Written by attorney Justin Sterling




The primary business entity formation for a nonprofit is the corporation. The corporation is a separate legal entity from the people who own, manage, and operate it. The corporation is composed of a Board of Directors and officers. The Board is responsible for overseeing and supervising the officers and employees of the corporation. The officers are responsible for the daily operations of the corporation. The directors and officers have limited personal liability for the business debts of the nonprofit organization. Creditors can only satisfy their debts incurred by the nonprofit organization from the corporate assets.

The difference between a for-profit corporation and a nonprofit corporation is that the for-profit corporation has shareholders who are the owners of the corporate property. Nonprofit corporations cannot have owners of the corporate property. There can be no private inurement or improper private benefit to anyone involved in the nonprofit. Whereas, a for-profit corporation can distribute its assets to its shareholders at any time during its operation through dividends. This encourages investment in the for-profit corporation and allows the shareholders to obtain a return on their investment. Nonprofit corporations do not allow this type of distribution.

A nonprofit is a corporation that:

(1) Has a mission to undertake activities in which profit is not the primary goal,

(2) Nobody has ownership of shares or interest in its property, and

(3) The property and income of the corporation are never distributed to any of its members, but are instead distributed to support the charitable activities.

Upon dissolution of the nonprofit, the earnings and assets of the nonprofit are directed toward the charitable activities rather than distributed to individuals for personal gain. Even if the organization fails to obtain tax exempt status by the Internal Revenue Service (IRS), the funds must still be used for charitable purposes and cannot be refunded or distributed to the donors.

California recognizes three types of nonprofit corporations: (1) Public Benefit Corporations, (2) Mutual Benefit Corporations, and (3) Religious Corporations.


A Public Benefit Corporation must be formed for public or charitable purposes and cannot be formed for private gain of any individual. Public benefit purposes include organizations such as childcare centers, shelters for homeless people, community health care clinics, museums, hospitals, schools, performing arts groups, conservation groups, and affordable housing groups.

The Public Benefit Corporation is legally restricted in that all its assets must be irrevocably dedicated to charitable, scientific, or educational purposes. In this sense, the nonprofit corporation is owned by the public. No private individual can claim ownership of the corporation. The board of directors and the officers cannot own the corporation’s assets.

For this reason, the Public Benefit Corporation cannot distribute dividends to any individual. If the organizers of the Public Benefit Corporation later decide to terminate the corporation, the assets of the Public Benefit Corporation must be transferred to another charity that has the same or similar purpose. The assets remaining after the debts and liabilities are paid must be transferred to another public benefit organization and cannot be transferred to any members of the former corporation or any private individual or any for-profit corporation. The property must be permanently used for charitable purposes. Moreover, a valuable asset to the nonprofit is its intellectual property. It is important that the nonprofit corporation also make the appropriate filings to protect its intellectual property, such as trademarks, service marks, copyrights, and patents.

In addition, because the Public Benefit Corporation is formed for charitable purposes, it must register and submit reports with the Attorney General’s Registry of Charitable Trusts. Moreover, Federal tax law requires that charitable organizations make available at their principal place of business the organization’s financial information, including applications for tax exemption, IRS Form 990, IRS Form 990EZ or IRS Form 990PF returns for the past three (3) years, and its IRS determination letter. These copies must also be provided upon written request from any person.


Groups organized for “charitable purposes” are exempt from income tax pursuant to Internal Revenue Code section 501(c)(3). Such groups include those organized and operated for religious, charitable, scientific, educational, or literary purposes.


The term “charitable purpose” is defined broadly and includes those services that are beneficial to the public interest. The organization must serve an open class of people and not a limited number of group members. For instance, charitable purposes include providing food to the homeless in the community, but not to specifically-named people. The beneficiaries of the organization’s purpose must be open and unspecified, but does not need to be large. Other examples of charitable purposes include: relief of the poor, distressed, and underprivileged; advancement of education and science; maintaining public buildings or monuments; lessening burdens of government; eliminating prejudice and discrimination; promoting the arts; or defending human and civil rights.


Educational purposes include instructing the public on subjects that are useful for the benefit of the community or for self-development. Particular viewpoints are allowed to be the focus, but there must be a full and fair exposition of pertinent facts so that individuals can form their own opinions and conclusions on the subject. If the curriculum only focuses on an unsupported opinion, the purpose is not considered educational for charitable purposes. Examples of educational purposes include: publishing public interest materials; public discussion groups, lectures, or workshops; correspondence courses; or museums, zoos, planetariums, orchestras, or other performances.


Literary purposes must involve books and reading. The organization must not target commercial markets and must sell the publications only at a modest price. Examples of literary purposes include: environmental preservation, highway safety, or drug and alcohol publications.


Charitable purposes may include those that promote social welfare by lessening neighborhood tensions, eliminating prejudice and discrimination, defend human civil rights, and prevent the deterioration of the community and juvenile delinquency. Charitable purposes may also include services that assist minorities, women, immigrants, or other classes that have been historically denied equal treatment because of race, gender, citizenship, or any other protected status.

Community development programs include job training, small business development, or affordable housing programs. Such purposes qualify for Federal tax exemption by: relieving the poor and distressed, combating community deterioration, eliminating discrimination, and lessening government burdens. The IRS defines a group as “poor and distressed” when there is an inability to afford “necessities of life” without undue hardship, and factors the lack of adequate housing, unemployment rate, and the government’s classification of the group as economically disadvantaged.


