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How It Works
Nonprofit Corporations are formed in order to conduct activities and transactions for purposes other than shareholder financial gain, while at the same time providing the same asset protections and limited liabilities of a standard corporation. A nonprofit corporation can make a profit, but this profit must be used strictly to forward the goals rather than to provide earned income (in the form of dividends) to its shareholders. It is understood that most of the transactions and activities of a Nonprofit Corporation will not be commercial in nature.
Goals and Missions of the Non-Profit Corporation
Nonprofit organizations or corporations are often charities or service organizations; they may be organized as a not-for-profit corporation or as a trust, a cooperative, or they may be purely informal. Sometimes they are also called foundations, or endowments that have large stock funds. Most foundations give out grants to other nonprofit organizations, or fellowships to individuals. However, the name foundations may be used by any not-for-profit corporation -- even volunteer organizations or grass roots groups.
A nonprofit may be a very loosely organized group, such as a block association or a trade union, or it may be a complex structure such as a university, hospital, documentary film production company or educational book publisher.
In many countries applying Germanic or Nordic law (e.g. Germany, Sweden, Finland), nonprofit organizations typically are voluntary associations, although some have a corporate structure (e.g. housing corporations). A voluntary association is usually founded upon the the principle of one man–-one vote. A large, nation-wide organization usually is organized as a league: the local level has a town- or county-level association with natural person membership, these associations being members of the national association. This is perceived to achieve local-level maximized autonomy, while still protecting the general corporation from the legal or financial blunders of any single association. The organization of such leagues (e.g. trade union or a party) may be extremely complex. There are often separate laws regulating usual, "idealist" associations (anything from a sports club to a trade union), political parties and religious denominations, restricting each type of organization to its chosen field.
Legal Issues to Consider
Most states have individual laws regulating the establishment, structure, and management of nonprofit corporations. The same holds true for different countries: most have laws which regulate the establishment and management of nonprofit organizations, and which require compliance with corporate governance regimes. Most larger organizations are required to publish their financial reports detailing their income and expenditure for the public. Although very similar to business, or for-profit, entities, they can differ on very significant levels. Both nonprofit and for-profit entities must have board members, steering committee members, or trustees who owe the organization a fiduciary duty of loyalty and trust. A notable exception to this involves churches, which are often not required to disclose finances to anyone, not even its own members if the leadership choose.
Tax Exemption Status
In many countries, nonprofits may apply for tax exempt status, so that financial donors may claim back any income tax paid on donations and so that the organization itself may be exempt from income tax. In the United States, after a recognized legal entity has been formed at the state level, it is customary for the nonprofit corporation to seek tax exempt status with respect to income tax. That is done by applying to the Internal Revenue Service (IRS). The IRS, after reviewing the application to ensure the purpose of the organization meets the conditions to be recognized as a tax exempt organization (such as a charity), issues an authorization letter to the nonprofit granting it tax exempt status for income tax purposes. The exemption does not apply to other Federal taxes such as employment taxes.
The Main Difference between Nonprofit and For-Profit Organizations
Most experts consider that it is the legal and ethical restrictions on the distribution of profits to owners or shareholders which fundamentally distinguishes nonprofits from “for-profit, or commercial enterprises. A more precise term to describe most nonprofit organizations is 'not-for-profit', rather than 'nonprofit', and this is often used in legislation and texts. Nonprofit corporations generally do not operate to generate profit, a defining characteristic of such organizations. However, a nonprofit organization may accept, hold and disburse money and other things of value, and it may also legally and ethically trade at a profit, provided that the proviso that any profit generated will be used to further its cause, goal or mission is adhered to. The extent to which it can generate income may be constrained, or the use of those profits may be restricted. Nonprofits therefore are typically funded by donations from the private or public sector, and often have tax exempt status. Private donations may sometimes be tax deductible.
Additionally, a nonprofit organization may have members as opposed to shareholders.
Formation and Structure
In the United States, nonprofit organizations are normally formed by incorporating in the state in which they expect to do business. The act of incorporating creates a separate legal entity enabling the organization to be treated as a corporation under law and to enter into business dealings, form contracts, and own property as any other individual or for-profit corporation may do.
Much like a standard, for-profit corporation, nonprofits can have members although many do not. The nonprofit may also be a trust or association of members, and the organization may be controlled by its members who elect the Board of Directors or Board of Trustees. Nonprofits may have a delegate structure to allow for the representation of groups or corporations as members. Alternately, it may be a non-membership organization and the board of directors may elect its own successors.
A primary difference between a nonprofit and a for-profit corporation is that a nonprofit does not issue stock or pay dividends, (for example, The Code of the Commonwealth of Virginia includes the Non-Stock Corporation Act that is used to incorporate nonprofit entities) and may not enrich its directors. However, like for-profit corporations, nonprofits may still have employees and can compensate their directors within reasonable bounds--but these must be, as is the case with for-profit corporations, precisely documented and kept in the corporate minutes or corporate record.
Issues Faced by Nonprofits
Operational Capacity support is an ongoing problem faced by nonprofits that rely on external funding to maintain their operations, largely because nonprofit organizations have little control over their source(s) of revenue. Increasingly in the United States, many nonprofits rely on government funds to support their operations, often through grants, contracts, or customer-sided subsidies, such as vouchers or tax credits. The form of revenue is quite significant to the viability and stature of the nonprofit corporation as it influences the reliability or predictability with which the organization can hire and retain staff, sustain facilities, or create programs.
Types of Non-Profit Corporations
There are two types of nonprofit corporations: membership corporations and charitable corporations. It is necessary to distinguish between the two types because the responsibilities of each vary.
A membership corporation carries on activities that are primarily for the benefit of its members. It is supported by its members through fees, donations, loans or any combination of these. Examples of membership corporations are golf clubs, social clubs, special interest organizations, day cares, etc.
A charitable corporation carries on activities that are primarily for the benefit of the public. It may solicit donations from the public, receive government grants in excess of 10% of its yearly income or register as a charity within the meaning of the Income Tax Act.
Remember, both types of corporations have members. A corporation is not a membership corporation just because it has members; a charitable corporation has members too. The members of any nonprofit corporation, membership or charitable, have a status similar to that of the shareholders of a business corporation, and are usually afforded .
The main differences between a membership corporation and a charitable corporation are:
who benefits from the activities (the members or the public); who supports the organization financially; and how the surplus is distributed upon dissolution
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