Most new charitable organizations are looking to become tax-exempt under Internal Revenue Code section 501(c)(3). However, before making the decision to incorporate as a nonprofit corporation and apply for tax-exemption, it is important to know the pros and cons.
Operating a nonprofit corporation with 501(c)(3) status comes with significant advantages, namely income tax-exemptions for the organization, tax deductions for donors, eligibility for public and private grants, and protection from personal liability. However, there is a tradeoff. Some disadvantages include regulations and restrictions, and significant amounts of paperwork. Below, we’ve provided a breakdown of the key advantages and disadvantages.
Nonprofit corporations that are tax-exempt under Internal Revenue Code section 501(c)(3) are exempt from paying federal income tax, and, in some cases, state taxes, such as sales and use tax, state income tax, and property tax. Additionally, donations to your nonprofit are tax-deductible to individual or corporate donors (and this may be applied to both federal and state income tax deductions as long as the taxpayer itemizes their charitable contributions on their tax returns).
Eligibility for Public and Private Grants
A significant portion of revenue for most charities comes from donations and grants. Many public grants (such as government funding) and private foundation grants are available only to 501(c)(3) nonprofit organizations.
Protection from Personal Liability
Directors of a nonprofit corporation generally are not personally liable for corporate debts. According to the law, the assets available to creditors and courts are limited. These protections, however, do not allow an individual to use the nonprofit corporation as a way to commit illegal or irresponsible acts. Directors have a fiduciary responsibility to act in the best interest of the nonprofit, otherwise, they can be held liable.
Regulations and Restrictions
Like almost everything else, nonprofit organizations are subject to government oversight, meaning there are specific regulations and restrictions they must comply with. For example, there are restrictions on the types of political activity a nonprofit can engage in (think: political campaigning). Another disadvantage associated with operating a 501(c)(3) is that the finances of a nonprofit are made open to public inspection, and thus, open to public scrutiny. Personal control over the policies and practices adopted by a nonprofit corporation is also limited.
Paperwork and Expenses Tied to the Incorporation Process
Incorporating as a nonprofit and filing for tax-exemption requires filling out an extensive exemption application. Along with the paperwork are the fees. There are added expenses tied to the incorporation process, such as hiring an attorney who specializes in nonprofit law to properly prepare the necessary documents. After the filing process is complete, a nonprofit corporation must submit annual filings to state charity regulators and IRS, requiring the nonprofit to keep detailed records.
Your Next Steps
The pros and cons of operating a 501(c)(3) are often specific to each charitable organization, and are contingent on the mission, objectives, and residency of the nonprofit. The Law Firm for Non-Profits is available to answer any questions on whether your organization qualifies for tax-exempt status. If your organization does make the decision to incorporate and file for tax-exemption, our lawyers are here to help you understand the start-up process as well as how to best comply with nonprofit laws. For more information on your next steps, please visit our website, or call us at (818) 623-9898.