I remember my first nonprofit formation; it was during a semester I spent at Volunteer Lawyers for the Arts of Massachusetts. We didn’t realize, at first, that we were going to have to do a full-blown application; this was back when the changes to the reporting process were just beginning to cause small nonprofits to automatically lose their tax-exempt status.
You see, the IRS had decided that, even if a given charitable organization didn’t have enough revenues to justify requiring them to return a full-blown 990 (the tax return that charities file), it was still going to insist on being sent some basic information – the identities of the board and managers, essentially. Any organization that failed to do this for three consecutive years would have its status automatically revoked.
They put in an exemption for religious organizations, naturally, but that’s a separate issue.
So, we got a call from a small nonprofit that had seen its status revoked for failure to submit the postcard for three consecutive years. This was in the mid-to-late fall, so the holiday fundraisers were coming up and this was going to have a huge impact on the nonprofit’s viability – a nonprofit that had been around for a significant period of time.
Getting that organization’s exemption reinstated was something like a trial by fire for me; I spent 5 hours on the phone with the IRS (mostly on hold) to figure out how to answer very specific questions and how to deal with very specific events (for example, a natural disaster had destroyed some of the organization’s old documents – including its bylaws – and no other copies existed). The most basic and important thing that I learned? Filing for nonprofit status is a very unique and specific practice.
That said, I wanted to give those who are interested in forming their own organization a brief overview of how that process works. Perhaps more than any other topic I’ve discussed thus far, however, I would advise having an attorney assist you in this process; working with the IRS is always a very detailed and exacting process, and nonprofit formation is incredibly complex.
You can, however, go through a web tutorial offered by the IRS here. You can also download and look over the IRS publication on 501(c)(3) organizations here. The relevant text begins at or around page 23.
So, you want to form a nonprofit. Where do you start? Ideally, by forming a valid business entity of one of the three general types accepted by the IRS for 501(c)(3) entities: a trust, a corporation, or an association. For small nonprofits, this is usually accomplished by filing as an LLC in the organization’s home state.
Now, with your valid and accepted entity formed, you have to establish that you belong to one of the groups that are eligible for tax exemption. The most basic is the “charitable organization" class, which required that the organization have an appropriate charitable purpose. Examples include:
- Relief of the poor, the distressed, or the underprivileged,
- Advancement of religion,
- Advancement of education or science,
- Erection or maintenance of public buildings, monuments, or works,
- Lessening the burdens of the government,
- Lessening of neighborhood tensions,
- Elimination of prejudice and discrimination,
- Defense of human and civil rights secured by law, and
- Combating community deterioration and juvenile delinquency.
Some other classes include literary organizations, amateur athletic organizations, scientific organizations, religious organizations, and organizations devoted to the prevention of cruelty to children or animals. (see IRS pub 557)
So, now you have your exempt purpose and you know the class to which you belong. Congratulations! Now you get to file form 1023, the IRS form requesting recognition of a tax-exemption. You also get to apply for an EIN – a federal employer identification number.
Sounds like you’re done, right? Nope. You see, to be eligible for tax exempt status, your organization must have adopted both appropriate organizing documents and effective policies regarding a number of issues (including whistle-blower protection, sexual harassment prevention, non-discrimination in hiring and firing, and more).
For a new organization, you’re also going to need to provide your current financial statements and budgets for the next two years “including a detailed breakdown of revenue and expenses." You’re going to need to identify the attorney representing you in filing the 1023, if you’re using one. When all that’s done, you still have to enclose a check for the filing fee – currently either $400 or $850, depending on your organization’s annual gross receipts.
When you’ve finally put together all of this information that’s necessary for the 1023 and it’s sent away, the feeling is one of great relief. But sending off the 1023 doesn’t mean that you have an exemption; you have to wait for the official letter of exemption to come back from the IRS.
It’s a lot of work, but that shouldn’t scare away people who are passionate about creating an organization to introduce positive change into the world. Besides, that’s what lawyers are for – it’s our job to make the whole process feel as easy as possible. Even if we sometimes want to pull our hair out after an hour and a half on hold with the IRS to ask which box to check in response to a certain question.