Many Americans are inspired to do good for others by starting a nonprofit organization. In 2016 alone, almost 80,000 people or groups started a nonprofit or, more technically, were approved as 501c3 public charities or private foundations by the Internal Revenue Service (IRS).
In this overview of how to start a nonprofit, we walk you through 5 key steps:
- Wait! Are you sure you want to start a nonprofit?
- Recruit the right people to start the nonprofit with you.
- Ask: Can we build the revenue to fund the work we envision?
- Complete the required legal paperwork at the local and state levels.
- File for federal tax exemption with the IRS.
STEP ONE: Wait! Are you sure you want to start a nonprofit?
The very first step in how to start a nonprofit is actually to consider whether to start one at all.
Is starting a nonprofit organization the best way for you to pursue the ideas that you have been nurturing about how to make the world, or your community, a better place?
ASK YOURSELF: Are you committed to creating an endeavor that is “owned” by a group rather than just you, one that is broadly accountable and willing to be transparent?
There are requirements to starting a nonprofit that relate directly to some of these issues. It is important to understand them—not only because you want to comply with the law, but also because you believe the requirements help create a unique kind of structure, one that justifies your tax exemption. It’s a structure that is collectively held, publicly accountable, and does not allow for private enrichment.
The public has a right to expect this from you—and so do your accrediting bodies, which will include, at the very least, the IRS and your state charity offices.
That means that when you opt into becoming a nonprofit organization, you will also be opting into federal, state, and local legal, regulatory, and tax issues. Regulations exist around governance, conflicts of interest, financial reporting, fundraising, and a host of other concerns. Don’t forget that you’ll need to apply for corporate status with your state before applying for tax exempt recognition from the IRS. You’ll need articles of incorporation, a corporate board, by-laws, and financial projections, among other documents.
This will mean developing and becoming responsible to a board of directors. Depending upon your field of work and the activities you wish to pursue, you may then need to develop an organizational plan, recruit volunteers, develop and keep a budget that the board monitors, hire staff, raise money, deal with vendors and suppliers, and have insurance. Depending on your organization’s mission and activities, your organization, you personally, your staff, and volunteers may need permits, licenses, and/or bonding. If your organization plans on working with children, it’s quite possible that you, your volunteers, and your staff will be required to have background checks performed.
If this doesn’t sound like fun, the good news is that you probably don’t have to start a new charity to make a difference. There are more than 1.2 million 501c3 nonprofit organizations already in existence, with hundreds likely operating within an hour of your home. Search for others who are helping in your community, and you’ll likely find people and organizations with a mission similar to yours. These organizations may agree to help you get started even before you attempt to become a formal corporation. In other words, they can provide you with a corporate vehicle for a test drive. If you do find such a match, it may or may not work out as a permanent home, but it might be willing to act as an incubator as you explore viability. If you do find a match and the group is not a seasoned fiscal sponsor (see below), think about developing a contract that clearly lays out expectations and responsibilities and maybe a timeline for decision making to allow you the option to go independent if that ends up being what you wish to do.
The other option for delaying a decision to become a standalone is to contract with a fiscal sponsor. In these cases, unincorporated groups contract with an established nonprofit that agrees to share its corporate umbrella and a set of basic back-office capacities with you. These may include financial management, human resource management, and compliance. This sharing usually has a fee associated with it that may be scaled to the size of your budget. More information about fiscal sponsors can be accessed here.
Even if you don’t find exactly what you’re looking for in your search for a shared home, your walk-around investigation will yield two important results. First, you’ll know way more about the field of work you’re thinking about entering, and second, you will have built relationships and networks that can help you fit properly into the existing landscape. You may find other people who could become advisors, collaborators, champions, board members, and more. And there’s always the possibility that someone else already is doing what you envisioned, and you can just join forces.
ASK YOURSELF: Will this nonprofit fill a niche that’s currently neglected by others?
STEP TWO: Recruit the right people to start the nonprofit with you.
A nonprofit is not meant to be owned or controlled by one person.
ASK YOURSELF: Are you ready to share power?
Nonprofit organizations are, by their nature, “owned” by the community at large. The community’s representatives are the trustees or board members who make sure the organization operates in the best interests of the mission and the community it serves or represents. There are no sole proprietorship nonprofits, especially if they seek IRS recognition as a 501c3 organization! Even if you’re an experienced nonprofit sector professional or volunteer, it’s unlikely you’ve performed all the internal and external functions required of a new nonprofit.
In fact, since a nonprofit can’t be owned by an individual or company, founding leaders of new nonprofits may have a difficult threshold choice to make. Do you want to act as a trustee/board member or a staff person? In some cases, a founding board may constitute the whole; in other words, they will both make the decisions and do the work that needs to be done, at least until enough money is cobbled together to pay a salary. In other cases, the organization may start with enough to pay a salary. In general, most feel it is unwise to have a paid staff person on the board with a vote, and NPQ generally agrees that a separation is wise to create a guard against self-interest or dominance.
