Starting a Nonprofit Organization

Starting a nonprofit is exciting and rewarding, the purpose of any nonprofit organization is generally to improve the quality of life for others at a community, local, state, national, or even global level. These organizations are not dedicated to private or financial gain but to the advancement of public interest.

While starting a nonprofit Charity organization or religious organization is an exciting and rewarding opportunity, it can also be challenging.

A nonprofit organization commonly performs some type of public or community or religious benefit, without the purpose of making a profit. There are various categories of nonprofits recognized by the Internal Revenue Service (IRS): 

A nonprofit is an organization that qualifies for tax-exempt status under the regulations outlined by the Internal Revenue Code. Each category has different tax benefits and requirements. While the majority of nonprofits are classified under 501(c)(3) of the IRS Code as charitable organizations.

Types of Nonprofits

Charitable or Religious Organizations

charitable organization or charity is a non-profit organization whose primary objectives are philanthropy meaning they desire to promote the welfare of others, expressed especially by the generous donation of money to good causes. And social well-being (e.g. charitable, educational, religious, or other activities serving the public interest or common good).

Examples: Charitable Organization:

The exempt purposes set forth in Internal Revenue Code section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and the prevention of cruelty to children or animals. 

The 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; erection or maintenance of 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.

Social welfare organizations

social welfare organization is a nonprofit civic organization operated under Internal Revenue Code section 501(c)(4)exclusively for the promotion of social welfare; and. local associations of employees whose earnings are devoted to charitable, educational, or recreational purposes.

Examples: Some nonprofit organizations that qualify as social welfare organizations include:

  • An organization operating an airport that serves the general public in an area with no other airport and that is on land owned by a local government, which supervises the airport’s operation,
  • A community association that works to improve public services, housing, and resi­dential parking; publishes a free commu­nity newspaper; sponsors a community sports league, holiday programs and meetings; and contracts with a private se­curity service to patrol the community,
  • A community association devoted to preserving the community’s traditions, ar­chitecture and appearance by represent­ing it before the local legislature and administrative agencies in zoning, traffic and parking matters,
  • An organization that tries to encourage in­dustrial development and relieve unem­ployment in an area by making loans to businesses so they will relocate to the area and
  • An organization that holds an annual festi­val of regional customs and traditions.

Other Types of non-profits:

  • Labor and agricultural organizations
  • Business leagues
  • Veterans organizations

Why Incorporate a Nonprofit ?

For organizations seeking tax exemption, incorporation is the first step . … The primary reasons for incorporation are limited liability protection of the directors, credibility, and tax purposes.

Forming a nonprofit corporation, a legal entity, is different from federal or state tax exemption. Incorporating a non-profit is similar to creating a regular corporation except that you have to take the extra steps of applying for tax-exempt status with the IRS and their state tax division.

How to Incorporate a Nonprofit:

  • Choose a business name:
    Check the state-by-state information on the various laws that apply to name a nonprofit in your state.
  • Appoint a Board of Directors:
    Draft your bylaws with guidance from your Board of Directors. These are the operating rules for your nonprofit.
  • Decide on a legal structure:
    Choose whether your organization will be a:
  • Trust:
    In general, a trust is a relationship in which one person holds title to the property, subject to an obligation to keep or use the property for the benefit of another. A trust is formed under state law. You may wish to consult the law of the state in which the organization is organized. Note that for a trust to qualify under section 501(c)(3) of the Code, its organizing document must contain certain language. Publication 557 contains suggested language.
  • Corporation:
    In general, a corporation is formed under state law by the filing of articles of incorporation with the state. The state must generally date-stamp the articles before they are effective. You may wish to consult the law of the state in which the organization is incorporated. Note that for a corporation to qualify under section 501(c)(3) of the Code, its charter or articles of incorporation must contain certain language. Publication 557 contains suggested language.
  • Association:
    In general, an association is a group of persons banded together for a specific purpose. To qualify under section 501(a) of the Code, the association must have a written document, such as articles of association, showing its creation. At least two persons must sign the document, which must be dated. The definition of an association can vary under state law. You may wish to consult the law of the state in which the organization is organized. Note that for an association to qualify under section 501(c)(3) of the Code, its articles of association must contain certain language. Publication 557 contains suggested language.
  • File your incorporation paperwork:
    You must next file formal paperwork or articles of incorporation, and pay a small filing fee to your state. State law may require charitable organizations to register and file periodic reports.
  • Apply for tax-exempt status:
    A nonprofit organization may be eligible for exemption from federal income tax to determine your eligibility you must Apply for Section 501(c)(3) Status.  
  • Obtain necessary licenses and permits:
    Check with your state, federal and local authorities for the nonprofit licenses and permits needed to comply with federal, state, and local rules?

