Are you looking to do a little good in the world? Many philanthropists and community activists want to know how to start a nonprofit organization to create a formal structure for their charitable activities.
Forming a Nonprofit Corporation gives you the ability to raise money as a tax-exempt 501(c)(3) organization, which can help significantly in becoming more accessible to potential donors. If you want to make the biggest difference and do the most good in your community, start a nonprofit organization to give your cause added credibility while also helping to protect your personal assets.
What Is a Nonprofit?
Unlike a for-profit corporation (such as an LLC or S Corp), a Nonprofit Corporation is not designed to make a profit for shareholders. Instead, it is established for a specific noncommercial purpose, often to further educational, literary, charitable, religious or scientific goals.
None of the organization's income gets distributed to its officers or directors. Some common examples of nonprofit organizations are schools, colleges, universities, hospitals, houses of worship, museums, fraternal organizations, homeless shelters, food banks and other volunteer organizations. Nonprofit organizations are not intended to “make money;” instead, they have a mission of “making a difference.”
Tax Advantages of Nonprofits
Nonprofit Corporations have a special advantage in the U.S. tax system: they may be eligible for not paying corporate taxes on income related to their stated purpose. If your organization qualifies for this tax-exempt status, this means that your donors may be able to deduct donations to your Nonprofit Corporation on their federal and state income tax returns.
The most commonly used federal tax exemption for Nonprofit Corporations is in Section 501(c)(3) of the Internal Revenue Code. This is why nonprofits are often referred to as “501(c)(3) organizations” or even just “501(c)(3)s.”
To be treated as tax-exempt entities, though, nonprofits must apply and qualify for federal and state tax-exempt status; it is not just automatically granted by forming the Nonprofit Corporation. To apply for federal tax-exempt status, file IRS Form 1023 and make the appropriate tax-exemption application at your state level as necessary.
Tax-exempt status can be a requirement to qualify for a variety of private and public grants. Having your 501(c)(3) organization registered as a recognized tax-exempt nonprofit organization is a big part of building credibility with donors.
Liability Protection Under Nonprofits
Like standard for-profit corporations, Nonprofit Corporations provide limited liability protection for their officers, directors and members. This means that the personal bank accounts, homes and other assets of these individuals typically can’t be used to satisfy the debts and liabilities of the nonprofit.
The personal liability protections for members and directors of nonprofits do not apply for an unincorporated association or club, no matter how noble the cause. So if you want personal liability protections, you need to start your nonprofit as a formal, legal entity.
Unlike regular corporations, however, a Nonprofit Corporation cannot distribute any profits to its members, contribute money to political campaigns or engage in lobbying activity (except in very limited circumstances).
Forming a Nonprofit Corporation
Even though Nonprofit Corporations are established and regulated under different state laws than standard for-profit corporations, the process of forming a nonprofit is fairly similar. Here are the steps involved in the process of helping you start a nonprofit organization:
1. Choose a Name for Your 501(c)(3)
Generally speaking, your nonprofit’s name can’t be the same or confusingly close to another, already-registered corporation, and it can’t contain certain potentially misleading words or terms (like Federal, National, Bank, United States, etc.). Some states also require a corporate designator at the end of the name, such as “Corporation” (Corp.), “Incorporated” (Inc.), or “Limited” (Ltd.). There are many states that require a corporate designator with for-profit corporations that do not require designators for Nonprofit Corporations.
Once you have decided upon a name and entered your information online, Incfile can automatically perform a name search against the corporate database in your state of incorporation to check the availability.
2. File Nonprofit Articles of Incorporation
To actually form your Nonprofit Corporation as an official legal entity, you will have to file Nonprofit Articles of Incorporation with the appropriate state agency and pay the necessary state filing fees (usually fairly small). In some states, this may be called a Certificate of Incorporation, a charter, or a Certificate of Formation.
Regardless of what they are called, the formation documents need to include specific information and language to make sure you’ll qualify for tax-exempt status. If you form your Nonprofit Corporation with Incfile, they'll automatically include the necessary verbiage required by the IRS for 501(c)(3) status.
3. Apply for Tax Exemptions
After your state’s corporate filing office returns a copy of your filed articles, you can submit your federal 501(c)(3) tax exemption application to the IRS. The steps have to be done in this order because the IRS requires you to submit a copy of your filed articles with your application. This is a crucial step as you start your nonprofit organization, since most of the real benefits of being a Nonprofit Corporation are dependent on gaining 501(c)(3) tax-exempt status. The application fee ranges from $300 to $750.
