Forming a Nonprofit Corporation
Unlike a for-profit Corporation, a Nonprofit Corporation is not designed to make a profit for shareholders. Instead, it is established for a specific noncommercial purpose, such as educational, literary, charitable, religious, or scientific, for example. None of the income of the organization gets distributed to its officers or directors. Some common examples are schools, colleges, universities, hospitals, houses of worship, museums, fraternal organizations, homeless shelters, food banks, and other volunteer organizations.
Nonprofit Corporations may be eligible to benefit from not having to pay corporate taxes on income they receive that is related to their stated purpose. This tax-exempt status, if obtained, means that donors may be able to deduct their donations to your Nonprofit Corporation on their federal and state income tax returns. This can be a requirement to qualify for a variety of private and public grants. And, just like a for-profit corporation, members and directors of nonprofits are generally protected from personal liability for the operation of their Nonprofit Corporation, which is not true for an unincorporated association or club, no matter how noble the cause.
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.
The most commonly-used federal tax exemption used for nonprofit corporations is in Section 501(c)(3) of the Internal Revenue Code. This is why Nonprofit Corporations are often referred to as “501(c)(3) organizations” or even just “501(c)(3)s”.
To achieve that critical tax-exempt status, though, nonprofits must apply 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, IRS Form 1023 must be filed with the IRS, and the appropriate tax-exempt application made at the state level as needed.
Like standard for-profit Corporations, Nonprofit Corporations provide limited liability protection for their officers, directors, and members, so that their bank accounts, homes, and other personal assets typically can’t be used to satisfy the debts and liabilities of the 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.
Choose a Business Name
Generally speaking, your Nonprofit Corporation’s name can’t be the same or confusingly close to another, already-registered Corporation, and can’t contain certain potentially misleading words or terms (like Federal, National, Bank, United States, and the like). 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.com automatically performs a name search against the corporate database of the state of incorporation to check the availability.
Nonprofit Articles of Incorporation
In order to actually form your Nonprofit Corporation, 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. Incfile.com automatically includes the necessary verbiage required by the IRS for 501(c)(3) status.
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. This has 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 in forming your nonprofit, 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 that’s the case, the IRS will tell you where the shortfall was; this is often correctable by including more specific or 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, your state tax exemption will be automatically granted, or will be granted once you furnish a copy of the IRS approval.
After filing your Articles of Incorporation and tax-exempt applications, it’s time to create your corporate bylaws, which lay out your nonprofits’ 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 and 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.com’s nonprofit incorporation kit. Bylaws are typically adopted by the corporation’s directors at their first board meeting.
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.
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.
Normally a corporation’s officers include, at a minimum, 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.”
The purpose of this first, organizational meeting of the board of directors is where several significant company actions should be approved, such as electing officers, adopting bylaws, selecting the main office or headquarters location, choosing a bank for corporate accounts, designating the accounting period or fiscal year, initial tax elections, and documenting the receipt of federal and state tax exemptions.
Officers (who may also serve on the board) carry out the day-to-day business of the corporation and sometimes do 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.
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.