So, you’re interested in learning how to start a nonprofit? Founding a nonprofit organization (NPO) is a philanthropic, charitable endeavor. This type of organization works in diverse ways to achieve the betterment of society. Whether conducting scientific research, starting an animal rescue center, offering support to low-income families and individuals, there’s no doubt these types of businesses are beneficial in creating a better world. Yet, establishing a nonprofit isn’t exactly easy. While founders will walk through many of the same steps required for for-profit business owners, there are several measures people must take in order to receive nonprofit tax exemption. For this reason, it’s important to learn and fulfill each phase of how to start a nonprofit so you can successfully begin operation.
In this article, find out everything you need to know before fundraising, collecting donations, and applying for grants. Discover how to incorporate a nonprofit company for legal protection and become a 501(c)(3) organization (or receive another form of tax exemption).
What is a Nonprofit Organization?
Nonprofit Definition
A nonprofit is an organization that does not operate with the purpose of generating a profit. Due to their socially beneficial work, nonprofits are eligible for local, state, and federal tax exemption. Once an organization receives tax exemption status, donations and charitable contributions are also tax-deductible. Unlike other legal business structures, nonprofits do not have private business owners or shareholders, and cannot be sold. Additionally, money raised, donated, or granted can only be used for keeping the organization running.
Common types of nonprofits include:
- Schools
- Churches
- Charities
- Museums
- Food banks
- Animal shelters
- Political parties
- Public or private foundations
- Social advocacy and welfare organizations
- Veterans organizations
- Business leagues
- Labor and agricultural organizations
Learn more about the different types of nonprofits eligible for tax exemption, here.
Famous examples of nonprofit institutions:
- Metropolitan Museum of Art
- American Red Cross
- PBS
- NPR
- Feeding America
- National Geographic
- World Wildlife Fund
- Mayo Clinic
- Alzheimer’s Association
- Doctors Without Borders, USA
How Founders and Employees Receive Pay
Because staff members with active roles in the company are vital to keeping the organization operating, they can receive a taxable salary. This excludes members on the board of directors. With that being said, founders aren’t given a license to pay themselves any salary they desire. The IRS states salary must be reasonable compensation, which is defined as “the value that would ordinarily be paid for like services by like enterprises under like circumstances.” In short, salaries must be in the same range as people working for similar types of organizations. Overall, the main goal should be reinvesting any funds received into fulfilling the organization’s mission rather than distributing salaries. The IRS will take note of nonprofits who violate this by operating with the intent of turning a profit.
How to Start a Nonprofit: Steps to Incorporation
While a nonprofit does not have to be incorporated, doing so is a great business practice. It protects the founders by separating the business and the people who establish the business from one another. This is not the case with sole proprietorships, which face unlimited liabilities. A sole proprietorship is also not a legal entity, which can limit the public’s perception of the legitimacy of those learning how to start a nonprofit.
Not registering the organization as a corporation can affect your ability to gather donations and receive charitable gifts. Tobias Mathis for Anderson Law Group explains to those figuring out how to start a nonprofit: “file a corporation with the state, then file for exemption as a corporation with the federal government.” This makes the corporation not a C or S corporation, but a third type of corporation—exempt. Should a nonprofit choose to not seek tax exemption, then taking the following steps are not necessary.
Step 1: Select a Name
The regulations vary state-by-state when it comes to naming a nonprofit. Typically, the general rule is you cannot operate with the same name as a business in your state. Nevertheless, check with the state where you’re incorporating the organization to learn their guidelines for naming.
To check or apply for a registered trademark, visit the U.S. Patent and Trademark website. Should your desired name be available, go ahead and secure your website domain name on sites like GoDaddy, Squarespace, or Google Domains.
Step 2: Choose the Board of Directors
By law, incorporated organizations, excluding LLCs, must have a board of directors. It’s important to spend time seriously selecting members since they will be the governing body of the nonprofit. Founders should choose a group of people who seek to serve one unified, collective mission. At a minimum, a board consists of three people, which is the IRS’s standard requirement. Board members are not required to serve indefinitely. Their usual term ranges from one to five years. While the IRS and most state laws mandate board members meet once per year, most boards meet quarterly to discuss and make important decisions about the organization.
Step 3: Create Bylaws
After establishing the board of directors, the first order of business is for them to begin drafting the nonprofit’s bylaws. Bylaws legally define the organization’s operating rules. In essence, they dictate how the board conducts the nonprofit.
