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By Richard Nevins

Attorney at Law

A popular misconception among many people who want to create a tax-exempt corporation is that they want to use this type of corporation to get grants and earn money for themselves without paying taxes.  In reality, the actual owner of a tax-exempt non-profit corporation is the board of directors.  The government uses the board of directors as a watchdog over the corporation.  As the true legal owners of the corporation, the board of directors are held personally responsible for the correct operation of the corporation, even though the board of directors are all volunteers and may only meet once per year.

The creation of a tax-exempt non-profit organization is based upon an important exchange between the government and the corporation.  The trade is that the government will allow a corporation to operate without the payment of income tax in exchange for the corporation donating all of its assets to charity and for using all of the corporation's resources for the benefit of the general public, instead of for the private benefit of a few key individuals.

A non-profit corporation and a tax-exempt corporation are not exactly the same entity.  These two terms signify the two major applications filed in this process.   The first step in the creation of any corporation is to state an intention to operate the corporation either as a for-profit or non-profit corporations.  The Articles of Incorporation is the document used for this purpose and it is filed with the California Secretary of State.  Once the Articles of Incorporation is approved, the corporation is officially formed and can begin operations. 

The second step is that a non-profit corporation must file an application with the California Franchise Tax Board and with the Internal Revenue Service to request that their newly-formed non-profit corporation become exempt from federal and state income taxation. 

The result of these two applications is the creation of a tax-exempt non-profit corporation that is completely owned and controlled by the board of directors.   It is very common that a single individual will initiate and pursue this two-step application process.  To become a for-profit corporation, a single individual can own operate and control everything.  However, to become a tax-exempt, non-profit corporation, the founder of an organization must agree to relinquish ownership of everything that the organization owns and also agree, via a declaration in the Articles of Incorporation, that none of the assets of the organization will be used for the private personal benefit of any individual, including the founder.

The IRS and the Franchise Tax Board has the power to revoke the tax-exempt status of any organization for violation of this basic requirement.  Revocation will also mean that all donations previously received by the organization will not be tax deductible by the individuals who made those donations.  Revocation may also result in personal liability to the board of directors for failing to properly supervise the actions of their corporation.

Richard Nevins has been an attorney for 18 years.  His law firm provides legal advice in estate planning and small business law.  For more information, please visit his website at www.RichardNevins.com

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