Incorporated vs. Unincorporated Nonprofits

When people think of nonprofits, they typically think of incorporated nonprofits like the American Red Cross, the American Civil Liberties Union Foundation, and other formally created organizations. However, many people take part in unincorporated nonprofit associations without ever realizing they’ve done so.

Unincorporated nonprofit associations are the result of two or more people collaborating for the purpose of providing a public benefit or service. For example, if you ran a lemonade stand with your best friend when you were five years old and gave the proceeds to a pet adoption center then you and your friend formed an unincorporated nonprofit association.

People usually form unincorporated nonprofit associations for short periods of time until they meet a specific goal and then move on to other projects. If you have long-term goals for your nonprofit, however, you may want to consider incorporation or forming another type of acceptable legal entity. Doing so formalizes your nonprofit organization as a separate legal entity, which provides certain benefits like limited liability protection, an enhanced ability to raise funds and apply for grants, and even discounted rates on stamps as well as certain marketing and advertising costs.

While incorporating a nonprofit offers multiple benefits, unincorporated nonprofit associations remain a popular option. In fact, unincorporated nonprofit associations can still claim tax-exempt status if they meet certain requirements — although that may prove challenging in some cases.

Public Charities vs. Private Foundations

Public charities and private foundations represent two other common forms of nonprofit organizations. Public charities tend to provide service programs while private foundations typically raise funds to support public charities. Moreover, many foundations tend not to raise funds from public donations, but rather private money or funds from a small group of people like family or corporate donations.

Structurally, public charities must follow rigid governance rules and operate with a high degree of transparency under public scrutiny. Public charities also must have a diverse board of directors that represents the community — with more than 50 percent of the members unrelated by blood, marriage, or outside business co-ownership.

In contrast, private foundations may operate in a more closely held manner under the oversight of an individual, family, or corporation. The Bill & Melinda Gates Foundation is one example of a private foundation. This type of nonprofit does, however, face more mandatory paperwork and regulations to ensure proper use of the funds it raises. Why? With such a small group running this kind of nonprofit under far less public scrutiny, it’s easier to misuse funds.

The Internal Revenue Service (IRS) uses a system called the National Taxonomy of Exempt Entities - Core Codes (NTEE-CC) to classify public charities into 26 major groups under 10 broad categories. The 10 categories include:

  1. Arts, culture, and humanities
  2. Education
  3. Environment and animals
  4. Health
  5. Human services
  6. International, foreign affairs
  7. Public, societal benefit
  8. Religion-related
  9. Mutual/membership benefit
  10. Unknown, unclassified.

Private foundations may include family foundations, private operating foundations, and corporate foundations. As noted above, they typically don’t offer any services and instead use the funds they raise to support other charitable organizations with service programs.

Private foundations also tend to require more startup funds to establish the organization as well as to cover legal fees and other ongoing expenses. While the amount of capital you need to start a foundation can vary greatly, you should expect a minimum initial investment of $1 million to $2 million. In some cases, donors may start with a more modest upfront investment and then plan to add more assets over time.

Because ensuring ongoing compliance with diverse state and federal requirements can prove challenging, many foundations engage professional attorneys, business advisors, and/or other professionals to help staff with regulatory compliance and various other operational tasks. While this outside support does increase operating costs, it’s often money well spent. For example, hiring an attorney with experience in foundations and trusts can help advise you on how best to form and run your foundation.

Nonprofit Trusts

Nonprofit trusts — another common type of nonprofit organization — come in three varieties: charitable trusts, charitable remainder trusts, and pooled charitable trusts. Here’s a brief overview of each:

  • Charitable Trusts: The first legal form of a nonprofit organization, charitable trusts must irrevocably dedicate all of their assets to a charitable purpose. Grantors deposit assets, such as cash, property, jewelry, and art, into a trust for beneficiaries that include nonprofits or other charitable organizations. The assets remain in the trust while the grantor is alive and the grantor may manage the assets, such as buying and selling stocks or real estate. All assets deposited into — or purchased by — the trust remain in the trust with income distributed to the designated beneficiaries. These trusts can survive the grantor if they include a provision for ongoing management in the documentation used to establish them.
  • Charitable Remainder Trusts: Another form of irrevocable trust, charitable remainder trusts feature a different income distribution plan. Instead of distributing income to a designated nonprofit or other charitable organization, this type of nonprofit trust distributes income to the grantor or whomever the grantor specifies as a “receiver.” Upon the receiver’s death — whether that’s the grantor or other specified individuals — the assets transfer to the nonprofit beneficiary.
  • Pooled Charitable Trusts: If you wish to leave a legacy to a school or charity, a pooled charitable trust can provide a great option. With this type of nonprofit trust, the benefiting school or charity sets up the trust and then accepts donations from anyone who wishes to contribute. This approach pools all donations into one fund, invests those combined funds, and pays the resulting income to you. Once you pass away, the trust distributes any remaining assets to the designated charity.

The easiest way to set up a charitable trust is through a major life insurance, financial services, or investment management company. These companies not only provide services that ensure you set up your trust properly, but also offer disbursement, asset management, and charity evaluation services. Alternatively, you can hire a trust attorney to help you create a charitable trust and advise you on how to manage it moving forward.

Political Organizations

While most other forms of nonprofit organizations have a limited ability to participate in or advocate for political activity, political organizations operate under different rules. People form this type of nonprofit — which may include committees, parties, funds, associations, or other organizations — with the goal of influencing public office elections and appointments. Under Section 527 of the U.S. Internal Revenue Code, political organizations may accept contributions, make expenditures, or both, as a tax-exempt nonprofit.

Churches and Religious Organizations

Churches and other religious organizations also qualify as tax-exempt nonprofit organizations. Focused on serving the community, many provide programs designed to benefit the public like setting up schools or feeding the homeless.

Other Nonprofit Organizations

While you may already know about 501(c)(3) organizations — nonprofits that range from those serving religious and scientific purposes to groups fostering education or the prevention of child and animal abuse — many other varieties of 501(c) organizations exist. In fact, the IRS currently recognizes a total of 27 different 501(c) organizations as well as several other types of organizations also classified as nonprofits.

These include social welfare organizations, civic leagues, social clubs, labor organizations, business groups, and more. To learn more about which types of organizations qualify for tax-exempt status, visit the IRS’s website.

Conclusion

With so many different types of nonprofit organizations available, determining the best fit for you may seem like a daunting task. To help simplify this process, start by considering the purpose, mission, and goals of your organization. Does your nonprofit meet the requirements of a 501(c)(3) organization? Does it qualify for a different tax-exempt status? This information will help you determine whether you want to set up an incorporated or unincorporated nonprofit, a public charity or foundation, or even a trust. To get started, check out our How to Form a Nonprofit guide.

As you evaluate your options, be sure to consult with an attorney to determine the best approach for your organization and to ensure its proper setup.