Surprisingly, there is no legal definition of a nonprofit organization. In general, a nonprofit organization is one that is organized to achieve a purpose other than generating profit. Despite this, a nonprofit organization is not precluded from making a profit or engaging in profit-making activities. It is prohibited from passing along any profits to those individuals who control it, like founders, directors, officers, employees, and members. Nothing, however, prevents a nonprofit from paying reasonable salaries to officers, employees, and others who perform a service for it.
This section is aimed at those seeking to start and operate a nonprofit corporation that is a public charity under section 501(c)(3) of the U.S. Internal Revenue Code (the "tax code"). A corporation is the most common and generally most appropriate structure used to create a nonprofit organization. You should seek the advice of an experienced nonprofit lawyer if you wish to establish a nonprofit organization using some other business structure.
Section 501(c)(3) of the tax code exempts certain nonprofit organizations from federal corporate income taxes. Gaining tax-exempt status gives a nonprofit corporation credibility with potential donors because it shows that the organization has a legitimate charitable purpose, a formal structure for accomplishing its goals, and is publicly accountable. Section 501(c)(3) tax exemptions are denied to any nonprofit organization engaging in certain political or legislative activities, which will be discussed below.
Section 501(c)(3) classifies nonprofit organizations into private foundations and public charities. In all likelihood, you want your nonprofit organization to avoid being classified as a private foundation because a number of complex additional regulations and restrictions apply to them. When you fill out your application for 501(c)(3) tax-exempt status, you should request to be classified as a public charity in Part X of Form 1023, usually by checking the box in Line 5g, 5h, or 5i (depending on the nature of your funding).
In order to qualify as a public charity, a nonprofit
corporation must be formed and operated for a charitable purpose.
"Charitable" is a narrow descriptor given the many types of
organizations covered under section 501(c)(3). The section
also applies to organizations with religious, educational, scientific,
or literary purposes, among others. These purposes must be for the
benefit of some significant section of society, whether it be the
general public or a specific community.
Additionally, a public charity must be publicly supported. This means that the nonprofit corporation must normally receive funds from governmental entities or multiple private donors. Contrast this with a private foundation, which typically gets its funds from a single source. The calculations behind what "public support" means are complicated, see the Nonprofit Law Blog's Public Support Tests for details.
Keep in mind the following factors as you consider whether to operate as a nonprofit public charity corporation:
Like other corporate entities, nonprofit organizations can be sued for any number of reasons, including:
Like shareholders in a for-profit corporation, directors of a nonprofit corporation, and other individuals who participate in the founding and/or operating of the nonprofit organization, enjoy limited liability for the debts and obligations of the organization, including for the unlawful acts of other directors, officers, and employees.
However, directors, officers, and employees may be personally liable for their own wrongful conduct, regardless of whether they are paid for their work or are volunteers.
Note that if you apply for a small business loan to help fund your nonprofit corporation, the lender probably will require you to give a personal guarantee. In that case, you are personally responsible for the paying back the debt, even if your business is a nonprofit corporation and even if there is no basis for piercing the corporate veil.
Nonprofit organizations usually incorporate in the state where they expect to do business. Forming a nonprofit 501(c)(3) corporation is burdensome. The section on Forming a Nonprofit Corporation provides the steps necessary to get established in general; the section on State Law: Forming a Nonprofit Corporation outlines what is required by the fifteen most populous U.S. states and the District of Columbia.
There are two main steps involved in forming a nonprofit corporation:
1. Incorporating as a nonprofit corporation at the state level
If you want to incorporate, you must file articles of incorporation with a state office, usually the Secretary of State. Creating articles of incorporation for a nonprofit corporation can be more involved than creating one for a for-profit corporation because you will need to include language about the purpose of your nonprofit corporation in order to be eligible for 501(c)(3) tax exemptions. Drafting the articles of incorporation generally does not require the assistance of a lawyer, and usually the filing fees are significantly less than the filing fees for incorporating as a for-profit corporation.
You will also need to create corporate bylaws which are the internal rules and procedures of the nonprofit corporation. Drafting bylaws that are highly customized to your business may involve some complexity. Additionally, you must keep a records book at the nonprofit's place of business.
