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Part of the Series Guide to PhilanthropyCreating a Charity
Private Foundations/Donor-Advised Funds
A 501(c)(3) nonprofit corporation is a type of charitable organization that the Internal Revenue Service (IRS) recognizes as tax-exempt. A nonprofit corporation does not pay income tax on its earnings or the donations it receives.
Whenever taxpayers make a donation to a 501(c)(3) nonprofit, they can reduce their taxable income by the amount of their donation if they itemize their deductions on their federal income tax return. This incentive encourages private charity and makes it easier for nonprofits to raise money.
If you’ve ever wanted to raise money for a cause on your own terms, you might want to start a 501(c)(3). Here is what you should consider before you decide and how to get started if you choose to move forward.
Federal tax law states that if you want to operate as a 501(c)(3), your organization must exclusively pursue one of the following purposes:
You should also be sure that your organization is not designed to profit an individual and that it provides a public benefit.
When you’ve determined that your organization roughly meets the IRS requirements and you want to proceed, it’s time to start dealing with the red tape. A lawyer can provide personalized guidance and help you avoid costly mistakes, but some people do manage on their own.
Corporations are formed at the state level, so you’ll need to find out what the procedure is to form one in the state where your organization will be based. The steps vary by state but will generally include the following:
In addition to following the official, required steps, it’s not a bad idea to make a business plan, just like you would if you were starting a for-profit business. Although your organization will be a nonprofit, you will still have to operate in the black if you want to keep it running.
Nonprofits are allowed to make money; they just have to use those profits to further the organization’s public purpose. By contrast, a private corporation exists to enrich its employees, managers, and shareholders.
After meeting your state’s requirements for forming a corporation, you’re ready to apply for tax-exempt status with the IRS.
First, you’ll now need to apply for a federal employer identification number (EIN). This is a requirement for all tax-exempt organizations, even if they don’t have employees. You can apply online for an EIN through the IRS website, by phone, or by mailing or faxing in Form SS-4, Application for Employer Identification Number.
Next, complete and submit Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. This can only be done online. The information that you include on this form will serve as the basis of whether the IRS decides to grant your organization tax-exempt status. Set aside plenty of time for this task; the main application is 11 pages long and quite detailed. And depending on the type of organization you are forming, you will also need to fill out one of the attached schedules (e.g., Schedule A for churches; Schedule B for schools, colleges, and universities; etc.)
IRS Form 1023 helps ensure that you’ve included all required information in your application and will help to prevent delays in processing.
Submit your application. The IRS will let you know if it needs more information or if your form has been forwarded for review. When the IRS has all of the information it requires, it will issue a determination letter either granting or denying tax-exempt status to your organization. The evaluation process usually takes a few months. If you are denied, you can appeal.
If your organization gets approved for tax-exempt status at the federal level, that’s great. Next, you’ll need to make sure it will also be tax-exempt at the state and local levels, so it doesn’t have to pay state corporate income tax, sales tax, or property tax. Requirements vary by state, but your IRS approval may be all your organization needs to also be recognized as a nonprofit at the state level.
When you’ve met your state’s requirements for operating as a nonprofit, you’ll need to get any permits or licenses required to operate your business and make sure to comply with building codes and other local regulations.
Before you start operating, familiarize yourself with corporate requirements, such as holding meetings, keeping minutes, and filing information returns.
When you’ve been approved at every level, there’s still work to do. Maintaining your nonprofit status is an ongoing process, and the consequences are severe if you don’t abide by the rules. Here is a list of self-imposed guidelines you need to follow on a regular basis:
If you have a sizable number of employees, consider starting a qualified retirement plan. These plans resemble 401(k) plans in many respects but are specially designed for nonprofit entities.
Subsection 501(c) is a subsection of the Internal Revenue Code (IRC)—or what's often referred to as the tax code. It covers nonprofit organizations and tax law; specifically, it lists 12 types of organizations that are exempt from paying federal income tax. The third—501(c)(3)—includes "corporations, funds, or foundations that operate for religious, charitable, scientific, literary, or educational purposes." This is the sort of nonprofit most people are likely to have contact with—the American Red Cross and Direct Relief are two common examples—and to which they donate money.
Filing your nonprofit's articles of incorporation with your state typically costs about $100 to $250, depending on your state. The IRS Form 1023 filing fee is $600. However, for organizations that expect less than $50,000 in annual earnings, Form 1023-EZ can be filed for $275. But remember: You may also want to budget for legal help. A lawyer can provide guidance for your particular nonprofit and help you avoid costly mistakes.
After you submit a completed Form 1023, the IRS will let you know if it needs more information. Depending on how thoroughly you've prepared the application, the evaluation process can often take several months. When the IRS has all of the information it requires, it will issue a determination letter either granting or denying tax-exempt status to your organization. (You can appeal.) Form 1023-EZ applications usually take less time to process.
Starting a 501(c)(3) can be an exhausting process. Before you tackle the challenge, weigh the pros and cons of meeting all the legal and tax requirements when you form and operate an official nonprofit organization. It may well be worth it; people may donate more than they otherwise would because of the tax exemption and perceived increase in legitimacy 501(c)(3) status conveys.