A reader of my previous articles on non-profit organizations asked, “Why would someone want to form a non-profit organization and not want to become a 501c3?”

What is a Non-Profit?

Simply put, a non-profit — or not for profit — is an organization that does not distribute its profits to shareholders or owners. Instead of distributing taxable wealth to owners (like a for-profit company), a non-profit uses profits in order to fund its programs and services.

A non-profit can hire employees and a management team and do anything else required to operate. After all such expenses are paid, a non-profit business treats its surplus money differently than a for-profit business.

Instead of paying profits to stockholders, the “extra” money is instead used within the organization to pay for and expand its programs and services.

Non-profit is a legal status pertaining to how and why an organization is being run. It doesn’t confer tax-exempt status, nor must such an organization necessarily pursue tax-exempt status.

What is a Tax-Exempt Organization?

Tax-exempt is a taxation status. Tax-exempt means that your organization will not pay regular income taxes on monies left over after expenses are paid.

While you may be running a non-profit organization in terms of how you handle “extra” funds, you might or might not have a need to obtain tax-exempt status.

Your organization will be doing things to raise money to afford the products and services you want to offer, and some of that money will be used to pay your employees or marketing or other operational costs. After those things are paid, you have a profit.

Do you want that profit to be taxed, or do you want that profit to be tax-exempt?

If you want the Internal Revenue Service to exempt your organization from paying the same taxes as other businesses, you must seek approval for one of the many tax-exempt statuses available. The most commonly known tax-exempt status is 501c3.

You apply for 501c3 status with the IRS. If approved, your organization will be tax-exempt. As I explained in Now You’re Ready for Tax-Exempt Status, having a tax-exempt status does not mean that you don’t have to file with the IRS. You will have to file, and you will have paperwork.

Do I Need Both Non-Profit and Tax-Exempt Status?

Again, your organization can be non-profit and tax-exempt, or it can be non-profit and not tax-exempt.

You will have to weigh the costs versus the benefits against the objectives of your organization. These are not decisions to be made lightly. However, these decisions can be changed as your organization grows and perhaps changes some of its objectives.

Now that you have written your organization’s business plan, you have a clear idea of how you’re going to accomplish the goals of your non-profit.  You are ready to apply to the IRS for tax-exempt status.

Remember that tax-exempt and non-profit are not interchangeable.

Non-Profit is Not Tax-Exempt

Non-profit means that your organization uses any monies it raises to fund the cause of the organization.  At the end of the year, you will not be paying out profits or dividends or disbursements to shareholders or owners like a for-profit business.  Any fundraising or donations to the organization are used to run the organization and to expand the organization’s reach.  This is a state-level status.

Tax-exempt is a filing status with the Internal Revenue Service.  This means that you do not have to pay taxes on the activities within the organization.  The idea is that the funding activities are to support the cause of the organization and not for individual profit or gain.

Where to Find IRS Information

You can read about different types of tax-exempt entities in IRS publication 557.  The IRS website has lots of information for tax-exempt entities.  Be sure to look through the Tax Information for Charities and Other Non-Profits page as well.

Another great resource is the IRS publication 4220, which is a great introductory piece on tax-exempt organizations and the things that classify you as tax-exempt.

While you can prepare your application for tax-exempt status yourself, it is not an easy task.  The applications are lengthy, especially for 501 c 3 status, so it is a great idea to enlist the help of a good accountant or someone who is experienced in helping non-profit organizations through this process.

While many organizations exist to help non-profit organizations get through this whole process, keep in mind that they will charge you for those services.  Be sure to ask lots of questions and get a clear explanation of what each service provides and what is the total cost to you.  Then you can choose the services that are right for you and your organization.

When Can I Start Acting Like a Non-Profit?

Your organization can begin conducting its affairs through the non-profit corporation that you set up at the beginning.  It is important, though, to get the process of applying with the IRS started as soon as possible.  The process can take anywhere from 6 weeks to 12 months, depending on how back-logged the IRS is and on how well your application is prepared.  Many applications are rejected on the first filing; that does not mean that you won’t be able to get approved. If your application is rejected, the IRS is usually looking for more information. The rejection letter will detail what is needed to re-apply.

While the application process can be time-consuming and can seem quite detailed, once you have received your approval, your organization can gain many benefits.

During September, I start thinking about all of the fall activities, such as the new school year for my kids, football games, and Halloween costumes.

The summer time is often spent thinking about vacations or outdoor activities or even just plain staying cool. As the summer comes to a close, it’s time to focus once again on all of the things that seem less important than what flavor Slurpee you want to try.

Fall is Here

Along with school and football, September brings back to the forefront thoughts of marketing and business getting back in full swing once again.

Fall is here, and it’s time to focus on all of those business things that we let fall to the wayside during the summer months.

Why Wait?

If you have been thinking all year about setting up a corporation or LLC for your business, now is a great time to get it done. You still have time to take advantage of some tax savings for your business, and the investment for starting a new business entity will be a write-off for your business this year.

