IRS’s requirements, which can result in forgoing tax-exempt status that your nonprofit may have otherwise been entitled to receive.

What Is a 501(c)(3) Nonprofit?

You may have heard of the term “501(c)(3) organization.” These organizations are the most common type of charitable group, and they are usually what we think of when we hear the term “nonprofit.”

The Tax Code Section 501(c) covers nonprofits generally. Under that code section, there are 27 types of nonprofits that receive some kind of exemption from federal incomes taxes. Section 501(c)(3) covers most charitable groups that serve the following purposes:

  • Religious
  • Educational
  • Testing for public safety
  • Scientific
  • Literary
  • Preventing cruelty to children or animals
  • Fostering amateur sports competitions

They also have a catch-all “charitable” description. As such, this particular code section covers a broad range of organizations. Examples of “charitable” purposes include anything that will be beneficial to the public interest, such as:

  • relief of the poor or underprivileged;
  • erection or maintenance of monuments, public buildings, or works;
  • defense of human and civil rights;
  • decreasing the burdens of government;
  • combating community deterioration; and
  • lessening neighborhood tensions.

There are two types of charities that fall under 501(c)(3) status: public charities and private foundations. A private foundation receives income from investments or endowments instead of soliciting funds from the public. In contrast, a public charity will request funds from the general public or the government. Donations must come from a variety of sources instead of just a few donators. As public charities solicit donations from the public, they are often significantly more well-known compared to most private foundations.

Requirements of 501(c)(3) Tax-Exempt Status

It is not a requirement to be incorporated to receive tax-exempt status, but it can make the process easier. Section 501(c)(3) organizations must meet the following exemption requirements:

  • It must be organized and operated only for exempt purposes
  • None of the earnings may be provided to shareholders or individuals
  • It may not attempt to influence legislation as a substantial part of its activities
  • It may not participate in any campaign activity for or against political candidates
  • It cannot operate for the benefit of only private interests

The entity may also be charged excise or other taxes under certain circumstances. That means that although the company may be exempt from income taxes, it may have to pay other types of taxes.

Why Incorporate Your Nonprofit Organization?

Incorporating your nonprofit organization will require that you fill out some paperwork and keep up with state-mandated filing requirements. However, incorporating is often well worth the time and effort for nonprofits because of the many money-saving benefits.

  • Tax-exempt status – If your nonprofit makes a profit, it can be taxed as a regular business. However, if the company incorporates correctly and meets tax-exemption filing requirements, it will not have to pay income tax at either the state or federal level. Although it is possible to have tax-exempt status without incorporating, it is often harder to do. Keep in mind that the profit must be earned related to the business’s charitable activities for it to be tax exempt. In addition, some nonprofit corporations may also be exempt from property taxes; your county assessor will be able to tell you more about this potential benefit.
  • Applying for grant money – If you do not have tax-exempt status, you may not be able to apply for public or private grants. Many grants require that you have tax-exempt status before you can even begin the application process. As it is easier to apply for and obtain tax-exempt status as a corporation, incorporating is often a critical step in becoming tax exempt.
  • Soliciting donors – Other people also gain tax advantages when they donate to tax-exempt charities and organizations. Individuals and entities can only take charitable deductions when they donate to entities that are tax exempt. Some people may be more likely to give when they have this extra tax advantage.
  • Asset protection – Like any other business, nonprofits can benefit from asset protection when they incorporate. Nonprofits can be sued just like any other business, and incorporating the nonprofit protects the owners’ personal property from lawsuits or other liability. This benefit is particularly relevant for those nonprofits that engage in politically charged activities, such as providing funding for birth control, as they may be more likely to be sued for various reasons.
  • Special postage rates – As a tax-exempt nonprofit corporation, the entity can apply for a mailing permit that allows decreased postage expenses. This can be extremely beneficial for nonprofits who rely heavily on postings to spread educational material or solicit donations. Nonprofits often receive additional benefits as well, including discounts at some stores.

What Are Articles of Incorporation?

