Complying with bylaws, attaining and maintaining tax-exempt status, managing a Board of Directors… Starting and registering 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 is without its challenges. Starting a nonprofit requires strategy, planning, commitment, and organizational skills. Not to mention, years of hard work and strong willpower are required to sustain a successful nonprofit in the years to come…
When establishing a new nonprofit, the first step for most organizations is to apply for the official 501 (c)(3) status.
Section 501(c)(3) is the part of the US Internal Revenue Code that allows for federal tax exemption of nonprofit organizations. A 501(c)(3) organization is a corporation, trust, unincorporated association, or other types of organization exempt from federal income tax under section 501(c)(3) of Title 26 of the United States Code.
Organizations must be considered “charitable” by the IRS to receive a 501(c)(3) classification. According to the IRS, a charitable organization is one that has been established for the below purposes :
Organizations that also help the poor and underprivileged, help erect or maintain public buildings or national or state monuments, promote civil rights, and combat juvenile delinquency and urban decay can also be considered nonprofit organizations.
There are many reasons why organizations choose to apply for the official 501(c)(3) status.
A public charity, identified by the Internal Revenue Service (IRS) as “not a private foundation”, must obtain at least 1/3 of its donated revenue from a fairly broad base of public support, i.e directly or indirectly, from the general public or from the government. Public support must be fairly broad, not limited to a few individuals or families, it can be from individuals, companies, and/or other public charities.
Public charities are defined in the Internal Revenue Code under sections 509(a)(0) through 509(a)(4).
Donations to public charities can be tax-deductible to the individual donor up to 60% of the donor’s income. In addition, public charities must maintain a governing body that is mostly made up of independent, unrelated individuals.
A private foundation, sometimes called a non-operating foundation, receives most of its income from investments and endowments. This income is used to support the work of public charities through grants, rather than being disbursed directly for charitable activities. They are not required to be publicly supported, so revenue may come from a relatively small number of donors, even single individuals or families.
Private foundations are defined in the Internal Revenue Code under section 509(a) as 501(c)(3) organizations, which do not qualify as public charities.
Donations to private foundations can be tax-deductible to the individual donor up to 30% of the donor’s income. The administration of a private establishment can be considerably more firmly held than in a Public Charity.
In general, a private operating foundation is a private foundation that devotes most of its resources to the active conduct of its exempt activities.
These associations frequently maintain active programs like open charities however they may have traits, (for example, close administration) like an establishment. Thus, private working foundations are regularly viewed as half-breeds. The majority of the income must go to the conduct of the program.
A private operating foundation is any private foundation that spends in any event 85 percent of its balanced net gain or its base speculation return, whichever is less, straightforwardly for the conduct of exempt activities.
On top of that, the foundation has to meet one of the following tests:-
Also, Contributions to private operating foundations as described in Internal Revenue Code(IRS) section 4942(j)(3) are deductible by the donors to the extent of 50 percent of the donor’s adjusted gross income.
Here’s a short video tutorial on How to Start a 501(c)(3) Nonprofit Organization in 10 Steps:
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) nonprofit organization.
At first glance, this might not seem like an essential task when discussing the practicalities of registering a nonprofit. However, getting clear on 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.
Once you’re able to clearly and succinctly communicate your purpose, every subsequent step will be simpler – particularly Step 2.
Once you have the answers to these questions, you can begin to flesh out a clear mission statement and a one to three-year plan of action for your organization.
Pro tip: Don’t rush the process. Spending some time now to get clear on your purpose will pay off later. Reflect on the information you gather, write more than one draft, and gather feedback from key stakeholders.
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:
There are 29 types of nonprofit organizations that can file for tax-exemption under section 501(c) of the Internal Revenue Code. The most common of these is the 501(c)(3), which includes all charitable, religious, scientific, and literary organizations. Other types of tax-exempt nonprofits fall under different 501(c) codes such as:
If your nonprofit identifies with one of the above or another type of organization, you can view the whole list here.
Pro tip: Plan for startup costs for your nonprofit. For example, depending on your state, incorporation can cost you from $8 (Kentucky) to $270 (Maryland). If you intend to start a 501(c)(3), expect to pay between 275$ if you fill out the simpler Form 1023-EZ and $600 for the more complex Form 1023 (which has more detail).
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.
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.
Pro tip: Your state’s corporation’s office can tell you how to find out whether your proposed name is available for your use. For a small fee, you can usually reserve the name for a short period of time until you file your articles of incorporation.
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 501c3. Hiring the right Board is essential to 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.
Another important point, as The Nonprofit Answer Guide mentions, is your Board should be made up of individuals who have expertise and resources in different areas.
A good rule of thumb when recruiting is:
- One-third from individuals who have access to financial resources or soliciting donations.
- One-third from individuals with management expertise in areas of financial, marketing, legal and the like.
- And one-third from individuals connected at the community level, with expertise in your service field.