Benefits and Responsibilities Of 501(c)3 Tax Exemption

Before you can be sure that tax-exempt status is right for you, you’ll need to understand some of the benefits and responsibilities that come with tax-exemption, the steps required to become tax-exempt, and the rules your organization must follow after you apply.

You must admit there are a lot of financial benefits to applying for tax exempt:

  • exemption from federal income tax
  • contributions to your organization are tax-deductible
  • you may be exempt from paying state income, sales, and employment taxes.
  • you have access to reduced postal rates
  • you are exempt from paying federal unemployment tax, and
  • you can receive tax-exempt financing.

With all these great benefits, comes great responsibilities.

Responsibilities

Responsibilities include recordkeeping, certain annual filing requirements, and disclosure requirements.

Recordkeeping
• Keep detailed recordkeeping
o Financial
o Non-financial

You should keep detailed records, including records you’d probably want to keep for any business. For example, you’re required to keep books and records detailing all activities, both financial and non-financial.

Annual Filings can include
• Form 990
• Form 990-EZ
• Form 990-N (Post Card)

The IRS doesn’t need to see all of your records on a regular basis. But the records you keep will allow you to have everything you may need to submit your required annual filings.

Most public charities recognized as tax-exempt under section 501(c)(3) of the Code are required to file an annual information return: either Form 990 or Form 990-EZ.

Certain categories of organizations are exempted from filing Form 990 or Form 990-EZ – including churches and very small organizations. However, most small organizations that aren’t required to file Form 990 or 990-EZ must file an annual electronic notice, the Form 990-N, also known as the e-Postcard.

Public Disclosures

There are specific records that need to be made public upon request. Section 501(c)(3) organizations must make their exemption application and the three most recent annual information returns (your Form 990s) available to the public, upon request and without charge (except for a reasonable charge for copying). If your organization has $1,000 or more in gross income from an unrelated business, it must file Form 990-T,
Exempt Organization Business Income Tax Return, and that must be made available as well.

You should make the documents available at the organization’s principal office during regular business hours and requests can be made in person or in writing

The Tax-exempt 501(c)(3) Process

Tax-exempt organizations are commonly referred to as 501(c)(3)s. 501(c)(3) includes both public charities and private foundations. The 501(c)(3) is a process with a life cycle, there are 5 steps to a life cycle of a tax-exempt organization:

  1. Starting out number
  2. Applying for exemption number
  3. Require filings
  4. Ongoing compliance and
  5. Significant events

The first two steps, starting out and applying for exemption, are unique because you should only do them once for any single organization. For the purposes of this tutorial, we’re only going to concentrate on creating and maintaining one organization at a time.

What’s different about the other three steps is that a single organization has to deal with each of those issues multiple times. Some required filings are annual, for example.

Lifecycle – Starting Out

When you’re creating your organization, you may need to create organizing documents based on the requirements of your state. You’ll need these if you apply for tax exemption. If you’d like to apply for tax exemption, which is a federal level status, you’ll need to acquire an employer identification number, or EIN.

Even if you have no employees, you still need an EIN. Your EIN is similar to your personal social security number, only it’s for your business. It identifies you to the IRS.

Next, you need to determine what type of tax-exempt organization you have. You’ll need this information when you apply for tax-exempt status.If you decide to apply, you’ll probably need more information on the EIN.

Lifecycle – Applying for Exemption

  • Apply to the IRS for Tax-Exempt Status
  • Form 1023

To apply for tax exempt status, you’ll need to fill out Form 1023 or Form 1023-EZ

You may be eligible to file Form 1023-EZ, a streamlined version of the application for recognition of tax exemption. You must complete the Form 1023-EZ Eligibility Worksheet in the Instructions for Form 1023-EZ PDF to determine if you are eligible to file this form. If you are not eligible to file Form 1023-EZ, you can still file Form 1023.

