My clients have many reasons for forming nonprofits. Sometimes it is the result of a traumatic event, like the death of a parent or child. Other times the client has an idea that addresses a societal problem or benefits an underserved community. Some clients have an idea for a nonprofit that is adjacent to a for-profit business that is already operating. Whatever the reason, my role is to counsel clients on the legal aspects of starting a nonprofit and, once formed, to comply with all legal obligations and operate it in a manner that successfully carries out its charitable mission. My focus in this article is on the formation of a public charity that qualifies for federal tax exemption under Code Section 501(c)(3), which is what is often thought of as a “nonprofit .”This category includes charitable organizations, hospitals, churches, and schools that are primarily supported through public donations and grants.
Pre-Formation Planning. Before taking any legal steps to form a nonprofit, there are a number of non-legal issues to consider. Will you be able to build a strong, motivated Board (let alone find individuals to serve on the Board)? Do you have a business plan? Is this nonprofit addressing a new need rather than duplicating the efforts of an already existing nonprofit? Will the nonprofit be able to seek donors and funding in an already-crowded nonprofit space? Will the community support the nonprofit long-term? If the answer to some or all of these questions is “no,” it may mean that your philanthropic and altruistic goals may be better served by exploring other options. If you can answer “yes,” it’s time to involve an attorney and accountant who are well-versed in nonprofit issues.
Entity Formation. The first step in forming a nonprofit is to form a nonprofit corporation or, in some cases, a nonprofit limited liability company. This generally involves filing Articles of Incorporation with the state where the nonprofit will be domiciled, obtaining an EIN/TIN from the Internal Revenue Service, and preparing important legal documents like Bylaws and incorporation consents. Once the Articles of Incorporation are filed with the state, the nonprofit exists. However, unless you move on to the next step, the nonprofit is subject to federal income tax.
Federal Tax Exemption. Applying for federal income tax exemption is how a nonprofit becomes commonly known as a 501(c)(3). An exemption is obtained by filing an online application with the IRS. The application includes disclosing the nonprofit’s governance documents, identifying the individuals associated with the nonprofit, describing the nonprofit’s activities, and disclosing additional information about the organization. The application also requires a proposed budget for several years into the future.
Other Tax Exemptions and Registrations. Other tax exemptions are available to certain charitable nonprofits, including exemptions from sales tax, property tax, and business privilege tax. In addition, most states require nonprofits that solicit donations from their residents to register in that state. In today’s world, where donors across the country can be reached with the click of a button, this often means registering in multiple states.
Governance. Now you have a nonprofit that has the appropriate tax exemptions in place. What’s next? Every nonprofit corporation is required to be overseen by a Board of Directors or Board of Trustees, as well as officers who are appointed by the Board. Nonprofits should hold regular meetings where the actions and votes of the Board are documented in meeting minutes, and an annual meeting should be held for the election of Board members and officers.
Operating Restrictions. Nonprofits that qualify as 501(c)(3) organizations are highly regulated entities. Strict rules apply to both their activities and their governance. No part of the activities or the net earnings can unfairly benefit any director, officer, or private individual. Reasonable salaries are permitted, but excess revenue cannot otherwise be distributed to individuals associated with the nonprofit. All of a nonprofit’s assets are permanently dedicated to a charitable purpose. In the event that a 501(c)(3) organization must cease operations, all assets remaining after debts are paid must be distributed for a charitable purpose. Finally, lobbying, and other legislative activity are highly scrutinized and should generally be avoided. Intervention in political campaigns or the endorsement/anti-endorsement of candidates for public office is strictly prohibited.
With a little pre-planning and guidance, an attorney can help make your charitable mission a successful reality.
