What Is a Nonprofit?
A nonprofit organization is created to fulfill a charitable, civic, religious, scientific, literary, or educational goal. Nonprofits do not have private owners, nor do they issue stock or pay dividends to shareholders. Aside from founders or staff being compensated a fair wage for their work in a nonprofit, the organization may not benefit individual stakeholders financially.
The United States federal tax code recognizes over 30 types of nonprofits. Some nonprofits are either fully or partially tax-exempt, meaning they do not pay certain taxes. Also, some types of nonprofits can accept contributions from donors (who may be able to take a tax deduction for their contributions to the organization). Nonprofit organizations are separate legal entities from their incorporators, directors, officers, and employees. A nonprofit corporation generally owns assets of the business and is entitled to receive the revenue from its operation. Nonprofits are usually managed by their board of directors or voting members or some combination of the two. As a state concept, nonprofit organizations must be formed and managed according to their state of formation’s rules.
The names of the types of nonprofits include the Internal Revenue Code section they fall under. You’ll recognize “501(c)” nonprofit organizations as the most common. 501(c)s are then further broken down into subclasses—for example, 501(c)(3), which is what most people think of when they hear the word “nonprofit.” Other types of nonprofits include:
- 501(d)
- 501(e)
- 501(f)
- 501(k)
- 501(n)
- 501(q)
- 521(a)
- 527
Nonprofits Options
According to IRS Publication 557 (Rev. January 2022), the types of nonprofits are described as follows:
- 501(c)(1) – Nonprofit corporations organized under an Act of Congress (such as Federal Credit Unions). These corporations may accept tax-deductible contributions provided they are made for public purposes.
- 501(c)(2) – Nonprofit corporations formed to hold title to property of an exempt organization. These corporations may not accept tax-deductible contributions from donors; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(3) – Nonprofit corporations formed for one of the following purposes: religious, educational, charitable, scientific, literary, testing for public safety, to foster national or international amateur sports competition, or prevention of cruelty to children or animals. Generally, tax-deductible contributions are allowed.
- 501(c)(4) – Civic leagues, social welfare organizations, and local associations of employees created to promote community welfare via charitable, educational, or recreational activities. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations. Contributions to volunteer fire companies and similar organizations are deductible if made exclusively for public purposes.
- 501(c)(5) – Labor, agricultural, and horticultural organizations focused on providing education and instruction to improve products, operational efficiency, and work conditions. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(6) – Business leagues, chambers of commerce, real estate boards, and similar organizations created to improve business conditions of one or more lines of business. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(7) – Social and recreational clubs. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(8) – Fraternal beneficiary societies and associations in a lodge system that provide for payment of life, sickness, accident, or other benefits to members. These organizations may accept tax-deductible donations for approved purposes.
- 501(c)(9) – Voluntary employees beneficiary associations that provide for payment of life, sickness, accident, or other benefits to members. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(10) – Domestic fraternal societies and associations in a lodge system that devote earnings to charitable, fraternal, and other specified purposes. These nonprofits do not provide benefits to members. They may accept donations for certain Sec. 501(c)(3) purposes.
- 501(c)(11) – Teachers’ retirement fund associations for payment of retirement benefits. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(12) – Benevolent life insurance associations, mutual ditch or irrigation companies, mutual or cooperative telephone companies, and similar organizations. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(13) – Cemetery companies that provide burial and related services. Generally, these organizations may accept tax-deductible donations.
- 501(c)(14) – State-chartered credit unions and mutual reserve funds that issue loans to members. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(15) – Mutual insurance companies or associations that provide insurance to members substantially at cost. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(16) – Cooperative organizations to finance crop operations in conjunction with activities of a marketing or purchasing association. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(17) – Supplemental unemployment benefit trusts that provide for payment of supplemental unemployment compensation benefits. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(18) – Employee-funded pension trusts (created before June 25, 1959) that provide payment of benefits under a pension plan funded by employees. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(c)(19) – Posts or organizations of past or present members of the Armed Forces. Contributions to these organizations are deductible only if 90 percent or more of the organization’s members are war veterans.
- 501(c)(21) – Black lung benefit trusts funded by coal mine operators to satisfy their liability for workers’ disability or death due to black lung diseases. Contributions to these trusts are deductible as a business expense for donors to the extent allowed by section 192 of the income tax act.
- 501(c)(22) – Withdrawal liability payment funds that provide funds to meet the liability of employers withdrawing from a multi-employer pension fund. Contributions are deductible as a business expense for donors to the extent allowed by section 194A of the income tax act.
