Starting a 501(c)(3) nonprofit helps organizations by allowing them to solicit tax-exempt funds legally from donors. The steps that go into starting a 501(c)(3) include choosing a name for your nonprofit, writing your purpose statement and bylaws, recruiting and establishing a board of directors, filing your articles of incorporation, applying for federal tax-exempt status as a 501(c)(3) and filing for state recognition of tax exemption.
What Is A 501(c)(3) Nonprofit?
A 501(c)(3) nonprofit is an organization that has applied and been approved for IRS recognition as a tax-exempt organization. Nonprofits rely on their 501(c)(3) status to solicit grants, donations and other funds. Nonprofit status helps organizations raise money because donors may be able to deduct contributions on their own taxes.
Benefits of a 501(c)(3)
The benefits of a 501(c)(3) include protection against liabilities, federal and state tax exemption, discounts and the ability to legally solicit donations from state residents. Here is a closer look at what these advantages mean for your organization:
Liability protection. The indemnification clause in a 501(c)(3)’s articles of incorporation protects board members of a nonprofit from personal liability around concepts like organizational debt.
Federal and state tax exemption. Donors who give money to the organization may be able to deduct the donations on their tax returns. In addition, the organization itself is exempt from federal and state taxes.
Solicitation of donations. Without your 501(c)(3) status, you are allowed to solicit donations legally from individuals, organizations and foundations.
More funding options. As a 501(c)(3), your organization can apply for government and foundation grants.
Higher donor attraction. Because your nonprofit undergoes government scrutiny to ensure its legitimacy and purpose, donors are more likely to view your organization as credible and worthy of their funds. In addition, they may get a tax deduction for their donation. Both of these factors contribute to a higher likelihood that donors will donate to your cause.
Discounts. Nonprofits use many tools for running their daily programs, such as social media marketing and customer relationship management (CRM) software. As a 501(c)(3), you can often receive discounts on such tools.
Drawbacks of a 501(c)(3)
The disadvantages of establishing a 501(c)(3) include the time and expenses involved, limited personal control over the organization’s direction, financial scrutiny by the IRS, a lot of paperwork at startup (and annually thereafter) and regulations and restrictions surrounding the work in which the nonprofit can be involved. Here is a closer look at these disadvantages:
Expenses. Starting a 501(c)(3) involves startup costs that go to federal and state fees and attorney charges, among other costs. Typically, these start at $2,500. Other costs associated with starting a 501(c)(3) include building an online presence. Then, annual costs to maintain a tax-exempt status add to the expenses on an ongoing basis.
Time consumption. Time-consuming tasks to start a 501(c)(3) include filling out and submitting an application, setting up recordkeeping systems, recruiting and building a board, filing articles of incorporation and writing your statement of purpose and bylaws.
Financial scrutiny. The IRS looks at all of your nonprofit’s expenses on a yearly basis to ensure donor dollars are fulfilling their intended purpose. Annual submissions of required financial statements mean this scrutiny is ongoing.
Regulations and restrictions. As a 501(c)(3), your organization must commit to regulations and restrictions regarding how money can be used and what causes you can support. For example, there are restrictions on the types of political activity in which a 501(c)(3) can participate.
Loss of control. Your nonprofit must adhere to your bylaws, the fiduciary duty of your board of directors, IRS and state requirements and donor intent. As such, the organization becomes an entity that goes beyond your personal interests.
Steps To Forming a 501(c)(3)
The steps to starting a 501(c)(3) include writing a purpose statement, naming your organization and appointing your board of directors. At that point, you can file your articles of incorporation and then file for your 501(c)(3) status with the federal government. Finally, to begin soliciting funds, you also must register your nonprofit in your state. Let’s take a closer look at these steps.
Write a Purpose Statement
A nonprofit’s purpose statement tells why an organization exists as a necessary entity. It is included in a nonprofit’s bylaws and is used to qualify the nonprofit for tax-exempt status. It also offers a statement for organizational directors to adhere to when fulfilling their duties as well as a compass for supporters who help to fulfill the organization’s purpose, such as volunteers, donors and partners.
It should have the following specifications and inclusions:
Length. A purpose statement should be no more than 50 words long.
Categorization. Offer a classification of the type of services the organization will perform. Examples include humanitarian, religious and educational services.
Descriptive language. Offer an overview of why the organization exists, its mission, and how it’s different from other organizations. Include descriptive language that adds more context to its categorization like specifics of the types of services offered and the geographical area the organization will serve.
Context that allows organizational growth. Your statement should be specific enough that it differentiates your organization from other organizations’ purposes while still offering room to grow. For example, if your nonprofit will offer food-insecurity relief, to allow room for growth, specify your service area as a region rather than a specific city.
Name Your Organization
Your nonprofit’s name should embody your purpose statement and be short enough to fit comfortably in domain names and social media handles. To choose an organizational name, use descriptive words that invoke the feeling of your purpose statement. Say your chosen name out loud to ensure it is easy to say. Write it out to ensure it is easy to remember.
Once you have brainstormed a name using the above tips, check to make sure your name isn’t already taken. For legal compliance, begin by checking the U.S. Patent and Trademark Office database to ensure your chosen name is not already trademarked. Then, search to ensure your name is not already being used for an organization in your state. Finally, make sure your name’s domain and social media handles are available to build your nonprofit’s public presence.
