Introduction
As of 2016, there were 22,743 nonprofit organizations in Illinois. These entities range from hospital systems with over 1,000 employees to high school robotics teams with volunteer staff and limited budgets. The common characteristic of all is that none of these entities have owners. Rather, they are run by boards, trustees, or members for one or more of the purposes allowed under state not for profit laws. If the entity seeks and obtains proper government approvals, the entity may be exempt from federal and state income taxation, and may be exempt from property and sales tax liability, as well.
Nonprofit Entity Laws
Illinois has several old nonprofit and religious organization laws, but most entities find the General Not For Profit Corporations Act easier to use, more comprehensive in governance, clearer in defining agency and management authority, and easier to use statewide than entities registered only in specific counties. This law allows religious, charitable, private foundation, and most other tax exempt or nonexempt organizational purposes to be pursued in nonprofit form, at very low cost ($50 for filing of articles of incorporation, and only $15 for annual reports.) Entity organization also avoids unlimited personal liability for all officers and members of unincorporated nonprofit associations, which is what people are if they conduct nonprofit business activities together and do not incorporate. For those who do incorporate, the articles of incorporation need to include:
Entity Name: To prepare your new organization's articles of incorporation, you will need to select a name which is distinguishable from any other corporation registered with the Secretary of State, and ideally from any other organization title on Google or in federal and state trademark records. This will avoid possible loss of profits and other liability under trademark or entity registration laws.
The name must end with “NFP” if the name suggests it is not organized for a nonprofit purpose. Regardless if using “NFP” is required, many nonprofits include in their legal name the word “nonprofit” or “NFP,” to provide public awareness of their nonprofit status. Note: as explained below, nonprofit status is maintained by complying with laws and regulations that govern nonprofits, not by merely including a description of the organization’s purpose in its name. Qualified legal counsel can advise on what is necessary to prevent the organization from losing nonprofit status and its tax benefits, which could result in having to pay a tax liability.
A nonprofit may also apply to conduct business under an assumed name with the Secretary of State.
Registered Agent: This can be a commercial service or a person or organization resident in Illinois, such as the entity's president, who receives legal notices for the entity. The registered agent address must be within Illinois and cannot be a post office box.
Board of Directors: There must be at least three (3) directors on the board. Board members do not need to be residents of the State of Illinois. The board runs the organization, and no individual can receive any profits from organization revenues. Fair market value can be paid for services or products, but it is good practice to avoid paying board members for their service, apart from expense reimbursement and possibly errors and omissions insurance. The board can hire or retain, supervise, and fire paid staff, contractors, lenders, etc.
Your board is often the best source of revenue for your nonprofit. Board members should help raise contributions from others, make contributions themselves, volunteer in various work capacities for the group, and recruit others for board, staff, and volunteer teams. There are many good guides to board and organizational governance, from the National Association of Nonprofits, local United Way organizations, religious denominations, and parachurch standards groups like the Evangelical Council for Fiscal Accountability.
Entity Purpose: The statute lists 34 different allowable purposes, from “charitable” to “cooperatives for ownership and operation of anaerobic digestor systems” (often found on pig farms). And in between these two, are other types of listed nonprofits including educational, civic, patriotic, political, religious, social, literary, athletic, scientific, research, agricultural, trade association, and condominium or homeowners’ association, plus several other types. Acceptable nonprofit purposes include activities that provide support for others. In contrast, purposes that result in generating profits are not acceptable and may prevent your organization from obtaining nonprofit status.
Most public charities find the two subsections of the "Names" section permitting organization for any purpose exempt from federal income taxation under sections 501(c) or (d) of the Internal Revenue Code, or for any purpose exempt under section 170(d) of same, most convenient, and most likely to help obtain such exemptions on application to the IRS. As explained herein, maintaining tax exemption requires the organization to adhere to its stated nonprofit purpose and comply with laws and regulations governing nonprofits. A qualified attorney can help the organization comply with these important requirements so they don’t lose their nonprofit status and exemptions.
Other Provisions: The Internal Revenue Service provides sample language for conflict of interest policies for boards and provisions guaranteeing that profits or assets on dissolution will go to non-exempt persons or organizations, provisions restricting individual shares in entity profits, and provisions restricting political activity. These should be in the articles, or, at least, in the organization's bylaws, if federal tax exemption is important for your nonprofit's work.
Bylaws: Similar to for-profit companies, nonprofit entities are governed by bylaws that may specify the purpose of the nonprofit, frequency of board of director meetings and quorums necessary, director voting procedures, powers of board of directors, size of board, regular and annual meetings of the board of directors, special meetings of the board of directors, conflict of interest policies, vacancies, officers of the board of directors, elections of officers and board members, procedures for entering into contracts by board members or officers, indemnification provisions, books and records, amendments to by-laws, and dissolution or winding-down of entity.
IRS instructions for the application for recognition of nonprofit entity exemption from income tax have sample bylaws, conflict of interest, and articles of incorporation provisions which should be included in your organization's documents to help assure such tax exemption will be available if your organization applies.
