Everything You Need to Know About Starting a Nonprofit
Starting a nonprofit provides the perfect opportunity to support the issues you care about while also helping to give back to your community and help those who need help. It can also be a great way to enjoy family bonding and build your family’s legacy.
When starting a nonprofit, there are many benefits to incorporating your organization and then registering for tax-exempt status, including your donors can claim the usual federal and state tax deductions on their personal income taxes due to your tax-exempt status, and the members of your board will be protected from personal liability because your entity is incorporated.
However, when it comes to understanding nonprofits as well as how to incorporate your organization, it brings with it various questions, which this short guide on nonprofits will help clear up.
What is a Nonprofit?
A nonprofit organization, also known as a public charity, is an entity that is created to provide a benefit to the public or to promote a social cause. This also includes both private and community foundations, whose rules regarding taxes and reporting are a bit different than public charities.
Nonprofit organizations differ from typical businesses in that when they make a profit, either via donations or fundraising activities, their revenue goes directly to providing the public benefit they support as well as back into the organization as a whole to pay expenses, such as overhead costs and employee salaries. On the other hand, when typical businesses generate revenue, it is distributed to their shareholders.
Nonprofit organizations also enjoy tax-exempt status, which enables the majority of their income to go directly to supporting their cause. It also enables donors to receive tax deductions for their contributions. However, like typical businesses, nonprofits, too, must also provide information regarding their finances and operations, except instead of providing it exclusively for their shareholders, it is made public so that donors can see how their donations are being used.
Before a nonprofit can become tax-exempt, it must, first, apply for 501(c)3 status from the Internal Revenue Service.
Nonprofit Organization Types
In the United States, there are four main types of nonprofit organizations, and though they each have different business structures and objectives, they all qualify for tax exemption.
A foundation is slightly different than a public charity in that instead of providing the public with benefits, its main purpose is to make grants available for entities who provide charitable funds or services. However, there are a few foundations that actually have their own charitable programs.
Foundations fall under either one of two categories: public foundations or private foundations.
Public foundations, also called grant-making public foundations, receive their funds via government agencies, foundations, and individuals. Meanwhile, the funds made available to private foundations come from private sources, such as corporations, families, and individuals.
Both foundation types qualify for tax-exempt status under IRS code 501(c)3; however, their requirements for reporting are different.
Public charities encompass a wide range of charitable organizations, such as schools, churches, and public foundations, and they typically exist to provide some kind of human service, such as services for the elderly and children, food help, and disaster assistance via direct assistance.
Their donations, unlike private foundations, also come from a variety of public sources, including the general public, the government, corporations, other public charities, and private foundations, so they have less operational independence. However, public charities also tend to enjoy higher donor tax-deductible giving limits as compared to private foundations.
Social Advocacy Organizations
Social advocacy organizations operate on behalf of society to support the natural and legal rights of those who cannot defend themselves as a way of achieving social justice. Some social matters they address include human rights violations, civil rights, migrant labor issues, and environmental preservation issues.
Social advocacy organizations also qualify for nonprofit tax exemption under section 501(c) of the IRS code; however, the amount of political activity they are permitted to engage in depends on the type of group. For instance, 501(c)3 groups are inhibited from engaging in political activities; however, if the organization is a 527 group, which is typically comprised of political candidates, committees, and parties, is permitted to raise funds for the main goal of supporting political activities, such as elections, as a means to affect an issue or policy, etc.
Social advocacy groups are generally funded via membership dues and donations, which are then used to distribute information regarding their particular social agendum.
Trade and Professional Organizations
Trade and professional organizations, also called business leagues, are an alliance of individuals with a shared business interest whose main goal is to promote this common interest instead of participating in business for a profit.
Under section 501(c)6 of the IRS code, such business leagues qualify for exemption; however, to be exempt, the league must be committed to improving the business conditions of the services or products within an industry as opposed to performing services for solely an individual. The league’s income also cannot be used to benefit private shareholders.
Financial support for business leagues is typically acquired via membership dues; however, it can also be funded by the general public through ticket sales from admission charges to performances that promote their exempt purpose.
The Perks of Becoming a Nonprofit
The main benefit of starting a nonprofit is to support your charitable cause. And then once your organization qualifies for 501(c)3 status, it will become tax-exempt, which provides many benefits of its own, such as it enables individuals to make charitable donations that are tax deductible, which will help encourage more donors to contribute. It also enables the bulk of your income to go directly towards supporting your cause.
Tax-exempt organizations are also able to cut various costs, such as expensive advertising costs, due to their exemption status.