Typically, board members and other volunteers are not paid for their service. However, they hire, evaluate, and, if necessary, fire the executive director. The executive director can be paid a reasonable salary, but he or she serves at the pleasure of the nonprofit’s board of directors—the board that sets employment terms, including compensation, for the executive director. It is very rare for the same person to be both board chair and executive director, and not a recommended practice. Many funders frown on this practice and see it as an impediment to providing support. Whether you see yourself as leading a movement, helping those in need, or initiating a community infrastructure project, an important part of your success will be how many others you can recruit to join you in your efforts. They will be your force multiplier, as well as your eyes and ears, your brain trust, and your “agony aunt.” They will give you energy, information, and capacity, along with advice and criticism that’s sometimes difficult to hear but is necessary for your organization’s success.
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With that in mind, recruit good people to assist you in building your nonprofit organization. These people can contribute all kinds of skills, talents, and passion, both in and supporting of your nonprofit. They can be recruited to be board members, your professional advisors, program or service volunteers, donors, and more. Include people who will be served by your nonprofit on your team, as the fruits of their hard-earned experience can be a reality check on your organization’s proposed design.
Seek people who have skills and backgrounds different from yours, since no one person can fulfill all nonprofit organizational roles. Some, like board members and volunteers, will need to share your passion for your charitable mission to be successful in assisting you. Others, like your attorney, banker, insurance agent, accountant, or technology providers, can contribute valuable expertise, support, and information to help your nonprofit organization without necessarily being personally invested in its mission.
STEP THREE: Draft the business plan for your nonprofit.
ASK YOURSELF: Do you really know what it takes financially?
Most of the elements outlined in steps one and two are key parts of your nonprofit’s business plan. (Yes, even though you may plan to operate as a nonprofit, you’re still going into business and should have a written plan.) Most issues facing new nonprofits—competition, applicable regulations, finding advisers and experts to assist you—are the same or similar to those facing for-profit businesses. Most books on creating business plans address for-profit businesses, but they still provide valuable templates and worksheets that will help you with your nonprofit’s plan.
Believe it or not, some organizations start with sufficient money or prospects to relatively accurately develop a two- to three-year budget, but for most the process of developing a reasonably stable set of revenue streams can take far longer. It is wise to study how other organizations in your field or of your type started out. Where did their seed money come from? How did they ramp up? What unexpected expenses did they encounter? How are more mature organizations in your field funded, and what are their recurrent problems in terms of financing?
This does not mean that you must follow the same paths others have. In fact, you may discover some paths you do not want to take in favor of others. NPQ has an excellent series about business models you may wish to examine, but doing research by walking around as you are beginning provides a sense of who may be around to advise you.
Just like for-profit businesses, many new nonprofit organizations fail to become sustainable. Each year, the IRS revokes the tax-exempt recognition of tens of thousands of 501c3 groups that either notify the IRS that they’re dissolving or have failed to send in their annual Form 990 information return for three consecutive years.
Planning is a continuous, iterative process. Expect your plan to grow, shrink, and change features as you learn more and attract new partners and collaborators. Your core mission may even change to accommodate an evolving understanding of the community and cause you serve.
STEP FOUR: Complete the required legal paperwork at the local and state levels.
A nonprofit organization needs to acquire a legal identity in order to conduct its business affairs. This is typically done by filing articles of incorporation with the nonprofit’s home state. The Secretary of State handles nonprofit registrations in most states, but it’s always good to check where your state assigns this responsibility. Filing fees are usually $100 or less, and the filing process usually happens quickly. Articles of incorporation can be as simple as a two- or three-page document stating the organization’s name, address, purposes (especially why the organization should be considered a nonprofit corporation), and a few additional details. There are many templates for articles of incorporation that can easily be adapted for your organization’s use.
The articles of incorporation are used to define the broadest possible parameters of your nonprofit corporation. Your organization’s by-laws will define how your organization is governed. Topics include important decisions such as who can be a board member; how many board members and officers the organization will have; whether the organization will have formal members and what those members’ qualifications, rights (like voting for board members and approving by-laws), and obligations (such as paying an annual membership fee) will be. There are numerous samples of by-laws available on the Internet and elsewhere. Be sure the by-laws your organization adopts are in compliance with your state’s laws. It’s a really good idea to have an attorney experienced in nonprofit law review the by-laws in draft form before they are adopted by your board to ensure that there are no problems.
