Complying with bylaws, attaining tax-exempt status, managing a board of directors… Starting a nonprofit can seem like a complicated and daunting task. However, equipped with the right information and a resilient approach, the process is easier than it seems.
This is not to say that establishing a nonprofit comes without its challenges. Starting a nonprofit requires strategy, planning, commitment, and organizational skills. Not to mention, years of hard work and strong willpower that are required to sustain a successful nonprofit in the years to come.
There are many reasons why organizations choose to apply for the official 501(c)(3) status. Here are some of the reported advantages:
- Tax-exempt status. Qualifying nonprofits can apply for federal and state tax-exempt status.
- Enhanced credibility. Potential donors may be more inclined to give to an organization that has an official nonprofit status.
- Tax-deductible donations. Donations made by individuals to the nonprofit corporation may be tax-deductible.
- Possible exemption from certain property taxes.
- Reduced postage rates.
To help you move through the motions of establishing a nonprofit, we’ve detailed out a guide below – with a special focus on how to start a 501(c)(3) organizations.
Step 1: Get clear on your purpose
At a first glance, this might not seem like an essential task when discussing the practicalities of registering a nonprofit. However, getting clear about your purpose is essential.
A clear purpose motivates staff and volunteers, attracts donors and supporters, and helps build a positive image amongst the general public.
When you’re able to clearly and succinctly communicate your purpose, every subsequent step will be simpler – particularly Step 2.
Step 2: Decide what type of nonprofit you want to establish
If you’ve completed Step 1, this step should be relatively easy. Based on your nonprofit’s purpose, decide which type of nonprofit you want to register as (e.g. arts, charities, education, politics, religion, research).
You must fall into one of these 8 broad categories in order to apply for tax exemption:
- Charitable (including poverty relief, combating discrimination, advancing education, etc.)
- Testing for public safety
- Youth/amateur sports competition
- Cruelty prevention for children and animals.
Step 3: Name your nonprofit
Every state in the United States has different rules and regulations when it comes to establishing a nonprofit. However, it’s safe to say you should select a name that’s unique and somehow related to the main activities of your nonprofit.
This decision will set the tone and influence your nonprofit’s brand for years to come, so it’s smart to take some time to think through this decision.
Make sure your nonprofit’s name is easy to say and remember. Use descriptive words, but try not to overdo it or make it too long. Don’t use technical/industry-specific jargon. Abbreviations are good if you use them well.
If you’re stuck on the name:
Try brainstorming with your team or your friends and acquaintances. See which names sound more inspiring or which ones are more memorable. Remind yourself of what your nonprofit’s mission is, what your main activities are, who your members are or even where you’re located. It might be a good idea to check the availability of web domains since that may impact the name you decide on.
If there’s a quality domain name available for purchase, we advise buying it right away – even if you’re not launching a website soon.
Many states require that nonprofits have a corporate designator, such as Incorporated, Corporation, Company, Limited or their abbreviations (Inc., Corp., Co., and Ltd respectively). Check your state’s incorporation web page to see if a corporate designator is required for your nonprofit.
When you have selected your name, you need to check with your Secretary of State to see if it is available and the U.S. Department of Commerce website to be sure the name you want is not trademarked.
Step 4: Form a Board
Forming a board before incorporating is generally a good idea. Some states require that you list the names of your board members in your incorporation documents. Even if your state doesn’t require this, recruiting a board prior to incorporating is helpful.
Your board can help you with the incorporation and the rest of the sometimes-challenging process of establishing a nonprofit. Hiring the right board is essential for the success of your nonprofit.
Who the “right” board members are will depend on your nonprofit. However, whatever the size or the purpose of your nonprofit – it’s essential to hire board members who are dependable, committed and aligned to your mission and values.
It’s also recommended that you recruit a board whose members all have different but relevant expertise (e.g. finance, fundraising, marketing etc.).
Take time to define their roles and job descriptions before starting with the recruitment.