To prevent legal liabilities, LegalZoom’s trademark check services are more thorough than online search tools. Your state’s business filing agency can tell you whether your chosen name is in use in your state as many have online tools that allow you to search business names. Check that your name’s domain is available by searching a domain registrar. Finally, search social media for your name’s handle using this format: @domainname
Appoint a Board of Directors
Your state may only require one director for a nonprofit board, but the IRS prefers that 501(c)(3) organizations have at least three directors. Five is even better. To identify and recruit potential board members, make a list of the skills your nonprofit needs. For example, many nonprofits need people who know about business finance, nonprofit law, fundraising, marketing and the industry in which the nonprofit serves.
Next, make a list of people with the needed skills. Consider people in your personal and social media networks and people in your community who might share your commitment to your nonprofit’s mission.
Your state’s association of nonprofits or United Way often also offers board-matching programs. Finally, Board Source offers board-matching resources by state.
Review your list of candidates. While many or all of them may seem like the perfect fit, it is best to test that fit before finalizing your decision. Do so by first asking potential candidates about their interest in serving. If they answer positively, consider asking them to volunteer in your nonprofit work for a time so both parties can ensure the candidate’s commitment to the organization and its work.
Write Your Bylaws
To write your bylaws, start by finding out what your state includes in its nonprofit corporate act for nonprofit bylaw inclusions. For example, the Florida Not for Profit Corporations Act states that, if a director is not allowed to vote by proxy, this restriction must be stated in the nonprofit’s bylaws.
Most nonprofit bylaws also include some standard provisions. These include provisions stating the nonprofit’s name, purpose statement, governing structure, decision-making process/rules, bylaw amendment rules, a conflict of interest statement and an indemnification act that protects directors against personal liability.
Bylaws govern the operation of your organization, and they’ll also be submitted to the IRS as part of your application for 501(c)(3) status. It’s best to get help from a nonprofit attorney before finalizing your bylaws to make sure they contain all necessary provisions and are written ideally for the best interests of your nonprofit.
File Paperwork To Establish a Corporation
Filing your articles of incorporation for a nonprofit corporation officially establishes your business as a legal entity but not yet a tax-exempt business. Your articles of incorporation must be filed with the business filing agency in the state in which you plan to conduct your nonprofit business. In most states, you’ll file paperwork with the Secretary of State, but in some states you’ll file with a different state agency.
Check with your state filing office to find out how you need to submit your paperwork. Some states, for example, allow you to form a corporation online while requiring you to submit Articles of Incorporation by mail. You can also expect to pay a filing fee.
Be sure to include all information and follow all steps required by your state.
Each state has different requirements for filing your articles of incorporation. For this reason, we advise you to seek a business formation or business incorporation lawyer at the local level for direction on how to correctly file incorporation paperwork.
To conduct the business of your new corporation, you will also need an employer identification number (EIN). You can apply for an EIN online at the IRS website, and you will receive it immediately after your application is submitted. You can also get an EIN by downloading IRS Form SS-4, filling it out and faxing or mailing it to the IRS at:
Internal Revenue Service
Attn: EIN Operation
Cincinnati, OH 45999
Apply for Your 501(c)(3) Status
Applying for 501(c)(3) status allows the IRS to examine your nonprofit’s structure, purpose and business dealings to determine if it qualifies as a tax-exempt organization. The IRS also seeks to ensure donor dollars will be used for donors’ intended purposes via the absence of any conflicts of interest.
To begin, locate the EIN assigned to your corporation in step five. To file for your 501(c)(3) tax-exempt status, most organizations must use this number to fill out IRS Form 1023 electronically on Pay.gov. This form is called an Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. The submission fee is $600 and must be paid through Pay.gov at the time of filing.
However, if your organization has three years of gross receipts under $50,000 and assets of less than $250,000, you may be able to file the simpler Form 1023-EZ. To file this form, you must first fill out the Form 1023-EZ Eligibility Worksheet in the Instructions for Form 1023 to determine your eligibility. If your organization is eligible to use Form 1023-EZ, the user fee is $275 and is due at the time of filing on Pay.gov.
Please note that filling out the IRS Form 1023 is a complex process. As such, many nonprofits should and do seek the services of a nonprofit lawyer to guide them in this step.
File Paperwork for Your State’s Recognition of Tax Exemption
Receiving a determination letter stating you are federally tax-exempt does not mean you are ready to solicit donations in your state. For this, you will likely need to register with each state in which you fundraise before receiving donor dollars from residents. All but a handful of states mandate some type of registration.
The forms and requirements to register for soliciting donations vary by state. Contact your state’s government office that handles registrations. You can find their contact information by searching by state on the National Association of State Charity Officials. Forms associated with charitable solicitation registration often must be filled out annually and many states will also request a copy of the IRS Form 990 is attached.
Most states, such as Virginia, grant nonprofit organizations in the state tax exemption status automatically if they are recognized federally as a 501(c)(3). Others require separate applications, including California and Texas. In California, for example, you must fill out a Form 199 or 199N (for smaller organizations) annually and submit it to the Franchise Tax Board.
Starting a 501(c)(3) nonprofit is time-consuming and expensive. However, as an established 501(c)(3) nonprofit organization, you stand to gain more donors and donor types, higher credibility in your space, discounts and a legal avenue for soliciting funds for your cause. For best results, given the complexity of the application and compliance process, it’s best to contact a local nonprofit lawyer to guide your organization in fulfilling the steps in this guide.
