If you’re considering starting a nonprofit, chances are you see a need in the world and want to participate in a tangible solution. This journey can be equal parts rewarding and intimidating, as you’re about to join over 1.5 million tax exempt organizations registered in the US according to the National Center for Charitable Statistics (NCCS). The nonprofit world is full of passionate people working in a highly complex and regulated sphere.
We know you’re probably anxious to get to the part where you’re rallying people around your mission, so we’ve put together this comprehensive outline of the process so that you can step forward with confidence., And when you’re ready to create the nonprofit legally, reach out to us. We’ve helped over 400 nonprofits get started nationwide.
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Starting a Nonprofit: The Essential Planning Phase
Developing Your Board of Directors: Recruiting the Right People
The Legal Steps: Making your Nonprofit A Reality
I’ve Received My Determination Letter – What Next?
How to Know if you are Ready to Start a Nonprofit
Assuming you have an idea of what change you’d like to see in the world, we’re going to start out with seven simple questions (with more substantial explanations here) that can help you assess if you are ready to start a nonprofit and to make your vision a reality.
- Will you serve a “charitable class?” In other words, who do you plan to serve, and are they eligible to receive assistance or programming from charitable organizations? Generally, a charitable class is a specific group of people or other defined group, such as the homeless, vulnerable animals, wildlife habitats, etc. Learn more here to ensure you’re serving a charitable class.
- Do you have a charitable “program?” How will you accomplish your mission? The IRS will need to know details about the “who, what, when, where and how” you will practically carry out your purpose. Code § 501(c)(3) with the IRS requires that tax-exempt charities be organized and operated exclusively for (1) religious, (2) charitable, (3) scientific, or (4) educational purposes, among others (collectively “charitable purposes”).
- Can you feed and care for an organization? This question is referring to your ability to comply with reporting and record-keeping obligations. This maintains your charitable status and includes filing the Form 1023 with the IRS to qualify as tax-exempt, filing 990s on a timely basis every year, and making sure you are legally registered to fundraise in most states.
- Can you fund the startup? There are a number of ways to fund a startup nonprofit, like donations and grants. But if you cannot secure enough funding, then it might be better to work with an existing organization or charity to accomplish your charitable goals. To give you an idea, there are a number of costs up front including any materials you’ll need and filing for tax exempt status with the IRS. The IRS fee ranges from $245 to $600.
- Do you have an anticipated budget? Not only does budgeting help you understand what resources you will need to support your objectives, but this will also help you determine whether you are a private foundation or public charity, an important designation for when filing for tax-exempt status.
- Have you developed a funding plan? It is a common misconception that nonprofit means that you cannot make a profit, but this isn’t true. A nonprofit can, and should, have revenue that exceeds its expenses, but nonprofits cannot distribute that excess to its “owners” or other “insiders.” The phrase “no margin, no mission” reflects this reality well – plan to make sure you’ll be sustainable!
- Do you have a board? Lastly, you need to have a board of directors for your nonprofit. We’ll go more in depth about developing your board later in this article.
If you answered “yes” to four or more of these questions, then you are headed in the right direction and might be ready to start your nonprofit. However, if you answered “no” to four or more, you will want to invest more time in planning before you are ready to change the world.
That’s because these questions are common questions any nonprofit needs to be able to answer. They cover the basic groundwork and decisions that need to be made before jumping into the legal paperwork. Again, for more in-depth information about each of the questions outlined above, learn more here about the seven questions to know if you are ready to start a nonprofit.
How to Create A Board for your Nonprofit
When starting a nonprofit, selecting members for your board of directors is one of the most essential steps you can take to make it a reality. But before choosing board members, it’s important to understand the basics so that you can avoid common mistakes in the long run and remain compliant with the IRS. Here are our most frequently asked questions about creating your initial board of directors:
Do I have to have a board of directors?
Yes, every nonprofit organization is legally required to have a board to oversee its activities, and the IRS generally requires nonprofits to have a minimum of three members. Your nonprofit’s board will play an important role in how your organization is governed. Whether the board is making informed decisions about how the nonprofit operates or managing legal and financial risk, they act as the top of the chain of command.
While your nonprofit’s staff and/or volunteers work to keep its programs running smoothly on the ground, your board will spend more time on the big-picture items like ensuring the nonprofit’s programs are in line with the overall organizational goal or creating a strategic plan.
Who can (or cannot) be on my board of directors? Can board members be related?