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 could get to know each other.
Here’s a detailed guide on How to Hire a Great Nonprofit Executive Director
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:
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 into 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 a 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 (sometimes this needs to be done before), 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 part of the official record. This meeting is usually referred to as the “organizational meeting” of the organization. The minutes of this meeting is simply a formal record of the proceedings and actions taken, such as setting an accounting period and tax year, approving the issuance of memberships, authorizing and establishing the Board and other committees, approving the bylaws, approving the opening of a corporate bank account, and more.
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. You must register an account at pay.gov and pay a registration fee with a credit or debit card. 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. With the required attachments, schedules, and other materials that may be necessary, it is not uncommon for these submissions to the IRS to be up to 100 pages. Think of Form 1023 as an audit of proposed (and/or previous) activity and 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.
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.
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:
This includes the name of your nonprofit corporation, contact information, and when you filed your articles of incorporation.
Include a description of past, present, and future activities – in their order of importance.
*The IRS says that you should expect to hear from them within 180 days after submitting your application. The IRS goes over your application thoroughly, and if the information is incomplete, the agency may have to contact you. This may considerably slow down the process, which is why it’s crucial to be as prepared as possible before submitting the application.
Note: You might want to hire a lawyer who will help you with this process. Alternatively, you could work with one of the companies that assist in this area, such as Nolo.
Pro tip: 40 states also require Charitable Solicitations Registration which is usually administered through the Attorney General’s office, though not always. Most states require registration prior to soliciting donations. Furthermore, while most states recognize the federal 501(c)(3) status as valid for state corporate tax exemption – California and Texas are big exceptions. They both require their own application process for charity status in their state.
Once you’ve obtained the 501(c)(3) status, you do not need to file any kind of document to renew the application. In other words, there is no expiration date on a 501(c)(3) organization. However, there are other actions that need to be taken to maintain tax-exempt status.
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.
Keep adequate accounting records of income, expenses, assets, and liabilities. You also need to keep appropriate records for employees, such as payroll records and payment of withholding taxes, workers’ compensation, unemployment taxes, etc. If you hire any independent contractors, you need to keep copies of any Miscellaneous Income (Form 1099-MISC) documents that are provided to them.
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.
Should you wish to change your name or address in the future, the IRS mandates that an exempt organization must report the name, address, and structural and operational changes. When an organization files an annual return (such as form 990 or 990-EZ), it must report the changes on its return. If your organization needs to report a change of name, see Change of Name- Exempt Organizations. If you need to report a change of address, see Change of Address – Exempt Organizations. The EO Determinations Office can issue an affirmation letter showing an organization’s new name and/or address and affirming the section of the Internal Revenue Code.
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.
Pro tip: Check with your state department of consumer affairs (or similar state licensing agency) for information concerning state licensing requirements. For instance, if you sell anything to consumers, you’ll need a sales tax permit, and your activities may require a zoning permit.
As a 501c3, donors to your organization can now receive tax deductions for their gifts. Nonprofits have several fundraising options, including solicitation letters and events, but online giving is quickly becoming the most popular and affordable alternative.
The popularity of online giving is growing, and nonprofits have several options to choose from to collect these donations. Donorbox is one of the easiest and most affordable choices for nonprofits to collect online donations.
For a small 1.5% processing fee on donations and no contracts, Donorbox offers nonprofits custom donation forms, donor management programs, third-party integration with your current website apps, and more. Below is a list of why Donorbox stands out from the competition.
Recurring donations are a fantastic revenue source for nonprofits. These funds can be depended on and included in your annual budget. Donors love the convenience of recurring donations because they can regularly support their favorite organizations without needing to think about it. Donorbox gives nonprofits the chance to collect weekly, monthly, quarterly, and annual recurring donations. Muso is a great example for you.
Donorbox has partnered with Double the Donation to give nonprofits an affordable alternative for company gift matching. Nonprofits can offer their donors an easier way to find out if their companies offer matching gifts. Integrate Double the Donation on your website and watch your revenue increase.
Donors are raising funds through crowdfunding for their birthdays and to help people in need. Nonprofits are hoping to jump on the crowdfunding bandwagon. Donorbox allows nonprofits to create crowdfunding campaigns, send updates to donors, and share successes online. With these customized campaigns, nonprofits can encourage donors to get involved and share their stories with a new audience. Here’s an example –
Text-to-give donations are quickly becoming a favorite of younger donors and nonprofits. Donorbox gives nonprofits an easy way to collect donations using donor smartphones. Local nonprofits, churches, and politicians have all found success with these campaigns.
By sending your donors a text that contains your campaign ID and a link to your donation page, donors can make a one-time or recurring donation within minutes. Take advantage of how easy this is and add a text-to-give campaign to your next event.
There are numerous perks of being tax-exempt under Section 501(c)(3).