The incorporators and/or directors of a newly formed nonprofit corporation should hold an initial organizational meeting to adopt bylaws and elect initial directors (if not named in the articles of incorporation), among other things. Minutes of this meeting must be recorded.
2. Applying for 501(c)(3) corporate income tax exemptions at the federal level
You need to file Form 1023 in order to apply for tax-exempt status under 501(c)(3). The application process is complicated, but can be done without the assistance of a lawyer if you are willing to devote the requisite time and energy in to the process. IRS resources (both the website and the call centers) are of immense help as is Anthony Mancuso's book on "How to form a Nonprofit Corporation" which provides line-by-line guidance on how to complete the application form. The filing fee for the application is high: $300 if your gross receipts have not exceeded or will not exceed $10,000 annually over a 4-year period, and $750 otherwise. You do not have to apply for tax-exempt status if you anticipate bringing in gross receipts of less than $5,000 per year. If you actually bring in more than $5,000 in any particular year, however, you will need to file Form 1023 within 90 days of the end of the year. See Application for 501(c)(3) Tax Exemption for details.
Note that if the IRS classifies you as a private foundation and not a public charity, you should contact an experienced nonprofit lawyer immediately to understand the implications of such a classification.
Like other corporations, a nonprofit corporation consists of the following classes of people:
Another category unique to nonprofits is members. Members are a special class of individuals and/or organizations that have rights to participate in the current and future affairs of the nonprofit organization. Nonprofit organizations are not required to have members. You should consult with an experienced nonprofit lawyer if you wish to become a membership organization.
State corporate laws and the nonprofit organization's corporate bylaws govern such things as:
The full array of issues surrounding nonprofit governance is beyond the scope of this Guide. For example, there are reasons to both limit a board's numbers (concentrate control) and broaden a board's numbers (live up to the ideals of representation). A good legal professional or legal resource should be able to help you find the best structure for your nonprofit. For the board example above, in "Starting and Managing a Nonprofit Organization," Bruce R. Hopkins suggests creating an additional advisory committee, thus satisfying concerns of representation and control. You should seek out resources such as Hopkins' book, or consult with a lawyer experienced in nonprofit matters.
Operating a nonprofit organization is often burdensome and costly. There are reporting requirements and operating restrictions that you need to keep in mind in order to to comply with the law and maintain 501(c)(3) exempt status. Expect increased paperwork and red tape in order to comply with:
Note that the operating restrictions and requirements are even more stringent if your organization qualifies as a private foundation and not as a public charity.
Additionally, you will also be responsible for the tax and other regulatory obligations imposed on all small businesses. For more on the tax obligations of small businesses, see the Tax Obligations of Small Businesses section and the IRS's informational guide, Publication 583 (1/2007), Starting a Business and Keeping Records.
Once incorporated, the newly created nonprofit organization is a separate legal entity from its incorporators, directors, and employees. In fact, a nonprofit has no owners, at least not in any ordinary sense. The nonprofit corporation owns all assets of the business and is entitled to receive all profits from its operation. Among the most important assets of any nonprofit corporation that operates a website or blog are its articles, posts, videos, and other content. For details on who owns what from a copyright perspective, see the Copyright Ownership of Articles and Posts section.
Despite its name, a nonprofit organization is not precluded from making a profit or engaging in profit-making activities. However, a nonprofit is prohibited from passing along any profits to those individuals who control them, like founders, directors, officers, key employees, and members. (A handful of states allow a nonprofit corporation to issue stock as a mechanism of control, but no dividend rights accompany the issued stock.) Instead, a nonprofit organization must use any profits to further its program activities or "exempt functions." It may also invest profits in another tax-exempt organization.
Although a nonprofit organization may not distribute profits to its directors, officers, key employees, or members, a nonprofit organization may pay its employees a salary and give them benefits. A nonprofit organization may also pay directors for their expenses and time spent attending director meetings. The key is that the salaries and payments must be reasonable. Excessive payments or exorbitant amounts posturing as salaries or compensation violate the tax code and may lead to penalties and a loss of tax-exempt status.
