Starting a New Nonprofit

Resources & Information

We’re often asked: “What does it take to start a new nonprofit organization?” CNM offers a recurring informational seminar on the subject and, through our Helpline, each month answers dozens of questions about the steps involved in creating a new nonprofit organization.

With the help of Public Counsel, we’ve put together these informational pages that review the core concepts and key steps shared in this popular course. Please note that these webpages are intended as a general overview of the concepts and issues involved in forming a charitable tax-exempt nonprofit corporation, and is not intended to provide specific legal advice. 

This webpage should not be construed as all-inclusive, nor as the provision of legal services to any individual or entity; reading this webpage does not create any lawyer-client relationship.

Last Updated on December 8, 2020

What is a nonprofit?

There is no legal definition of nonprofit. When we use the term in these resources, we are talking about a California Nonprofit Public Benefit Corporation that is exempt from federal taxation under section 501(c)(3) of the Internal Revenue Code. A Nonprofit Public Benefit Corporation is:

  • A separate legal entity

  • Organized and operated for a recognized public or charitable purpose

  • May not distribute corporate assets

Should you form a new nonprofit?

Questions to Consider

  • Size and scope of proposed programs

  • Resources available to comply with filing requirements and laws

  • Existing volunteer or employment opportunities

  • What is required by potential funding sources?

  • Are there alternatives?

  • Cost of formation and compliance vs. cost of alternatives

 

Alternatives to Forming a New Entity

  • For-profit entity (e.g., donating proceeds to charity, B-Corp models, targeted hiring)

  • Join/volunteer with an existing nonprofit

Start-Up Fees

* For organizations eligible to file Form 1023-EZ, the filing fee is $275

** No fee with 3500A

Fiscal Sponsorship

An arrangement under which an existing 501(c)(3) public charity (“Sponsor”) assists an individual or organization with a charitable program (“Project”) by permitting the Project to solicit tax-deductible contributions or grants through the Sponsor.

When is it appropriate?

  • The proposed charitable program is small in scope, or temporary in nature

  • When the business plan is in its beginning stages

Advantages

  • Ability to receive tax-deductible contributions

  • Ability to get off the ground faster

  • A wider base of support

  • Technical support /administrative support

  • Potentially lower insurance costs

Disadvantages

  • Surrender of control to the Sponsor

  • Administrative fee

Incorporation and Structure

Articles of Incorporation

 

Employer Identification Number (EIN)

  • Every corporation that will apply for federal tax- exemption must obtain an EIN (IRS Form SS-4)

  • EIN is the corporation’s tax ID number for all federal tax purposes

  • There is no separate “tax-exempt” number

  • Just having an EIN does not mean that the corporation is tax-exempt

 

Bylaws

  • Bylaws Sample (pdf)

  • The Bylaws establish the procedures for governing and operating the corporation’s activities. The Board governs as a group and must vote as described in Bylaw

  • Typical bylaws provisions:

    • Number of Directors

    • Time, Place, and Manner of Director Meetings

    • Voting Procedures

    • Director and Officer Duties

    • Committee Structure

    • Amendment Procedures

The Board

Board Composition: 49% Rule

  • In a Public Benefit Corporation, no more than 49% of the board can be “interested” persons!

  • Interested” means persons who have been compensated for services they provide (this does not include situations where the director is compensated for services provided as the director) during the previous twelve months, and their family members

  • Board Recruitment Matrix (pdf)

     

Legal Responsibilities

  • Duty of Care: Performing a good faith act, believed in the best interest of the nonprofit, with the care an ordinarily prudent person would exercise under similar circumstances

  • Duty of Loyalty: Good faith; Best interests of the corporation; Trustee relationship

     

Board Duties (adapted from Ten Basic Responsibilities of Nonprofit Boards, Board Source)

  • Determine Mission & Vision Select CEO

  • CEO Support/ Assessment Effective Planning

  • Build Competent Board

  • Financial Oversight

  • Monitor & Strengthen Programs

  • Enhance Public Standing

  • Ensure Legal & Ethical Integrity; Accountability

  • Ensure Adequate Financial Resources

Federal Tax Exemption

Subject to a few exceptions, nonprofit corporations with federal tax exemptions are NOT taxed by the IRS on income received.

501(c)(3) Status

501(c)(3) organizations are eligible to receive tax-deductible donations because they are organized and operated for an exempt purpose such as charitable, religious, or educational.

Benefits of 501(c)(3) status:

  • (Mostly) free from federal income taxation

  • Donors may deduct contributions from taxable income

  • Eligible for foundation grants

Limitations of 501(c)(3) status

  • Must be organized and operated exclusively for exempt purposes

  • Must irrevocably dedicate assets to exempt purposes

  • Cannot confer excessive financial benefits on ‘insiders’ or other ‘disqualified persons’

  • Cannot provide substantial private benefits to ANY individual

  • Cannot support or oppose candidates for political office and may not devote a substantial part of its activities to lobbying

 

How to obtain 501(c)(3) status

  • File IRS Form 1023 Tax-Exemption Application Form ($600 application fee)

  • Form 1023 must be filed within 27 months of incorporation in order to obtain tax-exempt status retroactive to date of incorporation. Corporations filing after 27 months will be tax-exempt as of the application date. This means that they may have to pay income tax and all donations received prior to the application will not be tax-deductible.