Certain businesses and stores offer discounts to nonprofits and their employees. Some publications also offer nonprofits advertising discounts. Many other businesses and stores readily offer nonprofits and their staff discounts if they’re able to present a copy of their 501(c)(3) status document issued by the IRS.
That depends on which IRS form you use to file, and you have two options.
The user fees must be paid through Pay.gov when the application is filed.
There is also the cost of hiring an experienced advisor or professional to prepare your 501c3 application Learn in detail about the cost of filing for 501c3 here.
Typically, IRS 501(c)(3) approval takes between 2 and 12 months, inclusive of likely written follow-up questions. Sometimes it takes a little less; sometimes a little more.
Filers of Form 1023-EZ experience a shorter time frame due to the streamlined process of e-filing.
One of the primary reasons for the long review period is the amount of time it takes for a particular case to be assigned to a review agent. It can also depend on the time of year, the type and classification of the nonprofit, and the complexity of the application itself.
The expedited review can be requested if a new organization is being formed to provide immediate disaster relief or if a promised grant is substantial relative to the organization’s budget and the grant has a defined expiration date. However, there is no guarantee the IRS will grant expedited review requests.
There are informal nonprofits — those without formal recognition from the IRS — and it is entirely permissible for them to remain that way. However, without official IRS 501(c)(3) tax-exempt status, the group is not tax-exempt, and people giving it cannot deduct the amount from their taxes.
Typically, very small nonprofits with annual gross receipts under $5,000, and churches and integrated auxiliaries of churches and conventions or associations of churches operate without 501(c)(3) status. Donations to these organizations are tax-deductible even though the nonprofit does not hold the tax-exempt status.
Grantmakers typically fund organizations that qualify for public charity status under Section 501(c)(3) of the Internal Revenue Code. There are few grants that are offered to organizations without a 501c3 designation- but they are few. Nonprofits can apply for fiscal sponsorship, a formal arrangement in which a 501(c)(3) public charity sponsors a project that may lack exempt status. This enables the project to seek grants and solicit tax-deductible donations under your sponsor’s exempt status.
Yes, you can donate to your own 501(c)(3) organization. You can make a tax-deductible donation to any 501(c)(3) charity, regardless of your affiliation with it. It is not technically your own charity as charitable organizations have no owners. However, money donated to charity must be used for charitable purposes.
You must make sure that the organization gives you a signed receipt for the donation. That indicates what was donated, the value of the donation, and states that no goods or services were received in exchange for the donation.
Organizations under Section 501(c)(3) of the IRC are generally exempt from most forms of federal income tax, which includes income and capital gains tax on stock dividends and gains on sales. As long as the 501(c)(3) corporation maintains its eligibility as a tax-exempt organization, it will not have to pay tax on any profits.
Properties owned by charitable nonprofits used for a tax-exempt purpose are exempt from property taxes under state law. If the property or any portion of it is not used to promote the nonprofit group’s mission, the group can be liable for property taxes. For instance, if the group owns a property, but leases part of that property to a for-profit business. Then the group is liable for property taxes on the leased portion of the property.
The Board of Directors is the governing body of a 501C3 nonprofit, responsible for overseeing the organization’s activities. The board is required to ensure that the organization is legally compliant and is being run in the best possible way. In a 501c3 organization, the founders may serve on the company’s board of directors. Certain states require a 501c3 organization to select at least 3 people to serve on the organization’s board of directors. And, at least one director in the organization is responsible for making strategic and financial decisions for the organization.
You can check the IRS’s progress on applications on the IRS website. Once an agent is assigned for your application, your application review process will begin. You can check the status of your 501c3 application by contacting the IRS Exempt Organization Customer Account Services at (877) 829-5500. You will need to provide tax identification and the mailing address of the organization. The IRS only provides information regarding the status of your 501(C)(3) application to an identified officer of the organization.
As a 501c3 founder, you can pay yourself a reasonable compensation for your actual services in the nonprofit. The IRS examines reasonableness on the basis of comparable salaries in other comparable nonprofit organizations. You must be careful to pay yourself reasonable compensation and in order to avoid any possible claim for excess taxes-benefits from being paid “too much”. The salary should be within reasonable limits based on the number of hours worked, the overall budget of the organization, the required level of education, and compensation averages in your area.
Yes, All 501c3 Organizations are exempted from federal and/or state corporate income taxes. Although not all activities are tax exempt. Activities that are not related to a nonprofit’s core mission or purpose are taxable. This can be any activity/business to support a nonprofit’s income. Typically, these are categorized as unrelated business activities.
Without a doubt, the process of establishing a nonprofit is challenging.
It’s 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.
Note: By sharing this information we do not intend to provide legal, tax, or accounting advice, or to address specific situations. The above article is intended to provide generalized financial and legal information designed to educate a broad segment of the public. Please consult with your legal or tax advisor to supplement and verify what you learn here.