At this point in your planning you know what your general goal is for your non-profit, but now you need to put it in writing in a way that is clear, concise, and answers the question about why you started the non-profit. Take care in constructing your mission statement, as it will serve as guidance to everyone who chooses to work with you in the future. The statement should be no more than a few sentences. After you have firmed up your mission statement, you can begin working on a draft of your purpose. Your purpose outlines the more specific tasks that your non-profit will be engaged in. While the mission statement responds to the “why” question, the purpose responds to the “how”.
Recruit a Board of Directors
Your board serves an important purpose both legally and as a guide to keeping the non-profit’s activities in line with the mission. Most importantly, your board must share your passion for the mission. Ideally, your board includes people who are energetic and well-connected in their communities, and together represent a diverse palate of resources and opinions. All of your board members must understand the importance of fundraising to furthering the non-profit’s mission and be willing to pitch in to the fundraising effort. The number of directors on the board is up to you, as long as it meets the minimum mandated by your state. For your initial board, it is not necessary to follow a specific process while recruiting- you may only be able to get volunteers at this point. Make sure your board understands their duties, length of term, and expected time commitment.
Choose a Name and Register With the State
Your state’s Secretary of State web page will provide the necessary information and forms to move forward in the process of choosing and registering a name. You can often search in a database of registered names to ensure your name isn’t already in use. Pay special attention to the rules on renewing the name- you don’t want someone else to pick it up because your paperwork is late!
Once you have decided to incorporate your non-profit, your next task is to prepare to file with the state government to attain official non-profit corporation status.
The first stage of your preparations includes articulating your purpose as an organization and drafting a mission statement. You also need to recruit a board of directors. Whether you have your new board work together on articulating the purpose/mission statement or you recruit your board based on your pre-drafted purpose/mission statement will vary. You also need to select a name for your non-profit and register it with the state you are filing in.
Once you have those steps completed, the second stage of incorporation is submitting your completed Articles of Incorporation to your state’s Secretary of State. Most states host a website for their Secretary that include PDF forms, samples and instructions. You also must draft your organization’s corporate bylaws. While bylaws are not necessary, they are an important part of obtaining 501(c)(3) status with the IRS. All non-profits must also obtain a federal Employer Identification Number (EIN) to establish a business tax account with the IRS. For those non-profits who qualify for federal tax exemption as a 501(c)(3) organization, additional paperwork is necessary for representation by an agent under power of attorney or to elect to be permitted to make limited expenditures to influence legislation. In addition to the IRS paperwork, you must register within your state for permission to solicit funds for your organization.
After the initial paperwork has been submitted to both the state and the IRS, you must plan to make an annual filing with the IRS for your taxes and with the state for your financial reports. You must review your state’s ethics and accountability laws to ensure you are in compliance. California’s Nonprofit Integrity Act is available here. No other state legislature has yet passed similar legislation, but you can learn more about IRS Form 990 as well as look up your state’s specific codes on the National Council of Nonprofits Ethics and Accountability page.
You can also apply for a bulk mail permit at your local post office for a discount on your outgoing mail expenses. Please see the following blog posts for more details on the aforementioned steps.
A public benefit corporation that files for tax-exempt status under 501(c)(3) to the IRS is further classified into one of two categories: public charities and private foundations. The two classifications differ in the amount and type of paperwork that must be filed to the IRS, and you can read up further on the specifics on the Life Cycle of a Public Charity/Private Foundation page from the IRS.
A public charity normally receives a substantial part of its income, directly or indirectly, from the public or from the government.
A private foundation receives a substantial part of its income from investments and endowments. The income is used to make grants to other organizations, rather than being applied directly to a charitable activity.
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If you have decided to incorporate your non-profit as a public benefit corporation with the ultimate goal of obtaining a 501(c)(3) status and federal tax exemption, please consider the following explanation of one of the terms commonly used in the non-profit lexicon.
The requirements for a federal tax exemption for qualifying as a 501(c)(3) organization are contained in 26 U.S.C. §501(c)(3) state:
“Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.”
