“Our group is a nonprofit. We don’t really take in that much money and almost all of it goes to cover our expenses. There really isn’t much left over at the end of the year. Since no one is making a profit, we are a nonprofit, right.”
I’m glad to hear that your budget seems to be well balanced between income and expenses! It’s really very common to assume that if your group or co op doesn’t make a profit, it is automatically a nonprofit.
But that’s not the way it works.
Nonprofit Status is a State Law Concept
Whether or not your co-op is a nonprofit is determined by whether your state says you are a nonprofit or not. Every state has a legal definition of a nonprofit. Every state has specific criteria that an organization has to meet in order to be called a nonprofit. There are usually two requirements. The first is how your organization operates and the second is how you’re organized. You need both of these to be considered a nonprofit.
How a Nonprofit Operates
In very general terms, states define nonprofit organizations as groups that are formed and operate for nonprofit purposes such as:
- Educational purposes
- Charitable purposes
- Religious purposes
- Community or member services
Nonprofit organizations may have more income than expenses (create a profit), but the monies have to be used in service of the nonprofit’s purpose. This is different from a for-profit organization, where the profits are distributed to owners or shareholders.
If your group is operating as a nonprofit, but not organized (or formed) as a nonprofit, you’re only halfway there!
Organized as a Nonprofit
To be considered a nonprofit, all states will require these three things that demonstrate a group has formed or organized as a nonprofit:
- An organizing/forming document (Articles of Incorporation or Articles of Association), that establishes your group or co-op as a legal entity
- A governing group of people, commonly called a Board, that is responsible for making sure the group operates according to state and federal laws.
- A governing document (Bylaws)
Organizing Documents
There are usually two “entity” options when organizing a nonprofit. Your co-op/group could be established as either a Nonprofit Corporation or an Unincorporated Nonprofit Association. The organizing documents, though different for each of these entities, describe why the co-op was formed, who formed it, and provide some basic information about the co-op.
If your co-op/group wishes to become a Nonprofit Corporation, you will need to create Nonprofit Articles of Incorporation, which are filed with your the Secretary of State. There is a fee to file. You should explore the Secretary of State website for your state to find out if there is specific language that should be included in your Articles of Incorporation. If you wish to apply for 501(c)3 tax exempt status with the IRS in the future, there is specific language that the IRS requires you to include in your Articles of Incorporation.
If your co-op/group wishes to form as an Unincorporated Nonprofit Association, you will need to create Articles of Association. These are generally not filed with the Secretary of State. Some states have statutes that recognize Unincorporated Nonprofit Associations as legal entities. If you search for “Unincorporated Nonprofit Association Act” for your state, you should be able to find out whether your state requires specific language in the Articles of Association.
A Governing Leadership Group
Nonprofit Corporations and Unincorporated Nonprofit Associations must be governed by a board rather than a single individual. The board has what is referred to as fiduciary duties. In general, this means the board is legally responsible for the operations of the organization. Your state law will determine what the minimum number of board members is. The number may be different in every state, but three is usually the minimum.
If your co-op/group intends to apply for 501(c)3 tax exempt status, the IRS requires a minimum of three board members, who are unrelated by blood or marriage.
Bylaws
Nonprofit bylaws are often referred to as a governing document. Bylaws are a legal document that provides basic information about your nonprofit and defines, at a high level, how the nonprofit will operate. For example, bylaws describe the number, term length, and term limits of your board members. Bylaws would not describe how many classes your co-op will offer.
Even though some states do not require a nonprofit to create bylaws, creating bylaws is always recommended. If your co-op ever wants to apply for 501(c)3 tax exempt status, the IRS requires that it has bylaws.
Your group may have taken the steps to become organized as a nonprofit, but that alone is not enough. You must still be operating for nonprofit purposes. So, if you’re not also operating as a nonprofit, you’re only halfway there!
Why is This Important?
If your group/co-op hasn’t formed as Nonprofit Corporation or an Unincorporated Nonprofit Association, then you’re most likely operating as a sole proprietor, which is for-profit business. There are three big reasons that you need to take the steps to make sure your group/co-op is both organized and operates as a nonprofit. Those reasons are:
- Reporting income and possibly paying taxes
- Personal liability
- Using volunteers
Reporting Income and Paying Taxes
Since someone is handling money as an individual, the IRS expects that person to report all of the group income on their taxes. They can also claim the group’s expenses as business deductions, but if a profit is made, they may have to pay taxes! In most cases, your state also expects them to report their business income, so they may also have to pay taxes to your state.
Even if you’ve organized as a nonprofit, if you are not using your income to support a nonprofit purpose, your group may end up owing taxes. Most people do not want to pay taxes, if they can avoid it!
Personal Liability
A sole proprietor is personally responsible for their business operations and is personally liable in the event of a lawsuite. That means you could be risking your personal assets, such as your home. That’s a big risk to take!
Using Volunteers
A for-profit business, such as a sole proprietorship, partnership, LLC, or corporation, is not legally permitted to use volunteers. Since your group/co-op is a for profit by default, it is considered that anyone who volunteers for your group is doing labor so that someone else can make a profit. The Fair Labor Standards Act (FLSA) is the primary and relevant law for determining whether someone is considered an employee or a volunteer.
Make Sure You’re Both Organized and Operating as a Nonprofit
I hope you can see why it is important for your group/co-op to be both organized and operating as a nonprofit. If you have any questions, about this topic, please get in touch by using my contact form!
Note: Some states use the term Charter or Certificate of Formation, rather than Articles of Incorporation