Note: If you dissolve your nonprofit organization, you must invest all profits into another nonprofit organization.
If you obtain 501(c)(3) tax-exempt status, your nonprofit corporation will be exempt from paying federal corporate income tax. However, the 501(c)(3) tax exemption does not apply to unrelated business taxable income or "UBTI," which refers to income generated from regular trade or business activity that is not substantially related to the nonprofit organization's exempt purpose. Consult the IRS publication, Tax on Unrelated Business Income of Exempt Organizations, for examples of what constitutes "unrelated business income."
Note that your nonprofit corporation may engage in unrelated trade or business activity, but will be liable for the taxes on the gross income exceeding $1,000 generated by it. In this situation, you will need to file Form 990T, the UBTI return, with the IRS.
If you achieve 501(c)(3) tax-exempt status, you will still need to file an annual tax return with the IRS, unless your organization's gross receipts are normally $25,000 or less. Organizations beyond the $25,000 threshold with gross receipts below $100,000 and total assets at the end of the year less than $250,000 can file the return on Form 990EZ. Organizations with gross receipts above $100,000 and assets above $250,000 must file the return on Form 990. For details, including how to calculate gross receipts, see the Instructions for Form 990 and Form 990-EZ.
Beyond exemption for federal income tax, qualifying under 501(c)(3) provides another important benefit: donations to the organization will be tax deductible by donor, making fundraising easier. Moreover, some donors, like foundations and the federal government, are barred from funding projects that don't have 501(c)(3) status).
You may also be eligible for other special benefits, such as:
Taxation is a very technical subject and you should consider having the nonprofit corporation's tax returns and reports handled by an experienced tax accountant.
An important issue is the federal tax code's rule against 501(c)(3) organizations engaging in political and legislative activities. Because the proscribed activities violate the tax code (and may result in the revocation of the organization's tax-exempt status, the imposition of an excise tax, and liability for back taxes), you must understand how 501(c)(3) defines each type of activity. See the section on Prohibitions on Political and Legislative Activities in this guide for more information.
As discussed above, forming and maintaining a 501(c)(3) nonprofit corporation can take a lot of time, energy, and money, especially if you are beyond the gross receipts threshold requiring you to formally apply for 501(c)(3) exempt status. You may worry that the work needed to incorporate will distract you from your online publishing activities, but also believe that the benefits of tax-exempt status are too important to pass up.
One option to explore is whether a relationship with a "fiscal sponsor" is right for you. Fiscal sponsorship is the mechanism by which a nonprofit organization with 501(c)(3) status lends its legal and nonprofit status to persons, groups, or businesses that engage in activities related to the sponsor's mission. Through fiscal sponsorship, you may be able to function as a nonprofit organization (including receiving tax-deductible donations) without going through the hassle of forming your own independent organization. Fiscal sponsorship also offers the possibility of benefiting from the sponsor's established administrative infrastructure, financial liquidity, and expertise. In exchange for these services, the fiscal sponsor generally keeps a percentage of each financial transaction or charges a monthly or yearly membership fee. Note that fiscal sponsors that work on a percentage basis or provide services beyond simply acting as an umbrella organization often have a minimum fundraising requirement for eligibility.
Seeking a fiscal sponsor may be best if you are:
You will need to weigh the benefits of gaining immediate tax-exempt status and administrative support (if selected) against taking the time and effort to apply for fiscal sponsorship, relinquishing some control, and paying the fees charged by a sponsor.
Some examples of fiscal sponsors include:
In order to form a nonprofit corporation, you must file articles of incorporation (sometimes called a "certificate of incorporation" or "charter document" or "articles of organization") with the state and pay a filing fee. The filing fee generally ranges between $30 and $125 depending on the state. See State Law: Forming a Nonprofit Corporation for details on state filing fees.
