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Starting a nonprofit to serve a need in your community is a noble endeavor that many are inspired to do. What many are unaware of, however, is the tremendous amount of work and resources that starting and maintaining a nonprofit entails. Before we even get to the business of filing paperwork to create a nonprofit, it’s important to do your homework. In a recent post, we addressed five items that should be checked off your to-do list before filing your formation documents.
Along with that preparatory work, it is also critical to have a basic understanding of the rules and requirements for nonprofits. Having an experienced lawyer help you understand and navigate these rules and requirements from the beginning will help set your organization up for success. In this post, we’ll explain the basic paperwork involved with setting up a nonprofit organization, which is a multiple-step process that involves agencies at the state and federal levels.
First, let’s clarify some of the terminologies around nonprofits. A nonprofit organization is a group organized for purposes other than generating a profit and in which no part of the organization’s income is distributed to its members, directors, or officers. Nonprofits are organized under state law and can take various forms; for example, an unincorporated association or a corporation. Nonprofit corporations do not have owners in the same way that for-profits do, this is why they are termed “non-stock corporations” under certain states’ laws (i.e., nonprofit corporations and non-stock corporations mean the same thing).
The term “tax-exempt” is a tax classification. A nonprofit can seek tax-exempt status, which means – if granted – it would be exempt from paying taxes on its income. The U.S. Internal Revenue Service (IRS) grants exemption from federal income tax and many state and local governments often grant tax exemption from state and local taxes based on the IRS’s determination. There are 25 tax-exempt categories under the Internal Revenue Code (the “Code”). When people think of “nonprofits,” they are often thinking of organizations that are tax-exempt under Section 501(c)(3) of the Code, which are public charities and private foundations. This post focuses on 501(c)(3) public charities, which must be organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes or to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals.
When you’re ready to create your nonprofit, here’s what’s involved:
Filing this document with the state will officially create your nonprofit corporation. Most states have their own form of articles of incorporation and allow for online filing; however, be aware that some state forms only comply with state law requirements for organizing a nonprofit corporation and do not include the provisions required by the IRS for tax-exempt status. Your articles of incorporation should meet both the state law and IRS requirements. For the articles, you will generally need the name of the corporation, address, registered agent, initial directors, whether the corporation has members, the purpose of the corporation, and additionally, the IRS provisions required for tax-exempt status.
In DC, you may file the Form DNP-1 Articles of Incorporation for Domestic Nonprofit Corporation. In Maryland, you may file Articles of Incorporation for a Tax-Exempt Nonstock Corporation and, in Virginia, the Form SCC 819 Articles of Incorporation of a Virginia Nonstock Corporation. In practice, however, it is more common to draft articles of incorporation rather than use the state’s forms because it allows for more flexibility and the state’s forms may not include the provisions required by the IRS (of these three jurisdictions’ forms, only the Maryland form includes the required IRS provisions.) Each of these jurisdictions allows for online filing and charges a filing fee. If you need your articles processed quicker, you can pay a fee to expedite your processing.
Once you have created your new entity, you will need a federal tax identification number, which is called a federal employer identification number (EIN). This number is needed, even if the organization does not have employees. To obtain an EIN, file a Form SS-4 with the IRS on behalf of the organization, which may be done online, by telephone, fax, or mail. You can obtain an EIN immediately if done online or by telephone, but fax or mail will take several days. There is no fee to obtain an EIN.
This step requires the longest amount of lead time than any other step in the set-up process. Preparing the application form requires more information than other filings needed for set up and the processing time is longer than any other step in the process. For tax exemption under 501(c)(3), a Form 1023 Application for Recognition of Exemption must be prepared and filed with the IRS. There are two versions of the form, the regular (long) Form 1023 and the streamlined (short) Form 1023-EZ. The streamlined form requires less information and the processing time by the IRS is much shorter, so if your organization is eligible to file the 1023-EZ, this version of the form should be used.
