Business organizations are commonly put together for the purpose of making a profit. This is the not the case for all organizations, however, which is why nonprofit entities have been put together. Such entities are very popular among religious and public-interest organizations.
Nonprofits often enjoy tax-exempt status, but that’s not necessarily the case, as tax exemption is a status determined at the federal level, by the IRS, whereas nonprofit status is determined at the state level. It is important to understand that tax exemption is a separate process and that a nonprofit does not automatically get it; it must be separately applied for.
A key decision is deciding what form a nonprofit organization should take, and there are four choices.
- The standard nonprofit corporation. This, of course, is the most popular choice. Advantages of a nonprofit corporation include limited liability, which means that most people in the nonprofit cannot be personally sued, although there are exceptions to that. Another advantage is that there is a great deal of legal certainty in terms of how nonprofits can and should operate. However, a disadvantage is the potential loss of control that the founders of a nonprofit may experience once they are no longer directly involved in it. The board of directors or members of a nonprofit potentially could make decisions for it that run counter to what the founders had desired. If this is a concern for the founders and they want to maintain strict control once they are no longer actively involved, then perhaps a trust is a better choice.
- The charitable trust. Public charities and private foundations often use trusts. Whereas the nonprofit corporation is a legal entity – which means that, for legal purposes, it basically is considered a person – the trust is not. Rather, the trust is a legal relationship between the “grantor” or “settlor” who creates the trust, the “trustee” who runs the trust and the “beneficiaries” who benefit from the trust and for whom the trust was established. Trusts may be tax-exempt or not, depending on many factors. Advantages of a trust include easy formation and a great deal of control by the founders, who won’t have to worry that the purpose for which the trust was formed will be altered without their approval. Disadvantages are that the rules for trusts are not as well-established as they are for nonprofits, for example, so there could be some unpredictability when disputes arise. Trusts also aren’t as flexible as nonprofits in responding to changing needs.
- The limited liability company. Although the LLC generally is used by for-profit businesses, it also could be wise choice for nonprofits under some circumstances. A major advantage of LLC is built into their name: limited liability for members and managers. LLC’s can be tax-exempt, or they can have what’s known as pass-through tax treatment, meaning that their members and managers are taxed at their personal rate instead of being subject to higher corporate tax rates. Another advantage of LLC’s is that all members may full participate in governing and managing the LLC, so one feels as though their input is limited. Yet one more advantage of an LLC over a nonprofit is that they have less restriction than corporations in terms of how their governed and organized. The biggest problem for an LLC is that, the IRS only has limited circumstances under which it will grant an LLC tax-exempt status.
- The unincorporated nonprofit association. This could be a wise choice for small organizations with very simple needs because such associations are informal and relatively easy to put together. The problem with such associations, however, is that it may be difficult to acquire tax-exempt status.