Monday, April 17, 2017

15 Key Steps to Set Up a Charity

By Richard D Harroch and Harris D. Bass

Nonprofit charitable organizations are intended to operate for the public good. When a nonprofit charitable organization is qualified as tax exempt under Section 501(c)(3) of the Internal Revenue Code (IRC), donors can generally deduct their contributions to the charity on their tax returns. Donors are thus more likely to support charitable organizations that have an IRC §501(c)(3) tax exempt status.

A qualified IRC §501(c)(3) charity also has the benefit of being exempt from federal and state income tax on its activities, with some limited exceptions. Setting up a qualified IRC §501(c)(3) charity, however, requires compliance with a number of federal and state laws. In this article, we outline some of the key steps and requirements to validly establish a qualified IRC §501(c)(3) charity.

1. Learn About the Different Types of Charities You Can Start

Charities can be started with different missions. Here are examples of common types of charities:

  • Animal charities—formed for the purpose of animal rescue, wildlife conservation, or animal welfare
  • Health charities—formed for the purpose of supporting the sick and disabled, curing diseases, medical research, or family and patient support
  • Education charities—formed to serve students, including by way of private elementary schools, high schools, and universities, and through scholarships
  • Art & culture charities—formed for supporting the arts and culture, including by way of museums, public broadcasting, or the performing arts
  • Environmental charities—formed for supporting environmental protection and  conservation
  • International non-governmental organizations—often referred to as “NGOs” and formed to support disaster relief, humanitarian aid, or peace missions
  • Religious charities—formed to support specific religions and worship, or for religious-oriented media
  • Human services charities—formed to provide assistance to people in need, such as supplying care for the elderly, food, or shelter

For IRS purposes, IRC §501(c)(3) charitable organizations are classified in one of two ways: a “public charity” or a “private foundation.” Public charities, such as the American Cancer Foundation or the ASPCA, generally receive a greater portion of their funds from the public and governmental units. Public charities are the organizations people generally think of when they hear the word “charity.”

A private foundation is typically a nonprofit formed, funded, and controlled by a family or by a small group of individuals (examples include the private foundations set up by tech executives). Private foundations are subject to a number of operating restrictions not applicable to public charities, and must donate at least 5% of the fair market value of their assets each year to permissible donees. Private foundations typically use their funds to make grants or gifts to public charities for charitable, religious, educational, or other causes that help the public. Some pubic charities (such as the United Way) act like foundations by making grants to public charities.

You will need to decide what kind of charity you wish to form, as the IRS will presume you are a private foundation unless you can establish that you are going to be a public charity.

2. Verify That Your Charity Will Qualify as an IRC §501(c)(3) Organization

The IRS provides that to be tax-exempt under IRC §501(c)(3), an organization must be organized and operated exclusively for “exempt purposes.” According to the IRS:

“The exempt purposes set forth in section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. The term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.”

The organization must also not be organized or operated for the benefit of “private interests,” and no part of the organization’s net earnings may inure for the benefit of any private shareholder or individual. However, this requirement does not prevent the founders or employees of the charity from receiving fair compensation for their services.

The charity must apply to the IRS to get exempt status, and jump through a variety of hoops, as outlined in Section 6 below under “What Do You Have to File with the IRS to Get Tax Exempt Status for Your Charity?” State qualification may also be required.

The IRS website has a helpful section entitled Tax Information for Charitable Organizations that lays out the requirements for qualification.

3. Come Up With a Good Name for the Charity

Before you form your nonprofit, you need to come up with a name that will be accepted by the Secretary of State’s office where you will incorporate. Each state has its own rules, but here are typical requirements:

  • The name of the nonprofit can’t be the same as (or confusingly similar to) the name of another corporation on file.
  • The name will typically be required to end with “Inc.”, “Incorporated”, “Corp.”, “Corporation”, or “Ltd.”
  • The name can’t include certain prohibited words such as “Bank”, “Insurance”, “Federal”, or “United States.”

