Launching a nonprofit organization offers significant rewards, benefiting both founders and society broadly. Yet establishing such an entity, similar to launching a for-profit enterprise, requires thorough planning and due diligence.
Counsel for nonprofit founders must not only establish the entity under applicable state law but also structure the organization and its governing documents to support the client’s intended activities and, where applicable, qualify for federal and state corporate tax exemption.
Understanding the Basics of Nonprofit Formation
This article demystifies the formation process and provides an overview of the steps involved in creating a nonprofit corporation, from incorporation to obtaining an EIN, drafting corporate documents, and applying for recognition of federal tax-exempt status.
Nonprofits come in all shapes and sizes and can be formed in any state, the District of Columbia (DC), and all territories of the United States. For brevity, this article focuses primarily on forming a DC nonprofit corporation, though the incorporation process is similar in most other jurisdictions.
Defining Mission and Structure
1. Identify the Nonprofit’s Mission and Organizational Structure
Before preparing the nonprofit’s initial corporate documents, counsel should work with the client to identify the nonprofit’s proposed activities, anticipated funding sources, governance structure, and intended federal tax-exempt classification.
At a minimum, they should understand the following:
- what activities the nonprofit will conduct
- who will benefit from those activities
- where the nonprofit will operate
- how the nonprofit will be funded
- whether the nonprofit will have statutory members (i.e., individuals or entities who have some level of control and voting power within the nonprofit, such as electing the nonprofit’s directors and officers or the ability to approve a merger or dissolution)
- whether the nonprofit will solicit contributions from the public
- whether the nonprofit will charge for goods or services
These are not merely business planning considerations. They directly inform the nonprofit’s appropriate entity structure, type of federal tax exemption, state and local tax obligations, licensing requirements, and charitable solicitation registration requirements.
One recommendation is advising the client to develop a detailed business plan covering the above and other information about the nonprofit, its operations, and finances. Doing this work early can save time and expense later in the formation process.
Additionally, they should discuss the composition of the nonprofit’s initial board of directors. A nonprofit corporation should have at least three directors (but preferably five or more) who will manage and oversee the nonprofit’s affairs.
In many jurisdictions, the initial directors must be listed in the nonprofit’s articles of incorporation, so identifying them early is key.
At this stage, the client should also consider who will serve as the nonprofit’s initial corporate officers (e.g., president, secretary, treasurer). These individuals are responsible for the nonprofit’s day-to-day activities, so they should be genuinely committed to its mission.
Incorporation and EIN Essentials
2. Prepare and File Articles of Incorporation, and Obtain an EIN
After addressing these preliminary items, the next step is to prepare and file the articles of incorporation. These documents state the nonprofit’s name, initial directors, office address, registered agent information, whether it will have statutory members, and other basic details.
To qualify for federal tax exemption, some nonprofits must also include specific IRS-required language in their articles. For example, a 501(c)(3) entity must include a purposes clause and a dissolution clause that comply with the federal Internal Revenue Code and corresponding U.S. Treasury Regulations.
Since the articles become public record once accepted, it’s advisable to keep them concise, disclosing only the legally required information and what’s necessary for federal tax exemption.
Once drafted, the articles must be submitted with a state filing fee to the corporation regulator in the jurisdiction of incorporation. In DC, this is the DC Department of Licensing and Consumer Protection.
Upon approval, the department (or other applicable regulator) issues a certificate of incorporation, officially recognizing the nonprofit as a corporation.
Some states also require publication of certain information or a copy of the articles in a local newspaper. Always reference the jurisdiction’s nonprofit corporation statutes to ensure compliance with all requirements.
Immediately after incorporation, counsel should obtain a federal employer identification number (EIN) from the IRS for the nonprofit. This is done by filing IRS Form SS-4 online, which typically takes ten to twenty minutes.
The EIN is essential for opening a bank account, registering for state-level taxes, and applying for federal tax-exempt status, so securing it early is important.
If the nonprofit plans to operate as a 501(c)(4) organization, counsel should prepare and file IRS Form 8976 within sixty days of incorporation to notify the IRS. Failure to do so may result in financial penalties.
Bylaws, Policies, and Meetings
3. Draft Bylaws, Policies, and Organizational Meeting Documents
After incorporation, counsel should prepare bylaws and governance policies for the nonprofit.
The bylaws detail the nonprofit’s internal structure and operating procedures, including rules for director and officer elections, meetings, board committees, and other business conduct.
They should align with the articles of incorporation and the jurisdiction’s nonprofit corporation statutes.
Standard policies include confidentiality, anti-discrimination and harassment, joint venture, whistleblower protection, executive compensation, and conflict of interest.
Additional policies may be needed based on the nonprofit’s activities, such as a scholarship policy for scholarship programs or a foreign transactions due diligence policy for international aid.
Many jurisdictions, including DC, require the board to hold an initial organizational meeting after incorporation. Here, the board adopts bylaws, policies, and handles other formalities like setting a fiscal year, electing officers, and opening a bank account.
This is often done via unanimous written consent—a document signed by all directors—instead of a meeting. Counsel should prepare draft organizational meeting minutes or a consent document to guide the client.
Securing Tax-Exempt Status
4. Apply for Recognition of Federal Tax-Exempt Status
Once incorporated, with bylaws, policies, and an organizational meeting completed, the next step is to file a federal tax exemption application.
There are four applications: IRS Form 1023, IRS Form 1023-EZ, IRS Form 1024, and IRS Form 1024-A. The appropriate form depends on the nonprofit’s size and the type of exemption sought.
For instance, IRS Form 1024-A is for 501(c)(4) status, while IRS Form 1023 is for 501(c)(3). IRS Form 1023-EZ is also for 501(c)(3) but is for smaller, simpler nonprofits.
These applications (except 1023-EZ) are detailed, requiring a thorough explanation of the nonprofit’s operations, finances, and plans. This includes a description of activities and financial projections for the first few years.
Being detailed maximizes approval chances and minimizes IRS inquiries. The application is filed online with a mandatory user fee, and processing typically takes six to eight months.
If filed within twenty-seven months of incorporation, the exemption is retroactive to the incorporation date, making prior donations tax-deductible once approved.
5. Register for DC Taxes and Apply for Licenses and Charitable Solicitation, if Necessary
As a corporation, the nonprofit is subject to state and local taxes, which vary by jurisdiction. In DC, if it has employees, it must withhold DC-level income tax from wages and register with the DC Office of Tax and Revenue (DC OTR) using Form FR-500.
In DC, certain 501(c)(3) organizations may qualify for exemptions from income, franchise, sales, use, and personal property taxes by filing Form FR-164 with the DC OTR.
If the nonprofit sells goods or services, it must obtain a Basic Business License from the DC Department of Licensing and Consumer Protection.
Most jurisdictions require charitable organizations to register for charitable solicitation if they solicit donations within that state. In DC, this involves applying for a Basic Business License under the “Charitable Solicitation” category.
To maintain this registration, the nonprofit must file annual reports, including its most recent IRS Form 990. The definition of “solicitation” varies by state, and even a website “donate” button may trigger registration requirements.
Counsel should determine registration needs before solicitation begins, as rules differ by jurisdiction. Third-party compliance vendors can assist with this process if needed.
Leave a Reply