There is no uniform definition of “poor.” This “charitable class” is essentially made up of low-income, minority, elderly, disabled, or other 501(c)(3) organizations. Examples of organizations that qualify include: Organizations that offer services to obtain and maintain employment, vocational training, child care, counselling, financial services to businesses owned by “needy” individuals, or housing, legal, food, and transportation services to the “needy.”


In order to qualify as lessening government burdens, the activity must be government’s responsibility and the activity must in fact lessen the burden to the public. Generally, there must be a government policy or code that applies to the activity, such as housing or economic development. The government must have an involvement in the activity on a regular basis, provide funding, and perform the activity directly. The nonprofit organization’s purpose must directly address the burden to the public. The nonprofit should have a favorable relationship with the government entity and improve the government’s function without additional government expenditures. Examples include: affordable housing for low-income families, job creation, small business growth, recycling services, community land use plan, recreational facilities and public parks.


A Mutual Benefit Corporation is an organization formed for the benefit of its own members, not for the purpose of charity. Mutual Benefit Corporations include organizations such as private homeowners’ associations, private clubs, and trade and professional associations. The assets of the Mutual Benefit Corporation can only be distributed to its members upon dissolution, not during its operation. Whereas, Religious Corporations are nonprofit organizations formed solely for religious purposes.

Mutual Benefit Corporations are different than Public Benefit Corporations and Religious Corporations in that they are generally not considered charitable organizations. Therefore, because Mutual Benefit Corporations do not benefit the public, they do not qualify for 501(c)(3) tax exempt status.


Social welfare organizations, also known as “Civic Leagues,” involve activities that are directed toward members or toward influencing public opinion and legislation. These organizations are exempt from Federal income tax pursuant to Internal Revenue Code section 501(c)(4) if the organization operates primarily to further the common good and general welfare of the community. These organizations may engage in political activities, but politics must not be their primary purpose. Examples include: volunteer fire companies, community associations, crime prevention groups, or groups promoting industrial development in the community. The difference between 501(c)(3) status and 501(c)(4) status is that donations to an organization exempt pursuant to 501(c)(4) are not tax deductible.


A California Nonprofit Public Benefit Corporation may be formed by completing certain steps. These include:

Name Availability ($10.00 Fee): It is best to check the availability of a particular name for the nonprofit corporation and reserve the name with the Secretary of State.

Articles of Incorporation ($30.00 Fee): The Articles of Incorporation is the formal document that legally creates the corporation and must be filed with the Secretary of State. The Articles must specify the charitable purpose of the organization, the name of the organization, the principal place of business, its officers, and any limits on its operation. The Articles must include language ensuring that is not organized for private gain of any individual, that it will comply with the requirements for nonprofit status, and comply with the requirements for tax exemption. The specific clauses that should be in the Articles include:

Clause stating the corporation is organized and operated exclusively for charitable purposes and shall not engage in any activities or exercise any powers that are not in furtherance of its primary charitable purpose, except to an insubstantial degree; Clause stating that no substantial activities should consist of propaganda, influence legislation, and the corporation shall not participate in any political campaign in support or in opposition of any candidate for public office; Clause dedicating income and assets to charitable purposes, and no part of net income or assets shall inure to the benefit of any director, officer, member, or private individual; and Clause stating that upon dissolution, the remaining assets shall be distributed to another corporation exclusively for charitable purposes with 501(c)(3) tax exempt status.

Bylaws: The incorporator or the initial board of directors should prepare and adopt the Bylaws immediately after filing the Articles of Incorporation. A copy of the Bylaws, signed by an officer or certified by the Secretary, must be submitted with the application for Federal and State tax exemption. The Bylaws set out the structure and rules of operation for the Public Benefit Corporation. The Bylaws should include the method for electing directors and officers, the procedures for how the board of directors shall operate, and the procedures for amending Bylaws.

Incorporator’s Initial Action: If the Articles were only signed by an incorporator and not the initial board of directors, the incorporator will need to appoint the first board of directors as an initial action. At this time, the incorporator may also adopt the Bylaws, appoint officers, and authorize a bank account to be opened in the name of the Public Benefit Corporation. The corporate minutes should reflect these actions.

Employer Identification Number (EIN) (No Filing Fee): An Employer Identification Number (EIN) must be obtained from the Internal Revenue Service (IRS) by filing an IRS Form SS-4. The EIN will be the identification number on all Federal tax returns and reports for the nonprofit.

Statement of Domestic Nonprofit Corporation ($20.00 Fee; also referred to as Statement of Information; Form SI-100): Within ninety (90) days of filing the Articles of Incorporation, a Statement of Information by Domestic Nonprofit Corporation must completed and submitted to the Secretary of State. The Statement must be submitted every second year during the existence of the Public Benefit Corporation.

Register with Attorney General (Up to $300.00 Annual Fee based on gross annual income sliding scale; $25.00 Initial Fee per Form CT-1, Renewal Fee based on sliding scale per Form RFF-1): Pursuant to California Government Code section 12585, all charities must register with the Attorney General within thirty (30) days after receiving their first assets. The Articles of Incorporation and the Bylaws must be filed with the Attorney General’s Registry of Charitable Trusts. The registration must be renewed every year. In addition, the Public Benefit Corporation must file financial information reports every year with the Attorney General. These include Form RRF-1 and Form 990, 990-EZ, or 990-PF. Corporations organized primarily as a hospital, school, or religious organization are exempt and must provide substantiating evidence to the Attorney General.

