A nonprofit status gives business benefits they would not otherwise receive. Tax exemption is one of the main reasons companies reorganize as nonprofit organizations.
Nonprofits are eligible to receive many kinds of government grants and other funding. Being a nonprofit enhances credibility among donors. Nonprofits receive donations and their donors claim deductions on their income tax. Nonprofits also get discounts on postage.
Becoming a nonprofit involves doing some research, incorporating, and changing your tax status to a 501(c)(3) charitable one.
To qualify to become a nonprofit organization with 501(c)(3) tax status, your company must be one of just a few types of businesses. Nonprofits are usually charitable organizations, such as a religious or educational one, or an organization that serves the public good. However, social clubs, business leagues, and labor and agricultural organizations may also become nonprofits. You may want to meet with a nonprofit attorney to find out for sure if your business would qualify as a nonprofit.
Do Your Research,
Once you know that your business qualifies to become a nonprofit organization, you need to do some extensive research.
You will want to know what the IRS regulations are regarding nonprofit organizations. You will need to research your state’s requirements. You’ll find the state requirements at the Attorney General’s office or at the Secretary of State’s office. It is important to note that the state may require you to obtain pre-approval before you file for your nonprofit corporate status.
Nonprofit businesses must be incorporated. You’ll want to look into the costs associated with incorporation. Since incorporation laws vary dramatically from state to state, you’ll also need to learn what the laws are in the state you will incorporate in. You may decide to start your nonprofit in a state where you like the laws better.
Weigh the Pros and Cons
With all that you will have learned in your research, you will be equipped to weigh the pros and cons of becoming a nonprofit organization. Here are some of the general pros and cons of having a nonprofit organization:
Tax exemption or deduction – You will be exempt from paying corporate income tax. You will likely also be exempt from paying state and local taxes. Charitable contributions will be tax-deductible.
Ease of share ownership transferring – It’s easy to transfer corporation shares.
Eligibility for grants, both public and private – You’ll attract government agencies and foundations that only give grants to public charities. You will also be able to give tax deductions to businesses and individuals who give charitable contributions. Corporations provide advantages for raising capital.
Formal structure – Nonprofits are separate entities from their founders. The mission and the organization’s structure will always be followed before the personal interests of the people associated with the nonprofit.
Limited liability – The employees, members, directors, and founders cannot be held liable for the nonprofit’s debts.
Cost – In addition to time and effort, it costs money to start a nonprofit organization. You’ll need to pay fees when you apply for incorporation and tax exemption. You might also want to hire an attorney, accountant, or some other consultant.
Paperwork – Nonprofits must keep detailed records about their business for annual submission to the state and to the IRS by particular deadlines. This must be done to keep the exempt and active status and to make sure no penalties are assessed. If you file incorrectly for three years in a row, you’ll automatically lose your tax-exempt status. Missing or incomplete schedules are the most common errors that cause nonprofits to be sent a paper form to complete their return on, called a Form 990 series.
Shared control – Once your business is a nonprofit, you have limited personal control over it. Besides having to abide by laws and regulations, your creation may also have many directors. Some states require nonprofits to have several directors. Directors elect or appoint people who make policy.
Scrutiny by the public – A nonprofit’s state and federal filings are public because nonprofits are dedicated to the public’s interest. Both expenditures and salaries can be discovered.
Difficulty starting – On top of needing a lot of money, nonprofit organizations are often quite complicated to start, requiring a lot of planning, time, and effort.
Difficulty keeping doors open – Staying in business is an even bigger challenge because nonprofits need to develop and maintain reliable income streams. According to grantspace.org, some people estimate that fewer than half of new nonprofit organizations last more than five years and that about one-third of the survivors struggle financially.
Incorporation Risks – There are at least three risks that incorporation presents:
1.) Loans and other financial assistance may only be granted if the bank obtains personal guarantees that they’ll be paid back.
2.) Board members can be held liable for corporate criminal acts.
3.) The nonprofit can be dissolved and the personal assets of board members can be seized if legal formalities are not followed.