The articles function like a constitution for the nonprofit corporation. Ordinarily, the document is short and simple, and you can prepare it your own by filling in the form provided by your state. A number of items in the articles, however, are important in order to obtain tax-exempt status from the federal government, such as the statement of purpose and statements indicating that the organization will not engage in prohibited political and legislative activity and that all of its assets will be dedicated to its exempt purpose under 501(c)(3). These items are discussed below. Consult the IRS website for a list of the Required Provisions for Articles and sample articles of incorporation to help you draft articles that meet the federal requirements for tax-exemption. State requirements for nonprofit articles of incorporation vary, however, so you may need to adapt the IRS sample to meet your state's specific requirements. Below is a list of information commonly required by the states and the IRS:
Said corporation is organized exclusively for charitable, religious, educational, and scientific purposes, including, for such purposes, the making of distributions to organizations that qualify as exempt organizations under section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code.
Some states also ask for a Statement of Lawful Purpose and a Statement of Specific Purpose.
A sample "Statement of Lawful Purpose":
The purpose of the corporation is to engage in any lawful act or activity for which corporations may be organized under the laws of State.
A sample "Statement of Specific Purpose":
The specific purpose for which this corporation is organized is to publish a blog providing information to the public on deep sea fishing practices off Hawaii.
is not for-profit:
No part of the net earnings of the corporation shall inure to the benefit of, or be distributable to its members, trustees, officers, or other private persons, except that the corporation shall be authorized and empowered to pay reasonable compensation for services rendered and to make payments and distributions in furtherance of the purposes set forth in the Statement of Purpose hereof. The property of this corporation is irrevocably dedicated to [your 501(c)(3) exempt purpose(s)] and no part of the net income or assets of this corporation shall ever inure to the benefit of any director, officer, or member thereof, or to the benefit of any private individual.
will not engage in prohibited political and legislative activity under 501(c)(3):
No substantial part of the activities of the corporation shall be the carrying on of propaganda, or otherwise attempting to influence legislation, and the corporation shall not participate in, or intervene in (including the publishing or distribution of statements) any political campaign on behalf of or in opposition to any candidate for public office. Notwithstanding any other provision of these articles, this corporation shall not, except to an insubstantial degree, engage in any activities or exercise any powers that are not in furtherance of the purposes of this corporation.
if dissolved, will distribute its assets within the meaning of 501(c)(3):
Upon the dissolution of the corporation, assets shall be distributed for one or more exempt purposes within the meaning of section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code, or shall be distributed to the federal government, or to a state or local government, for a public purpose.
You can find the required forms and sample articles of incorporation on your state's page. If you must amend the articles, you can do so by filing articles of amendment with the same official to whom you submitted the original articles (usually the Secretary of State).
Bylaws are the rules and procedures for how a nonprofit corporation will operate and be governed. Although there are no set criteria for bylaw content, they typically set forth internal rules and procedures for the nonprofit corporation, touching on such issues as:
A comprehensive discussion of bylaw content is beyond the scope of this Guide. Drafting bylaws can be complex, but there are strategies for writing satisfactory bylaws without the expense of hiring a lawyer. Nolo publishes Anthony Mancuso's "How to form a Nonprofit Corporation," which guides the reader through creating bylaws appropriate to the nonprofit organization.
Nonprofit corporations are required to write and keep a record of their bylaws, but do not have to file them with a state office. Thus, unlike amendments to the articles of incorporation, bylaws may be changed without officially filing amendments.
The incorporator(s) (i.e., person(s) filing the paperwork) or initial director(s) (if named in the articles of incorporation) generally have the authority to adopt a nonprofit corporation's original bylaws at the nonprofit corporation's organizational meeting.
In addition to the two major "constitutional" documents (the articles of incorporation and the bylaws), nonprofit corporations are required to keep copies of a number of other records relating to the the organization, finances, and ownership of the business.
State record-keeping requirements vary. You can find links to your state's specific record-keeping requirements in State Law: Forming a Nonprofit Corporation. However, as a matter of best practice you should keep copies the following documents in the nonprofit corporation's principal office (where it is operating on a day-to-day basis) and on file with the nonprofit corporation's registered agent (this latter step is applicable only if the nonprofit corporation is incorporated in a state other than where it does business):
These requirements are in addition to those required for all small businesses for tax purposes. For more on the tax obligations of small businesses, see the Tax Obligations of Small Businesses section and the IRS's informational guide, Publication 583 (1/2007), Starting a Business and Keeping Records.