Board Meeting: The first board of directors meeting should involve adopting the Bylaws, electing officers, setting possible compensation amounts of wages or salaries for officers, establishing a bank account, authorizing the officers to apply for tax exemption, declaring the accounting year and the accounting procedures to be applied, setting a budget, clarifying operation procedures such as maintaining the minutes, Bylaws, and corporate records. These actions may be conducted through unanimous written consent signed by the directors, rather than in-person, so long as it is permitted by the Bylaws. The corporate secretary must record and maintain all signed meeting minutes and unanimous written consents.

Tax Exemption ($400.00 or $850.00 Fee for IRS Form 1023 depending on Annual Gross Receipts; $25.00 Fee for California FTB Form 3500): The Public Benefit Corporation must file IRS Form 1023 as the application with the IRS for exemption from Federal income tax pursuant to sections 501(c)(3) or 501(c)(4) of the Internal Revenue Code. In addition, FTB Form 3500 must be filed with the California Franchise Tax Board as the application for exemption from State income tax.


The major benefit of charitable nonprofit organizations is that they may qualify for exemption from Federal and State income tax. In addition, corporate donors may deduct contributions to organizations that are exempt under section 501(c)(3) of the Internal Revenue Code from their personal Federal income tax. A tax professional must be retained by the nonprofit because of the complexities involved. The process for obtaining tax-exempt status is separate from the incorporation process.


Section 501(c)(3) of the Internal Revenue Code, which is codified in Title 26 of the United States Code, states that the following are exempt from taxation:

“Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.”

Essentially the advantage of obtaining charitable Internal Revenue Code (IRC) Section 501(c)(3) tax-exempt status are:

Exemption from Federal and State income tax on earned and investment income, except for net income from unrelated business purposes, or investment income from assets acquired with debt; Charitable contributions from individuals are tax-deductible;

Many grants from Government, foundations, and corporations are limited to 501(c)(3) organizations; and Tax-exempt organizations qualify to purchase property through bargain sales, in which the property may be bought at a less than fair market value, and the seller will receive a tax deduction for the difference between the value and the sales price.

To qualify for exemption from Federal income tax, a nonprofit organization must satisfy both the organizational test and the operational test.


According to the Internal Revenue Code, a section 501(c)(3) organization must be “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes.” The organizational test is satisfied if the Articles of Incorporation includes language that limits the purpose of the organization to the exempt purposes listed in section 501(c)(3) of the Internal Revenue Code. The Articles of Incorporation must state that the organization cannot engage in any substantial activities which does not further the exempt purposes. Moreover, the organization must expressly dedicate its assets to exempt purposes in the event of dissolution.


The nonprofit must also satisfy the operational test, which requires the organization to engage primarily in activities to accomplish an exempt purpose specified in section 501(c)(3) of the Internal Revenue Code. The organization must not divert charitable assets to private individuals, pay excessive compensation to officers and directors, or engage in prohibited political activities. The organization must not participate in politics by supporting or opposing a particular candidate for public office. The organization must not engage in substantial lobbying. Moreover, to obtain tax exemption in California, more than half of the board of directors must be disinterested – meaning that not more than 49% of the directors can receive compensation or be related to a person receiving compensation from the organization.


A 501(c)(3) organization must be classified as either a Private Foundation or a Public Charity based on the level of public involvement in its activities.


A Public Charity receives the majority of its financial support from the general public or Government entities. In doing so, Public Charities interact greatly with the public. An organization will be classified as a Public Charity if it receives a certain percentage of its total financial or program support from Government sources, other Public Charities, or a broad base of individual donors. The calculation required to obtain Public Charity status from public donations is complex. Tax professionals will need to be consulted and an IRS Form 8940 must be submitted. If the organization is classified as a Public Charity due to receiving financial support from the public, the IRS classification status will be valid for five (5) years. In advance of the end of the five (5) year period, the organization will be required to submit IRS Form 8734. In addition, an organization can be classified as a Public Charity, and avoid the more rigorous classification as a Private Foundation, if it satisfies the IRS definition of a church, school, hospital, or museum.

Most active 501(c)(3) organizations are Public Charities because they have higher donor tax-deductible contribution limits and can attract support from other Public Charities and Private Foundations. Also, Public Charities have three possible tax filing requirements that range in complexity and depend on annual revenue: (1) Form 990 must be filed for Public Charities with annual revenue greater than $200,000.00; (2) Form 990-EZ must be filed for Public Charities with annual revenue between $50,000.00 and $200,000.00; or (3) Form 990-N E-Postcard can be filed for Public Charities with annual revenue less than $50,000.00. Whereas, Private Foundations must file the rigorous Form 990-PF each year regardless of revenue (it is comparable to the more complex Form 990 for Public Charities).


A Private Foundation is many times controlled by members of a single family, by a small group, or by a corporation retaining control over operations and grants. As a result, much of the Private Foundation’s financial support is from specific sources and investments. Private Foundations are not subjected to strict public scrutiny. However, Private Foundations are instead subjected to various operating requirements and restrictions. For instance, classification as a Private Foundation has disadvantages in that a two percent (2%) excise tax is imposed on the organization’s net investment income, there are limits on the deductions of charitable contributions by individual donors, and there are more burdensome financial reporting requirements.


Pursuant to tax laws, a section 501(c)(3) organization is presumed to be a Private Foundation. The organization must request and qualify as a Public Charity and receive a ruling or determination by submitting IRS Form 8940.


