Congratulations, you’ve decided to start a 501(c)(3) nonprofit organization! While it may be a daunting task, the time you put into preparing your application is instrumental to the success of your organization. This is why we’ve put together a comprehensive guide to not only help you through the process but also be successful at it.
Before getting into the planning and preparation, you need to have an understanding of the differences between a nonprofit and tax-exempt organization.
Nonprofit vs. Tax-Exempt Organizations
In the most general sense, nonprofits, with or without tax-exemption, usually serve communities or are focused on supporting specific causes (e.g. disease research, humanitarian aid, etc). While the two are closely related, that isn’t to say that they are the same. Becoming nonprofit and becoming tax-exempt have separate processes, as the former status is granted by the state, and the latter is granted by the federal government through the IRS.
The federal government recognizes three types of organizations for this purpose:
- A trust: not the best for community groups as it is usually formed for the benefit of a specific individual
- A corporation: incorporation is usually the best choice for a community organization, as the founders and members will only face limited liability (protection from personal liability in most cases). For example, if a member of the organization accidentally hurts someone, that person can only sue the organization, rather than the individual.
- An unincorporated organization: similar to a corporation, but there is no protection against personal liability.
You can be a nonprofit organization without being granted the status — i.e. being a neighborhood group that raises funds to feed the homeless. However, to apply for federal tax-exemption, the organization must first be recognized by the federal government as a nonprofit organization (and not all nonprofits are eligible to apply).
Tax-exempt organizations are exempt from federal, corporate and income taxes for most types of revenues, but it requires the organization to apply for the status after becoming a recognized nonprofit. The application forms are around 30 pages long and usually takes between 3 to 12 months to be granted status. New organizations can request an expedited review if they are being formed to provide immediate disaster relief, but there is no guarantee that the IRS will grant the request.
What is 501(c)(3)?
There are a total of 26 exemption categories under the tax code, all for different purposes, and organizations can choose which status best suits their needs, e.g. if they will be involved in heavy lobbying. The 501(c)(3) tax-exemption, also known as the “charitable tax exemption,” is the most common type and pertains to charitable organizations including those that are:
- Testing for public safety
- Fostering national or international amateur sports competition
- The prevention of cruelty to children or animals
Advantages of the 501(c)(3) Status
While applying for the 501(c)(3) status has benefits such as enhanced credibility, and being exempt from federal and state taxes (sales tax, income tax, property tax), many organizations want to achieve this particular status as is has a unique benefit — the 501(c)(3) status allows the organization’s donors to receive a tax deduction for the money they’ve donated. This is a vital advantage for organizations relying on contributions and grants, as it is more likely to attract the support of new donors.
Having the 501(c)(3) status also allows your organization to apply for grants directly, without needing the help of a fiscal conduit.
There are cases where some organizations automatically get granted the 501(c)(3) status without filing. These groups include:
- Churches or parts of/associations of churches
- Subordinate organizations that are covered by a group exemption
- Organizations that normally have gross receipts under $5,000 and are not private foundations
However, a lot of times, these groups still opt to go through the filing process to obtain the official letter of determination. This letter acts as leverage to solicit contributions and apply for state tax exemptions.
Disadvantages of the 501(c)(3) Status
To keep a fair assessment, you should know that although the 501(c)(3) status can be very helpful to your nonprofit organization, it doesn’t come without disadvantages:
- Your organization becomes more complex, with a new level of responsibilities and regulations, which can be hard for a volunteer-based organization to handle. For example, the organization must now send in annual tax-return to IRS, which can be very time-consuming.
- Filing for incorporation and tax-exemption can take more time and money than the organization has resources for—the legal fees alone can deplete the finances quickly
- The 501(c)(3) status is governed by bylaws that restrict the organization from participating in lobbying and advocacy activities (more details in the following sections)
- Your organization is still taxable on activities unrelated to the performance of tax-exempt functions
- Sometimes it’s better to focus on developing the organization to gain a good track record before considering becoming incorporated and tax-exempt
Are You Ready?
If you’ve considered all the advantages and disadvantages, and still want to go ahead with starting a 501(c)(3) nonprofit organization, here are some important things you need to take note of.