If you choose to apply for 501(c)(3) tax exemptions yourself, set aside an entire day to devote to the form; the IRS says it takes ten hours for the average person to complete. While line by line guidance on how to fill out Form 1023 and advice on strategy are beyond the scope of this Guide, here are some things to keep in mind:
1. Check whether your nonprofit corporation has to apply in order to gain 501(c)(3) statusAssuming that your nonprofit organization has been established as public charity with a 501(c)(3) purpose, you do not have to apply for federal tax exemption if the organization's gross receipts are normally less than $5,000 per taxable year.
i. $7,500 or less in gross receipts, during its first tax yearii. $12,000 or less in gross receipts, during its first 2 tax years
iii. $15,000 or less in gross receipts, during its first 3 tax years
You will want to have your tax exempt status retroactive to the date of incorporation, so that your nonprofit corporation can take advantage of the exemptions and so that any donations are tax-deductible. You have 15 months from the date of incorporation to file Form 1023, with a 12 month extension. (If you delay, your tax exempt status is retroactive to the date of application.)
4. Request public charity classification in Part X of your application
Every organization that qualifies for 501(c)(3) exempt status is further classified into a public charity or a private foundation. Private foundations are subject to different tax obligations and the IRS imposes additional restrictions and requirements on them. In all likelihood, you will want your nonprofit organization to avoid being classified as a private foundation. To do so, you must give notice to the IRS that your organization is not a public charity. You do this in Part X of 1023, usually by checking the box next to Line 5g, 5h, or 5i (depending on the nature of your funding).
5. While Your Application Is Pending
While waiting for the IRS to approve your application, your nonprofit corporation may operate as a tax-exempt organization. When you file your annual federal and state information returns for your nonprofit corporation, note that your 501(c)(3) application is pending IRS approval.
6. Advance and Definitive Rulings
If you have not completed a tax year of at least 8 months at the time of application, you must ask for an advance ruling.
7. Know your audience
Remember that your application is not only going to be read by the IRS, but also (at least potentially) by members of the public.
8. Sign up for "Exempt Organizations Update"
Stay abreast with the latest developments about 501(c)(3) with Exempt Organizations Update, a newsletter published by the IRS.
An important issue is the federal tax code's rule against 501(c)(3) organizations engaging in political and legislative activities. Because the proscribed activities violate the tax code (and may result in the revocation of the organization's tax-exempt status, the imposition of an excise tax, and liability for back taxes), you must understand how 501(c)(3) defines each type of activity.
a. Political activity
Political activity refers to direct or indirect participation in any political campaign for elected public office. The focus is the partisan nature of the activity. Some guidelines:
Deciding whether or not any particular activity is prohibited "political activity" may often require some difficult line drawing. Refer to the IRS' Revenue Ruling 2007-41 for more information. The Revenue Ruling outlines 21 scenarios and explains why each situation does or does not run afoul of the ban on political campaign intervention.
b. Legislative activity
Legislative activity refers to attempts to influence legislation, popularly known as lobbying. While the prohibition discussed above bars any political activity supporting or opposing a candidate running for office, the prohibition on legislative activity is more nuanced. No "substantial part" of a 501(c)(3) organization's activities may be devoted to lobbying.
Influencing legislation includes any of the following activities:
The focus is on influencing legislation and legislative bodies, like
Congress or a state legislature, and not on influencing executive,
judicial, or administrative bodies. However, the prohibition against
political activity applies to these arenas as well. For example, a
nonprofit organization may not endorse or oppose candidates running for
judicial office. Refer to the IRS Publication on Lobbying which lists detailed examples of legislative activities.
At this point you may be asking yourself: what exactly can I do without jeopardizing my 501(c)(3) status?
You may author and publish:
This area of law is complex. In particular, determining whether your writing is "political activity" or "issue advocacy" requires difficult and fact-sensitive analysis. In addition, figuring out whether a particular lobbying activity involves a "substantial part" of your organization's overall activity is challenging. Given the penalties for violating these prohibitions, you should seek a lawyer's assistance when deciding whether to undertake activities that seem borderline.