If you are not entirely convinced that creating a nonprofit is what you want to do, you may want to research alternative ways to serve the same mission.
Find organizations, nonprofit or for-profit, that are already fulfilling the needs of the populations that you had planned to as a nonprofit. You’ll find them in Foundation Directory Online, internet search, 211 directories, and GuideStar for a business you want to work with or support. Approach your favorite kindred organization to help them in one of the following ways:
• Become a Consultant – You can contract to work for existing organizations as a consultant.
• Start a Donor-Advised Fund – This option may be a good one for you if you had wanted to start a nonprofit to give away scholarships or grants. You approach financial institutions, community foundations, and some public charities to see if they offer donor-advised funds or some other philanthropic services.
• Seek Fiscal Sponsorship – In this arrangement, you sponsor nonexempt projects so that they would have a chance to qualify for funding that only goes to a 501(c)(3) organization, such as grants.
• Propose Ideas to the Organization’s Leaders – The leaders to whom you pitch may like your ideas and ask you to take some sort of action on it. You may organize a local chapter or fundraiser
Create a Business Plan
If you decide to move forward with converting your business into a nonprofit one, you will need to create a business plan. A business plan explains why your organization should become a nonprofit. It will lay out what your organization’s goals, mission, and pursuits would be, where it would obtain money from, and how that money would be allocated. You would include your bylaws in the plan as well.
Before You Incorporate
You’ll need to obtain pre-approval if your state requires them before you incorporate your business.
Before you file for incorporation, you may also want to use an attorney who practices contract law to draw up an Incorporation Agreement. This agreement is similar to a business plan, but it is created for use by the primary parties. This is the time for key business decisions to be made. People who utilize this tool oftentimes make the decision to abandon plans to incorporate when certain things come to light in the agreement.
A corporation is the most complex type of business entity of all because of the legal requirements that a corporation is bound to. Any deviation from these requirements will lead to the dissolution of the company.
An Incorporation Agreement:
• Assures that there will be no misunderstandings as to what will be the expected roles, responsibilities, and salaries of the future directors/corporate promoters.
• Defines the scope of liability of each officer and director in the event that someone files a claim for damages against the corporation.
• Statement that the corporation is obligated to conduct business according to the state’s statutes.
Since the directors can be held personally liable for a breach of agreement if the nonprofit is not formed, the Incorporation Agreement should acknowledge that the corporation is not yet formed at the time of the document’s creation and signing. This document should include the following terms:
• The corporation’s name
• Reason for the corporation’s creation
• Business address
• Director names and addresses
• Initial shareholder contribution
• Who will conduct financial transactions for the corporation
• Who will have authority to conduct business
Incorporate your business by following these steps:
• Pick a business name that is not already taken.
• File for an EIN using the business name.
• Prepare and file the Articles of Incorporation with the corporate filing office in your state, and pay the fee.
• Create bylaws if you haven’t already done so in your business plan.
• Appoint your first board of directors.
• Hold the first board of directors meeting needed to do business in your state or city. Corporations are required to hold regular board meetings.
• Apply for the necessary licenses or permits.
File for Your 501(c)(3)
After you have filed paperwork for incorporation and have received your articles of incorporation in the mail, you can finally apply to the IRS for your 501(c)(3) status. You’ll need to do this within 27 months after incorporation.
You can choose from two different IRS forms that are based on the number of gross receipts. Smaller organizations are ones that have less than $250,000 in assets and less than $50,000 in gross receipts. For a $275 fee, small organizations can file form 1023-EZ online. Larger companies need to complete IRS Package 1023. You can obtain IRS Publication 557 Tax-Exempt Status for Your Organization to guide you when filling out forms. The IRS website has many forms you need.
Since this status would enable you to avoid paying taxes, the IRS will have some questions for you. They will want to know why, besides a tax exemption, you now want to convert your business to a nonprofit one. Perhaps your business has now grown enough to enable you to use it to serve the community. Do you have something you could share with the schools?
The IRS will look over the application. They may ask you for more information or they’ll send you a “determination letter.” They may deny your application, in which case you may want to seek legal counsel.