– Lifecycle – Required Filings

Once the IRS has granted your organization tax-exempt status, it’s important that you meet the mandatory annual filing requirements. You’ll need to file annual exempt-organization returns, and you could be required to file unrelated business income tax filings and other returns and reports to StayExempt.

Lifecycle – Ongoing Compliance

An organization can avoid jeopardizing its taxexempt status. To do that, you’ll need to understand employment taxes, public disclosure requirements, and other ongoing compliance issues.

Lifecycle – Significant Events

Significant events all have to do with your tax-exempt status. The events include, but aren’t limited to:

• Audits
• Private letter rulings and
• Termination proceedings

Preparing to Apply for Tax-Exempt Status

An organization must have one or more specific purposes to qualify as tax-exempt.

A 501(c)(3) organization (also known as a public charity) is one that is organized and operated exclusively for purposes that are:
• Religious
• Charitable
• Scientific
• Testing for public safety
• Literary or educational
• Designed to foster national or international amateur sports competition, or
• For the prevention of cruelty to children or animals.

There are many kinds of organizations that fall under these categories. For example, organizations that provide relief to the poor, distressed or underprivileged; those that lessen neighborhood tensions; or those that defend human and civil rights usually qualify as charitable organizations. Educational organizations can be schools, museums, symphony orchestras, training for the unemployed, dance classes, and zoos.

Apply for an EIN

The first step is to apply for an EIN, there are a number of ways you can apply for an EIN. The fastest is to go to the IRS website or call our toll-free number and get an EIN you can use immediately. You can also fax your Form SS-4, Application for Employer Identification Number, and you’ll receive your EIN within 4 business days. or do it the old-fashioned way by completing Form SS-4 using the form’s instructions and mailing it to:
Internal Revenue Service Center
Attn: EIN Operation
Cincinnati, OH 45999
Fax-TIN: 859-669-5760
Visit the IRS website for more information

Organizing Documents

Next, you’ll need to gather your organizing documents. An organization can’t qualify for exempt status without an organizing document. To qualify for exemption under Section 501(c)(3), the organizing document must contain three provisions.

Sample-Organizing-Documents2021-1

By-Laws

By-laws are an organization’s internal operating rules. Federal tax law
doesn’t require specific language in the by-laws of most organizations. However, state law may require you to have by-laws, so it is a good idea to contact your state to find out the specific requirements.

Organizational and Operational tests

All types of tax-exempt organizations must meet the Organizational and Operational tests

Organizational Test:

The Organizational Test is used to determine if the organization is
properly organized. To pass this test the organization must:
• Limit its purposes to one or more of the exempt purposes listed in Code section 501(c)(3)
• Not permit the organization to engage in a nonexempt activity and
• Assets of the organization must be permanently dedicated to an exempt purpose.

If you write your organizing documents correctly and include these provisions you need to have in your organizing documents, this test will be easy to pass.

The Operational Test

The operational test covers how your organization is actually operated. To pass the operational test, your organization must show that its principal activities will be to further its exempt purposes. Conversely, your organization has to limit the participation in certain kinds of
activities and absolutely refrain from others.

Though this test is conducted when you’re first applying for tax-exempt status, if the balance of your activities gets out of line after you receive your status, or your organization engages in prohibited activities, you can lose your tax-exempt status and be subject to both taxes and penalties.
Some prohibited activities including intervening in political campaigns.

If your organization openly endorses a candidate, that’s a prohibited activity. There are many other kinds of political (and other) activities that aren’t allowed which could possibly jeopardize your tax-exempt status such as unrelated business income, required discourses, and employment issues.

Public Charity versus Private Foundation

Statutory Charities
• Churches
• Schools
• Organizations providing medical or hospital care (including medical education and research)

Other Public Charities
• Organizations that receive significant public support
• Organizations that provide support to other public charities.

When an entity qualifies as a tax-exempt organization, the IRS presumes
it’s a private foundation unless it can show that it’s a public charity.