Before your organization can earn 501(c)(3) status, the IRS requires it to meet specific requirements, including:
- Being recognized by the federal government as a trust, corporation or association
- Avoiding any purpose that fuels discrimination
- Providing reason for the tax-exemption application
- Avoiding political involvement
- The organization must exist for three years before applying
- Funds and profits don’t benefit a sole member
- Profits being used solely for charitable activities
- The purpose is only to meet public needs
The organization must also provide their financial records to the IRS when applying for 501(c)(3) status to ensure that all funds were used according to the requirements above.
All nonprofit 501(c)(3) organizations are heavily regulated by the IRS, so it is no surprise that the status comes with some restrictions on activities. Organizations are expected to comply with the following rules:
- No member of the organization is to benefit financially from the institution
- In the case of disbandment, all capital gained must be passed on to another nonprofit
- The organization must not interfere with political campaigns or endorse a candidate
- The organization must keep lobbying to a minimum and only a small fraction of the funds can be used to do so
The organization is held accountable for complying with the IRS guidelines and requirements to maintain their status. If the organization fails to adhere to these restrictions, they can have their 501(c)(3) status revoked. They are expected to file documentation annually (such as Form 990, which outlines the income made by the organization) when taxes are due. Any income from activities unrelated to the charity focus must be reported and may also be taxed.
The charity should immediately report to the IRS in the case that it changes its focus area, and can do so by filling out Form 5768 to keep their nonprofit, tax-exempt status.
Steps to Starting a 501(c)(3)
Now that you have an understanding of what the 501(c)(3) status is, and its requirements and restrictions, it’s time to consider the steps to starting your 501(c)(3) nonprofit. Here is a detailed guide to the preparations you should make before applying to the IRS, what to do when filing for 501(c)(3) tax-exemption, and the ongoing compliance after being granted status.
Preparations Before Applying for 501(c)(3) Status
Step 1 - Research
Doing your research before starting a nonprofit is key to its success in being granted 501(c)(3) status. To assess the necessity of your nonprofit, here are some points you should consider researching to gain a better perspective:
- Evidence that nonprofit will fill an unmet need in the community
Having strong facts and numbers that back up your ideas will help you gather support, receive grants, and get donations. For example, if you want to set up a dog rescue, you should have a good estimate of how many stray or abandoned dogs are within an area with no shelter to take them in.
- Find out if the need is only being served by your organization
Making sure that the need your organization plans to serve isn’t already being serviced by another organization is important — you don’t want to be competing with another (already established) organization in raising funds for your nonprofit, as you could end up wasting resources unnecessarily. You can use the locator tool from the National Council of Nonprofits to find all the nonprofit organizations throughout the United States and in your area.
- Determine the target demographic you want to join your organization
It is crucial to gain support for your nonprofit as quickly as possible to ensure the success of your organization. You can easily do so if you have a target demographic in mind so that you can create resources about your organization catered to their interests. The American Fact Finder is a great tool to get you started with demographic research.
Step 2 - Build a Foundation That Lasts
Once you’re confident that your nonprofit is necessary to serve an unmet need in your community, you’ll need to build a strong foundation for your organization to ensure its survival. A great foundation starts with a great leader, and here are some necessary traits you should possess to guarantee your success:
- Self-discipline: discipline yourself to do what should be done, regardless of whether you want to do it or not.
- Integrity: be honest and transparent with what you do, so that you can build up trust with those you are working with, and in turn, they will be more willing to support you
- Persistence: you should be able to persist and overcome any obstacles, big or small, when they arise
- A clear sense of direction: developing a clear sense of direction will help you avoid letting day-to-day tasks or problems diverge you from your goals
- Decisive and action-oriented: being able to make decisions and send feedback quickly will let you try more things to find out what works for your organization
Not everyone will possess these traits naturally, so it is imperative that you try to develop these habits.
Step 3 - Business Plan
A business plan is the most important document to help you identify the opportunities you may have missed if you dived straight into incorporating your nonprofit. It also serves as a tool to attract potential investors, donors and board members by giving them a clear understanding of what your organizing is and what it stands for.
When writing your business plans, the seven main sections you need to cover are as follows:
- Executive summary: the elevator pitch of your business plan. The executive summary should be a short and concise overview of the entire plan to draw people in.
- Products and services: this is where you detail what value your organization will bring. Most organizations have memberships and events, as well as merchandise that helps raise funds for their cause e.g. bracelets, t-shirts, tote bags, etc.