A typical board of directors has three or more members, the majority of whom are unrelated. “Unrelated” simply means that the members cannot be related to you or each other by blood, marriage, or business (for example, two people who own a business together). You can have some related board members, but typically you must have additional members that can out-vote the related members. This is because related board members may pose a conflict of interest for your organization. A conflict of interest, in this case, is a transaction or arrangement that allows a person to gain personal benefits from their official position.
The exception to this rule is for private foundations. However, just because it is permissible for the board majority to be related by blood or marriage does not always mean it is advisable. Consulting with a nonprofit formation professional may be in order to help you understand best board practices for your specific organization’s situation and state guidelines to make sure you don’t run into any issues with the IRS.
Can Board Members be Compensated?
There certainly are some instances where board members are compensated. For example, it is not uncommon for boards of large, complex institutions (like healthcare systems) to be paid for their service.
However, the vast majority of board members serve as unpaid volunteers, dedicating their time, money and expertise to the nonprofit’s mission and operation. While there is no federal law that prohibits board members from being compensated, it is common practice for most nonprofit organizations not to pay their boards.
What kind of people should I select to be on my board?
Your board members should be people with a high degree of integrity, passion for your mission, and leadership experience. The people you consider for your board should be ready to advocate for your organization while also providing a level of relevant skill, which could include having a learned professional such as a lawyer, accountant, marketing expert, or someone with deep knowledge of your programming areas. This range of experience will ensure your board is covered by a wealth of trusted perspectives.
For example—you may have strengths in management, but if event planning is challenging for you, a board member who has this strength can assist when it’s time to host fundraising events. When your nonprofit is just starting out, or if the nonprofit is small (think under $50,000 in annual revenue), your board tends to be very involved in the day-to-day, hands-on aspects of your nonprofit. At this stage, one of the best things you can do is recruit board members who can help fill in gaps for you.
Keep in mind your audience and the demographic you hope to serve. For example, if your nonprofit will serve homeless veterans, having veterans on your board will allow for veteran voices to be represented in the organization’s decision making processes.
Lastly, when choosing board members, ensure that you educate them properly about their roles and duties to the organization. Your board is obligated by law to attend to these three duties, and failing to educate them properly can result in disastrous consequences for your organization that could include expensive liability. You’ll want board members who are team players, committed to avoiding these common board mistakes.
How can I recruit my first board members for my nonprofit?
Think about what types of talent your organization might need. You’re passionate about your cause, but it takes people of all different skill sets to create and operate a successful organization. For your first board, you’ll also need to elect positions within the board: President (often called “Board Chair”), Treasurer and Secretary are the positions that must be filled according to the IRS’s regulations.
As a general best practice, the initial board of directors should include:
- Someone who understands your target population. For example, if you’re starting an animal shelter, having a veterinarian or a dog trainer on your board would be great. You need at least one person on your board who has experience in that field and can help speak for your targeted population.
- Someone with experience raising money, whether that person is in sales, event planning, grant writing, or has helped fundraise for other nonprofit organizations. Every board needs at least one (preferably more!) person who isn’t afraid to seek funding for the organization. No matter how wonderful your cause is, if you don’t receive funding, you won’t be able to achieve your mission.
- Someone who is not afraid to disagree with you. Although it can be tempting to recruit board members who will all agree on everything, this can actually be a problem. If you don’t have disagreements, you might miss out on alternative solutions to problems that will arise. In a similar way, ensuring your board is diverse in gender, race, ethnicity, and background can also help provide a variety of perspectives, strengthening your nonprofit in the process.
- Someone who understands basic finance. Once you have funding coming in, the person you select as your board’s Treasurer will need to have some knowledge in the area of finance or bookkeeping. Typically, this role is filled by an accountant, bookkeeper, or other financial professional, but if your organization will be hiring an accountant instead, it would suffice to have someone with more basic knowledge on the topic. Keeping your nonprofit’s finances in order ensures you have the resources to do the great work you want to do. It’s also great to have your finances in order when your reporting is due to the IRS and to the state you’re incorporated in.
Depending on the type of organization you have, it can also be useful to have a few other key players on your board. An understanding of real estate can help if your organization is looking to buy, rent, or sell your first building. Someone with an intimate knowledge of technology might be able to help your organization leverage tech to better serve your mission. And many organizations recruit an attorney to their board for basic legal knowledge, though we would caution against taking too much advice from a free board attorney unless they specialize in nonprofit law. Nonprofit law is a niche area that differs from other areas of law, so a well-meaning divorce attorney might give your nonprofit incorrect guidance on accident.
For all the people on your first board, choose people with time to dedicate to your organization. At the start of a nonprofit, being on the board can be time-consuming, so make sure members understand the time commitment you’ll expect from them. And of course, your board should ultimately be made up of people who are committed to your mission.
