How to Legally Start a Nonprofit Business

Some aspects of starting a nonprofit organization are similar to starting a for-profit business, but nuances exist. Incorporating a nonprofit can be confusing and complicated. Let’s dive into what it means to be a nonprofit organization and explore some of the considerations and steps involved in becoming one.

Please keep in mind that the information that I’m about to provide in this article is not intended as legal, tax, or financial advice. It’s for general informational purposes. I encourage you to talk with your lawyer, accountant, and other licensed professionals for guidance and answers to your legal, tax, and financial questions.

What Does It Mean to Be a Nonprofit?

Generally, nonprofits have a mission to serve a public or charitable cause as opposed to making financial gains for business owners, shareholders, or some other entity. A nonprofit organization takes the profits it receives from donations, sponsorships, products, and services and uses them to further its mission.

A nonprofit is a concept of state law. Depending on the state, nonprofit organizations may be set up in different ways (such as nonprofit corporations or unincorporated nonprofit associations).

Nonprofit organizations typically have some restrictions that prevent them from engaging in certain activities and paying dividends. When nonprofits are dissolved, their assets must be distributed to another qualified nonprofit group rather than to individual shareholders.

Nonprofits and Tax Exemption

Many people automatically think of nonprofit organizations as being tax-exempt. However, nonprofits must meet certain eligibility requirements to qualify as income tax-exempt entities at the federal and state levels. Some states also grant nonprofit organizations exemptions from paying state sales taxes.

According to the National Council of Nonprofits, there are 29 types of organizations that are tax-exempt under Section 501(c) of the IRS Code. Except for nonprofits that qualify for federal tax exemption under 501(c)(1), 501(c)(3), 501(c)10, 501(c)13, contributions to other nonprofit organizations generally are not tax-deductible for donors. Any profits (called surpluses) that nonprofit businesses make must be reinvested into the nonprofit (for equipment, resources, etc.) to help it achieve its mission.

Note that some revenue-generating activities carried out by a nonprofit may be subject to income tax. This typically occurs when a nonprofit organization engages in an activity that the IRS considers “unrelated business” to supplement its income.

According to the IRS, an activity is an unrelated business if it meets the following three criteria:

• It’s a trade or business. The term trade or business generally includes any activity carried on for the production of income from selling goods or performing services.
• It’s carried on regularly. Business activities of an exempt organization ordinarily are considered regularly carried on if they show a frequency and continuity, and are pursued in a manner similar to, comparable commercial activities of nonexempt organizations.
• It’s not related substantially to furthering the organization’s exempt purpose. Trade or business is related to exempt purposes, in the statutory sense, only when the conduct of the business activities has a causal relationship to achieving exempt purposes (other than through the production of income). The causal relationship must be substantial.

What is a 501(c)(3) Nonprofit?

Most people associate the term nonprofit with 501(c)(3) corporations. The most common nonprofit designation, the 501(c)(3) status exempts qualifying organizations from paying federal income taxes. It also allows them to get funding via grants from foundations and government agencies and collect tax-deductible donations from individuals and businesses.

So stated another way, a nonprofit organization is a state designation and a 501(c)(3) status is a federal designation. That is probably one of the most confusing aspects of setting up a nonprofit.

To qualify for 501(c)(3) tax-exempt status, a charitable organization must be created to fulfill a cause in one of the following categories:

• Charitable
• Religious
• Educational
• Scientific
• Literary
• Preventing cruelty to children or animals
• Fostering national or international amateur sports competition
• Testing for public safety
• Fostering certain national or international amateur sports competitions
• Preventing cruelty to children or animals

IRS requirements for tax exemption vary for different types of nonprofits, so organizers need to understand the rules and comply with them to maintain tax-exempt status.

Additional Legal and Tax Considerations

Just as when forming a for-profit corporation, nonprofit corporations offer personal liability protection for their shareholders. So, if someone sues a nonprofit or the organization meets financial hardship and incurs debt it cannot pay, the individual shareholders’ personal assets are not at risk of being used as damages or restitution.