- Market analysis: this section will detail your target demographics, as well as the demographics of your competitors. You also include a SWOT analysis of your organization to determine how it will succeed.
- Marketing plan: this section is an important action plan for your organization to succeed, as it details who your organization will serve, how you will find engage people, and how you’ll convince garner the support from these people. Do not skip this section thinking that your organization will succeed through word-of-mouth!
- Operational plan: the basic logistics detailing where your office will be, the equipment that will be needed, how the services will be delivered and the type of staff and volunteers needed.
- Organizational structure: this is where you create an organizational chart to display the organization's structure, as well as list all the staff and their roles in the nonprofit.
- Financial plan: important section for applying to grants and loans, as well as attract potential investors. You should detail the cash flow analysis as well as the organization's budget. This is also where you detail the sources of revenue in the following years, and how you will generate them.
If you’re having difficulty starting your business plan, you can look for templates online to give you a guideline of what you need to cover. No matter how time-consuming this task might be, you must invest that time to make it as detailed as possible so that you have a clear idea of your organization’s benchmarks and goals in the coming years.
Step 4: Identify Your Sources of Revenue
There are four main sources of revenue for nonprofits. To make the most out of each source, it is best to have a specific strategy for each of them. Here are some ideas for how you can develop these strategies:
4.a. Fees for Services and Goods from the Private Sector
This is usually revenue generated from membership fees, event tickets and merchandise sold.
People pay a membership due (monthly or yearly) to become a member of your organization. However, they will only join if they can also benefit from the organization, such as having access to a community of like-minded people (networking events, annual conferences), and specialized information and resources in your niche (workshops, education sessions).
To draw in members, you need to create a community that people want to be part of and provide access to information exclusive to your organization. This is where market research is important, as you can pinpoint what resonates with your members (their values and interests), and find out what events, services, and resources they would be willing to pay for.
The next step is to have a clear and concise value proposition that tells your prospects how your organization stands out from its competitors, and why they should support you instead. How this is communicated should be catered to your target market, rather than having a blanket approach (e.g. we rescue senior dogs in the city of New York vs. we rescue dogs).
To identify your target market, ask yourself who would join your organization (e.g. mothers, doctors, university students), their demographics (age, gender, interests, income level), and where their geographical location (which affects where they hang out and get their news from).
From here, you can better advertise your products and services to prospects and entice them to pay a membership due to join your organization. The price can be hard to determine, but it should be a win-win situation, where members feel that their dues are kept low, but the organization can still cover as many operational costs as possible.
Membership dues alone don’t usually cover the costs to run the organization, but this is where events and merchandise come in to supplement the revenue. Events which you can host for your members can include:
- Education workshops and banquets
- Industry events with keynote speakers
- Conferences, conventions and retreats
However, it is essential to research what events are relevant and valuable to your members so that they would want to pay the event fee to attend.
4.b. Private Contributions
This is revenue in the form of donations from fundraising, corporate sponsors or regular individual donors
Many states will require your organization to complete Charitable Solicitation Registration before you can accept donations or host fundraising events. Make sure to check what your State’s regulations are in terms of soliciting donations!
The simplest way to increase revenue is through fundraising, as your members can help reach more prospects (i.e. their friends and family) through the events and campaigns. Pairing the fundraiser with an event is one of the best ways to attract attendees, such as doing a charity car wash, or organizing a fun run.
4.c. Government Grants
To successfully apply for a government grant, you should start your applications far in advance, to give you time to source any documentation or review the application for any errors. The US Government also has a great guide to help you determine your eligibility, give you application instructions and tips on avoiding grant scams.
You can look up grants to apply for from through places like Grants.gov and Foundation Directory Online
If your organization provides services on behalf of the government e.g. healthcare, education, etc. then another source of revenue would be from fees for services and goods from the government.
Investing the time and effort into your business plan is a long process, but it is completely worth it in the long run. If you’re going to spend so much time starting a 501(c)(3) nonprofit, you might as well do it right to increase your chances of success! Now that you have your business plan in place, and a clear goal to steer your organization towards, it’s finally time to name your organization.
Step 5 - Name Your Nonprofit
The name of your organization will set the tone and influence the branding of your nonprofit in the years to come. As they say, first impressions are hard to change, so it is important to pick a name that’s easy to remember, descriptive and captivates your target market. Don’t be afraid to brainstorm ideas with your team, and say the names out loud to see if it flows well.
