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Incorporating: Why is it Important?

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There are many steps involved in forming a nonprofit, with one of the most important steps being incorporation. While some organizations may choose to form a nonprofit organization without a corporate structure, an overwhelming majority of nonprofits choose to incorporate because of the various benefits and protections that incorporation offers.

In the simplest of terms, incorporation is what gets your organization recognized as a business with the state. The Articles of Incorporation is a document that is filed with the home-state of the nonprofit organization in order to have it legally recognized as a corporation. This form will vary from state-to-state, but most state’s forms contain the same general information. Unlike for-profit corporations, there are not any benefits to incorporating in one state over another, as it is actually more beneficial for your organization to incorporate in the state that your organization will be operating in, specifically when it comes to state tax exemptions.

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Incorporating as a Nonprofit

Incorporating as a nonprofit does not automatically mean that you are a tax exempt organization. The term “nonprofit” is a concept at the state level simply meaning that the organization and those in control of the organization do not intend to make a profit off of the programs, services, or other activities. Incorporation is widely regarded as the first of many steps in achieving the tax exempt status at both the state and federal levels.

Organizations that have elected to operate as an unincorporated association often have a much more difficult time in achieving these tax exemptions. While incorporation paperwork may seem like a substantial amount of work, having the proper organizational papers and operating rules established for an unincorporated association is an even more challenging task. Additionally, the Internal Revenue Service has extra steps and requirements in order for an unincorporated association to be in compliance with section 501(c)(3) that make achieving tax exempt status even more daunting. Overall, it is significantly easier to have the federal government and a state government to approve an income tax exemption of a nonprofit corporation than it is for an unincorporated association to achieve those statuses.

Both federal and state tax rates can be a significant cost, especially if your organization finds great financial successes in your organizations fundraising efforts or other financial achievements. Without the state and federal tax exemptions, all funds raised through your activities, services, and retails sales will be subject to taxation, leaving your organization with fewer funds available to achieve your charitable mission. Once an organization has achieved tax exempt status at both the state and federal level, they will no longer be required to pay income tax on any funds that were received in relation to their charitable mission, including income from retail sales, fees for services, and other fundraising activities.

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Benefits to your Donors

Not only does incorporating and obtaining the federal tax exemption and the state tax exemption benefit your organization, but it will also benefit those who wish to donate to your organization. When an organization has incorporated and achieved tax exempt status, any donations to your nonprofit corporation can be deducted from the donors’ federal and state income tax returns. When donors are made aware that your organization is recognized as a 501(c)(3) tax exempt organization, they will be more likely to make donations in order to receive this benefit.

Another way that individuals select organizations to donate to is based on their perception of your organization. Often times individuals’ first impression of your organization comes from the name of your organization. When an organization chooses to form a corporate structure, the name of their organization can contain a corporate identifier, such as “Inc.” or “Corp.” These corporate identifiers can help an organization with the appearance of legitimacy. When individuals choose an organization they want to ensure that the funds they are providing are going to be used appropriately and the corporate identifier in a corporation’s name provides the donor with a sense of security as they know that the organization is a legitimate entity recognized by (at least) the state.

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Grant Giving Considerations

Additionally, all grant giving organizations, whether public or private, require a potential grant recipient to have the tax-exempt status with the federal government. When applying for a grant from a foundation, the foundation always asks for information on your tax exempt status. Once the foundation sees that you are not approved under section 501(c)(3) of the Internal Revenue Code, they will immediately disregard your application. Grant giving organizations want to ensure that their funds are going to be used for something that they are passionate about, whether it is charitable, educational, scientific, religious, literary, or cultural.

Because an organization has to one of those purposes in order to achieve tax exempt status, foundations use this determination when it comes to choosing who they will fund. As I have mentioned previously, before an organization can become a tax exempt organization, there are a number of actions that need to be taken, but when an organization chooses to incorporate this process becomes more streamlined. The more promptly an organization is able to achieve the tax exempt status, the more quickly that they will have the ability to apply for funding from grant giving organizations or foundations.

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Protecting Assets

Possibly the most important reason for incorporating and the most common reason an organization will choose to incorporate is to protect the personal assets of those involved with the organization. Just like for-profit businesses, nonprofit organizations can also find themselves the target of a lawsuit for various reasons. When an organization chooses to incorporate, it separates those who formed the organization from the corporation itself by becoming a completely separate entity. In this sense, if a nonprofit organization elected to incorporate, the members and directors of the board will be protected against any liability, including lawsuits and debts, of the nonprofit corporation.

Creditors will only be able to go after the corporation’s assets, thereby ensuring that all board members, officers, and employees that are involved with the corporation will have their personal assets protected. Everyone involved with the organization will have the comfort of knowing that their personal funds, cars, housing, and other property will not be susceptible to paying off the corporation’s debts or liabilities.

In the case of an unincorporated association, these protections from personal liabilities would not be in place for the board of directors, officers, employees, or volunteers. If the unincorporated association were to be at the center of a lawsuit or default on any loans, these individuals could be held liable and have their personal assets put in jeopardy. While you may think your activities or actions will not be a cause for a lawsuit, the fact of the matter is that any nonprofit organization is always at risk for a lawsuit.

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Organizational Longevity

Not only does forming a corporation allow for protections from personal liability, but it also allows the organization to continue on in an existence after the involvement or lifetime of those who founded the organization. Because a corporation is a completely separate entity of those who formed the organization, those individuals who serve on the board of directors should (and will) be replaced over time.

The Internal Revenue Service puts limitations on the length of the term that each board member may serve at a time before they will have to run for re-election of their position. With the board of directors being continuously updated as board members move on from the organization, this allows the nonprofit corporation to continue in its existence indefinitely. In theory, a nonprofit corporation can continue its existence forever, thus allowing the founders and the organization’s legacy to continue on.

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In Regards to Authority

Furthermore, when the founders of an organization elect to incorporate their organization, the authority over the organization is given to the board of directors, who can then give this authority to the company’s officers. By having the governing body and this authority be well defined through the incorporation process, your organization will have a lesser likelihood of manipulation by a co-founder, co-owner, or employee.

With unincorporated businesses there is still a structure, although it is undoubtedly less defined. Given the lack of structure these unincorporated associations are significantly more vulnerable to this manipulation where a co-founder, co-owner, or employee tries to take complete control over the organization. This lack of structure can cause conflict and seriously affect the organizations chance of success. Overall, forming a corporation will allow for the elimination of the risk of your organization’s mission or activities being compromised by allowing a board of directors to make all governing decisions based on what is in the best course of action and interest for the organization.

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Conclusions

When you look at all the facts it is clear to see that incorporating your organization will benefit any nonprofit organization in achieving their mission and goals. Not only does it make achieving tax exempt status at both the state and federal level significantly easier, but it also protects the founders, board of directors, employees, and volunteers from having their own assets at risk. Essentially, not only is incorporating an intelligent decision, but it is also the most secure way to ensure that you are protected throughout your endeavors. When all the benefits of incorporation are taken into consideration, there is little to no reason why a nonprofit organization would choose to operate under an unincorporated association structure.

If you are not sure whether your nonprofit organization should incorporate or how to incorporate your nonprofit organization, please contact the offices at BizCentral USA to speak to one of our nonprofit experts at 407-857-9002.

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