Although startups are traditionally for-profit ventures, the same principles used to launch a successful startup also apply to the formation of philanthropic enterprises.
Generally when people discuss nonprofits, they are referring to Section 501(c)(3) public charities, a type of charitable organization that is organized under state nonprofit law and exempt from federal taxation under Section 501(c)(3) of the Internal Revenue Code (“IRC”). These types of organizations also include well-known private foundations. Section 501(c)(3) organizations are the most common type of nonprofits and are the only organizations that accept tax-deductible contributions from donors.
The following are key steps to form a Section 501(c)(3) nonprofit corporation:
Research. Articulate the educational, charitable and other exempt purposes your organization will address, specifically focusing on the scope and demographic the nonprofit will serve. Be prepared to demonstrate the public need for your organization’s services and to show how your organization is best suited to address that need.
Develop a business plan. A business plan should include a mission statement, setting forth a clear reason for the nonprofit’s existence, as well as outlining its general goals, stated objectives and how the nonprofit intends to implement and achieve its mission. Make sure to plan for how to measure your organization’s impact to demonstrate to funders that your organization is worth their donations.
Governance. It is important for your organization to implement proper governance practices, including establishing a board of directors that is legally accountable to help your organization meet its vision and mission. The board acts as trustee of the nonprofit’s assets and ensures that the nonprofit is well-managed and remains fiscally sound. Requirements set upon boards vary from state to state, so be sure to check with your state’s secretary of state or similar state agency to ensure compliance with your state’s rules. Additionally, your organization will need well-drafted bylaws to set forth its governance rules. Some states require the bylaws to include a statement identifying the corporation as a nonprofit. The organization also must adopt certain governance policies and procedures, including those related to conflicts of interest, whistleblower protection and document destruction.
Incorporate in your state. Requirements for incorporation vary from state to state so make sure to carefully consider your state’s requirements. Your organization will need to draft articles of incorporation that describe the primary purposes of the organization and that must be filed with your state’s secretary of state or similar state agency in order to legally create the organization. In addition to satisfying any state-level requirements, the articles of incorporation generally must include the following items in order to obtain tax-exempt status:
- A purpose clause that is properly limited to one or more of the exempt purposes set out in Section 501(c)(3) of the IRC.
- A statement that prohibits the nonprofit from engaging in non-exempt activities or using its earnings to benefit an individual.
- A dissolution clause that permanently dedicates the nonprofit’s assets to an exempt purpose. This means that if the nonprofit decides to dissolve, the assets will not be returned or distributed to any members or private individuals (unless otherwise required by law). The assets must instead be transferred to another non-profit that is a Section 501(c)(3) entity, or to the federal government or to a state or local government for a public purpose.
Secure your tax-exempt status from the federal government. The non-profit must file IRS Form 1023 (Application for Recognition of Exemption) in order to apply for tax exemption. When such status is granted, the IRS will send a determination letter confirming the organization’s tax-exempt status, which should be maintained in its minute book (the “Determination Letter”). The process of receiving a Determination Letter from the IRS may take anywhere from three to nine months and may require submission of additional information to the IRS for them to rule on your application.
Comply with ongoing reporting obligations and compliance, including filing for tax-exempt recognition at the state and local level, if necessary. Many states and local governments will require you to complete additional filings to receive recognition as tax-exempt from those institutions after the IRS issues a Determination Letter of your organization’s tax-exempt status. For example, nonprofits holding real estate will separately need to apply for tax-exempt status at the local level for real estate tax exemptions. If your nonprofit intends to solicit the public for donations, the organization must comply with state and local charitable solicitation laws. Your nonprofit organization will also be subject to ongoing reporting obligations including annual filings with state entities (to maintain nonprofit corporation status and to register for fundraising purposes), annual federal reporting to the IRS (IRS Form 990), and submitting any required reports to funders (whether foundations or governments) and acknowledging contributions from individual donors.