Most tax-exempt nonprofits must file informational tax returns with the IRS annually. IRS Form 990 is the reporting form that provides details about the nonprofit’s mission, financial data, and programs so that the IRS and the general public can evaluate the organization’s operations.

Individuals who donate to charitable organizations may only take a tax deduction if they itemize their deductions on their personal tax returns. The IRS website lists the qualified organization types to which tax-deductible contributions can be made. It also shares the limits placed on deductions.

Cost to Start a Nonprofit

As with any business venture, it requires money to start a nonprofit corporation. The startup costs vary depending on the type of nonprofit, the activities it will engage in, its state of registration, and other factors.

Below are a few of the nonprofit startup expenses you might expect:

• State registration – Forming a nonprofit requires filing Articles of Incorporation (or similar registration form) with the state to officially establish the nonprofit entity. The costs can vary widely from one state to the next. For example, Kentucky charges $8, Texas charges $25, New York charges $145, and Nevada charges $300.
• 501(c)(3) tax-exempt status – The fee will be $275 (if filing Form1023-EZ) or $600 (if filing Form 1023).
• State income and sales tax exemptions – Nonprofits that wish to be tax-exempt at the state level may need to submit applications (and pay application fees) to the state’s revenue or tax agencies.
• Staff wages and independent contractor payments – You will have your own paycheck to cover. Also, eventually, you will likely need to contract or hire people to scale your nonprofit. In 2019, the SBA’s Office of Advocacy published some interesting information about nonprofit employers in its “Spotlight on Nonprofits.”
• Rent, lease, or purchase of office space – If your nonprofit needs a physical location to serve its mission, it will require funds to secure and maintain it.
• Licenses and permits – Depending on the location and business activities, there may be state and local licenses or permits required to operate the nonprofit legally.
• Website – Nonprofits need an online presence where people can learn more about their cause and learn how to donate, volunteer, or otherwise get involved. There are free and low-cost website-building platforms out there that offer some attractive templates. Several you may want to explore include Wix, GoDaddy, Weebly, Squarespace, and Wild Apricot. You might instead consider working with a professional website designer or developer if you need additional functionality or support.

These are just a few examples of the costs associated with starting a nonprofit. It’s important to carefully assess what will be involved to launch and run your organization so that you can prepare a realistic budget.

Generating Profits

Nonprofits may make a profit. Those profits must be reinvested back into the organization to fund operational activities related to fulfilling the organization’s mission. When engaged in certain business activities, 501(c)(3) organizations must be careful about the amount of time they spend on them. If they exceed the limits, they risk having their tax-exempt status revoked. Also, realize that tax-exempt nonprofits may have to pay tax on some profits if they are considered unrelated business income.

Several potential ways nonprofit corporations might raise funds include:

• Donations – Nonprofits may accept contributions in the form of donations. Many states require nonprofit organizations to complete an application for Charitable Solicitation Registration before accepting donations or engaging in other fundraising activities. Often, nonprofits solicit donations using various methods, including online donations, social media donations, corporate campaigns, or mobile donations.
• Membership Programs – Some nonprofits offer memberships to raise funds and give supporters a way to become more engaged in the organization’s cause. One of the keys to a successful nonprofit membership program is developing attractive perks (such as members-only access to certain events or publications, etc.) to incentivize people to join.
• Events – Workshops, banquets, conferences, golf outings, walks and runs, and other events can bring in revenue from the registration fees paid by attendees. Also, nonprofits that put effort and energy into networking and forming strong relationships with the business community can raise money by offering event sponsorship opportunities.
• Fundraising Activities – Many nonprofits hold activities to get their communities involved in supporting their initiatives. Several examples include charity auctions, raffles and drawings, crowdfunding, trivia tournaments, and yard sales. Fundraisers like bingo, drawings, raffles, and other small games of chance may require a special license from the local or state government. Some states and jurisdictions may prohibit these types of activities. Nonprofits should check with their state and local governments (and consider consulting their attorney) before proceeding with those or similar fundraising ideas.
• Grants – The grant-writing process can prove daunting. It can be worth it, though, because it can potentially result in substantial funds for executing initiatives and achieving a nonprofit’s goals. The National Council of Nonprofits offers information about available grant research tools to identify sources of grant funding. Also, USA.gov provides information about government grants.