After the IRS reviews your application, it will send you a letter approving your nonprofit tax-exempt status, asking you for more information about your organization or denying your application outright if it doesn’t meet required standards. If your application gets denied, don’t give up! The IRS will tell you where the shortfall was in your application; this situation can often be corrected by including more specific details or more precise language in your application.
In some states, you will need to apply separately to get a state tax exemption. In other states, as long as you file nonprofit articles of incorporation with the state and get your federal 501(c)(3) tax-exempt status approved, your state tax exemption will be automatically granted (or it will be granted once you furnish a copy of the IRS approval).
4. Create Bylaws
After filing your Articles of Incorporation and tax-exempt applications, it’s time to create your corporate bylaws, which formally clarify and enumerate your nonprofit’s purpose and internal operating rules. These should include:
How directors are elected and what authority they have
How, when and where directors’ meetings are held
How decisions can be reached with or without a meeting
The duties and responsibilities of officers and how long they serve
Officers, constituency rights/responsibilities and standing committees
The organizational structure of the nonprofit
To create your Nonprofit Corporation bylaws, you can hire a corporate attorney—or you use Incfile’s nonprofit incorporation kit. Bylaws are typically adopted by the corporation’s directors at their first board meeting.
5. Appoint Directors
The next step is to appoint an initial group of directors. The directors of the Nonprofit Corporation have the overall authority and responsibility to manage and run the organization. Collectively, they meet periodically and make decisions about major business operations. Many states allow nonprofits to have just one director, but other states require at least three. The board is ultimately responsible for setting the vision and direction of the organization and providing oversight.
In most states you must designate your initial directors when filing your Articles of Incorporation. These directors will serve on the board until the first board of directors meeting, when the first elected board will be seated.
6. Hold a Meeting of the Board of Directors
The initial makeup of your Nonprofit Corporation board of directors may or may not change at the first board meeting. What’s important to notice is that the first slate of directors is appointed, and then from there on they are elected.
At minimum, a corporation’s officers normally include a president, treasurer and secretary (or their functional equivalents). It may be “Chief Executive Officer” instead of “president,” for instance, or “Chief Financial Officer” instead of “treasurer.”
At this first organizational meeting of the board of directors, several significant company actions should be completed, including:
Selecting the main office or headquarters location
Choosing a bank for corporate accounts
Designating the accounting period or fiscal year
Initial tax elections
Documenting the receipt of federal and state tax exemptions
Officers may also serve on the board; they carry out day-to-day business of the corporation and sometimes receive salaries. Depending on its structure, a nonprofit may or may not have formal members with voting rights. If your nonprofit doesn’t create a formal membership structure, the only people who participate in the management of the nonprofit operations are the directors and officers.
After the meeting is completed, minutes of the meeting should be created and filed in your corporate records book.
7. Acquire Licenses or Permits
Many businesses, whether operating as for-profit or Nonprofit Corporations, are required to obtain state or local licenses and permits before starting to conduct business operations. So, while your organization may not be subject to the kind of red tape that can entangle for-profits, you should check with your state department of consumer affairs (or similar state licensing agency) for information about any licensing or permit requirements for your type of organization.
For instance, a local business license (sometimes called a tax registration certificate) may be required for your activities, and if you sell anything to consumers, you may need a state sales tax permit or license.
If you’re ready to start a nonprofit organization, keep in mind that it does not happen overnight — getting approved for tax-exempt status requires filing the right forms with federal and state authorities. But if you successfully get approved for 501(c)(3) status, you will have a formal, legal, tax-exempt entity that can help your organization raise money more effectively. You'll be able to build credibility with donors, engage stakeholders and make a bigger difference in the communities you serve.
Are you ready to start a nonprofit organization? Talk to Incfile today! We offer a variety of premium nonprofit services to help manage the complexities of getting your organization launched, approved and on track for success.
Ben Gran is a freelance writer from Des Moines, Iowa. Ben has written for Fortune 500 companies, the Governor of Iowa (who now serves as U.S. Secretary of Agriculture), the U.S. Secretary of the Navy, and many corporate clients. He writes about entrepreneurship, technology, food and other areas of great personal interest.