1.1 – Benefits of Forming a Nonprofit Corporation

1.1.1 – Tax Considerations

A nonprofit corporation can qualify for tax-exempt status under state and federal law if it meets certain qualifications. Organizations that qualify and apply for 501(c)(3) tax-exempt status under federal law are exempt from paying federal income taxes. This means that organizations that obtain 501(c)(3) status do not pay federal income taxes on contributions from donors or earnings generated by their operations.

Donors are permitted to deduct contributions to 501(c)(3) organizations from income under Section 170 of the Internal Revenue Code. As a result, organizations that choose to apply for 501(c)(3) status may be more attractive to donors.

North Carolina also exempts nonprofit corporations from certain state and local taxes. Organizations that qualify for federal tax-exempt status are also exempt from North Carolina corporate income taxes and franchise taxes. Organizations that have not applied for 501(c)(3) federal-tax exempt status can also obtain an exemption from state corporate income taxes and franchise taxes if their organizing documents indicate that they operate for an exempt purpose. Nonprofit organizations that hold real or personal property for use in accomplishing their exempt purposes also may be exempt from property taxes by filing for an exemption or exclusion under N.C.G.S. § 105-282.1. Although North Carolina does not exempt nonprofit organizations from paying sales and use taxes, North Carolina nonprofit organizations may apply for reimbursement of their sales tax payments.

1.1.2 – Other Considerations

Nonprofit corporations may be eligible for public and private grants. Many foundations and government agencies limit their grants to public charities. If the nonprofit corporation applies for and receives 501(c)(3) status, it can also offer tax deductions to individuals or business that give charitable contributions.

Nonprofit organizations also receive discounted services from many service providers. For example, the United States Postal Service charges nonprofits much lower rates. Many advertising and law firms will represent nonprofit organizations for free. Radio and television stations may also promote a nonprofit and its activities for a reduced rate.

1.2 – Drawbacks of Forming a Nonprofit Corporation

1.2.1 – State Filing Responsibilities

North Carolina nonprofit corporations are required to register with the North Carolina Secretary of State. To maintain their registration, nonprofit corporations must comply with all state licensing and reporting requirements, including, for many nonprofit organizations, maintaining a charitable solicitation license.

1.2.2 – Federal Filing Responsibilities

Most organizations that obtain 501(c)(3) tax-exempt status must file an annual Form 990, Form 990-N, or Form 990-EZ with the Internal Revenue Service. The form required for each nonprofit organization is determined by the size of the organization:

  • Form 990-N: Required for organizations with annual gross receipts ≤ $50,000
  • Form 990-EZ: Required for organizations with annual gross receipts < $200,000, and total assets < $500,000
  • Form 990: Required for organizations with annual gross receipts ≥ $200,000, or total assets ≥ $500,000

Organizations that are eligible to file Form 990-EZ also are permitted to file Form 990. The full Form 990 is more burdensome to prepare, however.

1.2.3 – Commitment to the Nondistribution Constraint

Unlike for-profit entities, nonprofit organizations are prohibited from distributing net earnings to any private individuals. This means that the founders of a nonprofit organization who become its employees are permitted to pay themselves reasonable compensation, but if the organization ends up accumulating money, they cannot distribute that money to themselves and must plow it back into the organization’s mission

1.3 – What Exactly is a Nonprofit Corporation?

A nonprofit corporation is the most common entity choice for a nonprofit organization. N.C.G.S. § 55A authorizes the creation of nonprofit corporations. Like for-profit corporations, nonprofit corporations are legally separate “persons” distinct from their principals. In most cases, nonprofit organizations that intend to operate primarily in North Carolina should incorporate under N.C.G.S. § 55A.

1.3.1 – Benefits of Forming as a Nonprofit Corporation

  • Limited liability for directors and officers
  • Legitimacy and familiarity for donors, who typically are comfortable dealing with nonprofit corporations because they are so common
  • Can sue or be sued in the entity’s name
  • Can contract and hold property in the entity’s name
  • Defined governance structure

1.3.2 – Downsides of Forming as a Nonprofit Corporation

  • Burdensome corporate formalities that must be complied with
  • Require governmental approval (though today nonprofit corporations will get government approval if they comply with the terms of N.C.G.S. § 55A)

1.4 – Initial Questions for the Founder(s)

Before initiating the process of forming a nonprofit corporation, the founder(s) should answer the following preliminary questions:

1.4.1 – Are you sure you want to form a new nonprofit organization?

Has the founder determined there is a real need for charitable capital? If not, consider forming a for-profit corporation, which requires less paperwork. Is there any liability exposure? If not, the founder might wish to save time and money by keeping the charitable activities informal. Finally, has the founder considered incubating (or “beta testing”) the idea by seeking a temporary fiscal sponsorship arrangement with an existing nonprofit? By doing so, the founder can test the idea before devoting time and money to incorporating the organization.

1.4.2 – Have you done the requisite planning to form a nonprofit organization?

Be sure the founder has begun to answer the questions and consider the issues necessary to forming a nonprofit organization. These include:

a. Name of the Organization

The founder must decide on name for the organization before beginning the process of incorporating. In North Carolina, the Secretary of State maintains a database of names used by corporations operating in the state. The founder should check this database for availability prior to settling on a name. For a small fee, the organization can reserve a name for a certain number of days by filing an Application to Reserve a Business Entity Name with the Secretary of State.

b. Mission Statement

The mission statement is a short statement that communicates the organization’s purpose, the groups that it serves, and how it plans to serve them. Developing a mission statement is the first step to defining what the organization plans to do and what makes the organization different from others in the same field. Potential donors are likely to ask for the organization’s mission statement before agreeing to donate.

c. The Business Plan

The business plan explains how the organization will accomplish the purpose expressed in its mission statement. At a minimum, the business plan should address four items: (1) income sources; (2) operations costs; (3) program costs; and (4) capital structure. After reading the business plan, a donor should understand how a nonprofit organization will successfully achieve its mission.

d. Preliminary Budget

As part of business planning, be sure the founder has a preliminary budget in mind for accomplishing the organization’s mission. The founder should have a general idea of where the money will be coming from and how much the organization’s activities will cost to carry out.

e. Potential Directors

The founder should consider potential directors before filing the articles of incorporation. The board of directors should include broad community representation. This means that it should include respected members of the community who bring unique perspectives and capabilities to the decision-making process. For example, at least one director should have financial experience. Others might have expertise in risk management, fundraising, communications, or law. Ideally, the organization should have between seven (7) and fifteen (15) directors.

1.4.3 – Have you considered the administrative burden of forming a nonprofit corporation?

Nonprofit corporations are required under the North Carolina Nonprofit Corporation Act to keep minutes and corporate records. Before incorporating, the founder should consider buying a corporate meetings kit to assist the organization to comply with these recordkeeping requirements.

1.5 – In which state should the nonprofit corporation incorporate?

Once a nonprofit has a mission statement and business plan in place and chooses to move forward with incorporation, its founder must decide where to incorporate. Each state has its own nonprofit corporation laws, which vary from state to state.

Typically, a nonprofit corporation should incorporate in the state in which it plans to conduct most of its activities. Because North Carolina’s nonprofit laws are comparatively streamlined, and because its Secretary of State’s office is reasonably efficient and inexpensive, most North Carolina founders should form their corporations under North Carolina law. A common alternative is Delaware, which is known across the United States for having well-developed for-profit and nonprofit corporate laws that tends to be favorable to corporate officers and directors. If a new nonprofit organization intends to operate throughout the United States, it may consider forming under Delaware law.