Federal Income Tax Exemption
Not all nonprofit entities are eligible for tax exempt status.
Income tax exemption may be available for anything from federal credit unions to agricultural cooperatives. Most publicly supported charities organize for religious, cultural, educational, or scientific purposes, or some combination of these, and seek exemption under IRC Section 501(c)(3). Other sections have been popular in recent years, like the 501(c)(4) exemption for “social benefit” entities, but these have more exposure to unrelated business income taxes (i.e., income which is not directly related to its exempt purpose) if they have been organized for less than clearly exempt reasons that draw IRS or other official attention. As such, applying for 501(c)(4) exemptions may raise more risks to your organization’s exemptions and a nonprofit status may be perceived as a higher risk category by the IRS.
To apply for any exemption, the entity needs to have an employer identification number obtained from the IRS, needs proof of exempt purposes, and will need to pay federal application filing fees. Nonprofits that expect to have less than $50,000 in annual income can file a simplified application (1023-EZ) with a reduced filing fee, and will, if granted exemption, also have simpler information returns to file in future years on IRS Form 990-EZ. Entities that expect higher income need to file the full Form 1023, with information on primary supporters, board members, future budgets, and printed materials, websites, etc., showing exempt activity or planned future activities, and will have more rigorous annual filing requirements on Form 990. Failure to comply with annual reporting requirements may result in the revocation of the entity’s tax-exempt status.
The IRS may take six months or more to make a decision, so you may want to arrange for an existing nonprofit to open a bank account for your activity and report you on their tax returns until you get your 501(c)(3) letter. Contributions will be exempt if you get recognition of exemption and they were made after your date of application, but donors prefer certainty of deductions, not risks.
If exemption is granted, annual information returns are all that will be required, unless the organization has income that is not directly related to its exempt purpose. This “unrelated business income” has to be reported based on quarterly estimates, and then annual returns, and pays tax at the highest federal corporate tax rate. Many nonprofits choose to organize separate for-profit entities (which they can 100 percent own) that pay normal entity rates of tax. Nonprofit owners can receive exempt tax treatment for the income they receive as dividends. The for-profit subsidiaries also keep the nonprofit parent's income and outflow clearly charitable, so tax exemption is not at risk.
State Tax Exemptions
State Income Tax: No additional application is needed. Illinois recognizes federal tax treatment for organizations.
State Sales Tax: The Illinois Department of Revenue (“IDOR”) requires submission of an application form. They also need copies of incorporation documents, of the federal tax exemption letter, and proof the entity is operating and will operate exclusively for charitable purposes. Sales revenue returns will still be required, even if the entity is exempt from paying sales taxes.
If IDOR approves sales tax exemption for the organization, it will issue a letter ruling for the organization to use to provide to vendors. To obtain exemptions from sales taxes, the nonprofit will need to provide vendors with a copy of the letter ruling. No other nonprofit documentation, including the IRS exemption letter, is suppose to allow you to receive the sales tax exemption from the vendor. The Sales Tax Exemption Certificate expires about five years from issue and must be renewed.
Property Taxes: Property tax exemption requires application to a county Board of Review, whose decision is reviewed (and may be reversed) by the Illinois Department of Revenue. Proof of ownership by and (if a charity) exclusively charitable use by the nonprofit is required. Educational or religious organization exemptions can also be proved. The burden of proof is on the applicant, and nursing homes, hospitals, and other common types of nonprofits have lost significant exemption decisions in recent years.
Other Entity Registrations
Illinois Department of Revenue: IDORrequires that entities file online or paper forms listing persons who agree to be responsible for making sure tax returns are made and taxes paid, and providing information on which types of income, sales, or other excise tax returns they may need to make and taxes they may need to pay.
Illinois Department of Employment Security: IDES requires online or paper form submission and any other proof needed, if religious or nonemployer exemptions are claimed, to determine whether entities have taxable wages to report and UI taxes to pay.
Illinois Attorney General: The Charitable Trusts Bureau of the Attorney General's Office requires initial registration of all charities, whether religious or not. Religious organizations can file additional forms to show they are exempt from making annual financial information returns. Others need to file initial and annual cash balances and financial reports on outlays and income, to show continued charitable use. The AG's office also becomes involved if there are public complaints about misuse of funds or failure to apply funds to charitable purposes on dissolution. It also requires registration and reporting from fundraisers for charities.
Compliance Calendar
Annual: Not-for-profit corporation annual reports to Secretary of State, financial information forms to the Charitable Trusts Bureau of the AG's office, annual sales tax summaries to Department of Revenue, annual unemployment insurance tax returns to Department of Employment Security, annual information returns to Internal Revenue Service. Also annual meetings and officer elections for board members.
Quarterly: Federal and state employee income and Social Security/Medicaid tax withholding and payments, estimated unrelated business income tax payments, sales and other excise tax payments (could be annual or monthly or weekly or daily, depending on revenue from sales received).
Prepared by the Illinois State Bar Association's Business and Securities Law Section (2019)