Minnesota Law
Minnesota Associations & Nonprofit Law
- Associations & Nonprofit Law
Associations & Nonprofit Law
Today, many small organizations are interested in the benefits of tax-exempt, nonprofit status. Forming a tax-exempt, nonprofit corporation is a fairly complex endeavor that requires time, money and an understanding of legal and tax technicalities - all of which can be scarce in organizations that would most likely benefit from tax-exempt treatment and nonprofit status. Still, the benefits available to nonprofits are so great that it is often worth the time and energy to become familiar with the necessary steps. Some of the rules governing how a nonprofit corporation must be formed and run are complex. An organization will likely need professional advice from an attorney to establish the business, and from an accountant to oversee financial matters when the corporation is in operation. This chapter explores the issues uniquely of concern in forming a nonprofit corporation and the process of gaining tax-exempt status for a nonprofit corporation.
Becoming a Tax-Exempt, Nonprofit Corporation
The process of becoming a tax-exempt, nonprofit corporation actually has two distinct phases, first, creating the nonprofit corporation, then, applying for tax-exempt status for the corporation once it has been created. The chronology of these two phases is important. The second phase - applying for tax-exempt status - will be far simpler for organizations that keep that goal in mind during the first phase - creating the nonprofit corporation.
Benefits of Tax-Exempt, Nonprofit Status
The primary benefits of tax-exempt, nonprofit status are financial. All or most of the money made by a tax-exempt, nonprofit corporation is free of federal, state, and local taxes, so the organization can devote a larger share of its funds to the ends for which it was formed rather than turning it over to the government. Furthermore, nonprofit status is often a prerequisite to obtaining private grants or government funding. Donors are more likely to contribute financially to tax-exempt, nonprofits than to non-exempt organizations because donors can write off their donation on their tax returns. In addition to tax benefits, there may be low-cost postage and advertising rates available to nonprofit organizations and many retail stores offer reduced rates to nonprofits and their employees.
As with all other businesses, nonprofits are open to lawsuits and liability for the way they conduct themselves. Organizing as a nonprofit corporation can shield the individuals who run the organization from personal liability for the debts of their organization.
The often overlooked advantages of forming a tax-exempt, nonprofit organization are the internal benefits that the organization experiences when forced to commit to writing its management structure and corporate purpose. Many nonprofits start out as a small group of committed persons working toward a definite goal. If the organization grows, commitment levels can fall and goals multiply. Having to think through the organization's purposes and management procedures can bring clarity, focus, and structure at an early stage in the organization's life. These qualities can be invaluable as the organization grows, takes on new projects, and adds new members, or if internal disputes arise.
Drawbacks of Tax-Exempt, Nonprofit Status
Just because an organization qualifies for tax-exempt, nonprofit status does not mean that seeking nonprofit status is the best plan. Tax-exempt, nonprofit status does have drawbacks:
- Profits of the organization cannot be divided among workers or directors (although workers and directors can be paid reasonable salaries).
- Only a small amount of the group's income can be earned from sources unrelated to the organization's reason for receiving tax-exempt status.
- The assets of the group cannot go toward purposes other than those that warranted the tax-exempt status.
Many businesses do not take advantage of tax-exempt, nonprofit status because they prefer the flexibility and possibility of personal financial gain associated with for-profit status. Other organizations that could qualify as nonprofit simply do not incorporate in order to avoid the paperwork. For very small organizations that do not need donations or that have few tax obligations, forming a nonprofit corporation and seeking tax-exempt status may be more trouble than it is worth.
Nonprofit Corporations in Minnesota
Most nonprofit corporations in Minnesota are governed by the Minnesota Nonprofit Corporation Act. The Minnesota Nonprofit Corporation Act does not apply to cooperative associations, public cemetery associations and corporations, private cemeteries, and some religious associations. Under the Minnesota Nonprofit Corporation Act, a nonprofit corporation may not be formed for any purpose that involves pecuniary gain, paying dividends or any other pecuniary remuneration, directly or indirectly to its members, other than those members that are nonprofit organizations or subdivisions, units, or agencies of the federal state, or local government. There are many rules to be aware of when forming and running a nonprofit corporation.
