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How Does a Non Profit Company Work?

Nonprofit companies must be qualified and approved by the IRS.

Nonprofit companies must satisfy some explicit conditions before they can achieve this status with the Internal Revenue Service. When you receive "501 (c)(3)" status -- the IRS designation -- your company will be subject to different operating and income tax rules than other organizations. Along with tax-exempt status on a federal level, you must satisfy your local state laws and regulations, which differ depending on where your company is organized and registered.

IRS Approval

To qualify for tax-exempt status with the IRS, your company must be organized and operated exclusively for religious, charitable, scientific, educational, public safety, prevention of cruelty to children or animals, the arts or amateur athletic purposes. Don't bother to become overly creative, as the IRS publishes these purposes as requirements, not suggestions. Educational purposes also permit child care organizations that operate to enable parents and guardians to be employed.


Once you qualify -- and continue to qualify -- as a 501 (c)(3) corporation, your company will not be subject to corporate or individual income taxes. Always learn about your state regulations to avoid misunderstandings or obvious or "disguised" taxes that may apply to nonprofit corporations. If you wish to organize an "unincorporated non-profit" entity, be aware that states may have further different regulations. In most cases, you should incorporate your nonprofit company, as personal liability could become a future problem without the "corporate shield" in place.


When your company is organized for one of the permitted purposes, the tax benefits are self-explanatory. Yet, there are other positives you will enjoy. You will have the standard limited liability protection available to all corporations, protecting the personal assets of directors and officers of the company. Nonprofit corporations are also eligible to receive local, state, federal and private grants unavailable to for-profit organizations. Grants can be a wonderful source of operating income and capital. Donations and contributions are tax exempt for the donor, making it easier to solicit and receive cash contributions.


Your nonprofit company is not permitted to build up net profit in the form of Retained Earnings. You cannot work hard to generate a substantial "bottom line" and then reinvest these earnings in your organization. "Substantially" all income not used to pay operating expenses must flow out of your company for the stated purposes of the organization. The ideal operating result at year's end per IRS regulations is a net income of zero. Should you need to retain some income for future asset purchases, repairs or upgrades, keep detailed records and be prepared to justify this action.


While enjoying tax-exempt status is wonderful, nonprofit operating rules are designed to benefit the recipients of your qualified purpose, not stockholders or officers. When the company receives contributions, grants or other income, these funds can be used to pay direct operating expenses, with the remainder targeted to the primary charity or other qualified purpose. Paying "extravagant" bonuses to officers or purchasing expensive assets for the company will jeopardize your 501 (c)(3) tax-exempt status. Stay on target and focus on your company's purpose.



Article Written By William Pirraglia

For 34 years Bill Pirraglia served as a senior executive in the banking industry. Since 2005, he has authored articles, blog entries, tips and advice columns, SEO web copy and two published books. He specializes in personal and business finance topics, along with legal articles for clients large and small.