Although the organizations qualifying under 501(c)(3) are commonly called charitable organizations, that term is a bit misleading. While a charity is designed to provide an act of kindness or other such gift to a person in need, the term “charitable” encompasses actions beyond acts of charity. The word “charitable” includes every gift for a general public use, for the benefit of an indefinite number of people, and designed to benefit them from an educational, religious, moral, physical or social standpoint. So DO NOT rule out your eligibility under 501(c)(3) because your non-profit is not a charity – the statute allows a wide range of non-profits to qualify for the federal tax exemption. Please continue reading with our next blog post entitled Public Benefit Corporations Qualifying Under 501(c)(3): Public Charity vs. Private Foundation.
Non-profits that choose to incorporate are classified into one of the following three categories. The chosen category must be stated on the Articles of Incorporation that are submitted to the state for filing. The three differ from one another primarily in stated purpose, how their assets can be distributed, and the amount of regulation.
Public Benefit Corporations
A public benefit corporation may be formed for either a charitable or a public purpose, may not distribute assets to members or directors, and are subject to the most extensive regulation.
A public benefit corporation may apply for a federal tax exemption as a 501(c)(3). For more information on which public benefit corporations qualify under 501(c)(3), please read our blog post entitled Considering 501(c)(3)? Charity vs. Charitable.
Mutual Benefit Corporations
A mutual benefit corporation may be formed for any lawful purpose, may distribute assets to members or directors upon dissolution and are subject to less extensive regulation than a public benefit corporation.
A corporation with a public benefit or charitable purpose may file as a mutual benefit corporation to avoid the amount of regulation a public benefit corporation is subject to, but only if the corporations’ assets are not dedicated to a charitable, religious or public purpose. Additionally, if a non-profit corporation wishes to file for a 501(c)(3) tax exemption, they are not eligible as a mutual benefit corporation.
A religious corporation may be formed for a religious purpose, and may not distribute assets to members or directors, but are subject to the least regulation of the three categories.
A Non-Profit organization can be structured in several different ways. Depending on your organization’s liability risk, the type of activities your organization wishes to engage in, and the complexity of your finances, one of the following structures may suit you best:
A corporation is a separate legal entity that has the capacity to sue and be sued, to own property and to make contracts.
A corporation must be registered with the state and requires the most amount of steps to be established or dissolved. The law that governs a corporation is extensive and clear compared to the law governing an unincorporated association.
Members, directors and officers of a non-profit corporation are protected from personal liability for the debts of the corporation.
A trust exists when a person (the trustee) holds legal title to property but is under an obligation to use or hold the property for a charitable purpose. A “charitable purpose” can be religious, charitable, scientific, literary, educational, or to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals.
A trust would be the best option if the organization is primarily intended to hold, manage, or distribute property.
An unincorporated association is the least formal structure, and exists when two or more members with a common purpose mutually agree to engage in a lawful activity.
An unincorporated association, like a corporation, can sue and be sued, enter into contracts, and acquire and hold interest in property.
Unincorporated associations do enjoy some limitation on the liability of the management and staff of the organization, but the extent of personal liability is uncertain and depends on the nature of the situation and whether or not the individual assumed personal liability under the law.
The LLC structure provides personal liability protection for the directors and officers of a non-profit but is easier to file for and manage compared to a corporation.
A non-profit LLC can file for federal tax-exempt status. However, an LLC will only be recognized as tax-exempt in certain situations, such as when the members are exempt organizations themselves. For this reason, the main uses of a non-profit LLCs are by exempt organizations for managing subsidiary and joint-venture activities, as well as for holding title to property.
A corporation is the most commonly chosen form for a Non-Profit, and next I will explain the different types of corporations your Non-Profit can incorporate as.
Now that you have decided to start a non-profit organization, you must consider which legal structure you wish to use. The most common form of non-profit is the non-profit corporation, and later in this blog series I will explain how you can file for incorporation if you wish to do so. If you don’t want to go through the incorporation process, you can consider structuring your non-profit as either an unincorporated association or a trust.
