Nonprofit Basics

Nonprofit corporations are entitled to grants, tax exemptions, and limited liability protection.

Nonprofit corporations are entitled to grants, tax exemptions, and limited liability protection.
Nonprofit (or not-for-profit) corporations work well for all sorts of groups, from artists and musicians to people active in education, health, and community services. Often the reason for obtaining nonprofit status is simple -- it's usually a requirement for obtaining funds from government agencies and private foundations. Obtaining grants, however, is not the only reason to incorporate as a nonprofit. There are two additional important benefits of forming a nonprofit: tax-exempt status and personal liability protection.

Tax-Exempt Status

Many nonprofit groups seek nonprofit corporate status to obtain exemptions from federal and state income taxes. The most common federal tax exemption for nonprofits comes from Section 501(c) (3) of the Internal Revenue Code, which is why nonprofits are sometimes called 501(c)(3) corporations. If your group obtains tax-exempt status, not only is it free from paying taxes on all income from activities related to its nonprofit purpose, but people and organizations that donate to the nonprofit can take a tax deduction for their contributions.

Protection from Personal Liability

Forming a nonprofit corporation normally protects the directors, officers, and members of the nonprofit from personal liability for the corporation's debts and other obligations. Called limited liability, this shield ensures that anyone who obtains a judgment against the nonprofit can reach only the assets of the corporation, not the bank accounts, houses, or other property owned by the individuals who manage, work for, or participate in the business. Consider a nonprofit symphony that is sued by a visitor who falls through a poorly maintained railing on a staircase. If the court finds in favor of the visitor, it could issue a judgment against the nonprofit for an amount greater than the nonprofit's insurance coverage. The amount of the judgment is a debt of the corporation, but the directors, officers, and members are not personally responsible for paying it. By contrast, if an unincorporated association of musicians owned the premises, the principals of the unincorporated group could be required to pay the judgment amount out of their own pockets.

Exceptions to the Limited Liability Rule In a few situations, people involved with a nonprofit corporation can be held personally liable for its debts. A director or officer of a nonprofit corporation can be held personally liable if he or she: personally and directly injures someone personally guarantees a bank loan or a business debt on which the corporation defaults fails to deposit taxes or file any necessary tax returns does something intentionally fraudulent, illegal, or clearly wrong-headed that causes harm, or co-mingles nonprofit and personal funds. To cover some of these exceptions, reasonably priced insurance is available to protect volunteer directors, who may be reluctant to serve without it.

Believe it or not, there are still more reasons to incorporate your nonprofit group; for more, read below.

Who Should Consider Becoming a Nonprofit

The types of groups that typically seek nonprofit status vary widely. Here's a partial list of associations that may be eligible:

• childcare centers
• shelters for the homeless
• community health care clinics and hospitals
• museums
• churches, synagogues, mosques, and other places of worship
• schools
• performing arts groups, and
• conservation groups.

If your group isn't on this list, it doesn't mean you won't qualify for tax-exempt status. As long as your group's activity is charitable, educational, literary, religious, or scientific, you should be able to get a tax exemption.

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