To apply for Federal tax exemption, IRS Form 1023 must be filed within twenty-seven (27) months of incorporation with the Internal Revenue Service. Form 1023 must be signed by a principal officer, an authorized employee, the Attorney for the nonprofit, or an agent with Power of Attorney to act on behalf of the nonprofit. Included with the Form 1023 must be:

Certified copy of the Articles of Incorporation from the Secretary of State; Copy of the Bylaws signed by a principal officer or certified by a declaration from an authorized officer stating that the Bylaws are the true and complete copy; Statement of receipts and disbursements; Current balance sheet; Proposed budget for two (2) years; and Executed copy of a consent to extend the period in which to assess tax (Form 872-C), unless the organization is a Private Foundation which does not need to submit Form 872-C.

The fee for Form 1023 is based on the projected gross receipts of the nonprofit. The fee is $400.00 if the nonprofit has an annual gross receipts of less than $10,000.00 in the preceding four (4) years of existence or if the projection for a newly formed nonprofit is less than $10,000.00. The fee is $850.00 if annual gross receipts are more than $10,000.00. It takes at least three (3) months after filing Form 1023 to receive an approval from the IRS.


In California, corporations are subjected to an annual franchise tax on net income. However, nonprofit corporations can apply to be exempt from this annual franchise tax.

To obtain exemption from State income tax, FTB Form 3500 must be filed with the California Franchise Tax Board with a $25.00 Fee. If the corporation has already received a letter from the IRS recognizing its 501(c)(3) exemption status, the corporation may file Form 3500A for no fee and attach the IRS letter.


Even though a charity is exempt from income tax, the organization is still responsible for applicable property tax and sales tax. Local and State property and sales tax statements and returns must be filed.

However, in California the corporation may apply for a property tax exemption known as the Welfare Property Tax Exemption for its taxable real or personal property.

In California there is no exemption from sales tax for charities. If the nonprofit is selling merchandise, a Sellers Permit and Resale Certificate from the California State Board of Equalization must be obtained.

The State Board of Equalization and local county tax assessor can be consulted to clarify what taxes are still required by the organization.


The nonprofit may be subjected to local business license permits and local business taxes. The local City Clerk should be consulted to determine if any other taxes are applicable to the nonprofit. Charitable corporations are often exempt from payment of local business license taxes.


Nonprofit corporations often retain an Attorney to provide an opinion on whether the corporation will be engaging in unrelated business activities that may be taxable.

To note, the organization’s activities can still be considered charitable even though they generate profits. However, the primary purpose must be charitable and not income generation. A for-profit business generates income on a regular basis; whereas, a non-profit organization engages in fundraising not on a regular basis. Factors that are considered in determining if the organization is charitable include:

How the income is derived, not how the surplus will be used; The nature and size of the business – is it affordable, below cost? Does it serve a charitable class – i.e. low-income, minority, elderly, disabled, other 501(c)(3) organizations; and Does the nonprofit operate in a commercial manner and compete against private business? A charitable corporation can engage in a limited amount of non-charitable unrelated business activity and still qualify for section 501(c)(3) status. As a general rule, not more than 15% of the income can be non-charitable.

Section 501(c)(3) organizations will be subjected to tax on the net income derived from activities that are not substantially related to the exempt purposes. The organization must submit additional State and Federal tax returns for its unrelated business income – IRS Form 990T and California FTB Form 109. An exception from tax exists for the passive income, such as rent from real property, interest on dividends, and royalties. However, if the activity is financed with debt the exception does not apply and the net income is taxed.

If too much of the organization’s activity is non-charitable, the 501(c)(3) status will be lost. For this reason, many charitable corporations will form a for-profit subsidiary to conduct the unrelated business activity, allowing the charitable corporation to retain control by electing the directors of the subsidiary and the funds can be transferred back to the 501(c)(3) pursuant to a services contract or as after-tax dividends. If the nonprofit corporation controls any subsidiary nonprofit or for-profit corporations, it is important that it monitors the performance and compliance with corporate formalities.

An activity may still be considered charitable even though it is partly supported by grants and also partly by income, such as a sliding scale fee based on ability to pay. In such situations, the income received is used to subsidize those who pay less than cost and the grants make up the difference.


Residential real estate activities may be charitable and qualify for 501(c)(3) status if the purpose is for the relief of the poor and distressed. Pursuant to IRS Revenue Procedure 96-32, entitled Low Income Housing Guidelines, at least 75% of the units in a real estate project must be for recipients who earn 80% or less of the median income in the area. Furthermore, either 20% of those units must be for families earning 50% or less of the area median income, or 40% of those units must for families earning 60% or less of the area median income. The remaining units may be provided at the market rate.

Another method for residential real estate to qualify for 501(c)(3) status is based on the facts and circumstances. For example, evidence may be introduced to show that the persons aided by the project could not otherwise obtain housing (i.e. housing for those who have very high medical expenses); or the project participates in a government housing program; or the project contains provisions for social services; or the project has a community-based board of directors and allows for community involvement in making operation decisions.

In addition, the residential real estate project may qualify for 501(c)(3) status by aiming to combat community deterioration. For example, the project may aim to rehabilitate or provide new construction in a blighted area designated by the Government or the facts and circumstances show that the area is blighted. Evidence of blight includes: studies showing that the area is old and deteriorated, the area has lower median income as compared to other neighboring areas, the area has few recreational facilities, declining property values, high abandonment and vacancies, high crime and drug rates, and many housing code violations.