It might also be helpful to create some onboarding files or an orientation guide for your new board members. You could also create a welcome event where everyone would get to know each other.
Here’s a detailed guide on How to Hire a Great Nonprofit Executive Director
Step 5: Write up your bylaws
The bylaws contain the operating rules and provide a framework for your management procedures. They are the tools of internal accountability and they outline the inner workings of your nonprofit.
The power to adopt, amend or repeal bylaws is vested in the board of directors. This is unless otherwise provided in the articles of incorporation or in the bylaws.
Bylaws contain the rules and procedures for things like holding meetings, electing directors, appointing officers, and taking care of other formalities.
An organization that is exempt from federal income tax, as described in Internal Revenue Code 501(c)(3), is required to report changes to its bylaws and other governing documents annually to the IRS on the organization’s IRS Form 990 – which is part of ensuring ongoing compliance.
Feel free to look up bylaws templates online. However, note that not all templates contain the required elements to obtain tax-exempt status. In order to obtain the 501(c)(3) status, you must include language in your articles of incorporation specifically stating that:
- The corporation’s activities will be limited to the purposes set out in section 501(c)(3) of the Internal Revenue Code.
- The organization will not engage in political or legislative activities prohibited under section 501(c)(3).
- Upon dissolution of the corporation, any remaining assets will be distributed to another nonprofit, government agency, or for another public purpose.
Contact your state office, (usually the Secretary of State) that oversees incorporation and ask for a template for your bylaws that you can use.
Step 6: Prepare and file your incorporation paperwork
Having chosen a name for your nonprofit and appointed a board of directors, completing and filing your incorporation paperwork should be simple.
Within your incorporation paperwork, you will be officially declaring your organization’s name, location, purpose, the initial board of directors and more.
You must file “articles of incorporation” with your state’s corporate filing office. Experts recommend that you incorporate in the state where you will conduct your nonprofit’s programs or services.
If you want to incorporate in another state, you would need to register and apply for separate tax exemptions in each state in which you conduct activities.
Filings and fees will vary by state. Incorporating your nonprofit does not make it 501(c)(3) exempt. The IRS requires you to include specific language in your articles of incorporation for those intending to apply for federal tax-exempt status.
After completing your paperwork, you will be ready to send them to your state filing office (in most cases, this is your secretary of state.) The requirements will vary from state to state. Some may want you to submit your articles electronically, others may ask for multiple copies sent via mail, etc. After filing your articles, many states also require you to publish a notice of incorporation with your local newspaper.
Obtain a federal employer identification number (EIN) prior to applying for 501(c)(3) tax exemption, even if you don’t have employees. You can do this quickly and easily. For information on how to apply for an EIN, including information about applying online, visit the IRS website at www.irs.gov.
EIN will be used to track your organization’s financial activity and make it possible to open a business bank account and to hire paid employees. Pretty much every major transaction your nonprofit engages in will require an EIN.
When the state approves your articles of incorporation, you should organize your first official board meeting. The chair of the meeting should report to the board that the state has approved the articles. At this point, the board needs to make the Articles of Incorporation as part of the official record. Then it is time for the board to officially approve your bylaws and elect your board officers.
Step 7: File for 501(c)(3) tax-exempt status
You apply for exempt status with the Internal Revenue Service (IRS) for recognition of tax exemption by filing IRS Form 1023. To get the most out of your tax-exempt status, file your Form 1023 within 27 months of the date you file your nonprofit articles of incorporation.
Be aware, the user fee will be $275 or $600, depending on your application method. It also can take 3-12 months for the IRS to return its decision, depending on how many questions the IRS has about your application. That’s why many experts advise starting with this process as soon as possible.
Form 1023 itself is up to 28 pages long. Including the required attachments and other supporting documents, an application package can be more than 50 pages long.
