FORMING A NON-PROFIT: AN OVERVIEW
Forming a non-profit corporation (also called a not-for-profit corporation or non-profit organization) involves several steps to ensure that the organization meets all legal requirements and is properly formed and organized to achieve its mission. However, before embarking on the journey of forming a non-profit, it is important to understand both certain aspects of the process, as well as some foundational questions, such as the kinds of not-for-profit organizations that exist, the difference between a "501(c)(3)" and a non-profit, the different types of tax-exempt status that are available, and the steps to obtain tax-exempt status.
Corporate law in California and New York covers non-profit organizations as well as business entities. In fact, other than the "profit motive," businesses and non-profits have much more in common than many people realize. At the same time, not-for-profit corporations and other charitable organizations have unique needs and complicated legal and special regulatory requirements. In addition to serving business corporations and LLC's, I have significant experience representing charitable organizations, and I continue to provide legal counsel in Los Angeles, Ventura County, New York City, and elsewhere to non-profit startups and founders, existing charitable organizations, and the boards of directors and management teams of non-profits in the exercise of their stewardship and fiduciary duties.
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What Is The Process To Form a Non-Profit Corporation?
Before considering the basic process, you should know that if you want your non-profit to have tax-exempt status, then there are both state and federal requirements that apply. In such a case, your non-profit is like a train riding on twin rails, one rail for state law requirements and the other for federal IRS requirements. You will have to ride both rails both to form and then to operate your charitable or other not-for-profit organization. You can form a non-profit corporation under the laws of a state, but that does not mean your organization will be tax exempt, or that donations to it will be tax deductible to your donors. That requires that you comply with the process of applying for federal tax-exempt status under Section 501(c)(3) of the Internal Revenue Code, or another applicable exemption.
In any event, here are the main steps that are taken when forming a non-profit corporation. Each step has a number of aspects, some specific and clear, and others nuanced or related to complicated legal and regulatory requirements. But, this is essentially an outline of the process for forming most charitable organizations.
- Define Your Mission. The first step in forming a non-profit corporation is to define your mission. This will help you determine the type of non-profit you want to form, such as a charity, educational organization, or religious institution.
- Choose A Corporate Name. Once you have defined your mission, you will need to choose a name for your non-profit corporation. The name should be unique and not similar to any existing organization. You can check for availability by searching the Secretary of State's website for your state; but, a word of caution: the public-facing information of many Secretary of State websites is not always current. I can have a more complete search done for you, and even if you are not ready to form, I may be able to secure the name you want for a period of time with a special filing.
- Identify Your Board of Directors. A board of directors is responsible for making decisions and setting the direction of the non-profit. The laws of each state will include any requirement that the board consist of a minimum number of directors ... at least three members is common ... and the members should represent as diverse a range of perspectives and experiences as possible under your circumstances.
- File Charter Consistent With State Law & IRS Rules. Next, you will need to file articles of incorporation with the Secretary of State in the state whose laws you want to govern your new non-profit. This document officially creates your non-profit corporation and outlines its purpose, name, location, and other important information.
- Create & Adopt Bylaws. Bylaws are the rules and regulations that govern the internal operation of your non-profit corporation. They should be written in accordance with state and federal laws and should outline the duties of the board of directors, membership, and other important aspects of the organization.
Adopt Accountability Standards Policies. A non-profit organization should have several accountability policies to ensure that it operates with transparency and accountability. Some of the key policies that many or most non-profits should have include:
Code of Ethics
Financial Management / Internal Controls Policy
Records Retention and Destruction Policy
Board Governance Policy
- Hold Organizational Meeting. Once the articles of incorporation and bylaws have been approved, you will need to hold what the law call an "organizational meeting" to officially launch the non-profit corporation. This is when the board of directors is elected and the bylaws are adopted. (Some states may require that the initial board members are named in the charter document.)
- Hold Your First Board Meeting. After the organization meeting is held (or a written consent in lieu of a meeting is signed), the initial board of directors should meet to ratify the actions of the organizer, adopt accountability policies, set any strategic objectives, formally approve application for tax-exempt status, and take other actions as they determine.
