State laws impose tight restrictions against nonprofit corporations' distributing profits to shareholders. Despite those restrictions, a nonprofit corporation can be beneficial because the income of a nonprofit corporation can be exempt from federal income tax, and people who donate money or property to the corporation can potentially receive a charitable tax deduction. Additionally, those working for the corporation can receive a wage or salary as compensation.
No Profit Distributions
A nonprofit corporation is, as the name implies, a special type of corporation that does not distribute profits to the shareholders or owners of the corporation. Instead, the corporation retains all of its net revenues each year. However, a nonprofit corporation can have paid employees and state laws typically don't restrict shareholders from also being paid employees of the corporation.
While it is true that many nonprofit corporations operate solely on volunteer labor, neither state laws nor federal income tax laws prohibit nonprofit corporations from compensating their employees. The key with a nonprofit corporation is that any compensation must be reasonable in amount and paid in exchange for services rendered to the corporation. For example, a passive investor/stockholder who does not actually engage in any employment activities for the corporation cannot receive any payment.
Like limited liability companies and for-profit corporations, nonprofit corporations can hire both employees and independent contractors. An independent contractor is a laborer who exercises independent discretion and control over her work, including such things as her schedule and her method of performing the work. The nonprofit corporation must withhold income taxes from, and pay payroll taxes on, the wages paid to an employee, but the corporation does not have the same obligations with respect to independent contractors.
For-profit corporations often compensate employees in one of two different ways, including base pay in the form of wages or a salary and commissions or performance bonuses. Base pay, meaning wage or salary, is always appropriate in a nonprofit as long as the pay is not so high as to be considered outrageous. However, performance bonuses and commissions are rarely appropriate in a nonprofit. The IRS generally considers commission and performance bonuses, particularly bonuses paid to executives, as an unreasonable payment that is more like a back-door distribution of profits.
The Constitution Guru has worked as a writer and editor for "BYU Law Review" and "BYU Journal of Public Law." He is an experienced attorney with a law degree and a B.A. degree in history with an emphasis on U.S. Constitutional history, both earned at Brigham Young University.