12 Steps to Start a Nonprofit Corporation

Similar to starting a for-profit business, incorporating a nonprofit requires a variety of steps and tasks. Below is an overview of the process.

1. Do Research to Validate the Need

As with any type of business, it’s critical to research the feasibility of a nonprofit organization before spending substantial money and energy on launching it.

Some questions you should ask about your future nonprofit:

• Will it meet an unmet need in the community it will serve?
• Are other organizations already trying to fulfill that need?
• Have you floated the idea past people whom the nonprofit will serve for their input and feedback?
• Have you asked for input and feedback from some of the people and businesses you want to target to support your cause?
• What are your anticipated startup and ongoing costs?
• What is your anticipated income?

It’s critical to consider these questions and many others to help determine the viability of your nonprofit business idea. While it may be deflating to discover your concept isn’t feasible, it’s better to learn that lesson before you’ve invested time and resources in the steps to follow.

2. Draft a Mission Statement

A mission statement captures a nonprofit’s purpose, what people or groups it serves, and how it strives to serve them. Effective mission statements clearly and compellingly embody why the organization exists. A mission statement should be at the heart of all the decisions that a nonprofit’s leaders make and the work that the organization does.

3. Write a Business Plan

Having a roadmap for guiding your efforts will help your nonprofit succeed. A thorough business plan will allow you to document your vision and mission for your nonprofit organization. It will also document the details you will need to provide when submitting various filings and applying for funding.

A nonprofit business plan might include the following elements:

• Executive Summary – An overview of what the nonprofit business will do (including its mission statement if not documented elsewhere in the business plan) and a summary of the programs, services, or products it provides.
• Services, Programs, and Products – Description of what the nonprofit will offer and how its services, products, and programs will benefit the nonprofit’s target market.
• Market Analysis – Description of the target market the nonprofit will serve, the needs of that market, the current state of that market and industry outlook, and the opportunities and challenges of serving that market.
• Marketing and Sales Strategies – Description of marketing activities and tactics that will be used to reach your target market, including advertising and public relations plans to promote the nonprofit.
• Management Team – Information about the expertise and experience of key members of the organizational team, along with information about members of the board of directors (or what qualities will be sought when developing a board).
• Financial Plan – Critical financial details, including income statements, balance sheets, cash flow statements, grants awarded, large donations, and fundraising plans (if not included in a separate section).

4.  Select a Business Name

A nonprofit’s name can affect how the organization will be perceived, so it’s essential to put a lot of thought into it. After you’ve zeroed in on what you want to call your business, conduct a name search to make sure no other company is already using (or has filed to use) the name. Nonprofits that will operate nationally should do a trademark search, as well, to confirm the name is available in all 50 states. You can do a corporate name search via CorpNet.

5. Choose Your Legal Structure

Depending on the state in which your nonprofit will be registered, the following you may be able to form at Nonprofit Corporation, Nonprofit LLC, Unincorporated Nonprofit Association, or a trust. Most nonprofits choose to register as a Nonprofit Corporation and then seek 501(c)(3) status from the IRS.

As I mentioned earlier, owners of nonprofit corporations receive personal liability protection. To retain that protection, the nonprofit must meet all business compliance requirements.

6. Appoint a Board of Directors

The legal entity type you choose for your nonprofit may require establishing a board of directors, a group of individuals that will be accountable for overseeing the organization and helping it fulfill its mission. A board will fulfill a variety of roles and responsibilities. Members should be diverse in their knowledge and strengths. Collectively, board members should bring experience and expertise that will serve to guide all aspects involved in running the nonprofit.