Depending on your nonprofit organization’s mission and activities, the state and/or local government may require certain additional permits, inspections, etc. Child care centers and animal shelters are two examples of such organizations. In addition, most states require nonprofit organizations to file annual reports about their operations, including updated contact information for key leaders. This is usually done through the Secretary of State’s office, as well. However, in most states, the attorney general likes to keep track of charitable fundraising, especially when done on behalf of the state’s nonprofits by a third-party fundraiser. Be sure to check with your state about which reports are required and who is required to file them. Some states provide automatic exemption from sales taxes to nonprofit organizations, while other states require nonprofits to apply for sales tax exemption. Some states also limit sales tax exemption opportunities to certain types of nonprofits, so it’s a good idea to check with the state’s department of revenue or similar sales tax collection agency.
Finally, don’t overlook local government as a source of nonprofit organization regulation. Local government makes decisions about property tax exemption for land and buildings owned by nonprofit groups. Even when property tax exemption is available, a county or city may levy taxes on portions of a nonprofit’s property, such as taxing the portion of a hospital’s fitness center not being used for medical rehabilitation purposes. This isn’t typically a problem for new nonprofits because most lack the funds necessary to own and maintain property. Some local governments require nonprofits to obtain permits or at least register when doing certain types of fundraising, like raffles, lotteries, and some types of special events.
NOTE: Once your nonprofit has a legal identity by filing its articles of incorporation with the state, it should apply for and receive a federal employer identification number (EIN). This can be done online in a few minutes. A number can be acquired online immediately and confirmed by letter in as little as a day or two. We recommend using the IRS website for this, though third-party sites also offer the same service.
Getting your organization’s EIN early is important. You’ll need it to complete state and local paperwork, and it’s required for federal purposes like applying for tax-exempt recognition, labor reporting, and the like. Establishing banking relationships will also require the nonprofit to have a tax number.
STEP FIVE: File for federal tax exemption with the IRS.
Obtaining federal tax-exempt recognition as a nonprofit carries multiple benefits for a charity. First, 501c3 charities are exempt from most federal taxes, though they may have to pay some state and local taxes. Second, donations to 501c3 charities are eligible for tax deduction by donors, subject to certain limitations, which opens up a key potential revenue stream. Third, many foundations and other potential funders require their grantees or contractors to be 501c3 organizations. And finally, there is a general reputational benefit: 501c3 groups are often assumed to be more “real” than informal groups that have not incorporated with their state and sought and received tax exempt recognition from the IRS.
Once you have your organization’s articles of incorporation and its business plan in draft mode, you can move to applying for federal tax recognition (often referred to as tax-exempt status) from the IRS. There are more than 25 classifications of tax-exempt organizations, but the vast majority are charities, designated as 501c3 organizations. There are two options for applying for tax exempt recognition—the IRS Form 1023 and the Form 1023-EZ short form. There are long essays that can be written about applying for federal tax exemption, and specifically about the relative merits of the 1023 and the 1023-EZ. Suffice it to say that the 1023-EZ is a quicker and less expensive way for very small nonprofits that do not plan to grow over the next few years to quickly secure recognition from the IRS. Nonprofits that anticipate growing, hiring staff, receiving grants of any significant amount, etc., are probably going to use the Form 1023 application.
The good news for nonprofits is that virtually all applications for tax exemption are ultimately approved by the IRS. The bad news is that about 30 percent of IRS Form 1023 applicants fail to include necessary information or send confusing information to the IRS that requires clarification and resubmission. There is a strong argument to be made that a new nonprofit should enlist the assistance of an attorney or tax advisor experienced with the Form 1023 and the application process. Expert assistance can help a new nonprofit submit all the required paperwork in the correct format the first time around, greatly speeding the approval process.
Starting a nonprofit begins with a core group of committed volunteers sharing a passion for a mission and a somewhat larger group of people with the diverse skills, talents, and interests to support building out the required elements of an incorporated charity. To be successful, these people will pool their knowledge and expertise to draft a business plan geared toward the organization’s long-term sustainability (or a planned and limited lifespan). They will fulfill the initial legal and regulatory requirements at the state, federal, and local levels and prioritize the ongoing compliance of the nonprofit and its leaders. And they will focus always on the best possible execution of their activities in service of their mission.
APPENDIX – What not to do:
- Recruit a board made up only of family and friends or business associates who see an opportunity to make a buck.
- Assume that, because you’re a nonprofit, everything you do to advance your mission is legal and ethical.
- Run headlong into providing direct services without planning and preparing the administrative and legal framework for your nonprofit.
- Blind yourself to the good work being done by other nonprofits—those organizations can be your supporters and collaborators, or they may be your competition for clients and funding.
- Believe only you can do the nonprofit’s work, or do it well.
- Stop talking—and listening—to others about your organization, its mission, and its place in your community.