So how do you find people for your first board?
First, think of the people you know who care about your cause. Whether it’s friends, coworkers, people you know from a social club, or people you know from church, odds are, you know other people who care about your mission. When you have initial people in mind, be sure to ask them if they know people who also may be interested in getting involved.
Don’t discount the power of networking. Most cities have networking groups you can attend to meet other people, so that can also be a great way to expand your options. Remember that you can have someone related to you on your board, but it cannot be the majority of people on your board.
How to Start A Nonprofit
Once you’ve completed your initial planning stages and you’ve begun recruiting board members, it’s time to start looking at the legal steps to starting your nonprofit.
Step One: Incorporate In Your State.
The first step is to incorporate with your state. This step is what brings your nonprofit from an idea to an existing entity, so you’ll want to have your nonprofit’s name decided at this point. Each state is a little different when it comes to processing this paperwork:
- Some states call this filing articles of incorporation, while others might call this a certificate of formation or something similar. Most states have a filing fee you’ll need to pay to accomplish this step.
- Some states process paperwork within a few days, while other states can take as long as a few months (so plan accordingly).
- Each state has different requirements for articles of incorporation, and many provide templates that outline what they ought to contain.
It’s important to note that if you’re looking to achieve 501c3 status, keep in mind the IRS requires specific language in your corporate formation documents that may not be included in state templates. If you’re unsure about these requirements and would like one of our nonprofit attorneys to handle the incorporation paperwork for you, let us know.
Step Two: Draft Your Remaining Corporate Documents
You’ll want to file for your Employee Identification Number (EIN) shortly after your articles of incorporation are approved, which is a nine-digit code the IRS uses to identify your organization.
Next, it’s time to draft your organizational actions, which is a document that accomplishes a number of startup steps. Your organizational actions document is essentially your roadmap to your first board meeting, where you will appoint your initial board of directors and their officer roles, choose who will open the bank account, and officially approve and adopt your bylaws.
Your conflict of interest policy will also be drafted at this stage. A conflict of interest is when an individual’s duty to serve the nonprofit’s charitable mission is in conflict with their own interests. In short, this policy will “help ensure that when actual or potential conflicts of interest arise, the organization has a process in place under which the affected individual will advise the governing body about all the relevant facts concerning the situation,” according to the IRS. It also outlines a procedure for how individuals who have a conflict of interest will be excused from voting when a conflict arises.
You’ll need your Articles of Incorporation and your EIN to open a bank account for your organization, and many might also ask to see your organizational actions, conflict of interest policy and some other additional documents.
Step Three: Drafting your Bylaws
Nonprofit organizations are governed by an official set of rules called bylaws. Nonprofit bylaws outline any state requirements for the nonprofit, as well as how the organization (and by extension, the people who run it) will operate on a high level. Bylaws are adopted when the nonprofit is established, and they act as the pillar that upholds the organization—every nonprofit must adhere to their unique bylaws.
Bylaws are essential because they determine how decisions are made, conflicts are resolved, and risks to the nonprofit are avoided. When it comes to legal concerns, it’s your bylaws that have the final word.
Failure to follow your nonprofit’s bylaws can result in a number of both logistical and legal consequences that open the door to liability. We’ll discuss this further when exploring common mistakes later in this section.
What Should My Bylaws Include?
Bylaws should eliminate guesswork, and effective nonprofit leaders refer to them often so they can be followed closely and consistently. On the most basic level, your bylaws should be able to answer practical questions such as:
- How will the board of directors be structured and run?
- If applicable, how do members fit into the organization?
- What will happen when the organization needs to dissolve?
- What if the nonprofit’s bylaws need to be amended in the future?
Read our Nonprofit Bylaws Basics resource for a more detailed breakdown of why each of these questions matter and items to consider when creating your bylaws, as well as a list of common mistakes.
Step Four: Applying for Tax-Exempt Status
Once you exist on the state level, select your board of directors, and draft and file your corporate documents, the moment of truth has come: it’s time to get your federal tax exemption (501c3 status).
Donations to 501c3 organizations are tax deductible, which is a great incentive for giving. Plus, 501c3 status reassures donors that your organization adheres to some level of transparency and accountability. This versatile designation is for charitable causes that are:
- Religious
- Educational
- Charitable
- Scientific
- Literary
- Testing for public safety
- Created to foster a national or international amateur sports competition, and/or
- Focused on the prevention of cruelty to children or animals
It’s worth noting that churches, synagogues, mosques, and other places of worship are automatically considered tax exempt by the IRS (as long as they meet certain requirements) without filing for recognition of 501c3 status officially. However, 501c3 status could be right for your church.