Check out the state’s corporate filing website to see if the name is available.

A few more naming tips:

4. Establish a Mission Statement for Your Charity

For multiple reasons, you want to establish a clear and compelling mission statement for your nonprofit. The mission statement in one or two sentences should sum up the essence and purpose of your charity. The mission statement:

  • Assists in your solicitation for donations
  • Explains why the charity exists
  • Describes who the charity serves and how it serves them
  • Is helpful for describing the purpose of the charity in your IRS and state filings

Here are some examples of mission statements from existing charities:

  • ASPCA: “To provide effective means for the prevention of cruelty to animals throughout the United States.”
  • American Diabetes Foundation: “To prevent and cure diabetes and to improve the lives of all people affected by diabetes.“
  • Save the Children: “To inspire breakthroughs in the way the world treats children and to achieve immediate and lasting change in their lives.”
  • Make-A-Wish: “To grant the wishes of children with life-threatening medical conditions to enrich the human experience with hope, strength, and joy.”
  • American Red Cross: “To provide relief to victims of disasters and help people prevent, prepare, and respond to emergencies.”
  • National Multiple Sclerosis Society: “People affected by MS can live their best lives as we stop MS in its tracks, restore what has been lost, and end MS forever.”
  • Doctors Without Borders: “We help people worldwide where the need is greatest, delivering emergency medical aid to people affected by conflict, epidemics, disasters, or exclusion from health care.”
  • Animal Rescue Flights: “Has been transporting animals to safety since 2008 with the help of volunteer pilots, cabin crews, planners, drivers, rescue, and shelter volunteers.”

5. Incorporate Your Charity

A nonprofit entity can generally be structured as an unincorporated association, trust, or corporation. However, the corporate structure is the most common. Therefore, a key step will be to organize your nonprofit as a corporation. Corporations are separate legal entities formed in accordance with state law.

Corporations are not complicated to set up. However, you do have to complete some important steps, including:

  • Choose a corporate name.
  • Choose a state where you want to incorporate (the state where you will be located will typically be fine).
  • Create and file the Articles of Incorporation.
  • Adopt bylaws (the rules and procedures that govern the internal management of the charity).
  • Appoint members of your Board of Directors. Having a qualified Board, including experts, can help accomplish your mission and demonstrate credibility to donors.
  • Hold the first meeting of the Board of Directors and prepare minutes.

You can set up a nonprofit corporation through legal filing services such as LegalZoom or RocketLawyer, or you can hire a business lawyer experienced in nonprofits to handle the documents for you. A nonprofit lawyer will already have ready standard forms of Articles, Bylaws, Board minutes, and other documents.

The “Articles of Incorporation” (sometimes called the “Certificate of Incorporation”) is the legal document you need to prepare and file with the Secretary of State to formally create the corporation. Sometimes a state has a pre-printed form you can use while sometimes you or your lawyer need to draft it.

Here are some of the key items typically needed in your Articles of Incorporation:

  • The name of the proposed corporation
  • The complete street address, city, state, and zip code of the corporation’s initial address (this will be a matter of public record and you can’t enter a P.O. box)
  • An Agent for Service of Process (the person or entity responsible for accepting legal notices or lawsuits) on behalf of the corporation
  • The complete address of the Agent for Services of Process
  • A statement that the corporation is a nonprofit public benefit corporation and is not organized for private gain of any person; in certain situations the corporation may be formed as a mutual benefit corporation or for religious purposes
  • The specific purpose of the corporation (such as charitable purposes for children or animals)
  • A statement that the corporation is organized and operated exclusively for charitable or educational purposes as allowed by IRC §501(c)(3)
  • A statement that the corporation shall not engage in any activities or exercise any powers that do not further the purposes of the corporation and that the corporation shall not carry on any other activities not permitted by IRC §501(c)(3)
  • A statement that no substantial part of the corporation shall consist of carrying on propaganda, or otherwise attempting to influence legislation, and that the corporation shall not participate or intervene in any political campaign (including the publishing or distribution of statements) on behalf of any candidate for public office
  • A statement that the property of the corporation is irrevocably dedicated to the purpose set forth and that no part of the net income or assets of the corporation shall ever inure to the benefit of any director, officer, or member of the corporation or to the benefit of any private person
  • A statement that the corporation will comply with the rules applicable to private foundations if appropriate
  • A statement that upon the dissolution or winding up of the corporation, its assets remaining after payment, or provision for payment, of all debts and liabilities of the corporation shall be distributed to a nonprofit fund, foundation, or corporation which is organized and operated exclusively for charitable, educational, and/or religious purposes and which has established its tax exempt status under IRC §501(c)(3)
  • A signature of the incorporator