States’ rules regarding the requirements (such as the number of directors, qualifications, etc.) for boards of directors vary in each state.

7. Draft Bylaws for the Organization

Bylaws establish how a nonprofit should be run, such as how much control the board of directors has vs. the shareholders, meeting rules, voting procedures, dispute resolution, and other details. Bylaws are usually required when filing incorporation paperwork with the state and when applying for federal tax exemption.

8. File Business Registration Paperwork With the State

Nonprofit Corporations must submit Articles of Incorporation to the Secretary of State office. The costs to file this documentation vary by state. If a nonprofit will have physical locations or a substantial presence in more than one state, it must be registered in each state where it will maintain operations.

If forming a different nonprofit entity type, check with your state about the filing requirements.

Nonprofits that intend to accept donations or participate in other fundraising activities should also check with the state to see if Charitable Solicitation Registration is required. Often, nonprofits complete this application when filing their Aarticles of Incorporation.

9. Apply for an Employer Identification Number

Like a for-profit business, nonprofit organizations need to have an Employer Identification Number (EIN) if they want to open a bank account, hire employees, apply for business licenses and permits, and complete certain business documents.

EINs (also known as a Federal Tax ID Number or Tax ID Number) are issued by the IRS by filing Form SS-4.

10. Request a 501(c)(3) Tax Exemption

To apply for 501(c)(3) tax-exempt status, a nonprofit must file Form 1023, which is an Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. This is filed with the IRS. Most other nonprofits that don’t fit the criteria for 501(c)(3) file IRS Form 1024 to request tax-exempt status.

Expect that the IRS might have questions about the application and that it may take between three to twelve months for the IRS to return its decision on granting  501(c)(3) tax exemption.

A word of caution is the IRS is very strict about compliance and the application process. Filing Form 1023 costs $600 each time you submit it to the IRS. You want to make sure you have all your necessary information and the application completely filled out so you don’t have to waste time and a lot of money resubmitting.

11. File for Required Business Licenses and Permits

A nonprofit might need to have certain business licenses and permits to operate legally. The requirements depend on the type of activities conducted and where the organization is located.

CorpNet’s Business License Service Packages help nonprofits identify and file for all licensing and permitting requirements at the state, county, and local municipality levels.

12. Fulfill All Ongoing Compliance Requirements

Nonprofits must stay on top of all compliance obligations to retain the liability protection benefits of a corporation.

Ongoing compliance responsibilities include but are not limited to:

• Having a registered agent
• Filing an annual report
• Filing a tax return such as the IRS Form 990
• Following its bylaws
• Maintaining charitable solicitation registration
• Renewing business licenses and permits
• Maintaining tax-exemption status by following the IRS’s rules

Helpful Resources for Nonprofits

Knowing how to incorporate a nonprofit organization and maintaining its compliance can be complicated. Because of nonprofits’ tax exemption status, they generally undergo a more intense degree of government scrutiny than most for-profit companies do.

As I mentioned earlier, to understand all the legal, tax, and financial aspects of starting a nonprofit organization, it’s best to consult professionals. An attorney, accountant, tax advisor, and or other qualified professionals can offer much-needed expertise and guidance.

Some other resources you might find helpful if you’re considering starting a nonprofit include:

• Tax Information for Charities on the IRS website
• National Council of Nonprofits
• National Association of State Charity Officials
• SCORE
• Small Business Administration (SBA)
• Nonprofit Technology Enterprise Network (NTEN)
• Nonprofit Finance Fund (NFF)
• LinkedIn for Nonprofits

And of course, CorpNet is here to assist you. We provide registered agent services in all 50 states. And we can help you complete and submit your nonprofit business filings including:

• Articles of Incorporation
• Articles of Organization
• Federal Tax Identification Number (EIN)
• Business licenses
• Sellers permit
• Sales tax registration
• Payroll tax registration
• Initial and annual report filings (Statement of Information)
• Applications for tax-exempt status
• Annual corporate monitoring, compliance, and filing services