- 501(c)(23) – Veterans’ organization (created before 1880) that provide insurance and other benefits to veterans. Contributions to these organizations are deductible only if 90 percent or more of the organization’s members are war veterans.
- 501(c)(25) – Title holding corporations or trusts with multiple parent corporations that hold title and pay over income from real property to 35 or fewer parents or beneficiaries. These organizations may not accept tax-deductible contributions.
- 501(c)(26) – State-sponsored organizations that provide health coverage for high-risk individuals. These organizations may not accept tax-deductible contributions.
- 501(c)(27) – State-sponsored workers’ compensation reinsurance organizations that reimburse members for losses under workers’ compensation acts. These organizations may not accept tax-deductible contributions.
- 501(c)(28) – The National Railroad Retirement Investment Trust, which manages and invests the assets of the Railroad Retirement Account. This organization cannot accept tax-deductible donations.
- 501(c)(29) – Qualified health insurance issuers that have received a loan or grant under the CO-OP program. These organizations may not accept tax-deductible contributions.
- 501(d) – Religious and apostolic associations operating a communal religious community where the members live a communal life following the tenets and teachings of the organization. Generally, these organizations may not accept tax-deductible contributions; however, they may establish a charitable fund to accept tax-deductible donations.
- 501(e) – Cooperative hospital service organizations that perform cooperative services for hospitals. These organizations may accept tax-deductible donations.
- 501(f) – Cooperative service organizations of operating educational organizations that provide collective investment services for those educational organizations. These organizations may accept tax-deductible donations.
- 501(k) – Childcare organizations. These organizations may accept tax-deductible donations.
- 501(n) – Charitable risk pools that pool certain insurance risks of 501(c)(3) organizations. These organizations may accept tax-deductible contributions.
- 501(q) – Credit counseling organizations. These organizations may not accept tax-deductible donations.
- 521(a) – Farmers’ cooperative associations that provide cooperative marketing and purchasing for agricultural procedures. These organizations may not accept tax-deductible donations.
- 527 – Political organizations, i.e., a party, committee, fund, association, or other organization that directly or indirectly accepts contributions or pays for political campaigns. These organizations may not accept tax-deductible donations.
When deciding whether to form a nonprofit and determining which type of nonprofit is most appropriate, it’s critical to talk with an attorney and accountant to understand what is involved and how your decision will affect you, other stakeholders, and the cause you wish to focus on.
Nonprofit Advantages
- Shareholder Liability Protection – If the nonprofit organization gets sued or runs into financial hardship, its shareholders’ personal assets are not at risk. Stakeholders are not liable for the nonprofits’ debts.
- Tax-Exempt Status – Realize that tax-exempt status is not automatic for nonprofits. Usually, paperwork is involved to request federal and state tax exemption.
- Grant Eligibility – Some types of nonprofits can apply for and receive public or private grants. This access to operating capital can help them succeed in fulfilling their purpose.
- Enhanced Credibility – Incorporation as a nonprofit demonstrates that an organization has taken the time, effort, and resources to formally establish its operations. This can give people peace of mind that the nonprofit’s intentions, services, and activities are legitimate.
A Word of Caution: Misuse of the nonprofit—through inappropriate gain or improper distribution of surpluses—can result in the organization losing its tax-exempt status and shareholders losing their personal liability protection.
Nonprofit Disadvantages
While forming a nonprofit business entity has many advantages for organizations with a humanitarian purpose, some potential disadvantages exist.
- Nonprofits have some restrictions on the activities they may legally conduct. For example, 501(c)(3) nonprofits may not participate in or contribute to political campaigns.
- Nonprofits cannot be sold. Upon dissolution, the nonprofit’s assets must get transferred to another nonprofit organization.
- Nonprofits face complex filing requirements at the state and federal levels to establish their organizations and maintain their tax-exempt status.
- Nonprofits may not pay dividends to shareholders. A nonprofit organization must reinvest its surpluses (i.e., profits) into the nonprofit (for equipment, resources, etc.) to help it further its mission.
How to Apply for Tax-Exempt Status
The application form that a nonprofit must file to apply for federal tax-exempt status depends on the type of exempt organization.
Possible nonprofit applications forms include:
- IRS Form 1023 (or 1023-EZ) – Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code
- IRS Form 1024 – Application for Recognition of Exemption Under Section 501(a) or Section 521 of the Internal Revenue Code
- IRS Form 1024-A – Application for Recognition of Exemption Under Section 501(c)(4) of the Internal Revenue Code
- IRS Form 1028 – Application for Recognition of Exemption Under Section 521 of the Internal Revenue Code
- Form 8871 – Initial Notice
In a few situations, additional forms may be required. For state tax exemption, nonprofits must follow their state’s instructions.
