Part One of our series in starting a nonprofit will guide you through the steps of formal incorporation. Part Two of our series will provide you with proven ways to raise those first dollars for your nonprofit. Let’s begin.
So you’ve come up with a great idea and a vision to form a nonprofit organization. But where do you start? Here we’ve provided your road map to get a new nonprofit off the ground with sustainability always in mind. The process of forming and incorporating a nonprofit is similar to a corporation, except for a few differences. A nonprofit cannot be formed from any of the following entities: Sole Proprietorship, Limited Liability Corporation or a Corporation “C” or “S”.
A nonprofit, like a corporation, is a legal entity separate from the founder(s); it can survive the life of its founder(s) and can exist infinitely. Unlike a corporation that is owned by its shareholders, a nonprofit does not have shareholders and is not owned by anyone, but is managed by the board of directors. The other distinct difference between a corporation and a nonprofit is how the income is taxed. Now, let’s take you through the process.
Step One: Recruit a Board of Directors. A board should include diverse representation from the following: finance, legal, someone who represents or is considered an expert with regard to your mission, someone who represents the people you exist to serve, local corporate executive(s) – specifically from a company who tends to fund organizations like yours, community/professional volunteer(s) – persons with a network of wealth, and another nonprofit executive. Ensure that you have a job description in place which clearly indicates board member expectations, including all information related to your nonprofit. Expectations should include: governance, financial support, and hands-on leadership. You do not want a board of directors that feels “just showing up” fulfills their duty. Finally, you never stop looking for good board members. Your board should have a set tenure to ensure there is always room for fresh faces, ideas, and connections.
Step Two: Formation Meeting. The formation meeting is a meeting of the initial board of directors to vote on incorporating and pursuing the tax exemption status as well as to establish the purpose of the nonprofit. During this meeting and all subsequent board meetings, make sure to take meeting minutes to show a unanimous agreement by the board before moving forward.
Step Three: Naming Your Nonprofit. Name selection is important because it identifies your purpose and creates your identity and brand. Pick your organization name like you pick your child’s name—repeat it often, pretend to answer the phone using the name to hear if it has a nice ring to it. You can choose almost any name you want for your organization as long as it is not already in use. You can check name availability on your state’s governing website to see if it is available before you file it. Generally this is the secretary of state’s office.
Step Four: Incorporate. The incorporation process is similar to that of a corporation. The Articles of Incorporation are prepared and filed with the state’s governing body; again, typically the Secretary of State’s office. Some states have sample articles which you can obtain and use in drafting your articles, however, meeting the state’s minimum filing requirement does not necessarily mean you meet the IRS’s requirements. Make sure you properly and carefully draft articles of incorporation that meet the requirements of the IRS if you plan to apply for federal tax exemption; which you will. There is a filing fee associated with this process paid to the state. The fee for the state is usually around $100; the filing fee for your tax-exempt status is around $850.
Step Five: The Bylaws. You are required to prepare bylaws for your nonprofit. Bylaws are the rules used by the board to govern your nonprofit. Most states do not require a copy of the bylaws to be filed with the state. Regardless of filing requirements, it is a state law requirement that an incorporated entity have written bylaws. The IRS will require a copy of the bylaws to be filed with your application for tax-exemption.
Step Six: Obtain your Federal Employer Identification Number (EIN). Once you’ve completed your paperwork, you will need to apply for an Employer Identification Number (EIN) also known as a federal tax ID from the IRS. You can do this quickly and easily online. Don’t forget to print out a copy for your permanent records. You will also need a copy to submit to the IRS with your tax exemption application. To apply for your EIN visit the IRS’s website. It is important to note that simply holding an EIN number does not mean you are approved as a 501(c)3 by your state or the IRS. You can raise money for your organization prior to approval. However, be mindful that more often than not, granting organizations require an approved 501(c)3 and will ask for a copy of your approved status letter.
Step Seven: Application for tax exemption to the IRS. After you have incorporated your nonprofit and obtained your EIN, then you can start your tax exemption application to the IRS using IRS Form 1023. The form can be obtained at the IRS website. This is a comprehensive application. You must carefully read the instructions, learn about the laws of compliance, complete the application, and collect & assemble the attachments. Hiring a professional to help you is highly recommended. If you are attempting to do this on your own, the IRS estimates a few hundred hours are necessary to complete this application. After your initial review, complete the application to the ‘letter’ of their instruction. If your application is not clear or missing important information, it will be sent back to you for more information. If it does not fit within the tax exemption regulations, it will be denied. As mentioned above, there is a fee associated with this application; approximately $850. The fee changes periodically, so be sure to check the filing fee before you submit the application. The IRS is currently taking between 6-8 months to assign the application to an exempt organization specialist. If your application is approved, you will get a “Letter of Determination” that classifies your organization as tax exempt. The nice thing about this long process is that the date of your exemption is retroactive to the date that the IRS first received your application. This means that if you did receive a donation requiring 501(c)3 status prior to your approval, you will ultimately be in compliance with the funding organization and the IRS. Yet, it is not recommended to raise funds externally until you receive your Letter of Determination.
State Tax Exemption. Most states recognize and accept the federal tax exemption “Letter of Determination.” However, there are a handful of states that have additional state requirements to be income tax exempt for state purposes. You will have to consult your state’s governing body to see if there are additional state requirements.
Ongoing Compliance. After you are officially incorporated as a nonprofit organization, there are a handful of things that you must do to maintain compliance with state and federal requirements. Some states require an annual report. Most states require an annual corporate renewal, and some states do not require state income taxes to be filed unless the nonprofit receives a certain threshold income. As you can see, each state operates differently. The key is to keep yourself informed and up-to-date with the requirements of your specific state. On the federal side, IRS Form 990 or a variation of Form 990 is required to be filed annually. This is the annual tax return form for nonprofit organizations regardless of income. Currently, the law states that if you fail to file Form 990 for three consecutive years, the IRS will automatically revoke your nonprofit status. If this happens, then the nonprofit can no longer receive tax-deductible contributions. Additionally, you will have to reapply for tax exemption again. You have taken the time to build your nonprofit, so take the time to take care of it and remain compliant.
Let’s quickly review your nonprofit incorporation steps:
- File the certificate of incorporation
- Select individuals to serve on the board of directors
- Develop vision and mission statements
- Establish bylaws and board policies
- Obtain an employer identification number (EIN)
- File for federal tax exemption
- Follow state and local nonprofit regulations
Next month look for a step by step process to raise those very first dollars for your newly incorporated nonprofit.