The 501(c)(3) application process is a thorough examination of your nonprofit’s governing structure, purpose and planned programs. The IRS is looking to make sure that the organization is formed for exclusively 501(c)(3) purposes and that its programs are designed to fulfill these stated purposes. In addition, the IRS is looking closely for conflicts-of-interest and the potential for benefit to insiders, both possible grounds for denial.
It is also possible that you can use a shorter application form (1023-EZ):
- Form 1023: The traditional 26-page application that is used by larger nonprofits
- Form 1023-EZ: A condensed 3-page application that can be used by organizations with gross receipts of less than $50,000 and less than $250,000 in assets.
Check the IRS website and instructions to the form which include an Eligibility Worksheet you must complete to determine if your nonprofit meets the requirements for using the shorter streamlined form.
You must also include your nonprofit articles of incorporation and your bylaws with this application.
So, before you start filling out form 1023, be sure you have:
- Filed your articles of incorporation
- Prepared your bylaws
- Held your first nonprofit meeting
The IRS is going to ask for some specific details to be documented in your application. So be ready to spend a few days filling out this form and gathering your resources. Your articles of incorporation and/or your bylaws are going to have to include:
- a statement of your exempt purpose(s), (such as charitable, religious, educational, and/or scientific purposes)
- a dissolution clause
- a conflict of interest clause
Also, prepare to give detailed answers about and/or include:
1. Basic information
This includes the name of your nonprofit corporation, contact information, and when you filed your articles of incorporation.
2. A copy of your articles of incorporation and your bylaws added to the application form.
3. Clauses as follows:
- a clause stating that your corporation was formed for a recognized 501(c)(3) tax-exempt purpose (e.g., charitable, religious, scientific, literary, and/or educational), and
- a clause stating that any assets of the nonprofit that remain after the entity dissolves will be distributed to another 501(c)(3) tax-exempt nonprofit — or to a federal, state, or local government for a public purpose.
4. A detailed, narrative description of all of your organization’s activities.
Include a description of past, present, and future activities – in their order of importance.
5. Information about all proposed compensation to, and financial arrangements with:
- initial directors
- initial officers (such as the president, chief executive officer, vice president, secretary, treasurer, chief financial officer, or any other officer in your organization)
- the five top-paid employees who will earn more than $50,000 per year, and
- the five top-paid independent contractors who will earn more than $50,000 per year.
6. A statement of revenues and expenses and a balance sheet.
Note: You might want to hire a lawyer who will help you with this process.
Step 8: Ensure ongoing compliance
The work doesn’t stop there. Once the state approves everything, you should prepare for annual reporting requirements.
In most cases, an exempt organization must file some version of Form 990 with the IRS, depending on its financial activity. Form 990 shows your finances, activities, governance processes, directors, and key staff, and it is open to public inspection.
States have their own reporting and renewal requirements too. Therefore, consider tracking your organization’s finances and activities throughout the year. This will help the reporting happen smoothly.
Many recommend keeping a corporate record book where you keep all critical documents (including registration papers, licenses, and permits, meeting minutes, etc.) to ensure you’re well-organized and fully compliant.
Furthermore, most experts recommend that you do not fundraise until you’ve received your letter of determination from the IRS stating that you are now tax-exempt.
If you receive a proposed denial of tax-exempt status and you wish to appeal, consider seeing a lawyer with experience of working with nonprofits.
Without a doubt, the process of establishing a nonprofit is challenging.
It is advisable that you consult with local expertise (either an attorney, accountant or someone familiar with the tax-exempt law and how nonprofit organizations operate in your state) to ensure that your new nonprofit complies with state and federal laws and requirements. An ounce of prevention is worth a pound of cure, and the best time to set your nonprofit up for success is at the very beginning.
Hurdles and obstacles should not discourage you. Remember why you’re doing what you’re doing. Come back to your mission and your beneficiaries whenever the process becomes a little bit too much.
We hope this article helped you begin to understand the process of incorporating and acquiring the nonprofit tax-exempt status.
For more nonprofit tips, visit our nonprofit blog.