Association & Nonprofit Law
The tax laws allow businesses that are set up for charitable, religious, or educational purposes to organize themselves in such a way that they are exempt from taxes. The reason, of course, is to encourage businesses with charitable, religious, and educational purposes.
In terms of the benefits of becoming a non-profit, it's less expensive to operate than a for-profit because of the tax-exempt status and certain other benefits, such as property tax exemptions and reduced postal rates. It is also easier to convince donors to give you money since contributions to a non-profit are tax deductible. One downside is the loss of flexibility because the laws restrict where revenues can come from and how assets can be used. Operating as a non-profit also means losing the chance for great personal financial gain.
By definition, a nonprofit business is one that doesn't disburse income based on ownership. The reason, of course, is that there are no earnings to distribute and there are no shareholders to distribute them to. A nonprofit corporation doesn't have to be incorporated, but the primary reason for doing it is the same as for any incorporated business - to protect the owners from personal liability.
It's wrong to think that nonprofit businesses cannot operate for profit or pecuniary gain. They can, and they do. What they cannot do is operate for profit or pecuniary gain to the incorporators or owners.
Incorporation. The process for incorporating a nonprofit business begins as it does for any incorporation, with the filing of articles of incorporation and the drafting of corporate by-laws. They provide the name of the organization, who will be on the initial board of directors, and who act as the business's registered agent to accept legal service on the corporation's behalf.
The corporate by-laws should be adopted at the first board meeting. The by-laws explain how the corporation will be run and who will make decisions. Most states have laws that specify exactly what language should be used to protect board members and other active participants from personal liability.
The Illinois General Not for Profit Corporation Act contains provisions, called fallback provisions, that determine how a not-for-profit will operate in the absence of specific provisions in the by-laws or articles of incorporation. Thus, a not-for-profit that doesn't intend to operate differently than the provisions call for need not put them in the by-laws or articles.
Within 90 days of incorporating, the non-profit should file the articles of incorporation with the Secretary of State and an application for tax-exempt status on forms supplied by the Secretary of State?s office. Within 15 days after receiving a receipt from the Secretary of State, the nonprofit must file the articles of incorporation in the county recorder of deeds. Each year, the nonprofit is required to file an annual report with the Secretary of State.
One of the key changes made by the Illinois General Not for Profit Corporation Act was to give directors and officers greater protection from personal liability, which had been a problem for Illinois nonprofits up to that time. The law extended the protection in its provisions by tracking the language contained in the Illinois Business Corporation Act, which governs for-profit businesses.
Unincorporated associations. As indicated above, not all nonprofits are incorporated. An association that doesn't intend to raise public funds or engage in activities that might subject the members to personal liability shouldn't incorporate. Illinois does not regulate unincorporated associations, but it does allow them to be sued.
The organizing document for an unincorporated association is the articles of association. It typically states the association's purpose, structure, and qualification for membership. If the unincorporated association falls into certain categories, such as it has a tax liability, borrows money, or seeks funds publicly, it needs to draft articles of association.
Tax-exempt status. Once the nonprofit has been created, the second step is to become tax-exempt. In order to become tax-exempt, a nonprofit corporation must file separate applications under both federal and state law to be granted tax-exempt status. Although most nonprofit corporations are tax-exempt, some are not.
Section 501(c)(3). The federal tax code section that governs most nonprofit organizations is Section 501(c)(3). It requires that if a nonprofit is to be tax-exempt, it must fall within one of the following categories: religious; charitable; scientific; testing for public safety; literary; educational; fostering national or international amateur sports competition; preventing cruelty to children or animals; civic leagues and social welfare organizations; labor, agricultural and horticultural organizations; business leagues, social and recreational clubs, fraternal societies, employee associations, credit unions, veterans' organizations, high- risk health coverage organizations, and workers' comp reinsurance organizations
The IRS will examine an organizations substance rather than its form look in determining whether it qualifies under 501(c)(3). It will also require that the business not be organized in order to benefit a particular individual.
Application process. The state tax-exempt status application is filed with the Secretary of State when the articles of incorporation are filed, as previously noted. Federal tax-exempt status is obtained by filing an application with the IRS, which is Form 1023.
Once the organization receives 501(c)(3) status, donations to it are tax deductible. The tax-exempt status, however, doesn't allow a nonprofit corporation to do whatever it wants. Its tax-exempt status can be revoked if activities outside of its tax-exempt purpose result in taxation on unrelated business income.