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Nonprofit Vs. Incorporation

Nonprofits and corporations maximize income, but nonprofit companies are tax exempt.

Nonprofit corporations are technically similar to standard incorporations, with the addition of tax exempt status granted by the Internal Revenue Service. The standard requirements of incorporation apply to both entities. Nonprofit organizations can also choose to be "unincorporated nonprofit" entities, although they don't enjoy the limited liability of corporations. While the differences are few in number, they are significant in importance.

IRS Tax Exempt Status

Organizers of a nonprofit organization must persuade the IRS to issue a tax exemption for their entity. Also called 501 (c)(3) organizations -- named after this section of IRS regulations -- qualified nonprofit companies, whether incorporated or not, enjoy freedom from income taxes. The IRS defines a qualified nonprofit company as one "whose funding comes from contributions, private foundations, grants, and government sources." Earning IRS acceptance is critical to creating a nonprofit organization.

Corporation Tax Issues

Corporations, whether organized as C or S corps, must pay taxes on their net income regardless of the size or source. The purposes, products, and/or services of most corporations eliminate any possibility of their achieving 501(c)(3) status. For example, if your corporation imports and sells diamonds from South Africa, attempting to convince the IRS that your purpose is charitable would be an exercise in futility.

Nonprofit Incorporation

Even if you want to create a nonprofit company, you should strongly consider incorporation. On some levels, it is more important to protect owners and directors of an altruistic nonprofit organization from subjecting their personal assets -- home, auto, bank account -- from creditors than in a for-profit environment. Incorporating a nonprofit company offers this personal protection, which encourages talented fundraisers and other important contributors to become involved in the cause and the company.

Bottom Line Considerations

For-profit corporations are focused on maximizing income and profits. Nonprofit entities target maximizing revenue, but should distribute "substantially" all net income to their favored recipients. Shareholders, directors, managers and other company employees should not share in any potential net income of nonprofit entities. Shareholders and others involved in for-profit corporations may share in net income as dividends to stockholders or bonuses to employees. Nonprofit companies must justify keeping any non-distributed net income to maintain their tax exempt status.

Income Sources

For-profit incorporation permits the company to receive income from all legal sources of sales of products, services, or intellectual capital -- ideas and patents. Nonprofit organizations generate income from product or service sales, contributions from others, and federal or local grants. Both company types should try to maximize their income, regardless of its source. Nonprofit organizations must carefully structure their distributions to fulfill their purpose or mission, and keep only excess income they need to function efficiently. Ideally a bottom line of zero dollars is perfect for a nonprofit entity.


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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.