An organization may be eligible to file Form 1023-EZ if the organization’s annual gross receipts are not projected to exceed $50,000 in any of the next three years and its assets do not have a fair market value in excess of $250,000. There are additional eligibility requirements, which may be found on the eligibility worksheet in the instructions to Form 1023-EZ. For many nonprofit startups, Form 1023-EZ may be appropriate.
Form 1023-EZ will require you to provide basic identification and contact information for the organization, including the name of the organization, address, EIN, phone number, and the names, titles, and addresses of the organization’s officers, directors and/or trustees. You will need to describe and attest to the organization’s mission and activities and choose a classification as a private foundation or public charity.
If the organization is not eligible to file Form 1023-EZ and must file the long Form 1023, in addition to supplying the information required for Form 1023-EZ, you are asked to provide the organization’s bylaws and other governance-related information, such as a conflicts of interest policy; a detailed description of past, present, and planned activities; describe any grants, loans, or distributions that will be made by the organization; disclose and discuss relationships with board members, operations in foreign countries, relationships other organizations, and fundraising activities; and provide financial information, including three years of financial data.
Additional schedules may be required if the organization will be engaging in certain types of activities (i.e., for churches, educational institutions, hospitals and medical research organizations, supporting organizations, low-income housing, and providing funding to individuals).
Regardless of which form is prepared and filed, the preparation and filing of Form 1023 is an important milestone for the organization and should be overseen and approved by the organization’s board of directors.
Form 1023s are submitted online and require a filing fee of $275 for Form 1023-EZ and $600 for Form 1023. The IRS posts information regarding when submitted applications have been assigned to a specialist for review: Where’s My Application for Tax-Exempt Status.
This step may be done concurrently with the preparation of Form 1023 but will most likely happen afterward due to the effort and attention required by Form 1023. Each jurisdiction has differing requirements for the tax registrations required by nonprofit organizations and may differ depending on the organization’s operations and activities, such as whether the organization has employees. In DC, you will file a Form FR-500 Combined Registration for District of Columbia business Taxes/Fees/Assessments with the DC Office of Tax and Revenue. Organizations that are not semi-public institutions are subject to DC’s personal property tax on personal property located in DC and therefore will be required to file Form FR-500. In Maryland, if the organization is required to register for certain types of tax accounts, including income tax withholding for employees, you will file a Form CRA Combined Registration Application with the Comptroller of Maryland. Similarly, in Virginia, registration is only required if the organization must register for specific types of taxes.
Before your nonprofit organization begins soliciting donations, you may be required to register for a charitable solicitation license. The regulation of charitable solicitation activities is important for consumer protection purposes and each state’s interest is in protecting the residents of its state. Therefore, if your organization plans to or is soliciting charitable contributions from residents of multiple states, you may be subject to those states’ charitable solicitation laws and be required to register. This can become administratively burdensome if an organization is soliciting donations nationwide, especially for smaller nonprofits.
Some states may require that the organization has received tax-exempt status from the IRS in order to register for charitable solicitation, so you may need to wait for a determination from the IRS before applying for a charitable solicitation license. At the very least, an organization should register for charitable solicitation in the state where it was formed.
Perhaps the last step of what might be considered part of the setup process is obtaining exemption from state taxes. States often grant exemptions from certain taxes, such as income tax or sales tax, to organizations that have received tax-exempt status from the IRS. This will, for example, exempt the organization from paying sales tax on purchases. To receive this, the organization will usually need to provide a copy of its IRS determination letter in the application process.
In all three jurisdictions, sales tax exemption certificates must be renewed every five years.
Overall, the process can take several months to up to a year to complete, largely depending on the length of time it takes the IRS to process Form 1023. As of the writing of this post in August 2022, the IRS has yet to assign to a specialist Forms 1023-EZ postmarked after August 16, 2022 and Forms 1023 postmarked after January 14, 2022.
At The Geller Law Group, we are happy to assist you with setting up your nonprofit and complying with these requirements so that you can get to the good work you set out to do through your nonprofit. Contact us today to set up a consultation.
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