5 steps to forming a 501(C) non-profit company

A 501(c)(3) non-profit company is a charitable organization recognized by the Internal Revenue Service as tax-exempt. This type of company does not pay income tax on its income or donations received.

Key points

  • The five steps to becoming a 501(c) company are: plan, form a company, submit documents to the IRS, comply with state and local requirements, and maintain status.
  • Becoming a non-profit organization means that you can be exempt from certain tax requirements that apply to other types of businesses.
  • Due to the complex tax situation, most of the time spent by 501(c) companies is to ensure that they are in sync with the IRS.

501(c) benefits

Any time taxpayers donate to a 501(c)(3) non-profit organization, if they itemize the deductions on the federal income tax return, they can reduce their taxable income based on the amount of the donation. Such incentives encourage private philanthropy and make it easier for non-profit organizations to raise funds.Please note that for the 2020 tax year (i.e. taxes filed in 2021), individual taxpayers can claim an “excess” deduction for cash donations provided to charities in 2020, up to a maximum of $300. Individuals do not need to itemize and claim deductions.

If you have ever wanted to raise funds for a cause on your own terms, you may want to start a 501(c)(3). This article explains what you should consider before deciding, and tells you how to start if you decide to move on.

plan

Federal tax law states that if you want to operate as a 501(c)(3), your organization must specialize in one of the following categories of activities:

  • religious
  • charitable
  • scientific
  • Literature or education
  • Public safety test
  • Promote domestic or international amateur sports competitions
  • Prevent child or animal abuse

You should also make sure that your organization is not designed for personal gain, but for public benefit.

Set up a company

Once you are sure you want to continue and your organization roughly meets the IRS requirements, it’s time to start dealing with red tape. A lawyer can provide personalized guidance and help you avoid costly mistakes, but some people can manage it themselves.

The company is established at the state level, so you need to understand the procedures for establishing a company in the state where your organization is located. The steps vary from state to state, but usually include the following:

  • Name the company and make sure your name is unique and allowed. In other words, you cannot use a name that someone else has already declared. In addition, the government does not allow companies to use certain words in their names to prevent companies from misleading the public.
  • Prepare and submit the articles of incorporation. The articles of incorporation are the documents that create the company.
  • According to your needs and state requirements, appoint one to three directors. All companies must have directors whose duties are to supervise the organization, provide advice to management, and make key decisions, such as hiring and firing company executives.
  • Convene a board meeting, appoint/elect officials at the meeting and prepare organizational documents and articles of association. In addition, start a record book where you can save the meeting minutes of this meeting and subsequent meetings.
  • Obtain a state tax number. The company is regarded as an independent taxing entity, and even if it does not pay taxes, it must have its own tax number (similar to a personal social security number).

In addition to following the official and required steps, it is also good to develop a business plan, just like you start a profitable business. Although your organization will be a non-profit organization, if you want to keep it running, you still have to operate profitably.

Non-profit organizations can make money; they only need to use the profits to promote the organization’s public purpose. In contrast, private companies exist to enrich their employees, managers, and shareholders.

Submit documents to IRS

After you meet the requirements for establishing a company in your state, you can apply for tax-exempt status from the IRS.

First, you need to apply for an employer identification number (EIN). This is a requirement of all tax-exempt organizations, even if they have no employees. You can apply online through the IRS website, phone or mail or fax Form SS-4, Employer Identification Number Application Form.

Next, fill out and submit Form 1023, an application for recognition of an exemption under Section 501(c)(3) of the Internal Revenue Law. The information you include in this form will serve as the basis for the IRS to decide whether to grant tax-exempt status to your organization. Allow plenty of time for this task; the main application is 11 pages long and very detailed.

In addition, depending on the type of organization you have organized, you will also need to fill out one of the schedules (for example, schedule A for churches; schedule B for schools, colleges, and universities; etc.). IRS estimated time to complete the record-keeping requirements of Form 1023. Approximately 90 hours, 5 hours to understand the form, nearly 10 hours to prepare the form, and another hour to copy, assemble and mail the form. This does not include the timetable.

IRS Form 1023 helps ensure that you have included all required information in your application and helps prevent processing delays.

Submit your application. The IRS will notify you if you need more information or if your form has been forwarded for review. Once the IRS has all the information it needs, it will issue a decision letter granting or denying your organization’s tax-exempt status. The evaluation process usually takes three to five months. If you are rejected, you can appeal.

Meet state and local requirements

If your organization is eligible for tax exemption at the federal level, that would be great. Next, you need to ensure that your organization is also tax-exempt at the state and local levels so that it does not have to pay state corporate income tax, sales tax, or property tax.

The requirements vary from state to state, but your IRS approval may be all that your organization needs to be recognized as a non-profit organization at the state level.

Once you meet the requirements of your state to operate as a non-profit organization, you will need to obtain any permits or licenses required to operate your business and ensure compliance with building codes and other local regulations.

Before starting operations, familiarize yourself with company requirements, such as holding meetings, recording meeting minutes, and submitting information declaration forms.

Keep your status

Once you are approved at all levels, there is still work to be done. Maintaining your status as a non-profit organization is an ongoing process. If you don’t follow the rules and follow a list of self-imposed guidelines that you need to follow on a regular basis, the consequences will be severe:

  • Make sure your organization operates in the way you stated in your application.
  • Regular board meetings are held and recorded.
  • Follow the annual IRS requirements to submit Form 990 or Form 990-EZ. In these tables, you will report on the organization’s activities, governance, income, expenses, and net assets.
  • Have diversified funding sources. 501(c)(3) The organization should be public; if the funding source is too small, it may need to be reorganized into a private foundation. The foundation must operate according to a completely different set of rules.
  • Run your organization like a business with its own bank account and credit card. Completely separate all financial transactions from your personal account.
  • Keep impeccable financial records in case your organization is audited.
  • Your organization is not allowed to participate in any political activities.
  • Don’t unfairly enrich anyone compensated by your organization.
  • Do not use your organization to achieve non-exempt purposes or conduct illegal activities.
  • Don’t let most of the activities you organize aim to influence legislation.
  • Avoid making irrelevant business income through your organization. This is income from regular activities and has no substantial relationship with the purpose of your organization. Such income is subject to irrelevant business income tax.

If you have a large number of employees, consider starting a qualified retirement plan. These plans are similar to 401(k) plans in many ways, but are designed for non-profit entities.

Bottom line

Starting 501(c)(3) can be an exhausting process. Before you tackle the challenge, weigh the pros and cons of meeting all the legal and tax requirements for forming and operating an official non-profit organization. But it may be worth it. As tax exemptions and 501(c)(3) status convey the increased legitimacy, people may donate more.

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