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A growing number of charities and so-called social entrepreneurs opt to form a non-profit corporation to advance their social mission. This business organization offers attractive advantages: greater legal securities (due to limited liability), extensive tax benefits and access to grants. But starting a non-profit corporation is associated with considerable bureaucratic burden and is subject to many formal requirements. In this step-by-step guide, we’ll explain what you have to consider when setting up a charitable organization.
The business purpose of a non-profit corporation is to serve a common good. Find out more about the basic principles of a non-profit corporation, what distinguishes this legal form in detail and its advantages and disadvantages.
This step-by-step guide provides an explanation of the steps you need to consider when launching a non-profit organization.
How do you start a non-profit corporation?
In the US, a non-profit organization is usually launched as a corporation. Limited liability companies (LLCs) can become non-profit LLCs, but only if all its owners are verified as tax-exempt non-profit entities. Because this is a very cumbersome process, it’s rare to find non-profit LLCs and most individuals will start a non-profit corporation instead.
But before you get started, you should ask yourself which charitable, benevolent or ecclesiastical purpose your non-profit fulfills. It’s important to develop a clear concept over which unmet needs your non-profit tries to address. Ask yourself if the corporation serves a unique purpose and who would be likely to support it. It’s also worth taking a closer look at the corresponding provisions classified under IRS Code 501(c)(3). This code clearly states that charitable businesses must be operated exclusively for charitable causes.
If the non-profit corporation is the right choice for you, you can begin to draft a business plan. This should include your company’s name, registered business address, mission, budgets, and an operational and organizational overview.
Before you incorporate your non-profit organization, let’s take a quick look at the costs of starting a non-profit corporation.
What are the costs of starting a non-profit corporation?
Non-profit corporations are businesses and as such you should have some capital right from the start to cover certain expenses. These include:
Registering for 501(c)(3) status: The simplest IRS form (1023-EZ) costs $275 whilst the more advanced 1023 form costs $600 to fill out. You may wish to consult a lawyer or accountant to help you fill out the form. This will incur additional costs.
Incorporation: Becoming incorporated is the formal step required to forming a non-profit corporation. The costs depend on the state you are operating the non-profit from. It ranges from as little as $10 to $300.
Office space and equipment: You may be able to set up the business at home to begin with, but as your business grows renting office space may become a necessity. Office equipment such as a telephone, laptop and paper should also be included in any preliminary budget calculation.
Staff: At the start, many non-profits set up by individuals can be run by them alone. But as your organization scales, you may have to hire staff. Salary calculations for your staff should include yourself. It’s important to pay yourself a fair wage for your hard work to set up and maintain a charitable business.
How do you recruit a board to start a non-profit corporation?
All start-up non-profits should have a solid organizational structure. So, before you can incorporate your non-profit corporation, some US states may require you to assemble a board and list the names of your board members.
A typical board has three officers – the President, the Secretary and a Treasurer. While the President heads a board meeting, the Secretary takes minutes and a Treasurer is in charge of managing the company’s books. But what makes the board of a non-profit organization different from many others is that its members must be passionate about the cause the company serves. Other important attributes include a strong and dependable work ethic.
Once you have recruited and trained your board, you can incorporate your non-profit organization.
How to incorporate a non-profit organization?
Incorporation is an important part of forming a non-profit corporation. There are several benefits for companies to become incorporated which include limited liabilities, tax deductions and an easier transfer of ownership. In addition, it lends your business a defined legal framework from which to operate. But it’s also a necessary step before applying for tax exemption status under 501(c)(3).
Incorporation describes the legal steps performed to form a corporation or company. It’s an official declaration that the company’s assets are separated from the owners’ and investors’ assets. Incorporated companies usually carry the words “Inc.” (Incorporated) or “Ltd.” (Limited) as part of their name.
Only once you’ve incorporated, your business formally exists as a non-profit corporation. Most businesses choose to incorporate in the state where they are operating or where they conduct their services from.
Information needed to incorporate usually includes your company name, business address, and the purpose of the corporation. But if you are also filing for tax exemption status under 501(c)(3), you must include the relevant information in your incorporation letter.
Specifically, you should include language stating that your corporation’s purpose is in line with those set out in 501(c)(3) and that it is not engaged in political or legislative actions. You should mention that if the organization dissolves, remaining assets are to be shared among other non-profit companies. The IRS provides guidance on the matter.
Filing for tax exemption
Now that you’ve incorporated your non-profit organization, you are ready to apply for tax exempt status under IRS code 501(c)(3). The following three legal forms can apply for tax exemption:
- Trusts, which are usually set up for individual and personal purposes.
- Corporations, which operate for business purposes.
- Associations, which is a group of people who come together for a shared purpose, for example a sports club.
Your corporation also must meet one of the exemption purposes set out in the IRS code. These include business purposes that are “charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and the prevention of cruelty to children or animals”. You can read more about charitable purposes on the IRS website.
You may need to use a different code for businesses that are fraternities (501(c)(8)), social and recreational clubs (501(c)(7)) and trade associations (501(c)(6)).
Besides the costs involved, you should be aware that when you’re starting a non-profit corporation, it can take 3 to 12 months for your application to be approved. Applications can also be denied. The most common reasons include organizations that are operating for-profit, those that apply using the incorrect code for their type of organization, and businesses that operate for private benefit rather than public good.
If you’ve assembled all the necessary information, you can apply for tax exemption via the IRS website.
Compliance is ongoing
After successfully forming a non-profit corporation, you must keep up with a series of compliances in order to keep your corporation’s tax exempt status.
Each year, you will be required to fill out a 990 form, which tracks your organization’s revenue, expenditure, achievements and any changes to its organizational structure, for example where a new board member joins. Even if you took in no money, you must fill out the form.
But before you can go and raise funds or accept charitable donations through your non-profit organization, you must also complete a Charitable Solicitation Registration.
Remember that setting up non-profit organization may sound cumbersome, but running a non-profit long-term is considerably harder. Nevertheless, if done correctly, it can be a rewarding and worthy endeavor.
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