If you’re still stuck, here are some questions you can ask yourself to get the process started:
- What will your nonprofit do? Will it be teaching, rescuing, feeding, giving… etc.?
- Who will your nonprofit help? Will the target market be children, homeless, elderly, animals… etc.?
- Who are the members? Are your members mainly doctors, parents, environmental activists… etc?
Don’t get too excited after you settled on a name. You must check if it has been taken yet with the Secretary of State in your state before you can officially adopt it.
Step 6 - Gather Your Board
In some states, you must gather your board before being incorporated, as they need their names in the documents. However, even if it is not required, it is still a good idea to recruit the board first so they can help with the process of incorporation!
Who to Recruit
While a candidate’s experience and skills are Important for the job they’re interviewing for, you should also look for someone with a lot of following qualities to determine if they are a good fit for the organization:
- Strong work ethic
- Has a positive attitude
- Is an effective communicator
These qualities can help create a supportive and motivated board that will help guide the organization on the right path.
You should also recruit people from different professions, with experience and skill set in different areas that could help the nonprofit. Have an even split between:
- Individuals who have management expertise in financial, marketing, legal, etc. areas
- Individuals with expertise in your organization’s field and have connections at the community level
- Individuals who can solicit donations or have access to financial resources.
Refer back to your organizational structure in your business plan to determine what roles your organization needs to be filled before starting the recruitment process. This will also help you focus on what qualities you should be looking for in each candidate to ensure that they will be successful in their roles.
For example, the secretary or committee chair is responsible for helping the organization from tasks such as executing projects to organizing meetings and taking meeting minutes. A successful candidate would have impeccable organizational and time management skills, and also strong communication skills to ensure that all board members are informed and on track.
Take some time to craft your job descriptions so that you can attract the right candidates, as well as draft bylaws which determine the procedures in which board members must follow when completing their duties.
The bylaws are set up to maintain internal accountability of the organization and should contain operating rules and give a framework for all the procedures within the nonprofit.
It would also be helpful to create onboarding files or an orientation guide for your new board members so that they can quickly get up to speed with the organization. Also, consider hosting a welcome party so that all the board members can get to know each other before starting work together.
Step 7 - Incorporate your nonprofit
As mentioned above, your organization can’t file for tax exemption until it’s incorporated. After you decide on the legal structure of your organization (most choose to be a corporation), you can file your articles of incorporation according to the regulations of your state and pay the state fees, whether electronically or via mail.
These regulations differ in each state, so you should check with the National Association of State Charity Officials before starting the process. The most common information in the articles of incorporation includes:
- Name and address of your nonprofit
- Name and address of the founder
- Names and addresses of the board members
- Type and legal structure of your organization
- Statement of purpose of your nonprofit
Note: if your organization is to operate in different states, you must register in each state separately
Once you've sent the paperwork to your state filing office and the organization is incorporated, you can apply for an Employer Identification Number (EIN) online, by fax, mail or telephone. The EIN will be used to track your organization’s financial activity and will be needed for any major transactions the organization engages in. Your EIN is also required by the IRS when you apply for tax-exemption.
Depending on your organization’s activities, you may also be required to obtain the necessary licenses and permits to comply with federal, state and local rules. For example, if your organization needs to operate oversized vehicles, you will need a permit issued by your state government to operate them.
Now that you’ve finally completed all the preparations, you can apply for tax-exemption status with the IRS!
Filing for 501(c)(3) Tax Exemption
Step 8 - Fill out the appropriate forms
The 501(c)(3) application process is a thorough examination of your nonprofit’s governing structure, purpose and planned programs. The IRS is looking to make sure that the organization is formed for exclusively 501(c)(3) purposes and that its programs are designed to fulfill these stated purposes. besides, the IRS is looking closely for conflicts-of-interest and the potential for benefit to insiders, which are both possible grounds for denial.
To register to receive tax exemption status, you must fill out the appropriate forms with the IRS and submit it with the appropriate user fee. To apply for 501(c)(3) tax-exempt status, you’ll need to fill out and submit Form 1023 or Form 1023-EZ within 27 months of the date you file your nonprofit articles of incorporation.
