Just like any other form of entity, a nonprofit corporation is recognized at both state and federal levels. At the state level, chapter 22 of the Texas Business Organizations Code (TBOC) covers essential aspects of structure and governance for nonprofit corporations. At the federal level, a nonprofit corporation can be recognized as an exempt organization under the provisions of section 501(a) of the Internal Revenue Code (IRC).
Of the twenty-nine forms of exempt organizations under the IRC, twenty-five are under section 501(c), one is under 501(d), and one is under 501(e). Other than 501(c)(3) charitable organizations, the most common are 501(c)(4) for civic leagues and social welfare organizations; 501(c)(6) for business leagues, sports leagues, and chambers of commerce; and 501(c)(7) for social and recreational clubs.
Chapter 17 in this manual largely covers nonprofit corporations under section 501(c)(3) that are tax-exempt for the following purposes: charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. These types of entities are also known as “charitable organizations” and are the most popular and common form of exempt organization at the federal level because they typically allow donors to take tax deductions for charitable contributions.
PRACTICE TIP: Tax exemption under state and federal laws is not automatic with nonprofit corporation formation. Exemption must be applied for at both the state level (with the Texas Comptroller of Public Accounts) and the federal level after the corporation is approved by the secretary of state. Certain types of nonprofit corporations (for example, churches and religious places of worship, primary and secondary schools, and disaster relief organizations) may also apply for exemption from property taxes assessed by local taxing units such as cities, counties, and school districts.
Texas recognizes a nonprofit corporation as the only form of incorporated entity eligible for exemption under state law. An unincorporated association may also be recognized as a nonprofit; however, as the name implies, it is not a corporation and thus is outside the scope of this chapter.
One important distinction between a nonprofit corporation and any other form of entity (for example, a corporation, limited liability company, or limited partnership) is that the nonprofit corporation does not allow any part of its income to be distributable to any members, directors, or officers (see the definition of “nonprofit corporation” under section 22.001 of the TBOC). No persons may own any equity in a nonprofit corporation, and there is no “owner” of a nonprofit corporation beyond the concept of a “public benefit” for a particular purpose set out in the corporation’s governing documents. In fact, dividends are expressly prohibited for a nonprofit corporation under section 22.053 of the TBOC.
On the other hand, a nonprofit corporation is permitted to pay compensation to its directors, officers, employees, and other persons, as long as such compensation is reasonable. Further, a nonprofit corporation is allowed to confer benefits to the corporation's members in conformity with the corporation’s purposes (for example, prayer space, intangible religious benefits to members of a church or similar place of worship, or access to educational resources to students). Special rules permit liquidating distributions to members upon dissolution, particularly to members that are 501(c)(3) nonprofit corporations themselves.
PRACTICE TIP: “Nonprofit” corporation is a bit of a misnomer. It is not that these forms of entities do not make a “profit” in a financial sense from their operations or investments—it is just that those profits are not distributed to any person, except in the form of reasonable compensation and benefits for exempt purposes. Some of the wealthiest entities in the United States are nonprofit corporations (for example, churches with property holdings and private schools and universities). Note, however, that profit earned through the “commercial business” of a nonprofit corporation may be subject to unrelated business income tax at rates similar to those levied on for-profit corporations.
A nonprofit corporation is governed by its board of directors. Under Texas law, a nonprofit must have a minimum of three directors. The board is appointed and maintained from the formation of the corporation throughout its setup, growth, and maintenance until its dissolution. The board is assisted by officers; a nonprofit corporation in Texas must have a president, secretary, and treasurer at a minimum, and the president and secretary have to be separate persons.
Some nonprofit corporations allow for one or more classes of members that are typically empowered to elect all or some of the directors and officers. See Tex. Bus. Orgs. Code § 22.151. Some nonprofit corporations do not have provisions for members, and thus the board of directors is empowered to increase, decrease, or replace board members or to fill vacancies on the board. Voting can be done by single vote for each position, or even cumulatively if set out in the corporation’s governing documents.
PRACTICE TIP: It is important that the founders of a nonprofit corporation consider from the outset whether the entity will have members. While this decision can be changed, doing so later requires a higher threshold of votes, and the entity must file an amendment with the secretary of state to recognize the change. In addition, provisions should be included for selecting replacement candidates as soon as possible after seats become available.