The residential real estate project may also qualify for 501(c)(3) status by eliminating prejudice and discrimination. The project may aim to provide housing to minorities who have historically been unable to obtain housing due to discrimination. The project may also aim to provide specialized housing for the elderly and handicapped.


Pursuant to IRS Revenue Rulings, commercial real estate activities may be considered charitable when:

The property is used as office space for the nonprofit organization’s own use; The property is rented out to other 501(c)(3) organizations at the lowest feasible rate; The property is rented to poor and minority business owners particularly in blighted areas; The property includes lease provisions requiring job training and employment of residents in a disadvantaged area; The rental income is used to make grants to other 501(c)(3) organizations; or The rental income is used to lessen the rent of other 501(c)(3) organization tenants of the property.


Annual financial reports must be submitted to the IRS and the California Franchise Tax Board. The board of directors should review the corporation’s annual IRS and State filings before submitted. Often, the nonprofit will retain an independent accountant to conduct a review of the organization’s financial statements and issue a report to the board of directors, which is a less expensive alternative to obtaining a complete audit. The nonprofit should hire a professional accountant to help implement a fiscal management system, addressing issues such as dual-signature requirement on bank accounts, regular review of monthly statements by the board, and an annual audit. The local chapter of the American Institute of Certified Public Accountants (AICPA) or the California Board of Accountancy’s Clearinghouse for Volunteer Accounting Services (CVAS) may be contacted for information on accountants who may provide free services or reduced-cost services to nonprofits.

Pursuant to California Government Code section 12586, referred to as the Nonprofit Integrity Act of 2004, a charitable organization with gross revenue of two-million dollars ($2,000,000.00 USD) or more must obtain independent audits and appoint an audit committee. The audited financial statements must be made available for inspection.

At any time during the existence of the nonprofit organization, the IRS or the California Franchise Tax Board may audit the organization to determine tax liability, penalties, or revocation of tax-exempt status.


Public Charities must submit annual filings to the IRS, including IRS Form 990 or 990-EZ (Return of Organization Exempt from Income Tax) and accompanying Schedule A within four-and-a-half (4 ½) months following the close of the organization’s tax year. This is the organization’s informational return stating its finances and activities. Certain organizations are exempt from this filing requirements, such as churches and organizations with annual gross receipts of $50,000.00 or less (except for Private Foundations). Rather, such organizations must file Form 990N, which is an annual electronic notice form. Private Foundations must file the more rigorous Form 990PF regardless of their gross receipts.

The California equivalent for the annual exempt organization return is FTB Form 199 and 199N.


An organization that has annual gross incomes of one-thousand dollars ($1,000.00 USD) or more from unrelated trade or business activities must file IRS Form 990T Exempt Organization Business Income Tax Return in addition to the annual informational return. The unrelated business income will be taxed at the same rate as the standard corporation Federal income tax. Moreover, if the organization has a significant amount of unrelated business income, the IRS may determine that the organization is spending a substantial amount of time on non-exempt activities and investigate its tax exemption status.

The California equivalent for the unrelated business income return is FTB Form 109.


In California, the Statement of Information by Domestic Nonprofit Corporation with a $20.00 fee must be submitted to the Secretary of State every two (2) years. Failure to comply will lead to penalty charges.

In addition, every Nonprofit Public Benefit Corporation must register the Attorney General’s Registry of Charitable Trusts within thirty (30) days of receiving its first assets. The initial registration form is Form CT-1. The corporation must file the Registration Renewal Fee Report Form RRF-1 with the registry every year. Nonprofit corporations with revenues of more than $25,000.00 during the preceding fiscal year must pay an annual registration fee based on a sliding scale. Also, all IRS Form 990, 990EZ, 990N, or 990PF, and schedules must be submitted to the Attorney General.


Membership for a Nonprofit Public Benefit Corporation is optional. The reasons for providing membership in a nonprofit include: (1) Attract funds through membership, or (2) Establish support in the community. However, many administrative burdens are associated with forming a membership organization and it is more common for a nonprofit to not have members.

If the nonprofit includes membership, the Bylaws must address the controlling provisions for membership such as qualifications, method of selection, expulsion, dues and fees, notice and frequency of meetings, the number required for a quorum to make decisions, and the number of votes required to order action on a matter. The Public Benefit Corporation may also create different classes of membership, which may be offered to individuals or corporate entities. Based on the provisions in the Bylaws, the members may have voting and statutory rights or they may simply be donors who have only honorary membership without any voting and statutory rights. In California, members have statutory legal rights when they possess voting power on electing directors or on how the charity’s assets will be disposed upon dissolution, merger, or conversion. Pursuant to California law, voting members have the right to inspect corporate records, elect and remove directors, receive notice of meetings, and they may sue the directors in a derivative action or third-parties on behalf of the nonprofit corporation. These statutory rights can be enforced in civil court actions. In addition, classes of voting members cannot be abolished without their consent, and also their voting rights cannot be changed without notice, due process, and consent.

As a practicality, the nonprofit corporation should maintain an alphabetized list of its members, including their name, address, class of membership, and applicable membership dues.


Every corporation must have directors and officers, who owe fiduciary duties to the corporation. The Bylaws address the method for selecting the board of directors and officers. The Public Benefit Corporation may have only one director, but it is more common for a board of directors to consist of three or more persons. To note, the IRS is unlikely to grant 501(c)(3) status to a nonprofit corporation that only has one director.