The main difference between a public charity and a private foundation is where the money comes from. Generally, a public charity has a broad base of support while a private foundation has very limited sources of support. There are also different tax rules – so, for example, public foundations are subject to excise taxes that aren’t imposed on public charities. There are more differences – there are more difference but for now, I will focus on public charities.

Some organizations automatically qualify as public charities based on the Code, so they’re called Statutory Public Charities. Some examples are churches, schools, and organizations providing medical or hospital care (including medical education and research).

These organizations still have to pass the Operational and Organizational tests. Or, if your organization receives significant public support or it provides support to other public charities, you may qualify that way. Otherwise, you’ll have to demonstrate you are a public charity by other means.

Grants, Loans, and Other Assistance for Faith-Based Nonprofits

While individual donors make up the largest contributors to nonprofit organizations, federal, state, and local governments offer grants, loans, and programs to support funding. Former President Bush started the faith-based funding initiative to make government funding easily available to religious organizations.

The Faith-Based and Community Initiative helps Faith-based and community organizations get funding with less stress! Faith-based and community organizations (FBCOs) have a long tradition of helping Americans in need and together represent an integral part of our nation’s social service network.

President Bush believed that besides being inherently unfair, that too often, the Federal government has put in place complicated rules and regulations preventing FBCOs from competing for funds on an equal footing with other organizations. He believed such an approach can waste tax-payer dollars and cut off the poor from successful programs and that Federal funds should be awarded to the most effective organizations—whether public or private, large or small, faith-based or secular—and all must be allowed to compete on a level playing field. Thus the Faith-Based and Community Initiative was birthed.

The Faith-Based and Community Initiative

President Bush created the White House Office of Faith-based and Community Initiatives and Centers for Faith-Based and Community Initiatives in various Federal agencies to strengthen and expand the role of Faith-based and community organizations in providing social services. The Federal government has worked to accomplish this mission through an array of regulatory and policy reforms, legislative efforts, and public outreach to Faith-based and community organizations.

Additionally, by making information about Federal grants more accessible and the application process less burdensome, the Initiative has empowered Faith-based and community organizations to compete more effectively for funds.

The Initiative Focus

  • Identifying and eliminating barriers that impede the full participation of Faith-based and community organizations in the Federal grants process.
  • Ensuring that Federally-funded social services administered by State and local governments are consistent with equal treatment provisions.
  • Encouraging greater corporate and philanthropic support for FBCOs’ social service programs through public education and outreach activities.
  • Pursuing legislative efforts to extend charitable choice provisions that prevent discrimination against faith-based organizations, protect the religious freedom of beneficiaries, and preserve the religious hiring rights of faith-based charities.

Increasing Accessibility

The underlying premise of the Former President’s Initiative is that a more open and competitive Federal grant-making process will increase the delivery of effective social services to those whose needs are greatest. Thus, Federal agencies have successfully undertaken a variety of measures to do this, including:

  • Making information more accessible
  • Providing training and technical assistance
  • Broadening program eligibility
  • Changing regulations
  • Streamlining grant applications
  • Focusing on the unique needs of grassroots organizations; and
  • Eliminating preferential treatment for existing and former grantees

Funding Opportunities for Faith Based Organizations

The Centers for Faith-Based and Neighborhood Partnerships, each center forms partnerships between its agency and faith-based and neighborhood organizations to advance specific goals, and all of the Centers are coordinated by the White House Office of Faith-Based and Neighborhood Partnerships. The White House Office of Faith-Based and Neighborhood Partnerships forms partnerships between government at all levels and non-profit organizations, both secular and faith-based, to more effectively serve Americans in need.

Federal agencies offering Faith-Based and Neighborhood Partnerships:

  • The U.S. Department of Agriculture
  • The U.S. Department of Commerce
  • The U.S. Department of Education
  • The U.S. Department of Health and Human Services (HHS)
  • The U.S. Department of Housing and Urban Development (HUD)
  • The U.S. Department of Homeland Security (DHS)
  • The U.S. Agency for International Development
  • The Small Business Administration
  • The U.S. Department of Labor
  • The U.S. Department of Justice
  • The U.S. Department of Veterans Affairs (VA)