So, You Think You Want to Start a Nonprofit?: Legal Steps From Incorporation Through 501(c)(3) Including Alternatives to Creating a New Charity by Erica Spangler Raz

So you have this great idea…Regardless of how great your idea is, there is a lot of work to be done to convert that great idea into a legally recognized nonprofit with federal income tax exemption (typically 501(c)(3) status). This article introduces some legal issues that you will confront as you begin the process.Start by asking “Is a nonprofit right for me?”  It may take anywhere from 12-18 months to properly set up a nonprofit and gain 501(c)(3) federal income tax exemption (or other appropriate exemption).  ((To learn what founders go through in making this decision, check out Elizabeth Newton’s personal exploration  http://wp.me/p1mPH7-x .))If starting a nonprofit is the right choice, begin by developing a solid plan.  Consider the main purpose of the potential organization, its goals, where it will operate, the programs it will offer, and possible funding sources. Choose a name for your organization that reflects that it is a nonprofit.  Recruit intelligent, committed, and compassionate people to serve on the board of directors for your organization. A good person to serve as a director should be just as committed to the mission as you are, and who does not expect any compensation. It is also important that the other directors are not related to you or to anyone else on the board. The minimum number of required directors will depend on your state of incorporation, but remember that there is a lot of work to be done. While every organization is different, I typically recommend an initial board of five directors to start.

Once you have your plan, you will need to incorporate as a nonprofit corporation. To do this, submit the Articles of Incorporation to your state’s Secretary of State and pay the necessary filing fees. The Articles of Incorporation should include the organization’s name, purpose, the name of the “registered agent,” and the board of directors.

You’ll need to apply for a Federal Employment Identification Number (FEIN) from the IRS. The FEIN is like a Social Security number, but for a business entity instead of an individual. It is used for official and legal purposes such as tax reporting and banking services. There is no charge and the application (Form SS-4) is fairly simple and available on the IRS website, www.irs.gov.

Your organization needs to adopt bylaws that describe the rules and procedures that will govern your its operations.  Your bylaws will establish the process required to make certain decisions including who has the power to make particular decisions. The bylaws should also outline the relationships between the board officers, board directors, staff, and members. It is important that your organization’s bylaws are tailored to the structure and needs of your organization while complying with your state’s laws on nonprofit businesses.

After incorporation, the organization can apply to the IRS for federal income tax-exempt status by completing the Form 1023 application and paying the associated filing fee (up to $850). The application must demonstrate in great detail that the group is organized and operated exclusively for the charitable purposes and that the organization provides a broad public benefit to a charitable class.  If the IRS decides that your organization is qualified, it will issue a determination letter explaining the nature of the exemption, the public charity status, and additional annual reporting requirements.

Also, before soliciting or holding donations you may have to register with the appropriate Attorney General’s office and file required annual reports.

If this sounds like too much, other options may allow you to better achieve your goals.  If you are pressed for time consider becoming a special project of an established organization. This would allow you to avoid the start-up delay and cumbersome management and administrative activities while still reserving the possibility of becoming a separate organization in the future.

Alternatively, a fiscal sponsorship agreement is an option for nonprofits that do not yet have tax exempt status.  A fiscal sponsorship is a contractual agreement in which the fiscal sponsor, an existing tax exempt nonprofit whose mission and purpose align with your organization, allows the new group to utilize its tax-exempt status to solicit grants and charitable donations. The fiscal sponsor typically will manage the new group’s charitable funds (including filing annual reports) in exchange for a small fee (usually a small percentage of funds received). Fiscal sponsorships are advantageous because a nonprofit can begin raising funds immediately and avoid the long process of obtaining tax exempt status. Also, nonprofits benefit from using the name and reputation of the fiscal sponsor to access funding sources.  Fiscal sponsorships can also benefit nonprofits that want to operate for a limited time or that are unsure of the success of the organization.

Whichever decision you make, education, careful planning, and proper set-up are key for turning your great idea into a great reality!

For more detailed information, check out the many resources located on The Law Project’s website (www.thelawproject.com) for Illinois nonprofits. If you are not in Illinois, contact your state’s local bar association to find the transactional pro bono project in your area.

Erica Spangler Raz is Staff Attorney for The Law Project’s New Nonprofit Program. The Law Project provides pro bono legal advice and services to community-based organizations. Erica has counseled hundreds of emerging nonprofit organizations, and regularly presents seminars on startup nonprofit business planning and income tax exemption to both community groups and attorneys.

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One Response to So, You Think You Want to Start a Nonprofit?: Legal Steps From Incorporation Through 501(c)(3) Including Alternatives to Creating a New Charity by Erica Spangler Raz

  1. Loren Santow says:

    Informative article. Part of the text reads “check out Elizabeth Newton’s personal exploration (Link to her article here).”—but the link was not provided. You may want to update.

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