Nonprofits are big business. According to recent IRS statistics, Michigan has over 50,000 nonprofit entities, holding more than $268 billion in assets, and employing over 470,000 people. Public charities, homeowners’ associations, private foundations, endowments, networking groups, chambers of commerce, are just some examples of nonprofit organizations.
Regardless of whether you have $5,000 local school bake sale to finance a field trip or plan to build a multi-million dollar hospital for needy children, you should formally organize as a corporation. The reason is simple – the corporate form protects members, directors, and volunteers from personal liability. After all, just like with a for-profit business, it is critical to insulate business debts, obligations, and liabilities from personal non-business assets. And this protection is essential regardless of how much money is involved.
A word of warning: Many people wrongly assume that just because they have set up a nonprofit with the State of Michigan, they do not have to pay taxes. But the term “nonprofit” is not the same as “tax-exempt.” Whether a corporation is a nonprofit entity is a matter of Michigan law under the Michigan Nonprofit Corporations Act. Whether a corporation is exempt from taxation is a matter of federal law and is determined under the Internal Revenue Code. While a nonprofit entity may qualify for tax exemption – for example as a charity under IRC 501(c) – the process is not automatic. As detailed below, the nonprofit corporation must be registered with the IRS and the Michigan Department of Treasury and comply with the requisite standards before being granted tax-exempt status. This is why it is especially critical to work with an attorney and a CPA to ensure that you are doing things the right way.
So what are the essential steps to setting up a nonprofit corporation?
1. File the articles of incorporation with the State of Michigan. Form 502 is the basic form that you must file to register your corporation with the State of Michigan.
- First, you must decide whether the corporation will be stock or nonstock. If it is a stock corporation, that means that you will be issuing shares, you need to designate the number of shares to issue, and describe the classes of shares, along with the respective rights and limitations associated with each class. If you elect the nonstock option, the State of Michigan requires that you describe and value of any real and personal property assets. Then, you must determine whether the corporation will be managed on a membership or a directorship basis. Organizations like sport clubs are often run on a membership basis, while charities and private foundations are most frequently formed on a directorship basis. So, there are several different forms that a corporation can take – stock membership, nonstock membership, stock directorship, and nonstock directorship – so be sure to consult with a professional before selecting the form that is best for your particular needs.
- Second, a nonprofit corporation must state a specific purpose for which it is organized and disclose a plan for financing. It is not enough to simply state that the corporation is organized for “all lawful purposes.” For example, if your organization intends to solicit donations from the public for the purpose of helping the homeless, you must expressly state that purpose in the articles. And, “donations” must be listed as the financing scheme.
- Third, you should strongly consider adding some optional articles to specifically address IRC 501 requirements for tax-exempt status. For example, you may wish to add an article restricting distributions of any net profit to charitable purposes. Or, the corporation may expressly assume liability for any volunteer director actions right in the articles. Again, consult with a professional to determine which optional articles are necessary and the best language to use.
2. Draft and approve bylaws. The bylaws are the governing document for the nonprofit corporation that set forth things like how decisions are made, who the officers or directors are, how money is accounted for, voting, and the rules for annual and special meetings. The Michigan Nonprofit Corporation Act also contains some special requirements unique to nonprofits – for example, the minimum number of directors is three. Membership eligibility and any dues and requirements may be established. If it is a stock corporation, the bylaws will have provisions restricting the transfer of stock. Officers may be appointed. Bylaws are especially critical for nonprofits as they are important evidence in any dispute regarding whether the corporation qualifies for tax exempt status. Also, the bylaws contain the all-important indemnification provisions that protect from personal liability.
3. Determine whether you need to register as a charitable trust with the Michigan Attorney General’s Office. Under the Charitable Organizations and Solicitations Act, any organization that intends to hold property for charitable purposes or to solicit donations must register with the Attorney General’s office within two months of incorporation or obtain an exemption. Under Section 13(b) of the Act, organizations that have only volunteer employees and do not receive more than $25,000 per year do not have to register are exempt from the reporting requirements. The exemption does require prior approval from the Attorney General’s Office. The articles of incorporation and the bylaws must be filed with the forms. Also, any IRS determination regarding IRC 501 tax-exempt status and any statements detailing financial activities must be filed as well – regardless of whether you are registering or seeking an exemption.
4. File Form 1023 with the IRS to qualify for tax-exempt status. Perhaps the most important step of all, the IRS requires a nonprofit to file Form 1023, together with its articles of incorporation, bylaws, and any solicitation materials. You may wish to involve a CPA at this stage to ensure that all of the IRS regulations are followed properly. Make sure that you have obtained an EIN (employer identification number) before filing form 1023.
Additional steps may be necessary, depending on the particular type of nonprofit organization and your particular goals and circumstances. For example:
- You may need to execute a power of attorney and representative with the IRS if you wish your CPA or attorney communicate directly with the IRS.
- There are also special forms and requirements if your organization intends to lobby legislation.
- If your corporation is not solely for charitable purposes, it may still seek tax exempt status under a different subsection of IRC 501 by filing form 1024 with the IRS.
- You or your CPA will be filing a special tax return Form 990 for nonprofits.
- If you are in the business of selling tangible property, you may need to obtain a sales and use tax exemption certificate from the State of Michigan.
Setting up a nonprofit corporation takes more time and effort than a for-profit entity. Given the various possible iterations that a nonprofit can take, as well as the importance of obtaining the tax-exemption approval from the IRS, it is critical to hire a professional to assist.
Disclaimer: This article is for promotional and general informational purposes only. It is not intended to and does not constitute legal, financial, or tax advice. You should not take any action in reliance on this article without first hiring and consulting with a professional about your particular set of facts and circumstances.
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