The three sectors

One very basic question about the Southern Michigan Railroad Society (indeed, any railway museum) is, "what kind of institution is it?" You've heard of the public sector - the government. And the private sector - industry. Less well known is the civic sector - nonprofits.

The civic sector is a significant part of our economy. It includes hospitals, schools, churches, retirement funds, museums, civic associations like the Boy Scouts or Kiwanis - even homeowner's associations.

A nonprofit is considered different from private industry because it works in a very different way. First, its causes are charitable - worthy of tax deduction and tax exemption. And second, once money enters the nonprofit system, it can never leave. No person or company can draw dividends or profits of any kind. They also cannot overcharge for goods or services. There are special rules constraining directors of a nonprofit from acting with a conflict of interest. This is enforced at the Federal level by the IRS.

Now, let's talk about taxation and liability. And for that, we need to look at the structure of companies, because a nonprofit is a kind of company. We journey back into the private sector.

What if you paint somebody's house and they pay you? It's just you, doing an informal business. The IRS calls that a "sole proprietorship" and you just tally the income and expenses on your personal 1040 (schedule C). As for liability, you have no protection, you can be bankrupted. If you do the same thing with friends, it's called a "partnership", and all the same applies.

Suppose you create "Paint Your House, Inc." Everything changes. A corporation is a separate legal "person". The corporation files its own taxes with its own SSN. You must keep your personal money carefully separate from corporation money, or else the corporation could be declared invalid! Why bother? Because a corporation stops liability. They can sue and bankrupt the company, but they can't touch you personally.

What is a nonprofit? Money put into a nonprofit is tax deductible, but can never leave the nonprofit system. Money must be carefully separate from personal finances of volunteers. It files a different tax return (form 990). The corporate model that fits this best is "corporation". And so, every nonprofit must also be a corporation.

It seems strange because we often associate corporations with all sorts of evil. But in this case, it's merely an organizational structure. Once a nonprofit incorporates, they apply to the IRS, which confers nonprfit status. There are many kinds of nonprofit status, both from the IRS, from states, and just in the nature of the structure chosen.

But that's for another blog entry.