Want to start a not-for-profit but overwhelmed by the morass of legal and tax regulations?
We love working with changemakers. But too often, clients who want to start a nonprofit are scared off by the laws and regulations that apply to those entities. We can help break down what a nonprofit needs to do to obtain and maintain tax-exempt status, and draft policies to ensure that conflicts of interest and other sticky issues are handled in accordance with the law.
Thinking about starting a nonprofit? People choose nonprofits over for-profit companies for several reasons, often driven by their mission, the nature of their work, and certain legal and financial considerations. Below, we’ll discuss the key reasons that people tend to choose a nonprofit entity, and the compliance requirements to form and maintain the entity.
Why Form a Nonprofit?
Individuals choose to form nonprofit organizations for a number of reasons, but typically, the impetus is a desire to use the company to serve the public good or to provide charitable services. Below are some of the reasons a nonprofit may be a good fit for your business.
- Mission-oriented goals
- Social, educational, or charitable mission: Nonprofits are typically organized for the purpose of serving the public interest. Their goals often include promoting social welfare, providing educational resources, contributing to health and science research, supporting culture and arts, or engaging in other charitable activities.
- Community impact: Founders who are more interested in impacting their communities than in earning profits may choose a nonprofit to better align with their vision of public or community service.
- Financial incentives
- Tax exemptions: Nonprofits with 501(c)(3) status are exempt from federal income tax on their earnings related to their charitable activities. They can also be exempt from state and local taxes.
- Donations: Nonprofits can accept tax-deductible donations, which can attract more contributions from individuals and organizations looking to support charitable causes and benefit from tax deductions.
- Grants: Nonprofits are eligible for public and private grants that are typically not available to for-profit companies.
- Legal structure and governance
- Limited personal liability: As with for-profit corporations, nonprofit corporations can protect their directors, officers, and members from personal liability for the organization’s debts and liabilities.
- Governance structure: Nonprofits are required to have a board of directors, guiding the organization’s strategic direction and ensuring it serves the public interest, thus establishing a system of accountability.
- Brand and public perception
- Public trust: The nonprofit label can instill a sense of trust among the public, volunteers, and donors, who may see the nonprofit as more likely to serve a public benefit rather than private interests.
- Volunteer involvement: The nonprofit status can attract volunteers and community members who want to be part of a cause or mission, which can be critical for operations and outreach.
- Market position
- Filling a niche: Nonprofits can operate in areas where for-profit entities may find it challenging to profitably deliver goods or services, such as in addressing issues faced by underserved or marginalized communities.
- Long-term sustainability: Nonprofits are able to invest any surplus they generate back into their services, outreach, and mission-related activities, contributing to the organization’s sustainability and growth.
- Collaboration and partnerships: Nonprofits can collaborate with governments, other nonprofits, and for-profit entities in ways that might not be available or applicable to for-profit businesses.
- Financial and operational discipline: The rigorous reporting requirements, oversight, and transparency expected from nonprofits can encourage more disciplined financial management and strategic operations.
Choosing between a nonprofit and for-profit structure depends upon the individual or group’s aims, the nature of the intended activities, funding sources, and how the organization plans to use its income. The choice reflects mission priorities, funding mechanisms, and the desired impact on society.
Forming and Maintaining a Nonprofit
All corporate entities require that their owners and directors take certain steps to keep them in good standing with their state of formation, the Internal Revenue Service (IRS), and other governing bodies. But nonprofits are a bit trickier, given that their directors have to take certain steps to maintain the company’s tax-exempt status. Below is a high-level summary of the steps that nonprofits need to take to get and stay in compliance.
- Initial compliance
- Articles of incorporation: File with the state’s Secretary of State or other designated office. In most states, this document will contain a statement of purpose that should match the nonprofit application that the company ultimately submits to the IRS.
- Bylaws: Draft and adopt bylaws that govern the internal management of the nonprofit.
- Board of directors: Recruit and appoint a board of directors in accordance with state law and the bylaws. Many states require a minimum number of directors, so be sure to check before you make these appointments.
- Organizational board meeting: Conduct an initial board meeting to formally adopt bylaws, appoint officers, and conduct other organizational matters.
- Federal tax exemption: Apply for federal tax-exempt status by filing Form 1023 or 1023-EZ with the IRS.
- State tax exemption: Apply for tax exemption at the state and local levels by filing the forms required by your state.
- Charitable solicitations registration: Register to solicit charitable contributions in the states where the nonprofit will fundraise.
- Licenses and permits: Obtain necessary business licenses and permits based on the nonprofit’s activities and geographic location.
- Ongoing compliance
- Annual IRS filings: Submit the appropriate version of Form 990 annually to maintain federal tax-exempt status and disclose financial information.
- State filings: Comply with annual or biennial reporting requirements, which typically involve updating information about the nonprofit’s address, directors, and finances.
- Charity registration renewal: Annually renew charitable solicitation registrations in states where the nonprofit is actively fundraising.
- State tax filings: File any required state tax returns or informational filings, especially if the nonprofit has unrelated business income.
- Board meetings: Hold regular board meetings, record the minutes of these meetings, and keep them on file as part of the corporate records.
- Record keeping: Maintain accurate and detailed financial records, board meeting minutes, personnel files, tax filings, and other important documents.
- Corporate governance: Follow the governance practices as outlined in the bylaws, such as board members are elected and how decisions are made.
- Compliance with public disclosure: Make key documents available for public inspection, commonly including the IRS Form 1023, IRS determination letter, and recent Form 990s.
- Conflict of interest policy: Adopt and enforce a conflict of interest policy, and disclose any related party transactions.
- Employment laws: Adhere to federal and state employment laws, including wage and hour laws, antidiscrimination laws, and workers’ compensation requirements.
- Review and update policies: Regularly review governance policies and compliance procedures such as the whistleblower policy, document retention policy, and gift acceptance policy.
- Notifications: Notify the IRS and state authorities of any significant changes, such as amendments to Articles of Incorporation, changes in exempt status, and address changes.
- Foreign qualification: If operating in states outside of where the nonprofit is incorporated, obtain the necessary foreign qualifications.
This list provides a general overview, but the specific requirements can vary by state and the type of nonprofit. It’s advisable for nonprofit organizations to consult with legal counsel specializing in nonprofit law to ensure they meet all their legal obligations and remain in good standing. Compliance is not only about legal conformity but also about maintaining the trust and confidence of stakeholders, donors, and the general public.
Next Steps
Preparing to form a nonprofit or wondering if it’s the best fit for your business? Book an exploratory call with us – we can help you explore your options and prepare to launch.