501(c)(3) status covers most types of nonprofits, from veteran’s organizations and youth sports clubs to animal shelters and many places of worship. Most federally tax-exempt nonprofits fall into this category—however, you may find that the activities you’re looking to engage in are better suited for another type. While there are over 20 types of 501cs, you can learn more about the most common types in this free resource: What Type of Tax Exempt Status is Right for Your Organization?
For the sake of simplicity, we’re going to use language for 501c3s in this section.
A determination letter is a document issued by the IRS confirming your organization is tax-exempt. To obtain this letter, nonprofit leaders file the Form 1023 or Form 1023-EZ with the IRS. If you’d like assistance selecting which form is right for your nonprofit, let us know. We’re happy to help complete either IRS form.
IRS Form 1023
The full Form 1023 requires detailed, narrative answers and multiple attachments (many of which are the documents you completed in earlier steps). It can be up to eight schedules and the IRS estimates the form will take 15 ½ hours to complete – but keep in mind this does not include the time to learn the form’s requirements, answer each question accurately, gather records and other related tasks. As a result, the full Form 1023 may take up to 185 hours of working time to file (almost a month’s worth of effort!) and can end up being 100 pages total.
If you are a church, school, or hospital, you will need to file the full Form 1023 by default. You will also file this form if you have or anticipate having over $50,000 in annual gross receipts, if you own over $250,000 in assets, or if you fall into another category that requires this form outside of the ones mentioned above. The IRS charges $600 to file the 1023.
IRS Form 1023-EZ
The Form 1023-EZ only takes about a total of 18 hours total from start to finish (including information gathering). It’s 2 ½ pages long and produces results in about 10% of the time it takes the IRS to approve organizations filing the full 1023. This form has similar requirements for eligibility:
- Having less than $50,000 in annual gross receipts
- Owning less than $250,000 in assets
- Not belonging to one of several specialty categories of tax-exempt organizations
With either form, the IRS is looking to make sure your nonprofit is charitable according to their standards for charitable purposes and activities. They examine everything from your organization’s governance structure, organizing documents and any conflicts of interest that may raise a concern. The IRS charges $245 to file the form 1023-EZ.
The IRS can take several months to approve these forms, so many organizations use fiscal sponsors to receive tax-deductible donations and apply for grants in the meantime. You can learn more about fiscal sponsorship in general here, and learn about Fiscal Sponsorship Allies’ program here.
Due to the lengthiness of this process and the numerous areas that can be easily filed incorrectly, it’s discouraging to be denied tax-exempt status after sinking that many hours into either form. That’s why we’d be happy to help you start your nonprofit and structure it correctly from the very beginning. Let us know if you’d like to speak to a member of our team to discuss. We can complete the entire startup process from start to finish in any state in the US. Packages start at $1600.
I’ve Received My Determination Letter – What Next?
If you’ve completed all the steps in this article, congratulations on achieving tax-exempt status! We’re thrilled that you’ve joined our ranks and are ready for a new chapter in carrying out your mission. Here are a few more steps to consider when really getting the ball rolling:
Charitable Solicitation Registration
In order to fundraise legally, you’ll now need to register to solicit donations in the relevant states (this includes asking for donations via email, newsletters, telethons, etc.)! There are currently 43 states that require this step. While the exact process for registration varies widely by state, the requirement as a whole is called Charitable Solicitation Registration (CSR). You can learn more about CSR and some practical considerations when registering here.
State Tax Exemptions
Unfortunately, even after achieving your federal tax exemption, this does not mean you are exempt from all state-level taxes. Some states, like Texas and California, do require additional steps for charity status in-state. These exemptions include sales and use taxes, income and franchise taxes, and property taxes. Don’t forget to double check to make sure your nonprofit stays compliant and isn’t missing out on additional exemptions.
Common Mistakes for New Nonprofits
Finally, check out our article Top 3 Mistakes Nonprofits Make for more tips and considerations for new nonprofits. We love to see new nonprofit leaders thrive and truly believe that knowledge is power. And if you need assistance with getting your nonprofit started legally, reach out to us for a consultation with a member of our legal team. We’ve helped over 400 nonprofits get started nationwide.
Making Your Nonprofit Your Full-Time Job
Many nonprofits begin as volunteer-led endeavors, spearheaded by people who have other day jobs. But it is possible for your nonprofit to turn from your passion project into your career. Learn more here about when you may be ready to take the leap into making your organization your full-time gig.