Here is the form for the Articles of Incorporation of a Nonprofit Public Benefit Corporation in California:

articles of incorporation nonprofit california

Costs for incorporating include a fee for the Secretary of State (typically $800), preparation fee for the Articles and Bylaws ($100-$500), and miscellaneous other costs.

See An Overview for Incorporating a Business.

6. File for a Federal Employer Identification Number

You need to obtain a Federal Employer Identification Number (EIN).

An EIN is your account number with the IRS, and should be included in all correspondence to the IRS. You apply for an EIN by completing IRS Form SS-4, Application for Employer Identification Number. You can submit the form online through the IRS website.

Don’t apply for your EIN until you have been legally incorporated. For more information on EINs, see IRS Publication 1635, Understanding Your EIN.

You will need your EIN and a copy of your filed Articles of Incorporation to open up a bank account.

7. File the Correct IRS Form to Get Tax Exempt Status for Your Charity

Being nonprofit is not the same as being tax exempt. You must separately file for both federal and state tax exempt status.

There are two basic options for filing with the IRS to obtain IRC §501(c)(3) tax exempt status:

IRS FORM 1023-EZ. This is for small organizations that meet a number of requirements. This is a streamlined process that is done online and requires a $275 filing fee. You definitely should try to use this form if you are able, as it streamlines preparation efforts and saves time in obtaining tax exempt status from the IRS.

The key elements to qualify for the short form 1023-EZ applications are:

  • The organization must have had less than $50,000 in annual revenue the past 3 years.
  • The organization anticipates less than $50,000 in annual revenue for each of the first 3 operational years.
  • The organization has less than $250,000 in assets.
  • The charity will not support or oppose political candidates.
  • The charity will not try to influence legislation.
  • The charity was formed in the United States.
  • The charity will only operate in the United States.
  • The organization will not engage in certain enumerated prohibited activities.

IRS FORM 1023. This is the alternative application if you don’t qualify for or don’t want to use Form 1023-EZ. The IRS estimates it will take you over 100 hours to complete this form and it must be mailed to the IRS. The IRS does provide a Form 1023 checklist. Once you have submitted the completed form, the IRS will typically take 3-5 months (and sometimes longer) to determine whether to grant you or deny you tax-exempt status.

Once you receive tax exempt status, it is usually retroactive to the date of the formation of your nonprofit organization.

Additional information regarding the requirements and procedures for applying for federal tax exempt status can be found in IRS Publication 557 (How to Apply for and Retain Exempt Status for Your Organization).

Understand that you will have to separately file for tax exempt status with your state.

8. Comply With Your State and Local Requirements for Charities

Many states, counties, and cities regulate organizations that solicit charitable funds. Compliance with these laws typically requires obtaining a license and filing an annual report (including a financial statement). Check your local laws for the needed filings, but here is an example of the types of filings necessary:

  • State or local business licenses
  • Registration with each state where you are soliciting donations
  • State application for exemption from state tax

The websites SimpleCharityRegistration.com and GoSinglePortal.com can help you through the charitable solicitation registration process.

State government websites provide useful information for tax exempt organizations. Here are links to the 50 states sites and for Puerto Rico and the Virgin Islands:

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