Before you decide which structure is the best for you, consider the differences in choosing between the legal structures. The main reason that a non-profit chooses to incorporate is to protect the management from personal liability from lawsuits or debt. Depending on the type of work your organization will be doing, and the type of assets the organization will be buying or owning, chances are that you will want the legal protection of a corporation. A corporation is a separate legal entity that has the capacity to sue and be sued, to own property and to make contracts. But if the corporation cannot meet its financial obligations, the personal bank accounts of the people in charge of the organization will be protected. Another option for your non-profit is to form a limited liability company (LLC). A LLC offers legal protection similar to that of a corporation but is easier to form and manage.
Once you have engaged in a risk-assessment analysis for your organization’s activities and you have an idea as to how much liability you will be exposed to, you can narrow your entity choice options. If you find that there is some exposure to risk, but perhaps not enough to justify the effort and expense necessary to file for incorporation, you can also consider investing in liability insurance. Other options for minimizing liability include using waivers or operating under an umbrella group that has its own insurance policy. Or you can try to eliminate the risky activities.
Not all business ideas fit squarely in either the for-profit or non-profit realms. Deciding which business model to pursue requires some consideration of your specific situation, including your access to both financial capital and human capital. The most significant benefit to starting your business as a non-profit is the ability to turn your altruistic vision into a means to make a living – you can turn your passion into your career. Beyond that, the realities of operating as a non-profit are for you to consider as you move forward in the choice of entity process:
FAVORABLE TAX TREATMENT
State tax exemptions: Incorporating as a non-profit exempts the organization from certain state sales and use taxes.
Federal tax exemptions: Further qualifying with the IRS as a 501(c)(3) tax-exempt organization allows for exemption from federal corporate and income taxes for most types of revenue, as well as allowing donors to deduct the donations from their taxable income, encouraging the inflow of donations.
Personality of an applicant: In terms of attracting employees, a non-profit has the ability to screen candidates based on their personal convictions for the organization’s mission, ensuring a motivated and dedicated staff.
Qualifications of an applicant: While a non-profit can attract motivated employees, the lack of a competitive benefits package may result in qualified talent looking elsewhere. In addition, the non-profit traditionally has a lot of entry-level and volunteer job duties that are filled by a broad range of candidates.
FINANCING YOUR ORGANIZATION
Fundraising: It is necessary to finance the organization by fundraising rather than traditional product sales.
Grants: A non-profit is eligible to receive government grants, some of which are set aside exclusively for non-profit organizations.
Board of directors: All decisions, both strategically and financially, must be agreed upon by the board of directors. For an entrepreneur with a background in sole proprietorship, this loss of managerial autonomy may be tough to adjust to.
Incorporation: The process to incorporate a non-profit is generally the same as incorporating a traditional for-profit organization, but there are several additional steps, such as including in the bylaws how the board of directors will be elected.
Maintaining state and federal tax exemption: After the additional initial paperwork is filed, there is a lot of paperwork involved in maintaining the non-profit status as the organization’s mission is underway. The additional paperwork is to ensure to the state and to the federal government that the organization’s business activities continue to align with the relevant regulations. The increase in paperwork for maintaining a non-profit status and a 501(c)(3) exemption may require outsourcing the task to an attorney and/or an accountant.
POLITICAL ACTIVITY RESTRICTIONS
Is lobbying a part of the organization’s mission? For an organization that has obtained 501(c)(3) tax exemption, there is a strict limitation to the political activity allowed. If part of the organization’s mission includes lobbying, it is necessary to consult with an attorney to ensure that the non-profit is following the applicable regulations.
These considerations can vary from case to case and may tip the balance in favor of pursuing either a non-profit business model or a traditional for-profit business model. Keep reading The Startup Garage’s blog series on Starting a Non-Profit Organization for more information on how to get your non-profit up and running.