Bylaws cover:
- Who governs the nonprofit
- When the board meets
- How meetings are conducted
- The number of directors and officers
- Rules for appointments or elections
- Terms of decision-making and voting
- Terms of service
- Language that affirms that the organization’s purpose is not intended for making and distributing profit
- Rules for resolving conflict
- Instructions for amending the bylaws
Additionally, ensure the bylaws are in alignment with the laws of the state you’re registering in. To find this out, check with the office of your Secretary of State.
Step 4: File Paperwork to Register as a Corporation
When registering a nonprofit, states require a completed articles of organization form. Obtain one by visiting your Secretary of State’s website or office. This form includes information about the company’s name, its location, the purpose of the business, and its management type. You’ll also need to provide the name and address of your registered agent. This person acts as a liaison for sending and receiving legal documents. Furthermore, states typically require a filing fee during this part of the process. Costs vary from state-to-state.
Step 5: Receive an EIN number and Start a Business Bank Account
Once the state mails a certificate of approval of incorporation, get a free employment identification number EIN number with the IRS. The IRS automatically generates these numbers after a person fills out an application. This is how the federal government identifies businesses for federal tax purposes. It is also needed before hiring employees, starting a business bank account, and reporting taxes.
After you’ve received an EIN number, open a business bank account. This is critical in properly managing the organization’s funds. To open an account, you’ll need two forms of ID, your EIN verification letter, and the nonprofit’s articles of organization. Additionally, think about selecting a bank geared toward helping nonprofits. PNC Bank, TIAA, Wells Fargo, Bank of America, and BB&T Bank are all banks that offer special discounts, rates, and savings to nonprofit organizations. Also, check with local banks to see what kind of offers they provide for nonprofits. Doing so can be a great opportunity to establish important business relationships within your community.
Step 6: Get Any Required Federal, State, and Local Licenses and Permits
Finally, before operating any type of organization, always make sure you’re legally able to proceed. For example, be sure you’ve applied and received all of the federal, state, and local licenses required for operation.
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How to Receive Tax Exemption
After incorporating the organization, apply for tax exemption status. Tax exemptions depend on the type of nonprofit founded. While there are nearly 40 different classifications, most NPOs fall under the same category. According to the 2017 Internal Revenue Service Data Book, 78 percent of nonprofits were classified as 501(c)(3) organizations. This category serves purposes involving education, religion, charity, science, literature, public safety, amateur sports, and the prevention of child or animal abuse. If you’re just learning how to start a nonprofit and your organization does not support any of these causes, visit this reference chart on nonprofit classifications.
Once the founder determines the nonprofit’s classification, apply for tax exemption with the IRS. The IRS breaks tax exemption paperwork into three different groups: 501(c)(3)’s, 501(c)(4)’s, and all other nonprofit and tax-exempt organizations. Begin the federal tax exemption application process, here.
The Approval Process
Don’t expect an immediate response from the IRS. For example, on average, the approval process for 501(c)(3) organizations takes between 2 and 12 months according to 501c3.org. It is recommended that fundraising does not happen until after IRS approval. If the organization is denied tax exempt status, it could negatively affect donors expecting a tax deduction for their charitable contribution. Additionally, it could put the organization at legal risk. This is why it is best to apply for tax exemption as soon as possible after beginning the process of learning how to start a nonprofit and incorporate it.
Should the IRS approve your application, you will receive a determination letter informing you. They will let you know if the application was approved, denied, or in need of more information. For an expert opinion, consult with an attorney experienced in helping founders establish 501(c)(3)’s and other tax-exempt organizations.
State Tax Exemption
Each state has different requirements for the founders of nonprofits seeking state income and sales tax exemption. To check your state’s rules and regulations check out Harbor Compliance’s list for receiving tax exemption status or visit your state’s Department of Revenue website.
What to Know Before Opening the Organization to the Public
Before operating any type of legal entity, always make sure you’re in compliance with federal, state, and local law. Be careful of receiving funding, whether charitable contributions, donations, or money from fundraisers, in states where the nonprofit is not registered to operate. If you plan to receive money from philanthropic patrons from outside the state where the organization is registered, file a solicitation license with their states to ensure you don’t violate charitable solicitation regulations.
Some types of nonprofits such as churches and nonprofit hospitals are exempt from this. Nevertheless, double-check to make sure you’re operating legally in states you’re receiving donations from. For more on what each individual state requires, view this summary of solicitation license requirements prepared by Lowenstein Sandler LLP.
It’s important to remember that forming a business as a non-profit doesn’t work for everyone.
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