If you’re looking into starting a nonprofit, you’re likely passionate about a particular cause. You have a plan to solve an issue or help a group of people and you want to take action to make a difference. You know that your first step is creating a nonprofit and you start by establishing a brand, building a website, and getting the word out.
Filing IRS documents might be the last thing you think to do in the startup phase, but the legal and accounting aspects of your organization are crucial from the very beginning. Follow these four steps to gain a 501(c)(3) status and maintain compliance for your new nonprofit:
Establish a nonprofit corporation
When you start your organization, form a nonprofit corporation to legally separate your organization from yourself. Through this process, your nonprofit will become its own entity, legally distinguishable from its founders. To get started, there are three necessary components:
- Articles of incorporation: This is the document you’ll file with the IRS to request nonprofit incorporation.
- Federal Employer ID Number (FEIN): This is a numeric identifier for your nonprofit, which the IRS will assign to you.
- Bylaws: You’ll need to establish some rules for how your board of directors will govern the nonprofit. Draft bylaws that comply with state and federal requirements.
Only qualifying entities can apply for 501(c)(3) determination from the IRS and a nonprofit corporation is one of them. Besides gaining 501(c)(3) status, Foundation Group explains that incorporation is also important for your own personal liability. Since it legally distinguishes you from your organization, it protects you as an individual from any personal liability associated with the actions of the organization.
File IRS form 1023
Once you’re ready to officially apply for 501(c)(3) status, you’ll need to fill out IRS Form 1023. This process might take a substantial amount of time since your final submission could include up to 100 pages of documents.
The IRS uses this form to thoroughly examine your organization. It evaluates the following factors:
Purpose
The IRS will determine whether or not your organization has a charitable purpose. There are many categories of nonprofits, but nonprofits need a charitable purpose to qualify as a 501(c)(3). This purpose might be religious, scientific, literary, or educational. A full list of charitable purposes can be found in IRS Publication 557.
Plans
Once you’ve established that your organization has a charitable purpose, ensure that any programs you’ve planned are aligned with it.
The IRS will use Form 1023 to evaluate the action you plan to take through your organization. The fundraising strategy you intend to follow and any services you’ll offer need to serve your charitable purpose.
Potential benefits
This form will also be used to determine if there are any conflicts of interest or potential benefits for the people involved in the startup. You’ll have to prove that your organization is really formed for its charitable purpose and not looking to unfairly benefit its founders.
Register for charitable solicitations
Before you can start fundraising, you’ll most likely need to register with your state to ask for donations. Forty states require you to complete a charitable solicitations registration before you can solicit donations. This means that if you host a fundraising event, sell products, or charge registration fees for events to raise money for your organization without registering, you’ll be considered non-compliant.
You also have to register in every state in which you’ll be soliciting donations. If your organization is based out of Georgia, for example, you’ll have to register separately in Florida before targeting potential donors there. Larger organizations might require registration in every state.
Depending on your state, this application could include an in-depth request requiring budget projections and information about your board of directors. For some states, this step comes after you’ve received your 501(c)(3) status. Once you’ve received your approval for charitable solicitations, you might also have to renew this application annually.
This application is the gateway to generating revenue for your organization, but it’s important to remember that a lot more goes into managing your nonprofit’s finances than simply getting permission to raise money. Establish internal controls to protect your nonprofit’s finances and ensure the responsible use of donations.
Apply for state corporate tax exemption
Although there are some exceptions, most states recognize an organization with 501(c)(3) status as tax-exempt. However, this doesn’t necessarily mean that your organization will be exempt from all taxes.
For example, if you have employees, your 501(c)(3) will still be subject to state and federal payroll taxes. Another example of taxed nonprofits is private foundations, which might be subject to taxes on investment earnings. Double the Donation explains that private foundations are subject to greater IRS regulations, such as a yearly payout requirement that obligates foundations to spend part of their assets each year on charitable purposes.
Each state has different tax requirements, so it’s important to understand what your state’s exemption expectations are. If your state doesn’t recognize a 501(c)(3) as automatically tax-exempt, you’ll need to go through a separate application process for charity status.
Securing 501(c)(3) status for your organization is the first step toward furthering your cause and accomplishing your goals. Before you jump into branding and fundraising, though, remember that there are other important parts of maintaining your 501(c)(3) status and healthy nonprofit operations.
Have a detailed financial plan and accounting system in place. Nonprofit accounting is different from for-profit accounting, so it’s important to understand the nuances of nonprofit finances before starting to fundraise.
The applications and paperwork can seem daunting, but once you get those out of the way, you can focus on doing what you set out to do with your nonprofit.
Author: Greg McRay
Greg is the founder and CEO of Foundation Group, one of the nation’s top providers of tax and compliance services to nonprofits. Greg and his team have worked with tens of thousands of nonprofits for over 25 years, assisting them with formation of new charities, plus tax, bookkeeping, and compliance services. He is credentialed as an Enrolled Agent, the highest designation of tax specialist recognized by the Internal Revenue Service. Based in Nashville, Tennessee, Greg and company work with charities and nonprofits all across the country and worldwide.