Necessary Documents
At the very beginning of the process of forming a nonprofit corporation, there are two documents that a group can use to file for incorporation - articles of incorporation and bylaws. The articles are the documents filed with the Secretary of State's Office and form the charter document of the corporation. Articles of incorporation must include:
- The name of the corporation
- The address of the registered office of the corporation and the name of the registered agent, if any, at that address
- The name and address of each incorporator
- A clear statement that the corporation is organized pursuant to the Minnesota Nonprofit Corporation Act
Although the list of required items is short, most articles of incorporation are complex, because incorporators want to craft an organization uniquely suited to the people who form it and the purposes for which it is formed. The Minnesota Nonprofit Corporation Act contains numerous "fallback" provisions detailing how the corporation operates. Some provisions automatically apply unless they are specifically modified in the articles of incorporation or bylaws. Other provisions can only be modified in the articles of incorporation. An attorney experienced in advising nonprofits can help an organization decide how much it wants to alter the "fallback" provisions of the Act and whether it is best to do so in the articles of incorporation or bylaws. Incorporators are charged with signing and delivering the articles of incorporation to the Secretary of State's Office.
The nonprofit corporation may, but need not, have bylaws. Bylaws usually define the rules and procedures under which the corporation will operate. Bylaws typically include:
- The number, qualifications, manner of election, powers, duties, and compensation of directors
- The qualifications for membership
- Different classifications for members
- The manner of admission, withdrawal, suspension, and expulsion of members
- Property, voting, and other rights and privileges of members
- Appointment and authority of committees
- Appointment or election, duties, compensation, and tenure of officers
- Time, place, and manner of calling, conducting, and giving notice of member, board, and committee meetings or of conducting mail ballots
- Making of reports and financial statements to members
- The numbers required to establish a quorum for meetings of members, committees and the board
Later, the articles of incorporation and bylaws must be submitted to the IRS when filing for federal tax-exempt status under section 501(c)(3) of the Internal Revenue Code, discussed below. In Minnesota, a nonprofit corporation should file bylaws and articles of incorporation with the Secretary of State's Office. All nonprofit corporations in the state are required to file an annual registration with the Secretary of State's Office. The organization must also register with the Charities Division of the Minnesota Attorney General's Office if it solicits donations within the state.
Required Officers
Corporations governed by the Minnesota Nonprofit Corporation Act must have at least two officers - a president and a treasurer - although the same person can perform both functions. Unless modified by the articles, bylaws, or resolution, the president shall:
- Actively manage the general business of the corporation
- When present, preside at meetings of the board and member meetings
- Ensure that orders and resolutions of the board are carried out
- Sign and deliver deeds, mortgages, bonds, contracts, and other instruments pertaining to the business of the corporation
Unless the corporation modifies the following requirements in its articles, bylaws, or resolution, the treasurer shall:
- Keep accurate financial records for the corporation
- Endorse and/or deposit money, drafts, checks, and notes in the name of the corporation
- Disburse corporate funds in the name of the corporation
- As required, keep the president and board informed of the financial condition of the corporation
Liability of Officers
Incorporating means that a business is considered a legal entity separate from that of its employees and directors, and thus is able to make contracts and incur liability in its own right. But the employees and directors can have legal responsibilities for actions taken on behalf of the corporation.
Minnesota Statutes require that the director of a nonprofit corporation discharge his or her duties in good faith, in a manner he or she reasonably believes to be in the best interest of the corporation, and "with the care an ordinarily prudent person in a like position would exercise under similar circumstances." A director who performed his or her duties in accord with this standard is not liable by reason of having been a director.
Getting Tax-Exempt Status for a Nonprofit
A fairly wide variety of businesses and groups can qualify for federal tax-exemption. Some groups such as chambers of commerce, social clubs, and credit unions may be entitled to federal tax-exempt status under very narrowly drawn statutes not discussed here. The most desirable form of tax-exempt status is found in section 501(c)(3) of the Internal Revenue Code. This is the most desirable form of tax-exemption because 501(c)(3) corporations are not only exempt from federal, state, and local taxes, but donors to the organization can qualify for tax write-offs for their contributions to the organization.
Nonprofits that Qualify for 501(c)(3) Status
There are five different purposes for which the IRS allows organizations to file for tax-exempt status as nonprofit corporations under 501(c)(3) of the tax code. They are:
Charitable Purpose
The term "charitable" here is more broadly defined than in common usage, referring to anything that has benefit for the public. Organizations established for a charitable purpose can be intended to benefit only a relatively small group of people, but not so small that the actual beneficiaries are specifically listed. Examples of charitable purposes include the maintenance of public buildings and relief for the poor.
Religious Group
This term is broadly interpreted. "Religious groups" include mainstream organized churches as well as many other organizations that have truly and sincerely held beliefs. The only necessary factor for qualifying as a religious group is that the group be pursuing the advancement of religion. It is more difficult to qualify as a "church" for tax-exempt purposes than it is to qualify as a religious group.
Scientific Organization
Groups whose primary purpose is scientific research in the public interest are also eligible for tax-exempt status. Research is considered to be in the public interest if the results are eventually made available to the public.
