To become a 501(c)(3), an organization must incorporate in the state where its principle office is. This means submitting Articles of Incorporation to the state and paying a fee. Each state provides a form that proscribes what must be included in the Articles – the name of the organization, address, purpose, initial Board of Directors, and the name of the incorporator or incorporators. Pretty simple. The state approves the Articles and sends them back with a stamp that certifies that the organization is a nonprofit corporation in that state.
There is, however, a catch. When it comes time to apply to the IRS for 501(c)(3) status, the Articles of Incorporation are included in the application, and the IRS will reject them if they do not contain certain paragraphs about the charitable nature of the organization and about how the organization will handle dissolution if that event were to ever happen. The organization has to amend its Articles to include those paragraphs and pay a small fee to do so. This takes time, and then the organization has to re-submit the Articles to the IRS, which slows down the process considerably.
Therefore, it is far better if the organization includes the required language about charitable nature and dissolution in the original Articles. The IRS provides that language in its publication 557.
It is easy to become confused by the difference between being an incorporated nonprofit organization and a tax-exempt nonprofit. Incorporation happens at the state level. When a group decides to form a nonprofit, one of the first steps is to incorporate as a nonprofit corporation in the state where the nonprofit’s principle office is located. Each state has its own rules and procedures for incorporation, which are all similar but different is subtle ways. All require a filing fee which ranges from $25 – $200.
TAX-EXEMPT STATUS. Obtaining tax-exempt status happens on the federal level.
Most nonprofits want to be a 501(c)(3) because it carries more tax benefits than other types of nonprofits. Becoming a 501(c)(3) requires that the group obtain an Employer Identification Number (EIN) and to submit form 1023 to the IRS, along with a fee of $850 (or in some cases, depending to anticipated revenue, $400).
NOTE: Incorporating as a nonprofit organization is a fairly easy process. Applying for 501(c)(3) status is not easy, and is further complicated by the fact that if you did not incorporate in the way the IRS requires, the IRS will require that you amend your original Articles of Incorporation and file for state incorporation all over again.
Several people have recently asked me if I help with setting up a 501(c)(6). The answer is yes. The IRS recognizes 32 different 501 categories. 501(c)(6)s are organizations that focus on economic development, such as Chambers of Commerce and business leagues. 501(c)(7)s are social and recreation clubs. 501(c)(3)s are defined as charitable, education or religious and are the most common.
Feel free to call me if you are not sure if you qualify as a 501(c)(3).
There are three main costs when starting a nonprofit. One, the IRS charges an application fee of $400 for an on line application. Most new organizations qualify for this type of application. Two, Incorporation fees vary from $25 to $200 depending on what state you in. And three, hiring a professional to help you with the process ranges from $400 to $2,500, depending whom you hire.
I am sometimes asked if a nonprofit can prevent other organizations from using their name. States do not allow corporations to have the same name, so once you have incorporated in your state, no one else can use that name in your state. The IRS, however, allows 501(c)(3) nonprofits to have the same name, so if a group incorporates in another state using your name, the IRS will allow it.
One way to distinguish your nonprofit from others is to use a geographical designation in the name, such as Georgia Movement for Youth, or Cook County Conservation Alliance.
No one owns a nonprofit. The Board of Directors is responsible for the organization but they do not own it the way an individual or partners own a for-profit business. Owners of a business get to pocket profits. Profits in a 501(c)(3) nonprofit are called surpluses, and they must be plowed back into the organization. No individual is allowed to profit from a nonprofit. If the Board votes to dissolve the organization, the assets have to be distributed to a nonprofit with a similar mission.
Every 501(c)(3) nonprofit organization must have a Board of Directors. The number varies state to state. The Board is responsible financially and ethically for the organization.
The most important qualification for a good Director is that he or she believe in the mission of the organization. They don’t have to have nonprofit experience, or have any special knowledge of the area in which the nonprofit operates, but they should have a genuine commitment to seeing the organization achieve its goals.
Some people choose family members and friends to sit on the Board because it is convenient to recruit them. This is a bad idea on two counts. One, the IRS may delay or deny your application if the Board includes too many family members. Second, family and friends rarely make effective directors.
Your Bylaws will indicate how many directors can be on the Board. It is best to express this in a range of odd numbers, such as three to five, or five to eleven. Having an odd number on your Board makes it easier to get a quorum to Board meetings.
Do you need an attorney or CPA to file for 501(c)(3) tax-exempt status? There are three ways to go about obtaining your 501(c)(3).
One, do it yourself. If you are someone who does your own income taxes, then you can probably handle all the paperwork that becoming a nonprofit entails. The problem is, there are several steps where it is easy to make a mistake. What ensues is a time-consuming correspondence with the IRS, and getting approval may be seriously delayed.
Two, hire a consultant who specializes in helping groups obtain their nonprofit 501(c)(3) status. This is the most economical and efficient way to do it.
Third, hire an attorney or CPA to prepare the documents. This is usually not a wise choice, because for most attorneys and CPAs, nonprofit documents are just one of many areas of their practice, and they are apt to make mistakes in the process. They also charge considerably more than most consultants.
What does EIN stand for? EIN stands for Employer Identification Number.
Does a nonprofit need to have one? Yes, the IRS requires that a nonprofit get an EIN before applying to 501(c)(3) status.
What about if a nonprofit does not plan on hiring any employees? It still has to have an EIN. The EIN is not entirely an employment number. It is also the number the IRS uses to identify the organization, and all correspondence with the IRS should include the EIN.
How does one get an EIN? One completes IRS form SS4. This can be done on-line, by phone or by mail. Obtaining an EIN is one of the things I do for you.
What are the three most common mistakes people make when trying to create a 501(c)(3) nonprofit organization?
1. Many people write Articles of Incorporation that the state corporation commission accepts but that the IRS rejects.
2. They create a Board of Directors which has too many friends or relatives on it, rather than people who believe in their cause.
3. Making extravagant claims in their application about what their nonprofit is going to achieve, claims which their budgets do not support.