- Prepare & Submit Your IRS Request for Tax Exempt Status. To be considered a non-profit organization, you must apply for tax-exempt status with the Internal Revenue Service (IRS). This can be done by filing Form 1023, “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.”
- Register With State Attorney(s) General. In most states, non-profit corporations are required to register with the state and renew their registration annually. This usually involves filing an annual report and paying a fee. This is particularly important to do before you solicit donations in any state. And, given the nature of the Internet, careful thought should be given to how you word your donation page on your website, and whether it requires registration in many or even all states. (Fortunately, there is a blanket registration process that makes this easy (or, easier, anyway). In any case, it is worth consulting with a non-profit lawyer to decide whether to register in more than the state you are registered in.
What is the Difference Between "Tax Exempt" And Non-Profit?
If you're considering starting a non-profit organization, it is important to understand the difference between forming a non-profit corporation and obtaining tax-exempt status. While the terms are often used interchangeably, they are two distinct processes that have important implications for your organization.
- Forming a Non-Profit. This is a state law matter. A non-profit (or not-for-profit) corporation is a legal entity created to serve a purpose other than making a profit for its principals. For example, this purpose could be anything from providing social services to promoting educational programs to operating an artists' colony or a triathlon program dedicated to improving the health of underserved communities. To form a non-profit corporation, you must follow the incorporation process in the state where your organization will be formed. This process involves filing articles of incorporation and complying with the numerous "corporate formalities" required under state law.
- Obtaining Tax-Exempt Status. This is a federal law matter. Tax-exempt status refers to exemption from federal income taxes granted by the Internal Revenue Service ("IRS") to qualifying organizations. This exemption is based on the qualifying purposes of the organization and the activities the organization will engaged in to further those purposes. The most well-known and common exemption is given under section 501(c)(3) of the Internal Revenue Code. To obtain 501(c)(3) status, a non-profit corporation or other qualifying organization must submit a detailed application to the IRS, possibly go through one or more rounds of questions from and IRS-appointed examiner, and finally be recognized as a tax-exempt organization with a "Determination Letter." This designation allows the organization to be exempt from federal income tax and also enables donors to make tax-deductible contributions to the organization.
What Kinds of Tax-Exempt Purposes Can A 501(c)(3) Have?
Under section 501(c)(3) of the Internal Revenue Code, a tax-exempt organization must be organized and operated exclusively for one or more of the following purposes:
Charitable. According to the IRS, "[t]he term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency."
Educational. The organization is organized and operated primarily for educational purposes, including the instruction or training of individuals to improve or develop their capabilities.
Religious. The organization is organized and operated for religious purposes, including the promotion of a particular faith or belief system.
Scientific. The organization is organized and operated for scientific purposes, including the promotion of scientific research or education.
Literary. The organization is organized and operated for literary purposes, including the promotion of literature, writing, or journalism.
Testing for Public Safety. The organization is organized and operated for testing products for public safety or for the improvement of public health.
Fostering National or International Amateur Sports Competition. The organization is organized and operated for fostering national or international amateur sports competition.
Preventing Cruelty to Children or Animals. The organization is organized and operated for the prevention of cruelty to children or animals.
What Kinds of Tax-Exempt Statuses Are There?
In addition to the familiar tax-exempt status under Section 501(c)(3), the Internal Revenue Code provides for many other different types of tax-exempt statuses for organizations. In fact, in addition to the 501(c)(3) status discussed above, the IRS recognizes approximately 30 others; and, while each offers its own benefits, none is nearly as desired as 501(c)(3). That said, under Section 501 of the Internal Revenue Code, in addition to 501(c)(3), tax exempt statuses under Sections 501(c)(4), 501(c)(5) and 501(c)(6) are also somewhat common ... even if far less so than 501(c)(3). But, these other statuses exist because there are other kinds of organizations that do not qualify for 501(c)(3), but which the federal government has still determined offer unique benefits to society and are thus to be given special treatment.
Contact a corporate attorney with relevant experience with not-for-profit corporations if you are contemplating starting a new non-profit organization or charitable organization, or if you are a decision maker for an existing charitable organization and are concerned about either contracting arrangements with outside, third parties or about good organizational housekeeping, regulatory compliance, or fiduciary responsibilities. Make an appointment now for a free consultation.
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