Literary Purpose
Literary purpose is a rarely-used category for filing because most literary organizations that could fit this classification file instead as educational organizations. Generally, groups that sell books that promote the public interest, sell them at or below cost, and make them available to the general public would qualify as groups organized for literary purposes.
Educational Organization
Educational organization is another broadly defined filing category in which endeavors that are aimed at self development as well as community benefit are allowed tax-free status for the purpose of education. A person or group may qualify under this purpose to espouse a point of view, provided it is not a political position.
Application for Federal Tax-Exemption
There are four publications and forms available from the IRS that should be used to apply for 501(c)(3) tax exemption.
- Package 1023
Application for Recognition of Exemption
- Form 8708
User Fee for Exempt Organization Determination Letter Request
- Form ss-4
Application for Employer Identification Number
- Publication 557
Tax-Exempt Status for Your Organization
Each of these publications is available free of charge and all come with detailed instructions or advice. The IRS will respond to the application in one of three ways - granting the exemption, requesting further information before making a final decision, or issuing notice of proposed adverse determination. Form 1023 is the nucleus of the application. The 1023 packet includes instructions for responding to a request for further information or notice of proposed adverse determination. If the nonprofit corporation is granted tax-exempt status, the determination letter will summarize the basis for the decision and conditions that must be met to maintain it.
Qualifying for State Tax-Exempt Status
In order to receive state tax-exemption, a nonprofit must file a separate application with the Minnesota Department of Revenue. The state decision of whether to grant a nonprofit corporation state tax exemption always follows the IRS decision regarding tax-exempt status, so nonprofits should not apply to the Department of Revenue until they receive an official notification letter from the IRS. The state application, known as M-120, is very simple to complete. Applicants must attach to the M-120 form a copy of their federal exemption application and a copy of the federal determination letter. If granted, the Minnesota exemption will be made retroactive to the date of the federal exemption.
Resources
Secretary of State, Business Services Division, 180 State Office Building, St. Paul, MN 55115, (612) 296-2803.
Minnesota Department of Revenue, Central Registration, Mail Station 4410, St. Paul, MN 55416-4410, (612) 282-5225 or 1-800-657-3605.
Anthony Mancuso, How to Form a Nonprofit Corporation (Nolo Press, Berkeley, CA, 2d ed. 1994).
Michael G. Trachtman, What Every Executive Better Know About the Law (Simon & Schuster, New York, NY, 1987).
Minnesota State Bar Association Continuing Legal Education, 40 Milton Street, North St. Paul, MN 55104, (612) 227-8266 or 1-800-759-8840 (The Practical Musician: A Legal Guidebook to the Music Industry).
John Cotton Howell, Forming Corporations and Partnerships (Liberty Hall Press, Blue Ridge Summit, PA, 2d ed. 1991).
Carolyn M. Vella and John J. McMonagle, Jr., Incorporating: A Guide for Small-Business Owners (American Management Associations, New York, NY, 1984).
Hoyt L. Barber, How to Incorporate Your Business in Any State (Liberty House, Princeton, NJ, 1989).
Barbara Singer, Nonprofit Organizations: Operations Handbook for Directors and Administrators (Callaghan & Company, Wilmette, IL, 1987).
Marcia L. Clifford et al., Nonprofit Organizations: Forms for Creation, Operation and Dissolution (Callaghan & Company, Wilmette, IL, 1987).
Claude Whitmyer and Salli Rasberry, Running a One-Person Business (Ten Speed Press, Berkeley, CA, 1989).
Neil Balter and Carrie Shook, The Closet Entrepreneur: 337 Ways to Start Your Successful Business with Little or No Money (Career Press, Hawthorne, NJ, 1994).
Resources and Counseling for the Arts, 75 Fifth Street West, Suite 429, St. Paul, MN 55102, (612) 292-4381.
SCORE - The Service Corps of Retired Executives is a fraternity of retired business managers who volunteer to help new or existing businesses and nonprofit organizations. Information about the services offered through SCORE can be gained by contacting one of its regional offices throughout the state. Three of the larger chapters are listed below:
Minneapolis SCORE
North Plaza Building, Suite 51
5217 Wayzata Boulevard
Minneapolis, MN 55416
Phone: (612) 591-0539
Rochester SCORE
Rochester Chamber of Commerce
220 Broadway South, Suite 100
Rochester, MN 55904
Phone: (507) 288-1122
St. Paul SCORE
St. Paul Chamber of Commerce
101 Norwest Center
55 Fifth Street East
St. Paul, MN 55101
Phone: (612) 223-5010