NPOs are formed the same way for-profit corporations are formed, under the laws and regulations of the state in which they are formed. First, it is important to do research to see what organizations already exist that have a similar purpose in the area. It may not make sense to have a competing organization in the same area that have the same goals and methods of achieving them. Once you have determined the organization you would like to form, there are a series of steps to take to form your NPO:
Choosing a Business Name and Availability of Name
Naming your NPO is obviously an important step, as it would be for forming any kind of corporate entity. Make sure that your name isn’t the same or similar to an already existing NPO or corporation. It should be unique and not infringe on any trademark.Do a business name search on the secretary of state website where you will be incorporating to make sure it is available.
Registering – Articles of Incorporation
ile the necessary documents, such as the articles of incorporation with the secretary of state and pay the applicable fee. Please note that the articles of incorporation need to be more detailed and restrictive than those for a normal corporation, which can often be broad in describing its purpose. The articles will ultimately be what limits its powers to function and maintain its purpose.
Designate Board of Directors
Next, choose who will be part of this organization and appoint the board of directors. Make sure that the other members of the team all share the same vision and are passionate about furthering the NPO’s goals. Also, consider how the NPO will accomplish its mission. How do other NPOs go about it? How can yours do it better to differentiate it from others in the field?
Prepare a Mission Statement
One of the most important steps in forming an NPO is to prepare a mission statement describing what the purpose of the organization will be. It is important because it is ultimately the NPO’s way of positioning itself as unique and worthwhile in a sea of charitable organizations. Consider how the NPO will accomplish its mission. How do other NPOs go about it? How can yours do it better to differentiate it from others in the field? The mission statement should be concise and to the point, conveying to the public what they need to do know about it:
- The cause itself and why it is important and
- How the NPO will accomplish its goals of helping its cause. Keep in mind that often, simpler is better. Simpler is more memorable. Lengthy mission statements that use jargon will not be effective.
Bylaws will also need to be drafted. The bylaws will serve as the backbone of how the NPO will operate and should be done carefully and clearly as these will not only need to be filed with the Secretary of State of the state that the NPO is formed in many instances and will also be necessary when filing for tax exempt status with the IRS which will be more thoroughly discussed below. Also have a copy of the bylaws at the NPO’s principal place of business. The bylaws will be approved at the first meeting of the directors. Don’t forget to apply for any local or state business licenses or permits that may be required by your state or business.
After filing the necessary corporate formation documents, you must submit an application to the IRS for a federal Employer Identification Number (EIN). An EIN is necessary if your NPO is going to have employees and will be necessary for filing for tax exempt status. Once you have an EIN, you can also open up a bank account for your NPO.
Filing for Tax Exempt Status – Section 501(c)
To qualify for tax exempt status, the corporation must apply with the Internal Revenue Service (“IRS”) under section 501(c) of the Internal Revenue Code by filing a Form 1023. In fact, NPOs are often called 501(c) corporations because of this.
Section 501(c) sets out the requirements to become exempt from some federal income taxes with a list of 29 categories that a corporation must fit in to in order to qualify to be tax exempt. The most common subcategory for NPOs to be formed under is 501(c)(3), which is for religious, educational, charitable, scientific, literary, testing for public safety, to foster national or international amateur sports competition, or prevention of cruelty to children or animals organizations.
Benefits of tax exempt status include lower postal rates; possible exemption from state income, sales and employment taxes. The tax benefits can vary state by state and it is important to check with your state’s tax laws or an accountant to avoid any surprise tax liabilities. Most states will automatically qualify a NPO for tax exemption if it qualifies for federal exempt status. Some states do require a separate application to be filed to become tax exempt for state tax purposes. Check with your state to make sure that you don’t miss out on filing if it is in fact necessary.
Keeping Exempt Status
While receiving tax exempt status from the IRS is an achievement in itself, this does not mean that the NPO can rest easy and enjoy that status in perpetuity. NPOs won’t have to pay federal income taxes, but depending on the state, may still have to pay employment taxes. This isn’t all that the NPO needs to worry about filing. The IRS will also require that most NPO file an information tax return every year, typically five months after the end of the NPO’s fiscal year called the 990 Form. NPOs that may not have to file a 990 Form are typically faith-based or religious organizations.
There are a few different 990 Forms:
- If your NPO has gross receipts of more than $50,000, a Form 990 or 990-EZ will be required.
- NPOs with less than $50,000 in gross receipts will be able to file a Form 990-N.
The IRS or your accountant can provide more information if you are unsure of which form your NPO should file. The important thing is making sure you do file it every year! Not filing it is a sure way that your NPO will lose its exempt status. The IRS will automatically revoke the tax exempt status if there are no 990 Form filings for 3 or more years and the NPO will have to pay federal income tax again and could face other monetary penalties as well. Once the IRS has revoked the exempt status, another 1023 application will have to be filed all over again. There is no way to appeal the revocation and the NPO will then have to wait again for the IRS to review and issue the Determination Letter. This could be disastrous for NPOs that count on their status for donations as there are no guarantees that the IRS will again approve the NPO for tax exempt status.