 

Qualifying Purposes

  • Relief of the Poor

  • Lessening the Burdens of Government

  • Lessening Neighborhood Tensions

  • Elimination of Prejudice and Discrimination

  • Defense of Human and Civil Rights

  • Combating Community Deterioration and Juvenile Delinquency 


Examples

  • Homeless Shelter

  • Affordable Housing Developer

  • Community Health Care Clinic

  • Job Training Program for Low-Income Individuals

  • Child Care Center

  • Domestic Violence Shelter

  • Youth Services Organization

 

IRS Form 1023

Provide Complete Description of Activities

  • Show that organization’s activities will serve the exempt purpose

  • Show that organization will actually conduct activities

Caution: IRS has denied exemption if the description is too vague to prove that activities are exempt.

 

IRS will scrutinize relationships with:

  • Founders

  • Board Members

  • Officers

  • Major Donors

  • Highly-Compensated Employees or Consultants

  • Other Private/For-Profit Persons

 

IRS Form 1023-EZ

Streamlined Exemption Process for Small Nonprofits

  • 501(c)(3) self–certification process using a 3-page online form

  • $275 filing fee

  • Quicker processing time

  • Generally available to organizations that have had no more than $50,000 of annual gross receipts in any of the past 3 years, or have projected $50,000 annual gross receipts in the current and each of the next 2 years

  • However—24 additional exceptions (e.g., schools, colleges, churches, hospitals or medical research organizations, organizations with total assets in excess of $250,000)

 

Public Charity or Private Foundation Status

  • IRS divides all 501(c)(3) charities into two types:

    • Public Charity: supported by the broad public, or from fees for charitable services

    • Private Foundation: supported by one or a few private individuals or private foundations

  • Private foundations are subject to limitations and excise taxes and are not eligible for some foundation grants—operating charities try to avoid this!

  • IRS will grant permanent ruling as a public charity if qualifying budget is submitted on Form 1023 (Beginning in 6th year, must satisfy public support test)

 

Program Development

For each program activity, figure out the following:

  • Why does it further exempt purpose?

  • Who conducts it?

  • When is it conducted?

  • Where is it conducted?

  • How is it funded?

  • % of total time/$ spent on it

Development a Program Budget (pdf)

Charging For Your Services

There is no prohibition against a nonprofit charging for its services. But…

  • The activity itself should be related to the nonprofit’s exempt purpose—income from an unrelated activity will likely be taxable and may threaten the organization’s tax-exempt status

  • The activity cannot be run like a commercial enterprise

  • Commerciality” factors—competition with for-profit entities, profit maximization, commercial pricing policies, etc.

 

Budget & Revenue

  • Current year plus two-year (detailed)

     

Form 1023 Sample Budget: EXPENDITURES

cnm budgetrevenue 01 Starting a New Nonprofit Organization
This is only a sample expenditure budget that does NOT reflect many costsyour organization may incure.

Form 1023 Sample Budget: Revenue

cnm budgetrevenue 02 Starting a New Nonprofit Organization
This is only a sample expenditure budget that does NOT reflect many costsyour organization may incure.

Developing a Program Budget (pdf)

 

Myths

Incorporation and tax exemption will NOT automatically generate grants or donations:

  • Many funders want to see a track record before giving any money

  • Grant resources are limited

  • Not quick money

  • Not all nonprofits generate enough revenue to pay salaries

 

Fundraising

4 Key Elements:

  1. Program Planning

  2. Building a Base

  3. Building Relationship

  4. Making the Ask

CA State Tax Exemption

Send IRS determination letter to Franchise Tax Board with Form 3500A

Note: you receive a letter from FTB specifying the effective date of exemption

– OR –

File Form 3500 with FTB

  • For charitable organizations, fill out Section 23701(d) of Form 3500
  • Pay filing fee ($25)

Ongoing Compliance

Federal (IRS)

  • Form 990

  • Form 990-EZ if receipts $200,000 or less and total assets are less than $500,000

  • Form 990-N (ePostcard) if receipts $50,000 or less

Deadline & Notice

  • Due by 15th day of 5th month after the end of the organization’s tax year

  • Failure to file for 3 consecutive years = Automatic Revocation of Tax-Exempt Status

California

  • Form 199

  • Form 199-N if receipts normally $50,000 or less

  • Secretary of State: Statement of Information (SI-100)

  • Attorney General Registry of Charitable Trusts

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Maura Harrington Ph.D., MBA

Executive Vice President
Center for Nonprofit Management

Maura is known for her expertise in organizational development and strategy and in all aspects of organizational development with a focus on strategic planning, assessment, and evaluation. At CNM, she oversees the client services team and provides consulting, training, and coaching services to a broad range of organizations. Much of her consulting and capacity-building work has been with community-based organizations and public health departments related to effective organizational operations, evaluation practices, and the use of logic models and other assessment tools to support planning, evaluation, and management. A BoardSource Trainer, a certified Advanced Associate, and a Trainer for the Connective Leadership Institute; Maura has completed certification as an executive coach under the International Coaching Federation. She holds a Ph.D. in Organizational Behavior from the Claremont Graduate School, an MBA from the Peter Drucker Graduate Management Center, a BS in Psychology from Georgetown University, and serves as an adjunct professor at USC’s School of Social Work and Department of Psychology. 

Speak With an Expert

Need expert advice? We're only an email or phone call away. Use this form to get in touch or call the Nonprofit Answer Hotline at the number listed below. You can also schedule a free, 15-minute appointment and we’ll match you with an in-house expert.








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CNM Nonprofit Hotline

Need expert advice? We’re only an email or phone call away. Use this form to get in touch or call the Nonprofit Answer Hotline at the number listed below.

You can also schedule a free, 15-minute appointment and we’ll match you with an in-house expert.








To select more than one item, hold Command on Mac or Control on PC.