Starting a nonprofit organization is one of the most effective ways to positively impact a cause or a community. A nonprofit is an organization that is designed to provide a certain kind of service such as a social, educational, religious, or cultural service. Nonprofit organizations, unlike for-profit businesses, use funds generated by the organization to directly support the programs and services they offer.
The most popular type of incorporation that nonprofits seek to obtain is 501(c)(3) status granted by the Internal Revenue Service (IRS) in the United States. Organizations with this status are exempt from paying federal taxes and contributions to the organization are tax deductible. 501(c)(3) organizations can be public charities or other charitable organizations, which also include private foundations. Each has its own requirements and advantages.
5 Steps to Achieving 501(c)(3) Status as a Nonprofit Organization
Step 1: Choose Your Mission
It is crucial that every nonprofit organization has a clear mission statement. This mission should briefly state the organization’s function, the reason for its existence, and the target population served. Formal mission statements are useful in helping an organization maintain focus on what it is seeking to achieve, and image it wishes to project to the public.
Examples of Mission Statements:
- The organization was established “to nourish families in need and combat food deserts by ensuring access to healthy, sustainable food for our community."
- "Our mission is to empower children in rural areas by fostering literacy through innovative reading programs and book sponsorship, opening doors to brighter futures."
- "Our mission is to protect endangered species and restore their natural habitats, while raising awareness to inspire global action for the preservation of our planet’s biodiversity."
Step 2: Form Your Nonprofit Organization
Once you have crafted a well-articulated mission statement, you can then start a formal nonprofit organization. This includes establishing a legal entity that can own property, hire staff, and engage in legal actions. Here are some key requirements:
- Board of Directors: By law, your nonprofit will require a board of directors, which is usually expected to be composed of at least three people to oversee the operations and exercise fiduciary responsibility. However, requirements vary by state. You can find the requirements in your state using the National Council of Nonprofits resources.
- Organization Name: Select an appropriate name for your nonprofit organization utilizing the guidelines of the state where you intend to register the name.
- Articles of Incorporation: Write and submit articles of incorporation to the Secretary of State in your state. This document contains the name of the organization together with the mandate and structure of the organization.
- Bylaws: Ensure that the articles of incorporation provide a framework of the rules governing the operations of the nonprofit such as board of directors meetings and voting.
- Strategic Plan: Having a well-formulated strategic plan is essential since it will assist the organization in attracting the required funding and also aid in its development.
Step 3: File With the Internal Revenue Service (IRS)
You are required to contact the IRS for your organization to seek federal tax-exempt status. This step enables your nonprofit to receive 501(c)(3) status from the IRS. This designation makes donations to your organization tax-deductible and ensures that your organization is not liable to pay federal income tax.
- Employer Identification Number (EIN): Obtain an EIN, also referred to as the Federal Employer Identification Number, on the IRS website. This is especially important for recording federal taxes, opening new bank accounts, and getting new employees.
- Form 1023 or Form 1023-EZ: Form 1023 or Form 1023-EZ should be filed in order to apply for recognition of exempt status. Form 1023 is more detailed and is often needed for larger organizations, while Form 1023-EZ is for small organizations with total receipts of $50,000 or less.
- Application Fee: The IRS has a filing fee of $275 for the 1023-EZ and $600 for the standard Form 1023.
- Determination Letter: Then the IRS will assess your application and may request further details. In the case of approval, they will write you a determination letter that will indicate that your organization will be exempted from paying taxes. This letter is important for fundraising purposes and especially when you are asked to provide proof of tax-exempt status.
This review will take several months if the IRS is experiencing a backlog and the application is also complicated. To ease this application process, proper preparation accompanied by adequate documentation on the organization is helpful.
Step 4: Compliance with State and Local Requirements
Earning federal 501(c)(3) status is just one piece of the compliance process. Your organization also cannot function without obtaining a license from the state and/or local government. Here are some common requirements:
- State Tax Exemption: Most states allow organizations to be exempt from state income tax and property tax if they fall under section 501(c)(3). There may be a need to apply for these benefits separately.
- Charitable Solicitation Registration: If your organization intends to engage in fundraising or solicitation, you might have to file with your state’s Attorney General or another office. Requirements vary by state.
- Annual Report Filing: It is common for most states to require nonprofits to submit an annual report in order to remain in operation. This report may contain new information on the board of directors and the organization’s financial transactions.
Noncompliance with state and local ordinances leads to fines or loss of 501(c)(3) status or other sanctions.