And if you have been waiting to start your entity to be ready for the new tax year in January of 2010, now is the time to get started. The transition of any business from a sole proprietorship to a corporation or LLC takes a bit of time; along with filing the entity, we will need to transition from the old way of doing to business to the new way of doing business, through an entity.

You may also be looking for creative ways of investing and protecting profits you will have in the business for the year. You still have time to plan for some of the available options you have for your profits.

Procrastination

Some business owners wait to take care of important details like their corporate minutes or their bookkeeping or even their marketing. Those kinds of details are much easier to maintain if you don’t get behind. So take this transition time to catch up on the details and then devise a plan for maintaining the details.

The summer is over. It’s time to dust off the old brain and get back to work.

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Business owners can find lots of information on starting a business entity from the internet, their accountant, their attorney, even their neighbor down the street. Sometimes all of that information can be a bit confusing. Even seemingly a bit contradictory.

How do you know which business entity is right for your business? How can you possibly have enough time to filter all of the available information? And which information is right?

Here I’d like to offer you a simple explanation of each entity type, and as you can all look up definitions, I’ll keep it more about when you might consider it. I’ll also include comments on any of the common things that you might have heard.

And from there, I welcome any questions you might have. I know deciding on which business entity to use can be a bit stressful for many business owners, so I hope this helps!

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Sole Proprietorship: If you are in business for real, this is a bad choice. You are the business. One and the same. You have the worst choices in tax advantages; the only way to save in taxes is to lose money. Most of us are not in business to lose money. Also, because you are the business, if you have any liability, if you ever get sued, you personally can lose everything in the event of the business lawsuit. Additionally, if you die, your business dies. This is simply not a good choice if you are serious about being in business. Remember: otherwise business people know this as well.

C-Corporation: The C-Corporation is what we call a “stand-alone” entity. Simply put, it does business, collects money, pays expenses, and then files a tax return at the end of the year. The corp does have officers and directors, and it does have stock. (It doesn’t matter how small you think your company is, you will have stock.). This entity separates the business from the stockholders and officers/directors from the business. (Keeping in mind that the individual states have different statutes regarding liability).

This can be a good entity to use if you will have substantial profits in your business. Remember to think about the big picture: you might show a loss the first year or two, but in the long run, most of us are in business to profit. So if the business profits, a stand-alone tax return for the business is usually a good idea. This is also a good choice if your business is taking on investors, as many times investors are looking for a traditional-type situation with stock, as opposed to the LLC discussed in a bit.

Double Taxation is the big buzz word here…doesn’t have to the problem that it’s cracked up to be. This corp can be a great choice if you use it well, as this corp has the most potential tax write-offs.

S-Corporation: The S-Corp is what we call a “Flow-through” entity. That means that the business makes money, pays expenses, and then the profits/losses flow through to the individual stock-holder’s tax return. It does not retain profits or losses. Again, you have stock and officers/directors with this one. Once you have elected S-Corp status, you are stuck for five years (currently), meaning you can’t change your mind and switch it back to C-Corp.

This is a good choice for someone that will be showing losses in the business. The losses will then flow-through to your personal tax return, off-setting other income that you have. For example, if you have a W-2 job, then you have losses from a side business that flow through, your W-2 income bracket can be reduced. Good planning. (If you show profits, the profits will go to your personal tax return and can bump up the other income bracket you’re in as well).

This is also a good choice if your goal is to build the business and sell it. This can reduce the taxes you pay when you sell the business.

Not a good choice if you want to have stockholders that are not US citizens and this S-Corp is limited to only US citizens and natural people. Which makes it a poor choice in estate planning, as another entity cannot hold the stock, either. (You can hold the stock in your Living Trust).

LLC (Limited Liability Company): This entity is kind of a hybrid of a corporation and a Limited Partnership. It takes good stuff from each of them and crams it together. The best parts are that you have the capability of limiting the liability of the owners of the business as well as the people running the business, and you also have the choice of how to have the business taxed with the Feds. So, again, you separate the business from the individuals, and you have lots of potential tax write-offs.

Good to use in a partnership situation, as you have an operating agreement that delineates how you run the partnership. That helps you avoid problems with your partners down the line. It’s all spelled out in the beginning.

This can also be a great tool in tax planning, if you use other entities in your mix.

This entity is also great for asset protection, particularly when you have assets that bring lawsuits to you, i.e. real estate, machinery, boats, etc. It’s a great choice for any business with a lot of potential liability, like real estate investors, limo companies, restaurants, etc.

MYTH: It is not a good idea to think that with the LLC you won’t have to do paperwork like with the corporations. If you want to take advantage of tax write-offs, you will have to document financial decisions or the IRS won’t let you have them in an audit!

Limited Partnerships can be a good choice for a number of different things, but most business owners won’t be using them. The LLC does what is needed most of the time and is usually a better choice. If you have questions regarding the LP, I will be happy to answer them later.

One more note: In some states, your profession will determine which entity you can use. For example, in CA if you hold state licensing of any kind, you must be a corporation, not an LLC. And some states have state-level taxation that might push you towards one entity over the other.