Since the process can take up 3-12 months before the IRS finalizes its decision, it is advised to start the process as soon as you can. Form 1023 itself is almost 30 pages long, and the entire application package can be more than 50 pages long after attaching required and supporting documents. It is recommended to refer to all related IRS resources to help you with completing your application including:
- Application for Recognition of Exemption
- Governance and Related Topics - 501(c)(3) Organizations
- Compliance Guide for 501(c)(3) Public Charities
- Frequently Asked Questions: Form 1023
If your organization has gross receipts of less than $50,000 and less than $250,000 in assets, you may be eligible to fill out Form 1023-EZ, which is a condensed 3-page application. You can check your eligibility on the IRS website and fill out the eligibility worksheet to determine if your nonprofit can use this form instead.
For the complete details of the documents required to be submitted with your application, click here.
Before filling out Form 1023, make sure you have:
- Filed your articles of incorporation
- Prepared your bylaws
- Held your first nonprofit meeting
The IRS requires very specific details to be documented in your application, so spending a few days to fill out the forms accurately and gathering your resources is advised. Here is a checklist of information you should have on hand:
1. Basic information
This includes the name of your nonprofit corporation, contact information, and when you filed your articles of incorporation.
2. A copy of your articles of incorporation and your bylaws added to the application form.
3. Clauses as follows:
- A clause stating that your corporation was formed for a recognized 501(c)(3) tax-exempt purpose (e.g., charitable, religious, scientific, literary, and/or educational), and
- A clause stating that any assets of the nonprofit that remain after the entity dissolves will be distributed to another 501(c)(3) tax-exempt nonprofit — or to a federal, state, or local government for a public purpose
4. A detailed, narrative description of all of your organization’s activities
Include a description of past, present, and future activities — in their order of importance.
5. Information about all proposed compensation to, and financial arrangements with:
- Initial directors
- Initial officers (such as the president, chief executive officer, vice president, secretary, treasurer, chief financial officer, or any other officer in your organization)
- The five top-paid employees who will earn more than $50,000 per year, and
- The five top-paid independent contractors who will earn more than $50,000 per year
- A statement of revenues and expenses and a balance sheet
Power of Attorney
If you want to be represented by an attorney, other people authorized to practice before the IRS, you must include a Form 2848, Power of Attorney and Declaration of Representative, with your exemption application. A specific individual must be authorized by the power of attorney to represent your organization and can’t be a whole organization or firm. A list of categories of individuals who can represent you before the IRS is in the form, and include CPAs and Officers.
Once your organization has been successfully incorporated with 501(c)(3) status, you must follow a few procedures to maintain your tax-exempt status.
Every year, you must fill out Form 990 with the IRS. This form details your organization’s activities, such as revenue, finances, activities, governance processes, directors, and key staff, and it is open to public inspection. Any activities deemed not directly corresponding with the organization's objectives must still be reported, and may be subject to tax.
There are different 990 forms, and which one you fill depends on the total of your gross receipts:
Here is a checklist of all the things you need to do each year to ensure your organization is compliant to the IRS and your specific state:
- File your Form 990
- Keep your organization’s records updated — financial records, organization information, members, etc.
- Keep accurate and complete records, such as IRS Letter of Determination, Articles of Incorporation, Revenue and Expenses, previous tax filings, etc.
- Make sure your tax-exempt status is up-to-date
- Make sure your nonprofit registration complies with State Nonprofit Requirements
- Update and maintain your Charitable Solicitation Registration
- Submit an Annual Filing Form to the Secretary of State, Corporate Division
- File for State Business License and permits needed for your organization to operate
- Maintain tax exemption with your State Revenue Department
If the organization decides to change its focus area, it must immediately file a Form 5768 to keep its nonprofit, tax-exempt status.
As you can see, establishing a tax-exempt nonprofit is no easy task, and requires you to dedicate a lot of time to do it right.
It is advised to consult with local expertise — whether an attorney, accountant or someone familiar with the tax-exempt law and how nonprofits operate in your state. This will give you insight on how to best register and establish your nonprofit 501(c)(3) successfully.
You can also hire a professional to help you keep all your corporate records and critical documents organized so that you can access them easily when the time comes to fill in your application forms, and expedite the application process as you already have all the information required by the IRS ready.
There will be hurdles that you’ll have to jump over, but now with a better understanding of the 501(c)(3) application process, you’re much better equipped to set up your charity with success.