In the beginning, it’s easier to learn how to create a 501(c)(3) than most people think. Section 501(c)(3) is part of the U.S. Internal Revenue Code that provides exemptions of federal taxes for qualifying nonprofit organizations. The IRS, under the U.S. Department of the Treasury, regulates and administers nonprofit organizations. While section (c)(3) is the most common type of nonprofit, the government has additional classifications for nonprofit organizations under Section 501(c)(1)-501(c)(29). It’s important to file under the proper classification.
Does Your Organization Qualify as a 501(c)(3)?
Nonprofit organizations fall into three categories — public charities, private foundations and private operating foundations.
Public charities are what most people recognize as nonprofits. They are charities for certain medical illnesses, churches, animal welfare, etc. Public charities must get at least a third of their money from public support, which usually comes from individuals, companies and other charities. Also, they must maintain a board of directors of mostly unrelated individuals. Individual donors may get a federal deduction for donations up to 60% of their income, and corporations may get a deduction for donations up to 10% of their income.
Private foundations don’t have active programs, and the government doesn’t require them to be publicly supported. These are often family foundations where the money comes from wealthy individuals or families. Private foundations often support the work of other charities through grants. These foundations get a deduction on their tax returns for up to 30% of their income.
Private operating foundations have attributes similar to private foundations and use their donations to run programs like a public charity.
Nonprofit laws vary somewhat by state. Most states also offer a deduction for state income tax purposes. State laws may also allow nonprofit organizations to be exempt from sales tax on purchases and property taxes. Nonprofits also get a special bulk rate on postage.
Qualifying organizations for nonprofits include the following categories:
- Testing for Public Safety
- Fostering of national or international amateur sports
- Prevention of cruelty to animals and children
9 Steps on How to Create a 501(c)(3) Organization
Begin with the following 9 steps to creating a 501(c)(3) organization:
- Apply to the IRS. Fill out Form 1023 or 1023-EZ. This form is the application for recognition of federal tax exemption. Upon receipt of this form, the IRS will examine the organization’s structure, governance and programs to ensure that it meets the requirements under Section 501(c)(3).
- Choose a name. Your charity’s name must be uniquely different than other registered nonprofits. Usually, a state’s Secretary of State’s office manages nonprofits at the state level and they can tell you if a particular name is available.
- File the articles of incorporation. Most states offer a nonprofit information packet that outlines the type of information you need to include in your articles of incorporation. This document requires specific language, so it’s best to be sure that it’s been done correctly. See this template of the articles of incorporation from Minnesota Council of Nonprofits.
- Apply for your state tax exemption. Some states require nonprofits to complete a separate application to get a state tax exemption. In most states, the state tax exemption occurs automatically when you file the federal forms. Contact your state tax agency to find out if you need to send them a copy of the IRS determination letter that approved your federal exemption.
- Draft your bylaws. A nonprofit’s bylaws list the rules and procedures for holding meetings, quorums and voting; electing board directors and officers; and other governing rules. The nonprofit’s directors usually approve the bylaws at the first board meeting.
- Appoint a board of directors. Most states require nonprofits to have at least three board directors. The odd number is by design so that there’s a way to break tie votes. A few states only require one board director. The board directors make the major policy decisions and manage the budget and donations.
- Hold the first board meeting. The first board meeting is an exciting time. It’s also a time for taking care of certain formalities like adopting the bylaws, electing officers, and recording the approval of federal and state tax exemption documents. The secretary usually takes board meeting minutes, but someone else can do it if the board slate isn’t yet full. The board will need to approve the minutes, and the board chair and secretary will need to sign them.
- Obtain licenses and permits. There may be licensing requirements for your nonprofit depending on the type of activities you will be doing. Your state’s department of consumer affairs (or a compatible state agency) will let you know whether you need a sales tax permit, a zoning permit or anything else to operate on an ongoing basis.
- Renew applicable documents for ongoing compliance. Put a system in place so that someone in the organization is responsible for complying with documents at the state and federal levels. Nonprofits must submit an annual report, IRS Form 990, and state charitable solicitations registration and renewal form.
Complying with Restrictions for 501(c)(3) Organizations
Boards of directors should know and comply with the rules for nonprofits. One of the main rules is that board directors, officers and private individuals may not unfairly benefit from the activities or governance of a nonprofit organization. Another important consideration is that a charity’s assets must be permanently dedicated to a charitable purpose. This means that if a nonprofit goes out of business, they must distribute assets to another charity. No one can keep any of the money left over from a nonprofit organization when it goes out of business.
Also, nonprofits have some limitations regarding lobbying and legislative activities. They’re not allowed to endorse any particular candidates for public office and they’re not allowed to do political lobbying of any substance.
Modern Governance from the Start
It’s never too soon for nonprofit organizations to get started with a board management software program like BoardEffect. It’s vital for nonprofit board communications and file sharing to be highly secure, even at the time of startup. BoardEffect is the modern governance solution to nonprofit board management. If it’s not in the nonprofit agenda to invest in modern governance board management software, make it one of the first items on the agenda.