The board of directors can be selected by voting members, act as a self-perpetuating body, be appointed by an outside organization or persons, or any combination of these procedures. The Bylaws must address the number of directors, qualifications, term of office, removal, filling vacancies, notice and frequency of meetings, number required for a quorum, number of votes required, and method for appointing officers and committees.

The Public Benefit Corporation must also have certain officers named, including the President, Chief Financial Officer, and Secretary. The responsibilities of the officers are addressed in the Bylaws, which often include maintaining the accounts, deposits, disbursements, meeting minutes, and notices. A director can also serve as an officer. However, pursuant to California Corporations Code sections 5213 and 9213, neither the Secretary nor the Chief Financial Officer or the Treasurer may serve concurrently as the President or Chair of the Board.


Charitable organizations must not pay its officers or employees unreasonable excessive compensation. The amount of compensation must be authorized by the board of directors or an authorized committee appointed by the board. The nonprofit corporation must conduct appropriate investigation to determine if loans, leases, and other transactions are made at fair market value to the nonprofit or are favorable to the nonprofit.

If any of the directors are to be compensated as an officer or employee of the Public Benefit Corporation, the amount of compensation must be approved by an independent board and the interested director must be excluded from the vote. An independent board requires that less than 49% of the participating directors are paid or relatives of others paid as employees or officers of the Public Benefit Corporation. That is, more than half of the board must not be receiving compensation or be a relative of someone receiving compensation from the Public Benefit Corporation. For example, if there are five (5) directors on the board, only two (2) can receive compensation as an officer or employee.

Reasonable compensation paid to a director or officer is not considered self-dealing so long as it does not impair their ability to serve and be disinterested in making decisions concerning the corporation. This determination is made on a case-by-case basis according to the facts and circumstances.

Self-dealing is prohibited and involves a contract, agreement, or transaction in which both the organization and a director are parties. Both the organization and the director have a material financial interest and the organization’s assets or income are affected. This creates a conflict of interest and such deals are inherently suspect. However, a self-dealing transaction will be valid if the terms of the deal are considered fair and reasonable to the organization. For example, the self-dealing transaction is fair when: the contract is for the corporation’s benefit solely, the corporation could not obtain a better deal, and the deal was approved in advance by a disinterested majority vote of the board of directors. The disinterested board must conduct a good faith review of the deal rather than a sham, which would be considered fraud and collusion by all the directors thereby incurring liability for the damage to the corporation.


Generally, directors and officers of a Public Benefit Corporation are not personally liable for the debts, liabilities, or obligations of the corporation so long as the director or officer acted in good faith, in the best interest of the corporation, and with reasonable care. However, a director or officer may be held personally liable when they have breached their duty of care and loyalty to the corporation. Limited liability does not apply when the director engages in self-dealing or makes and receives a prohibited loan or distribution. The Attorney General or other disinterested persons may sue the directors in a derivative action to recover actual damage suffered by the corporation, with interest, and even punitive damages.

The Public Benefit Corporation must not make loans to its officers or directors without the approval of the Attorney General. There is a limited exception concerning a loan for the officer’s primary residence. The Attorney General will apply a strict scrutiny standard of review when requested to review proposed loans from a Public Benefit Corporation to a director or officer. The Attorney General will ask: Is the loan strictly necessary to carry out the charitable purpose and protect the charitable assets? Are better alternatives available? Are the terms and interest rate fair to the organization? Is the loan secured?

Moreover, a director will be personally liable for making or receiving prohibited distributions of assets belonging to the Public Benefit Corporation. Prohibited transactions involving directors and officers include: transfer of corporate funds or assets without fair consideration, payment of excessive or unauthorized salaries, receiving non-contractual benefits or bonuses, improper gifts involving corporate assets, use of corporate assets unrelated to the organization’s charitable purpose.

In fact, California law requires that the Attorney General consents to certain transactions or at least receive notice, including those for dissolution, merger, sale of substantially all the corporation’s assets, and an amendment to the Articles of Incorporation to change the form of the organization from Public Benefit to for-profit. In the case of a conversion in the form of the organization, all the charitable assets of the Public Benefit Corporation must be distributed to another charity with similar charitable purposes.

As a practicality, the nonprofit corporation should obtain commercial general liability insurance, errors and omissions or other professional liability insurance, directors and officers liability insurance, and bonding for the individuals responsible for handling the funds of the nonprofit.


In order for donors to deduct their charitable contributions, the IRS guidelines require that the taxpayer donor show that the amount claimed as a deductible gift to charity is more than the fair market value of any benefit received. Moreover, it is important that the nonprofit corporation complies with disclosure, substantiation, and reporting requirements for the contributions it receives. The nonprofit must also comply with all State and local charitable solicitation laws and ordinances. For example, the Federal government requires the nonprofit to give a receipt to the donor making the charitable contribution. The receipt must be given before the earlier of when the donor’s income tax return is due or when the donor files the income tax return. The receipt must contain the following information: (1) Name of the donor; (2) Date the contribution was made; (3) Cash value of the contribution; (4) Description (but not the value) of the contribution if in the form of property; (5) Statement of whether the organization has or will provide any goods or services in return for the contribution; and (6) Description and good faith estimate of the value of any goods or services provided or to be provided by the organization.

Furthermore, if the nonprofit will be utilizing the mail, the nonprofit should obtain a nonprofit mailing permit to use special bulk third-class postal rates.