Step 5: Maintain Mission and Compliance
Now you are ready to carry out the requirements for 501(c)(3) status. Your organization has to go on implementing it mission, obeying legal and regulatory provisions, and running operations responsibly. Here’s how to stay on track:
- Hold Regular Board Meetings: An active board of directors is important because the board helps organizations monitor progress towards realizing objectives and oversees activities to ensure compliance with all regulations.
- Maintain Financial Records: To prepare tax returns and other required reports to the IRS, accurate financial records are very important. For example, the IRS requires many organizations to file Form 990 in order to be able to report on their activities in a particular fiscal year.
- Adhere to Bylaws: Review your organization’s bylaws and ensure that all decisions align with the regulations established at the time of incorporation.
- Avoid Political Campaigns: Another area of legal restriction for nonprofit organizations that are accorded 501(c)(3) status is that they are prohibited from supporting any candidates for an election or engaging in political campaigns.
- Engage in Mission-Aligned Fundraising: Ongoing fundraising is important to help you achieve the objectives for which your organization was created.
Compliance with these standards will help your organization maintain its good status with the IRS and the public.
Costs of Achieving 501(c)(3) Status
Starting a 501(c)(3) nonprofit involves both upfront and ongoing costs:
- Filing Fees: The cost of filing form 1023 or 1023-EZ is $600 and $275, respectively.
- Incorporation Fees: The costs of filing articles of incorporation and other state documents are between $50 and $500.
- Professional Services: It is common for many organizations to use the services of legal or accounting experts to manage the application. These services may be pricey but can be worthwhile.
How Long Does it Take to Achieve 501(c)(3) Status?
How long it will take to become a 501(c)(3) nonprofit depends on factors like the complexity of your mission, state requirements, and the time the IRS takes to process your request. Here’s an estimate of how long each step might take:
- Preparation Phase: It can take anywhere from a few weeks to a few months to draft bylaws and articles of incorporation and put together a board of directors.
- State Filing: The articles of incorporation are usually filed with the Secretary of State and take a few weeks.
- IRS Filing: If you file a Form 1023, it will take anywhere from two to six months for the IRS to process it, and a 1023-EZ may be processed in as little as two to four weeks.
Getting advice from professionals can prevent making mistakes that could delay approvals.
How to Find Grants as a 501(c)(3) Nonprofit
Grant funding is a vital source of support for many nonprofit organizations. Platforms like GrantStation offer databases of grant opportunities tailored for nonprofits. With a GrantStation subscription, organizations can access tools and resources to find suitable grants. Visit GrantStation's website to explore the services and subscribe to unlock access to comprehensive grant listings.
Is a Nonprofit Right For You?
Some of the advantages when forming a nonprofit organization include being able to issue tax-deductible donation receipts and being exempt from federal income tax. There are some questions that you should ask before launching a nonprofit, such as whether the effort is aligned with your goals as a founder and whether you are able to keep the nonprofit going. Here are some benefits and drawbacks to consider:
Pros:
- Tax Exemption: This means that your organization does not pay federal taxes, which allows it to have more money to fund its cause.
- Public Support: Being a nonprofit enables an organization to seek donations and volunteers to help achieve its mission.
- Credibility: Gaining 501(c)(3) status means that the nonprofit organization becomes more trustworthy to its donors and partners.
Cons:
- Ongoing Compliance: Nonprofit organizations are bound by reporting and compliance standards.
- Limited Profit Generation: In contrast with for-profit organizations, a nonprofit cannot award profits to its founders or the board members.
- Fundraising Pressure: The funding process can be a tiring one and at times will require constant effort to ensure that programs continue running smoothly.
Frequently Asked Questions (FAQ)
Q: Why does the IRS issue a determination letter?
The IRS determination letter is the government’s official statement that a nonprofit is federally exempt under 501(c)(3). It proves that the organization is tax deductible.
Q: If my nonprofit has low revenue, do I need to file Form 990?
Yes, even small nonprofits have to file a version of Form 990 to keep their tax-exempt status. Form 990-N, the e-Postcard, may be used by nonprofits with gross receipts under $50,000.
Q: Is a 501(c)(3) allowed to lobby?
501(c)(3) organizations may engage in limited lobbying for purposes of this section if their primary activity is the furtherance of other exempt purposes, but they are prohibited from participating in political campaigns or from endorsing or opposing candidates.
For more information, visit the IRS website or the National Council of Nonprofits website.