Basic Guide to Maryland Non-Profit Corporations
In my practice, I have had the occasion many times to counsel clients on setting up non-profit corporations for a variety of purposes: community welfare, religious education or common worship, animal welfare, fighting discrimination or the effects thereof, political advocacy, etc. The following is a brief description of non-profit status and how to establish a corporation for non-for-profit purposes and activities in compliance with both Maryland and federal law.
One of the main reasons to seek out non-profit status is beneficial tax treatment for the enterprise and for its donor base. Section 501 of the Internal Revenue Code defines a number of different valid corporate purposes which qualify for non-profit status. While many of us are familiar with Section 501(c)(3) of the Code, which governs specifically charitable and similar purposes for a corporation, other subsections of Section 501 such as (c)(4) and (c)(7) address non-charitable but still non-profit purposes such as civic leagues, trade associations, private hobby clubs, etc. It’s important from the beginning of the process to define the purposes of the non-profit corporation carefully, ideally to secure 501(c)(3) status if applicable. In general, the non-profit corporation if properly qualified will be immune from all or nearly all corporate taxation of its revenue deriving from activities related to the core of the corporation’s purpose.
The reason that 501(c)(3) status is so desirable is what that status does for the corporate donors’ taxes. Section 170 of the Code allows individual taxpayers to deduct the value of donations to charitable organizations from the taxpayer-donors’ own tax returns. To compare, if a taxpayer earns 100 dollars and hands over his net pay to a hotel for a night’s vacation, both the taxpayer and the hotel must pay taxes on what they receive. If the taxpayer earns 100 dollars and hands over her net pay to the Red Cross as a donation, the taxpayer can deduct (effectively exclude under Section 170) the funds from her tax return and the Red Cross – a major 501(c)(3) corporation – need not pay taxes on the money either. If a taxpayer earns 100 dollars and hands over the net pay to a non-profit country club as part of a dues payment, the taxpayer cannot deduct the payment as a charitable donation since private country clubs exist for their members, not for the public, and accordingly are not “charitable” 501(c)(3) organizations. But the country club will not have to pay taxes on the membership dues either, since a country club is ordinarily non-profit and the dues are related to the core purpose of the club’s reason for existing.
In general, if a non-profit can get charitable status in good faith without jeopardizing its mission, it absolutely should do so. Getting 501(c)(3) status effectively lowers the cost of raising funds from upper-income donors sharply, as the tax deduction partially eliminates the cost of the donation. Maryland similarly allows a charitable deduction for donations to 501(c)(3) organizations as do most state income tax regimes.
Maryland’s Code (the Annotated Code of Maryland) allows for the creation of a so-called “non-stock” corporation which, as its name suggests, cannot issue stock or other tokens or certificates of ownership. While one can control, manage, or dissolve a non-profit corporation, one cannot own a non-profit entity or a part thereof as an asset. In general, “owning” a corporation destroys the purely non-profit character of the company; accordingly Maryland law allows for a corporate form that has no stock shares and accordingly cannot be owned by anyone, only managed.
To form a non-stock corporation, an “incorporator” must create and sign Articles of Incorporation, also known as a corporate “charter”, for a non-stock corporation. In addition, the incorporator must select a willing “resident agent” – a person or another corporation resident in Maryland, who/which must likewise consent to participate. The corporation must also select three or more persons to serve on the corporation’s initial Board of Directors. If the incorporator seeks 501(c)(3) status, the charter must make it clear that the corporation’s purpose is to pursue goals and take actions consistent with 501(c)(3) status, that the corporation is disempowered to take any action inconsistent with 501(c)(3) and that the assets of the corporation will go to another 501(c)(3) corporation upon any dissolution of the corporation.
This completed charter, along with filing fees and in some cases surcharges, creates the corporation once filed properly under Maryland law with the MD Department of Assessments and Taxation (DAT or SDAT.) One may file this charter by U.S. Mail and wait a number of weeks for SDAT to process it, or pay an expediting surcharge to fax or walk the document through SDAT in a matter of hours or days.
After the corporation exists, the next act is to get a federal employer identification number (FEIN) from the IRS. Fortunately that process is far easier than it was 15 years ago; today one may apply for an FEIN online and receive the number literally in seconds on one’s computer screen. The corporation needs this number for a number of purposes including, but not limited to, employment tax compliance. After getting the FEIN, a Maryland non-profit corporation should file the Maryland Combined Registration Application, which handles income tax, MD employment withholding, sales tax numbers and tax exemption numbers, and the like. One may file this online as well. In addition, charitable organizations seeking charitable donations through outside fundraising companies or agents must, in most cases, file a declaration with the Maryland Secretary of State.
After creating the charter and filing the necessary tax number applications, the corporation must hold an initial meeting of the Board of Directors, during which the Board formally adopts the corporate charter and elects a new Board (often the same as the old board.) It is a wise practice for the Board to adopt or to make arrangements for By-Laws as soon as possible; in my judgment, By-Laws are one of those rare things in life for which a half-measure is actually a lot better than nothing at all.
After things settle down for the corporation and the general state of the finances of the corporation become clearer, the corporation may have to file Form 1023 (for charitable non-profits) or Form 1024 (for most non-charitable non-profits.) These forms are not necessary if the corporation’s revenues fall and appear likely to fall under de minimis guidelines, but are necessary otherwise. These forms are fairly lengthy and provide the IRS a pretty detailed picture of the structure and financing of the corporation. After the review, the IRS confirms preliminarily the non-profit/charitable status of the corporation, subject to continued lawful compliance and verification of the contents of the form, if requested. This confirmation is not required for the corporation actually to have non-profit/charitable status, but is nonetheless required; the IRS does not “grant” non-profit/charitable status so much as confirm the existence thereof.
Non-profit organizations must file an annual revenue and expense declaration on Form 990, unless exempt from filing. In addition, some non-profits may have to file a modified income tax return on income that is considered “unrelated business and trade income”, such as newsletter advertising revenue or similar income sources that, to some extent, compete in the for-profit marketplace. The purpose of this UBTI taxation is to keep non-profit corporations from competing unfairly against for-profit businesses in the same field; if the local church owns a McDonalds, they get taxed on their McDonalds income like every other restaurant, replete with deduction allowances, etc. UBTI is usually to be discouraged not only because of the tax burden but also because it may tend to shed doubt on non-profit status in the first place.
Non-profit corporations provide immense social benefits and are to be commended, but not every socially useful idea should find fulfillment in non-profit activities. Often it may be a better idea to create a for-profit business and to donate some portion of the revenues to an existing non-profit organization. In my own profession, for example, the goal of delivering legal services to the poor is a valid non-profit purpose. However, the non-profit sector of law practice is dependent on the talent and funds of mega-firms and local solo practitioners alike. If large numbers of big firm lawyer gave up big-firm lawyering for non-profit work, non-profits would probably suffer as a major funding source would shrink or disappear. If solo practitioners disappeared, a significant labor source for pro bono case management and representation for non-profit legal clinics would likewise disappear. The practice of law is arguably unique in this regard but perhaps not; other professions, trades and fields with non-profit service opportunities probably depend on corporate funding and local volunteering within the trade or professions as well. Accordingly, it may be wisest in some cases not to create a non-profit, but to fund an existing one from actual profits from one’s trade or profession.