Many times, the nonprofit may hire a commercial fundraiser or a fundraising counsel, which are both required to register with and are regulated by the Attorney General. Pursuant to California Government Code section 12599, a commercial fundraiser is an entity or an individual who is compensated to solicit funds for charitable purposes or is compensated to receive or control the funds. A fundraising counsel is a person who is compensated for planning, managing, or consulting on charitable solicitation within California.

A charitable organization is ultimately responsible for the control over its fundraising activities. A commercial fundraiser or fundraising counsel who is not registered with the Attorney General must not be employed by the organization. Proof of Registration with the Attorney General’s Office should be provided. The organization may request a fundraiser’s bond as security. Moreover, the organization must not raise funds for another charitable organization which is required to register with the Attorney General unless such organization is legitimately registered.

Registration with the Attorney General’s Registry of Charitable Trusts serves to protect against fraud. A commercial fundraiser must submit a $350.00 fee and obtain a $25,000.00 bond. The registration and bond must be renewed annually. A commercial fundraiser must also submit an annual financial report with the Attorney General which discloses the amount of funds obtained during the preceding year. Local cities and counties may also require the commercial fundraiser to register.

The charitable organization must comply with all county, city, and local ordinances regulating charity fundraising. To note, conducting a private lottery or raffle is illegal in California if it involves payment for a chance to win a prize. However, charity bingo and raffles are expressly permitted. California law and local ordinances permit tax-exempt organizations to raise money from bingo if: (1) Proceeds are used for charitable purposes; (2) The game is operated by volunteers from the nonprofit organization; (3) Proceeds cannot pay salaries; (4) The bingo proceeds cannot be commingled with other funds; (5) The nonprofit organization must obtain a license issued by the city or county; and (6) The nonprofit organization must account for all proceeds to the local licensing authority. In addition, pursuant to California Penal Code section 326.6, a nonprofit organization may lawfully conduct a raffle if ninety percent (90%) of the revenue is put toward the charitable purpose or program. Charity auctions are also permitted.

Moreover, the nonprofit corporation must comply with security laws by registering or qualifying for an exemption from registration for any debt instrument.


The California Attorney General represents all the public beneficiaries of charity, who cannot sue in their own right. Therefore, all charities must register with the Attorney General and the Attorney General’s Registry of Charitable Trusts maintains public files and financial reports for all charities registered in California. The Attorney General has the power to oversee the operations of Public Benefit Corporations. The Attorney General’s Charitable Trust Section has investigative audit powers and may bring civil actions to recover diverted charitable assets. The Attorney General investigates and audits charities to determine if directors have mismanaged, defrauded, or wrongfully diverted funds from the charity. In doing so, the Attorney General accepts anonymous complaints and may file legal actions against the Public Benefit Corporation on behalf of the public. The funds recovered by the Attorney General are returned to charity.

If a charity has two-million dollars ($2,000,000.00 USD) or more in gross revenue, which does not include government grants and contracts with government entities for which the government entity required an accounting for the funds received, the Attorney General will require the charity to do the following: (1) Prepare annual financial statements using generally accepted accounting principles and audited by an independent certified accountant; (2) Make those statements available upon demand by the Attorney General and the public; and (3) If the charity is a corporation, the board of directors must appoint an independent audit committee.

The Attorney General will frequently investigate the following: (1) Self-dealing transactions by directors of the Public Benefit Corporation; (2) Loans by a Public Benefit Corporation to a director or officer; (3) Losses of charitable assets from speculative investments; (4) Excessive salaries, benefits, travel, entertainment, legal, or other professional fees paid by a Public Benefit Corporation; (5) Sales of charitable assets or conversion of a Public Benefit Corporation to a for-profit corporation at a price that is unfair to the charity; (6) Illegal use of charitable funds; (7) Diversion of charitable funds from the intended charitable purpose; or (9) False or misleading solicitations of charitable donations.

Certain transactions must be noticed and consented to by the Attorney General. For example, a Public Benefit Corporation must give advance written notice to the Attorney General of its dissolution, merger, or a sale or transfer of all or a substantial amount of the Public Benefit Corporation’s assets. The Attorney General must give consent or a Court must approve the distribution of the Public Benefit Corporation’s assets upon dissolution. Pursuant to California Corporations Code section 6615, the Certificate of Dissolution filed with the Secretary of State must include a certificate from the Attorney General waiving any objections to the proposed distribution of assets or confirming that there are no assets.

Moreover, a Public Benefit Corporation must obtain prior written consent from the Attorney General before making a loan to a director or officer. As an alternative, the Court may approve the transaction. Residential loans to directors or officers do not require Court approval or Attorney General consent.

In addition, the directors must obtain prior written consent from the Attorney General before amending the Articles of Incorporation to convert the organization to a for-profit business or a Mutual Benefit Corporation. Prior consent from the Attorney General is also required when there is a merger of the organization with a for-profit business or Mutual Benefit Corporation. In such a case, all the assets of the organization must first be distributed to another charity with a similar purpose. If prior consent from the Attorney General is not obtained, the Public Benefit Corporation may only merge with another Public Benefit Corporation or a religious corporation.

The required documents that must be submitted to the Attorney General in order to obtain approval and consent of voluntary dissolution, merger, sale of assets, or a conversion include: (1) Letter signed by the nonprofit’s attorney or a director detailing the proposed action; (2) Copy of the election to dissolve, agreement of merger, or board resolution giving authorization to the proposed action; (3) Copy of the corporation’s current financial statement; (4) Copy of the corporation’s Articles of Incorporation and of any other corporation that is involved in the proposed action plan; and (5) Independent appraisal or evidence supporting a fair transaction including price and terms if required by the Attorney General. In the case of a conversion to a for-profit business or Mutual Benefit Corporation, additional required documents included: (6) Certification that all charitable assets will be transferred to another charity as a condition to consent by the Attorney General; and (7) Distribution Plan Statement for the assets to be transferred to another charity or Payment Plan Statement for the directors or purchasers to pay the fair market value of the corporation to another charity.

