What is a Nonprofit?
There are over 1.5 million nonprofit organizations in the United States. However, not everyone understands what a nonprofit really is.
First, many people think that nonprofits don’t make money, or don’t have any money. This is just not true. A nonprofit corporation should recoup its costs and may even make a profit, and some private foundations have more assets than the governments of small nations. These organizations are termed “nonprofits” because they are not organized primarily for profit.
Next, a nonprofit is not the same as a “501(c)(3)” organization. Charities that are exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code are indeed nonprofits, but the term nonprofit is much broader than just 501(c)(3) charities. The term “nonprofit” refers to how the entity is organized under state law, and section 501 of the Internal Revenue Code is a federal law. Also, section 501(c) encompasses 29 categories of organizations that are tax-exempt under federal law. For example, social welfare organizations are exempt from income tax under 501(c)(4) and have greater flexibility to engage in lobbying and political activities, but donations to these entities are not tax-deductible. Other nonprofits that are not 501(c)(3) charities include chambers of commerce and other civic or business leagues, fraternal organizations, and state-chartered credit unions. These nonprofit organizations are exempt from certain taxes because of the contributions they make in the community.Once you’ve decided your cause and your commitment are big enough and you need to do this on your own, the next step is to form a nonprofit entity in the state of your choice. An attorney can help you evaluate the pros and cons of the different entities available and the various state laws governing them so that you can decide which state and which entity to form in that state. Most people starting charities choose to form nonprofit corporations.
Establishing a nonprofit corporation involves several steps:
- File a Certificate of Formation (sometimes called Articles of Incorporation) in the state you select.
- Get an EIN from the IRS.
- Open a bank account for the entity.Create bylaws to govern the entity.
- Choose a board of directors that will govern the entity. Some states, including Texas, require a minimum of three directors for a nonprofit corporation. The IRS prefers that a majority of your Board be independent, which basically means uncompensated by the entity.
- Hold the organizational meeting of the Board of Directors, where you will take care of formalities such as adopting the bylaws, electing officers, recording the receipt of federal and state tax exemptions, setting a budget, and adopting programs. After the meeting is completed, minutes of the meeting should be created and filed in the nonprofit’s records binder.
- Draft the appropriate resolutions to take Board actions.
- File for federal tax exemption with the Internal Revenue Service (Form 1023). This is the most complicated step, and could take months of preparation. You will need to explain to the IRS all of your proposed activities, your budget, and the systems you have in place for governance of the entity, among many other things. You may have to wait several months for the IRS to approve your application. The more time and thought goes into the application, the more likely the IRS will streamline the decision. In the meantime, you can conduct activities as a nonprofit, and if your exemption is granted, the effective date will be retroactive to the date of formation, assuming you file the exemption application within 27 months of formation.
- Obtain your state tax exemption, based on your federal tax exemption.
- Obtain necessary licenses and permits to operate in your jurisdiction, such as sales tax licenses, etc. Continue to file necessary information returns and filings with the appropriate state and federal agencies on an annual basis. If you don’t, your entity’s tax-exempt status could be forfeited.
This process can take time, often up to a year or more. The advice of experts can be invaluable, saving you time and effort down the road. We are happy to help with setting up your nonprofit, and offer affordable hourly rates and even some fixed fee arrangements.