Even when tax-exempt nonprofits do not have to pay federal income tax, they must usually file annual informational tax returns. For federal income tax purposes, the majority must file Form 990, Return of Organization Exempt From Income Tax (or 990-EZ). Private foundations must file Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation.
Required Forms by Type of Nonprofit Organization
According to the latest IRS “Tax-Exempt Status for Your Organization” (Publication 557, Rev January 2022), here’s a rundown of the forms each exempt organization type must file for federal income tax-exempt status and the annual return form they must file. Most MUST be filed electronically via the Pay.gov website.
| Type of Nonprofit Organization | Application for Exemption Form | Annual Return Form |
|---|---|---|
| 501(c)(1) | No form | None |
| 501(c)(2) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(3) | Form 1023 (or 1023-EZ) | Form 990 or 900 EZ or 990-PF |
| 501(c)(4) | Notice on Form 8876, Form 1024-A | Form 990 or 990-EZ |
| 501(c)(5) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(6) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(7) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(8) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(9) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(10) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(111) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(12) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(13) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(14) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(15) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(16) | Form 1120-C, Form 1024 | Form 990 or 990-EZ |
| 501(c)(17) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(18) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(19) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(21) | Form 1024 | Form 990 |
| 501(c)(22) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(23) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(25) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(26) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(27) | Form 1024 | Form 990 or 990-EZ |
| 501(c)(28) | Form 1024 | Form 990 |
| 501(c)(29) | Form 1024 and Form 8718 | Form 990 |
| 501(d) | Form 1024 | Form 1065 |
| 501(e) | Form 1023 | Form 990 or 990-EZ |
| 501(f) | Form 1023 | Form 990 or 990-EZ |
| 501(k) | Form 1023 | Form 990 or 990-EZ |
| 501(n) | Form 1023 | Form 990 or 990-EZ |
| 501(q) | Form 1023 | Form 990 |
| 521 (a) | Form 1028 or Form 1024 | Form 1120-C |
| 527 | Form 8871 | Form 990 or 990-EZ, 1120-POL (for taxable income) |
Taxable Business Activities
Some revenue-generating activities carried out by nonprofits may be subject to income tax. When a nonprofit organization conducts “unrelated business” activities to supplement its income, the IRS will consider the income taxable.
The IRS determines an activity to be “unrelated business” when it meets the following three criteria:
- It’s a trade or business. – “The term trade or business generally includes any activity carried on for the production of income from selling goods or performing services.”
- It’s carried on regularly. – “Business activities of an exempt organization ordinarily are considered regularly carried on if they show a frequency and continuity, and are pursued in a manner similar to, comparable commercial activities of nonexempt organizations.”
- It’s not related substantially to furthering the organization’s exempt purpose. – “Trade or business is related to exempt purposes, in the statutory sense, only when the conduct of the business activities has a causal relationship to achieving exempt purposes (other than through the production of income). The causal relationship must be substantial.”
Steps to Start a Nonprofit Organization
Forming a nonprofit, any type of nonprofit, can be a complicated and time-consuming process.
In addition to some of the same requirements as other types of businesses, nonprofits must submit a mission statement that clearly defines the organization’s purpose. Nonprofits that do not adhere to the scope of their mission may risk losing their tax-exempt status and fall out of good standing with the state where they are registered.
The steps for forming a nonprofit vary by state and type of nonprofit. To get a general idea of what’s required, check out my How to Incorporate a Nonprofit Organization Checklist, which goes into detail about the following startup tasks:
- Write a business plan
- Select a business name
- Choose a legal structure
- Appoint a board of directors
- Draft bylaws
- Designate a registered agent
- File Articles of Incorporation
- Apply for an Employer Identification Number (EIN)
- Request tax exemption
- File for required business licenses and permits
- Stay up-to-date with ongoing business compliance requirements
As you can see, there’s much to consider when forming any type of nonprofit organization. Guidance from a lawyer and accountant who can advise you on the legal, tax, and financial aspects of starting and running a nonprofit is “mission” critical. In addition to state agencies and IRS, these professionals can help you understand what you need to do to legally launch a nonprofit and stay compliant.
References: https://www.irs.gov/pub/irs-pdf/p557.pdf
Let CorpNet Help!
The paperwork can become confusing, but with CorpNet’s expert team helping you, you can rest assured your filings are in capable hands. Whether you’re starting your nonprofit or need help with your ongoing compliance filings, we will get the job done accurately, efficiently, and affordably.
