Do you have an idea for a new venture with social benefits or environmental applications? You can set up as a for-profit entity — such as a C corporation, S corporation or limited liability company — with charitable functions. Or, if your key objectives are more altruistic, you may want to consider an alternative: forming a not-for-profit organization.
Usually, nonprofits are intended to provide significant benefits to the public, instead of profits to individual owners. There are many potential advantages to forming a nonprofit vs. a business, including exemption from federal income tax if your organization meets certain IRS requirements. But there are also risks involved and hurdles that must be cleared when running a charitable organization. Here are the main pros and cons of setting up your “company” as a charity.
Tax, Financial and Legal Benefits
Generally, nonprofits are structured to qualify as Section 501(c)(3) organizations under the Internal Revenue Code. This can provide several advantages:
Tax exemption. A 501(c)(3) organization may be exempt from income tax on both the federal and state levels. But you can’t qualify for tax exemption simply by having good intentions. Your organization must be operated exclusively for tax-exempt purposes. Among other requirements, none of its earnings may benefit any private shareholder or individual.
Separate entity. Nonprofits are legally separate from the individuals who own and operate them. In the for-profit world, owners often enter contracts in their own names and can be personally liable. Nonprofit organizations are solely responsible for their contractual obligations.
Limited liability. Similarly, not-for-profits offers liability protection to their board members, directors and officers. Thus, your nonprofit’s leaders can’t be held personally liable for the organization’s obligations or debts. By contrast, some for-profit business entities afford limited or no liability protection.
Grants. Not-for-profits usually are eligible to apply for grants from various public and private sources, opening up a potential stream of revenue.
Tax-deductible contributions. If they itemize, individual donors to 501(c)(3) organizations can take federal tax deductions equal to the amounts they contribute.
Perpetuity. Not-for-profits have a statutory right to exist in perpetuity. This advantage isn’t extended to certain for-profit entities, such as sole proprietorships and partnerships.
Exemptions and discounts. Your nonprofit could be eligible for certain benefits ranging from state sales and property tax exemptions to special postal rates and other discounts.
Potential Challenges
There are also drawbacks to forming a nonprofit. Before you make the decision, consider such issues as fees and expenses. For example, you’ll be required to file — and pay fees to file — documents with your state. In most states, you’ll also have to pay an annual fee and incur costs to engage a registered agent to receive government and certain legal paperwork on behalf of your organization.
Also know that operating a nonprofit doesn’t exempt your organization from certain business obligations. Nonprofits must:
- Comply with all applicable federal and state regulations,
- Produce annual reports,
- File IRS Form 990 annually,
- Draft bylaws (or an operating agreement), and
- Maintain appropriate accounting records.
Other rules and requirements may apply. In general, tax law dictates what not-for-profit organizations can and can’t do. For instance, 501(c)(3) organizations generally aren’t allowed to engage in political or lobbying activities. If they break these rules, they can lose their tax-exempt status and all of the benefits that go along with it.
Talk It Over
Your financial advisor can help you weigh the merits of forming a not-for-profit vs. a for-profit business. You might also want to discuss whether a B corporation — a hybrid nonprofit/for-profit business entity — might make sense. Your philanthropic intentions and financial objectives certainly will affect the decision. But don’t forget to consider all the details that potentially go into running a successful nonprofit.
© 2023
Michael Cecere, CPA, MST is a Gray, Gray & Gray partner and chair of the firm’s Non Profit Practice Group. He can be contacted by telephone at (781) 407-0300 or via email at: mcecere@gggllp.com.