What Is a Nonprofit, and
How Do You Start One?
When starting any organization, it’s important to decide what entity type works best for your situation. For profit companies like an LLC, Partnership, or Corporation can be great vehicles for creating a successful business and can be created for almost any reason. However, nonprofits are more restrictive. They need to qualify under a particular purpose for the IRS to approve it, and have certain restraints on how it spends money, and how they operate.
What Is A Nonprofit?
A nonprofit (NPO) is an organization created for a specific, qualified purpose other than to make a profit. They generally further a religious, scientific, charitable, educational, or humanitarian mission or area of work. (A full list of types of nonprofits and exempt purposes can be found on the IRS website here.) Many people wrongly assume that means a nonprofit can’t pay their employees well. While the law does restrict nonprofits from overpaying their employees, in comparison to comparable jobs in the area, an employee for a nonprofit can and usually is making just as much as their for-profit counterpart.
A big difference between for profit and nonprofit is that nonprofits operate under a “non-distribution constraint”, meaning they use their surplus revenues to further achieve their purpose or mission, rather than distributing that surplus to shareholders as profit or dividends.
Benefits
While there are certain limitations for nonprofits, there are also quite a few benefits. The biggest benefit is that, if approved by the IRS, it is exempt from income tax. In addition, many states have Sales Tax Exemptions, which would allow you to buy products for the nonprofit without being taxed. You would need to research whether your state offers that, and what forms would need to be filled out.
Donations towards a nonprofit are also tax deductible! You would need to provide a tax-compliant donation receipt for all qualified donors, (a value of $250 or more). The nonprofit also does not need to wait for the IRS approval letter before they provide donation receipts. As long as the 501c3 application was submitted in good faith, nonprofits may begin receiving tax-deductible donations immediately.
How to start a Nonprofit?
Starting a nonprofit can be very complex. Forming a nonprofit can take a lot of research, and preparation. While I strongly encourage you to have a lawyer provide guidance and assist with the paperwork, here are the most important steps:
1. Develop Your Dream
Before you even determine what the ideal entity is for your business, you should first create a detailed business plan. This would include a business name, mission statement, purpose, start-up costs, operating costs, marketing strategy, and revenue stream. This plan will provide you with a road map of what you need to make to cover expenses, and how you’re going to operate. It will also help with getting financing from investors, donations, or securing a loan.
You will need to look up the name of the business on your state website to confirm whether the name is already taken. I’d also recommend looking up all trademarks in the USPTO website, to see if your name, logo, or anything substantially similar, is already trademarked.
2. Incorporating as a Nonprofit
Now that you have done the proper research and know how you want to operate your business, you need to decide what type of entity you’d like to start. If you want to make significant profits, you may want to check out other entity types.
Assuming you want to continue with the Nonprofit entity, you need to incorporate. This is done on the state level, and requires the submission of “Articles of Incorporation” to the Secretary of State. The process is different in every state, but generally you can find the state’s website and instructions by searching online “Articles of Incorporation in (your state)”. You will also need to pay a fee, which varies per state. (Generally around $100.).
3. File for your EIN.
Whether you’ve decided to go for a for profit entity, or a nonprofit entity, every organization needs an Employer Identification Number (EIN). This is basically a social security number for your business and allows you to properly file with the IRS and is even required to open a bank account. You can file for an EIN online for free using the IRS website. Make sure you don’t go through a third-party site or unsecure site that charges you to submit.
4. Create Bylaws and Name Your Board of Directors
Bylaws are like the Constitution of your Corporation. It determines how you are operating, the division of powers and responsibilities for each Officer, and how meetings are to occur. Many states have their own laws on how a Corporation is to be ran, and how many Board Members are required. But generally, you need to have at least three Board Members, and no more than seven. You also want to make sure your bylaws don’t have conflicting laws to your state’s. (Reach out to a lawyer to know your State’s specific guidelines.).
Picking your Board of Directors is very important and isn’t just about recruiting. They will help guide the company and need to vote on any major decisions in the corporation’s future. While Board Members aren’t generally paid, at least at the beginning, they need to be able to offer some time and expertise to overseeing the nonprofit.
While it’s not required under federal tax law, it’s considered best practice and highly recommended for all nonprofits to adopt a separate “Conflict of Interest” Policy. A nonprofit must also describe it’s policy regarding conflicts of interests in the 1023 Form (discussed later), accordingly, it’s advantageous to have a clear separate policy. There is a sample in Appendix A of the IRS Form 23 instructions page.
5. Obtain IRS 501(c)(3) Status
Once your organization is officially registered with your State (through the Articles of Incorporation), and federally (with an EIN), you can submit an application to the IRS to file for tax exemption status. This process is the most complex part as there are several different forms, and depending on your situation, may include several attachments and Schedules.
For a normal nonprofit (501c3), you’ll use the IRS’s 1023 Form, (or the expedited 1023-EZ form if you qualify). The IRS recently moved the application to be completely done online at pay.gov. (Which currently also means combining all necessary attachments to one properly formatted file in order to submit). You will also have to pay a filing fee, which is presently $650. (or $275 for the 1023 EZ form, if you qualify.).
The IRS generally takes up to 6 months to approve or deny an application. They thoroughly examine all of the submitted paperwork and are looking specifically to confirm the organization is being formed for a proper exemption purpose, and if there are any conflict of interests or red flags. If you get a denial, it can be very time consuming to re-apply, and may even require another $650 submission fee. Or worse, you get approved but under a membership structure when you didn’t want to be, or you’re violating the commerciality doctrine, etc. It’s highly recommended you have an experienced attorney assist you.
6. File Additional Forms With Your State
Some states require a state-level tax exemption form for 501c3 status. (CA requires a Form CT-1 to be filed annually and a Form SI-100 to be filed every 2 years. California also specifically has a Franchise Tax Board, which you would need to file a Form 3500A, with your IRS Determination Letter, for a California Affirmation Letter.) Other states don’t have any of these, so you’ll need to check with your State or Attorney to confirm if any additional forms/compliance is required.
If you will be soliciting for funds, you will also need to file for Charitable Solicitation Registration (CSR) for most states. The IRS does have some more information here. You may also need to file/apply with your state for any additional licensing/permits, depending on your business industry. (GC License, Real Estate, CPA, etc.) Make sure you research your specific state requirements, or call an attorney.
7. Begin Operations
Now that you have submitted all the paperwork, you are good to begin operations, including marketing and building your brand. You can submit grant applications, start fundraisers, hire staff, accept donations, etc.
8. Ongoing Compliance
To maintain your 501c3 status, most organizations will need to file a Form 990 annually. Information on Form 990 and Instructions can be found on the IRS website. You’ll also need to make sure you’re up to date on your State filings, as well as having quarterly meetings with your Board Members and taking minutes.
Starting a nonprofit can be very rewarding, but as you can see, requires many steps. You may want to consider other avenues like joining or partnering with another nonprofit. Make sure to do research in your area for similar corporations like the one you want to start, as you may be competing with the same donor base.