Types of Nonprofit Organizations
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Before you file any government documents, it is critical to have a clear end goal in mind of how you want your organization classified in state and federal records. Choose both a legal structure (such as a corporation) and a tax exemption (such as an IRS 501(c)(3) public charity) for your nonprofit.
Why is this so important? We speak from experience. We provide "rescue services" to more nonprofits than we would like to - those who get all the way to applying for 501(c) exemption before they realize they're on the wrong path. Without knowing the final classification for your nonprofit, you may file the wrong document or fail to include necessary language in a document. For example, many articles of incorporation templates provided by the secretary of state to form a nonprofit corporation do NOT include the provisions required by the IRS for tax exemption under 501(c)(3). After discovering an error, getting back on the right track may require an amendment, a conversion to a different entity, or a full dissolution and starting over from scratch. All of this results in additional expense, delay, and, most of all, distraction from the mission of your blossoming nonprofit.
So take time to decide your legal structure and tax classification before you start filing government documents. By taking time to research and determine this vision, you will also discover the necessary qualifications and steps to make it happen.
Choose a Legal Structure for Your Nonprofit
"Legal structure" refers to the corporation, LLC, trust, association, or other legal entity for
nonprofit. Legal structures are formed under state law - which means your options will be
different in every state. When choosing a legal structure for your nonprofit, the goal is to
structure that will be easy to set up and run because it is natural fit for your organization.
example, an association may be all you need for a one-day food drive but a nonprofit corporation
appropriate when you have an ongoing set of decision makers (a board of trustees).
Nonprofit vs. For-Profit vs. Blended Structures
Once upon a time, a nonprofit corporation was the obvious legal structure for those who wanted to
the world by giving back. More and more, modern social entrepreneurs are mixing traditionally
and non-profit missions. In response to organizations like these, law makers have introduced new
structures like B-Corporations, L3Cs, and Flexible Benefit Corporations.
Take the example of Better World Books who collects and sells books online in order to donate books and fund literacy initiatives worldwide. You might think they are a for-profit because they are running a business in which they sell products. You might think they are a nonprofit because their ultimate goal is to donate books and fund literacy. Better World Books chose to become a B-Corporation, one of the new blended structures.
If you are struggling with the very fundamental question of whether your organization is non-profit or for-profit, then this is the first decision you need to make. By referring to the chart to your right, you can see all that other decisions stem from this choice. For help deciding this, click here.
The Case for a Nonprofit Corporation
A nonprofit corporation is a time-tested structure, especially for public charities. As a result, a nonprofit corporation offers many benefits:
- There is a history of case law supporting the limited liability protection it provides to directors.
- The IRS is accustomed to reviewing and approving tax-exempt applications for nonprofit corporations. This familiarity carries over to evaluating your organization for ongoing compliance with the exempt section of the federal tax code.
- Similarly, state tax exemptions are often written with a traditional nonprofit corporation in mind.
- When being evaluated for grants, the evaluators understand traditional organizations.
- Donors are familiar with contributing to nonprofit corporations and may question what it means to contribute to a less-familiar type of organization.
- The leaders of a nonprofit corporation (board members) have many resources to understand their duties, may bring experience from serving on a board, and avoid the distractions of learning new governance processes.
For all these reasons, there is value in following tradition if you can. Of course, there also many good reasons to deviate from tradition, accepting the obstacles it introduces.
List of Legal Structures Used by Nonprofits and Social Entrepreneurs
The following legal structures are used by traditional not-for-profits and by social entrepreneurs blending not-for-profit and for-profit missions. Remember that the available legal structures vary by state, so your state may not offer all these options.
- Nonprofit corporation
- A nonprofit corporation protects your directors and members from personal liability from any
financial debts and legal liability of the nonprofit. This is called limited liability.
limited liability protection is an unlikely and worst case scenario for your nonprofit;
nevertheless, this protection is the most important feature of a corporation. Nonprofit
may or may not have members (the equivalent to shareholders). The members elect the Board of
Directors to oversee the corporation; otherwise the Board of Directors self-perpetuates.
may further classify nonprofit corporations into a:
- Public benefit corporation
- Public benefit corporations are those serve the community at large such as volunteer firefighter departments, grantmaking foundations, and homeless shelters.
- Mutual benefit corporation
- Mutual benefit corporations serve a limited number of members with common interests. For example, your organization might be a homeowners’ association, snowmobile club, or trade association. These corporations typically do not apply for tax exemption under 501(c)(3), but may apply for other tax exemptions.
- Nonprofit professional corporation
- Professional corporations are formed to provide the services of licensed professionals, such as accountants, lawyers, or doctors.
- Religious corporation
- Religious corporations are used primarily for religious purposes.
- Cooperative corporation
- Cooperative corporations place more control of the corporation in the hands of the employees or patrons. This model is appropriate for local food cooperatives and others with a community-based mindset.
- A benefit corporation (B-Corporation) is a new type of corporation. It is a for-profit corporation that meets rigorous standards of social and environmental performance, accountability, and transparency. B-Corps are appropriate for organizations that attract significant investment and reward investors while at the same time giving directors additional license to make decisions in line with not-for-profit goals as opposed to shareholder profits. B-Corps often obtain third-party certification, such as "B Corp" certification from B Lab.
- Flexible Purpose Corporation (FPC)
- A flexible purpose corporation is a new corporate form available in California. FPCs must specify at least one "social purpose" in their charter and protect boards and management from shareholder liability when they weigh pursuit of the social purpose against shareholder value. It is different than a B-Corp in that this structure is meant for for-profit companies seeking traditional investment.
- Nonprofit LLC
- LLCs are a less formal structure to administer than a corporation. Only a few states offer nonprofit LLCs. Some states have a minimum number of directors required to form a nonprofit corporation and a nonprofit LLC can provide a loophole to form a smaller nonprofit. For example, in Missouri a nonprofit corporation requires three directors but you can form a nonprofit LLC with only one member.
- Low-profit limited liability companies (L3Cs) are for-profit social enterprise ventures. This structure was created to help bridge the gap between for-profit and non-profit investing by mirroring federal tax standards for program-related investing (PRI). It preserves the tax flexibility of a traditional LLC.
- Unincorporated nonprofit association
- A nonprofit that chooses not to incorporate is deemed an unincorporated nonprofit association. It is still subject to certain legal and taxation requirements. The members of an unincorporated nonprofit association do not have limited liability protection. This structure can be appropriate when you wish to perform short-term community service or fundraising.
- The most common example of a charitable trust is an estate left for charitable purposes. A trustee holds the assets that pass to the beneficiaries.