Articles of incorporation must be filed by any business that wants to incorporate, regardless of where you incorporate or whether you are considered a for-profit company. Articles of incorporation for nonprofits will set out basic information about your business, including:

  • the name of the organization,
  • the specific type of nonprofit you will be registering for (based on IRS standards),
  • the name and contact information of your registered agent,
  • the names of the individuals incorporating the nonprofit,
  • whether the nonprofit will have stock (most do not),
  • whether the nonprofit will have members,
  • the names of directors, and
  • a statement of purpose.

This document includes need-to-know information about your nonprofit so that anyone who is seeking basic information about the organization can find it. Once you file your articles of incorporation with the State, it becomes a public record that virtually anyone can access to learn more about your nonprofit.

You cannot be considered a valid corporation under either state or federal law if you do not have articles of incorporation.

Creating Articles of Incorporation for Your Nonprofit

Many states offer template forms that you can use to create your articles of incorporation; however, these models are not often not designed with nonprofit organizations in mind. They are often missing vital information that is required for a nonprofit to be tax exempt under Section 501(c)(3).

To meet the IRS’s requirements to become a 501(c)(3) charity, you must set out that your organization will either perform certain duties or refrain from taking specific actions. Your articles of incorporation should explicitly state that:

  • the nonprofit’s activities are limited to purposes set out under 501(c)(3);
  • the organization will not engage in the political activities that are prohibited for 501(c)(3) organizations; and
  • if the nonprofit dissolves, it will distribute its assets to another nonprofit, a government agency, or for some other public purpose.

Keep in mind that you cannot satisfy these requirements even if the terms are set out in the corporate bylaws or other regulations that apply to the company’s internal workings. They must be included in the articles of incorporation (or articles of organization for LLCs). Failing to include these provisions will invalidate your application for 501(c)(3) status.

Other Required Formation Steps

The requirements of formation of a nonprofit corporation are the same as a for-profit corporation, with a few exceptions. In addition to filing your articles of incorporation, you should also complete the following tasks:

  • Do a name search and reserve the name for your corporation (do this before filing the articles of incorporation)
  • Some states will require that you publish a notice of incorporation in the local newspaper
  • Draft the corporation’s bylaws so that your board of directors has solid direction on how to lead the corporation and carry out its mission
  • Hold an initial board meeting to adopt the organization’s mission and goals, articles of incorporation, and bylaws
  • Obtain any necessary licenses and permits to legally carry out the functions of your organization

In addition to these more formal legal requirements, there are a lot of practical steps you need to take to form your nonprofit. For example, you will need to consider whether your nonprofit will have a physical location and how you will pay for it. Your nonprofit will also usually need a separate bank account. You should consider who will have access to nonprofit funds and how funding will be restricted (i.e., Will only certain people pay for expenses or will the whole board be able to write checks?).

Applying for Tax-Exempt Status

Just because your articles of incorporation meet IRS standards does not mean that you will automatically be granted tax-exempt status. You must formally apply for the designation through the IRS. Being recognized as a nonprofit at the state level will not necessarily mean that the organization will be exempt from federal taxes.

Most organizations will be required to fill out one of two forms to apply for tax-exempt status: Form 1023, the Application for Recognition of Exemption (for charitable organizations) or Form 1024, Application for Recognition of Exemption (for other tax-exempt organizations). Depending on your type of organization, you may not have to fill out a specific application form and must submit your application by sending a letter with particular information to the IRS.

The application will request basic information about your organization, including:

  • the name and contact information for the organization;
  • how the entity is organized (corporation, LLC, etc.);
  • whether your organizational documents have the required provisions;
  • how officers, directors, employees, and independent contractors are compensated;
  • specific activities in which the organization engages;
  • whether the company has any affiliations;
  • a statement of revenues and expenses for the past two or three tax years; and
  • whether you are considered a public or private charity.

Some smaller organizations will qualify to file Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. To determine whether you can file this form, you should fill out the Eligibility Worksheet found at the end of the instructions for the form.

Those who can use Form 1023-EZ are limited by the amount of gross receipts (under $50,000 for the prior or next three years), the value of total assets, and formation restrictions. Certain churches, schools, hospitals, and agricultural research organizations will be unable to use this form.