Directors may give advance written notice to the Attorney General of any self-dealing transactions, which would then shorten the statute of limitations to bring a civil action. The required documents that should be submitted to the Attorney General in order to obtain approval include: (1) Letter signed by the nonprofit’s attorney or a director detailing the transaction, including the financial interest of the interested director and all material facts; (2) Copy of the corporation’s current financial statement; (3) Copy of the Articles of Incorporation and any amendments; (4) Copy of the Bylaws and any amendments; (5) Copy of all minutes relevant to the transaction; and (6) Letter signed by the interested director detailing the director’s financial interest in the transaction, all material facts, and all relevant facts disclosed by the interested director to the Board.

Any charitable corporation that is formed outside of the State of California but is conducting business or holding property within the State, must still register with the Attorney General. The foreign corporation must also satisfy the California Secretary of State’s requirements in order to conduct business in the State. This includes maintaining an agent for service of process within the State.


Many nonprofit organizations hire employees as staff to provide programs, conduct fundraising, maintain accounting, file taxes, and other services. The nonprofit has the same legal obligations to its employees as any private business corporation, such as prohibitions against discrimination and harassment. The nonprofit corporation is also obligated to report employee’s income and make withholder payments to the Federal and State governments, and is responsible for State unemployment insurance taxes, workers’ compensation insurance, State disability insurance, payment of the employer’s portion of Federal social security (FICA), Federal unemployment tax (FUTA), and Medicare. The nonprofit must also comply with standard employment terms and conditions including minimum wage, overtime, and break periods. The following forms must be filed with the Federal and State governments:

Employee’s Withholding Certificate (W-4) and California Form DE-4 Corporation Federal Quarterly Withholding Returns (Form 941E) and bank deposits of withheld income taxes and social security taxes Annual Federal Wage and Tax Statement (W-2) California Employer Registration Form California Income Tax Withholding Form SE-44 California Quarterly Unemployment and Disability Insurance Annual Federal Unemployment Tax Return It is important that the nonprofit correctly classify employees for purposes of Federal and State wage-and-hour laws. For independent contractors, the corporation must file IRS Form 1099 and California Form DE-542 if the contractor is paid more than $600.00.

As a practicality, the nonprofit should obtain Directors and Officers Insurance, which will protect the individuals from civil claims and employment lawsuits. An Employment Practices Liability Insurance (EPLI) policy covering employment-related claims may also be obtained.


If the existence of the venture is for a short duration, the nonprofit organization may not be the best structure. Nonprofits are good for long-term ventures. Alternatives include: (1) Operating as an informal organization under the legal umbrella of an existing charity, also known as fiscal sponsorship; or (2) Forming an unincorporated nonprofit association.


An alternative may be to obtain fiscal sponsorship, in which the “sponsee” can join an existing organization and operate under its tax-exempt status. This provides a small project the opportunity to be tax exempt through the sponsor’s IRS status and also pass overhead costs onto the sponsor. There are no incorporation costs in this situation. However, the sponsor most likely will retain control over the direction of the project and may also charge a fee from the sponsee. For example, a fiscal sponsor may charge administrative fees for the use of its facility, services, and staff. The advantage of a fiscal sponsorship is that the fiscal sponsor will assume the risk of liability.

A fiscal sponsorship may be created by forming an employer-employee relationship, in which the sponsor has direct control over the project. There is no legal separation between the sponsor and sponsee. That is, the sponsor will be both fiscally and legally liable for the project. Moreover, the insurance cost to the sponsee may also be lessened as the sponsor may be able to purchase an affordable blanket liability policy covering all projects.

A fiscal sponsorship may also be created by forming a grantor-grantee relationship, in which the sponsor remains separate from the sponsee. The sponsor only provides fiscal support to the sponsee through grants. The sponsor is not legally liable for the project, but the sponsor must exercise sufficient control over the project’s funds to ensure the funds are used according to the grant agreement. In this relationship, the sponsee must still maintain its own tax liability and is required to comply with the required tax reporting requirements for its particular legal status. That is, an organization that is an incorporated nonprofit that is receiving grants from a sponsor must still file its own IRS Form 990 even though it is receiving fiscal sponsorship. As a practicality, the nonprofit grantor must have appropriate safeguards to assure that the corporate funds granted to other organizations are being used for tax exempt purposes.

In order to facilitate the separation from the fiscal sponsor, the Fiscal Sponsorship Agreement should specifically provide terms for how the relationship can be terminated and identify the rights and liabilities for each party upon termination.


In addition, an unincorporated nonprofit association may also be created without the need to file forms with the Secretary of State and without compliance to the corporate formalities. The unincorporated association need not have regular formal meetings, has no incorporation costs, and no ongoing filing and reporting requirements. Essentially, there is no government scrutiny. However, in such situations, the members of the association may not be protected from personal legal liability for their acts or the acts of their fellow associates. In addition, such associations have difficulty in raising grants, contributions, and other funds. Moreover, the association may be treated as a legal entity for tax purposes, and will be taxed on net income and be required to file partnership or corporate tax returns.

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