Incorporating and legalities is not an excuse.

http://kulpreet.com/post/2575535086/incorporating-and-legalities-is-not-an-excuse

by kulpreet • 16 years ago

14 9 16 years ago

I'd like to offer a correction/clarification. My intention isn't to point out that you were wrong, but to prevent someone else from getting the wrong idea.

You said that you decided to form this corporation as a not-for-profit [assuming this was a 501(c)(3)] because: "a project of this sort could only generate so much revenue," and "since it was my first major project, it only made sense to start somewhere small and make the organization non-profit."

The revenue generating capability of an organization is not something you consider when you decide to go not-for-profit. There are non-profit organizations that receive hundreds of millions of dollars a year in income. Non-profit organizations can make a little or a lot, it doesn't really matter.

The size of a corporation also has little or nothing to do with whether or not you should structure your company as a not-for-profit. Examples of some large non-profits are:

Org (2010 revenue) Mayo Clinic ($7.9 billion) United Way ($3.84 billion) American Cancer Society ($926 million) National Red Cross ($3.21 billion)

Not-for-profit organizations have many strict limitations on their method of operation. Everything from funding to salaries are limited in some fashion. You typically opt to form a not-for-profit corporation when you are forming a charity that you want to protect from becoming a profit motivated enterprise once you've moved on.

kulpreet4• 16 years ago

You make a really good point. But as I mentioned in the article during my research process I found that for tax purposes if you keep the gross receipts of a non-profit below $5,000/year you automatically get 501(c)(3) status and the process of filing taxes is very straightforward. Before the Pension Protection Act of 2006 non-profits that made less than $25,000 weren't even required to file annual tax returns. Regardless, I wasn't expecting to make more than $5,000/year anyway.

Basically, since it was my first major project and I wasn't expecting to make more than $5,000/year non-profit seemed to be the way to go.

enjo• 16 years ago

Heavily edited

Ok, so my wife is around now. She's a CPA/PhD in accounting and does a lot of work with small businesses, so I suppose she knows what she's talking about. While non-profits are not her specific area of study, she does do the accounting work for a couple of local non-profits. She's never steered me wrong yet:)

So that said:

The $5000 exemption you reference does not alleviate you of the other requirements for operating a 501(c)(3). More specifically your company must operate for a specific "exempt purpose" (http://www.irs.gov/charities/charitable/article/0,,id=175418...).

If I'm following the article correctly, you wrote an iPhone app that does not fall under any of those exempt purposes. Therefore, even operating under the $5000 receipts limit, your company is not eligible for 501(c)(3) tax exempt status.

Any income that you made from the app should be treated as personal income. You don't even need to form a business entity to do business at all. You can take that $5000 and declare it as personal income just like any other income you make throughout the year. That does open you up to increased liability, which is why LLC's have become a preferred vehicle for proprietorships and partnerships. In most states it's nothing more than a very short form and $25-$100. It grants you some protection for your brand as well as limiting your liability in certain situations (for instance, it provides a shield to your personal assets for lawsuits around copyright infringement).

bhickey• 16 years ago

Did you incorporate in Rhode Island for any reason other than the absence of age restrictions?

We aren't exactly known as a business friendly state, unless you're an anti-government[1] retired up baseball player who has decided to take handouts from the governor [2].

[1] http://en.wikipedia.org/wiki/Curt_Schilling#Political_advoca...

[2] http://en.wikipedia.org/wiki/38_Studios

kulpreet4• 16 years ago

They also automatically grant state tax-exemption, if you are tax-exempt for federal taxes

rprasad• 16 years ago

Based on what you did, its pretty obvious that you did not consult a lawyer, because what you did is illegal under US tax law.

Nonprofits are required to meet specific requirements to get tax-exempt treatment before engaging in income-generating activity. 501(c)(3) status is not granted automatically (IOW, it is not granted "statutorily"). It is a legal status specifically granted by the IRS after a review.

Income raised prior to receiving the exemption is almost always treated as income earned through non-exempt (i.e., for-profit) activities. There are exceptions, of course, but you need to consult a tax lawyer (specializing in non-profit/charitable tax law) to figure out if you qualify for those exceptions. There are very important reasons behind this (including, but not limited to, the deductibility of transactions).

State tax law may be more permissive, but that only affects your state tax status. Federal tax law governs your federal tax status. It may be possible to be a non-profit for state taxation but a for-profit for federal taxation.

Also, to address inaccuracies in your blog post: 1) There are no age restrictions in any state on incorporation. However, few businesses will enter into contracts with minors unless their parents guarantee the contracts because minors have very special rights under American contract law.

2) There is no need to incorporate a solo operation. Incorporation is intended to simplify accounting for collaborative efforts. Individuals can simply register a DBA (if they're making up a "company" name"). In your case, incorporating is proper: you claim to be founding a charitable organization, so incorporation is a necessary step to receiving tax-exempt status.

3) It's humorous to see that you believe that a non-profit only needs to file 2 forms, online, once a year. Those two forms are just the start. There's a lot more paperwork involved.

You need to consult a lawyer, immediately, because you may receive a call from the IRS in the near future.

kulpreet4• 16 years ago

Thanks for the heads up. You're probably right that filling out 2 forms is humorous, but it is the bare minimum and I did get away with it for the 2009 tax year (which we had no activity because we incorporated late in the year). I'm eventually going to have to file the W-9 with Apple and some other forms if I plan on sending money abroad.

After I was done incorporating and everything was ready, I did consult an accountant and he did say there might be some issues down the road, but only if I was planning on taking money out of the country (which I kind of am). I also did have to make a phone call to one of the IRSs numbers to have them add the organization to the list of tax-exempt organizations, so I could file my 990N online. They did make me verify that my gross receipts were less than $5,000/year.

Regarding age restrictions: In New Jersey and a lot of other states, the law specifically states that you need to be 18 years or older to incorporate and/or be a board member of the organization. This isn't true in some other states, depending how lenient their laws are. I ended up incorporating in Rhode Island, because they didn't have any age restriction and you are automatically tax exempt at the state level if you are at the federal level.

Thanks for the advice. I'll probably contact you or someone else if I do have any issues.

wahnfrieden• 16 years ago

Only tangentially related to the article, but please use a more screen-friendly font than Helvetica Neue Light for bodies of smaller-point text. It was a bit painful to read.

Incorporating and legalities is not an excuse.

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