The Downsides of Becoming a Nonprofit
Though becoming a nonprofit has many benefits, it also has its share of disadvantages, which are important to keep in mind when determining if starting a nonprofit is right for you. For instance, starting a nonprofit takes ample commitment, effort, and money to get it up and running. In fact, it has taken some nonprofits years to finally realize their dream.
Furthermore, maintaining a steady influx of contributions can also be a challenge for new nonprofits, which is often why many nonprofits fail within the first five years. Once your nonprofit is off to its start, you are also required to keep thorough
records as well as file all required documents each year.
Lastly, since public nonprofit organizations exist to serve the public, if you are a public entity, you may find yourself under constant judgment by the community for your operations.
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Who is a Nonprofit Right For?
Nonprofit organizations generally benefit groups looking to make a major impact in the world, such such as those that provide shelters for the homeless.
Some other nonprofits making a major impact in the world include:
- Food Banks
Starting a Nonprofit
To start a nonprofit requires various steps, which, when done in the right sequence, can help make the process easier.
Draft a Mission Statement
The most important step to starting a nonprofit is to write up a mission statement, which defines the reason for creating your nonprofit, the audience it will serve, and how it will go about serving them. This will also provide you with a sounding board for all decisions.
Choose a Name
Choose a name for your nonprofit that sums up who you are and the support you provide so that your audience understands your cause. After you have chosen a name, you can then have a reputable filing company conduct a name search online to be sure the name is available.
Develop Your Board
Your board will be your nonprofit’s governing body, which means the individuals chosen will take on important roles and legal obligations concerning your organization, such as creating your bylaws, assigning a bank account for your organization, selecting your headquarters, choosing the accounting period, documenting the receipt of tax exemptions, and more.
Therefore, it is important to select individuals who can bear the responsibility. Your board will also most likely continue to grow as your needs increase. So, be sure to select an initial board who can decide with on future members. Usually, an organization’s first board members include a president, a treasurer, and a secretary.
The minutes of each meeting should also be taken so that it can be filed in the organization’s record books.
Develop Bylaws and Obtain Licenses
Bylaws describe your nonprofit’s objectives as well as your rules of operation, including how the nonprofit is structured. It also determines
a) How directors are voted in as well as the authority granted to them,
b) The duties and responsibilities of officers as well as the length of their term,
c) Officers and standing committees rights,
d) How and where meetings for directors are held, and
e) How decisions can be made without or with a meeting.
Registering your nonprofit as incorporation provides all the benefits of a corporation; however, it does not automatically make it tax-exempt.
File for Tax-Exempt Status
Nonprofits are not, automatically, exempt from taxes, they must apply for tax-exempt status and then be approved by the Internal Revenue Service first. Provided your organization is a U.S. based company, it can apply for tax exemption by filing for 501(c)3 status with the IRS. There is also an application fee, which varies from state to state.
Develop a Business Plan
It also helps to develop a business plan that helps outline in detail how your organization intends to meet its goals, which is also sometimes required by your board.
Incorporating your nonprofit gives it a conventional structure, which helps give your organization more integrity. It also adds more credibility to your charitable services and programs. Choosing to incorporate your nonprofit also helps limit the liability of the organization’s directors and officers, which your board will appreciate.
As a nonprofit, the IRS also requires that your paperwork and governance policies and procedures are maintained in a manner similar to corporations, so by incorporating your organization, you will already be one step ahead.
To incorporate your nonprofit, you will need to file nonprofit articles of incorporation with the appropriate state agency. There is also a fee for filing.
How to Qualify for 501(c)3 Tax Exemption Status
Provided an organization qualifies as a nonprofit, it may file for 501(c)3, which is federal tax-exempt status. However, once you obtain 501(c)3 status, your organization must be sure to adhere to the strict criteria required in order to continue to be tax-exempt. For instance, tax-exempt nonprofits are required by most states to assemble a board of directors to oversee its top-level decisions. The members of the board must also be individuals and not corporations.
If your organization is incorporated, the assets of your nonprofit must be endowed to an outside charity, especially in the event the organization ends, which is summed up in your articles of incorporation.
You must also create a statement of purpose, such as to support education, and then function solely within its guidelines.
How a Reputable Filing Company Can Help
Overall, there are various benefits to starting a nonprofit organization with tax-exempt status, which your board, as well as your donors, will appreciate. However, when incorporating your nonprofit, it can become baffling, which can cause you to become frustrated and contemplate giving up on your goals; however, you don’t have to do it alone.
In fact, not only can our filing company assist you with the process of incorporating your organization, but we can even assist you with filing your EIN, which also required for starting a nonprofit.
For more information on selecting the right status type to file, or to get started incorporating your nonprofit, feel free to contact a member of our staff.