Starting a Nonprofit Organization
Outlined below are steps to start a nonprofit organization.
STEP 1: DECIDE ORGANIZATION STRUCTURE:
A nonprofit organization can be organized either as a
1) Corporation or as
2) An Unincorporated Association.
There are other hybrid structures like trusts and cooperatives but they are rarely used for setting up a NPO in the country.
1) Nonprofit Corporation: A nonprofit corporation is formed under the respective State nonprofit corporation Act. A nonprofit organization comes into a formal legal existence by filing the article of Incorporation with the respective office of secretary of state. (See: State wise Incorporation procedure). As a thumb rule – If a nonprofit organization is expected to garner a gross receipt of more than USD 25000 in a given year, it should consider the incorporation route.
2) Unincorporated Association: Organizations which are likely to operate on a smaller scale, usually operate as unincorporated associations. (See: Starting an Association). Unincorporated associations offers the advantage of simplicity in operations and minimal reporting requirements. Unlike corporations, these associations do not need to file any documents with the state authorities.
STEP 2: DECIDING THE IRS CLASSIFICATION
501(c)(3) is the most common IRS section under which nonprofits are formed and includes religious, educational, charitable, scientific and research organizations. Organizations formed under 501(c)(3) of the IRS code can avail exemptions from Income tax payments as well as donations to such organizations are exempt in the hands of the donor.
Other than these 32 categories – nonprofit organizations may also be classified into these less common types of organizations.
IRS also requires nonprofit organizations to be further classified as private foundation (organizations with primary reliance on in-house funding) or as public charity (organization that raises funds from the general public or from a variety of funding sources).
Decide the most appropriate IRS classification is important at this stage as the treatment before moving ahead.
STEP 3: ORGANIZING PEOPLE FOR THE NPO:
A nonprofit organization requires the services of founders/directors/ employees and volunteers. In case of newly formed organizations a single individual may wear multiple caps.
For Nonprofit Associations: The minimum number of people required for starting a nonprofit association is 2.
For Nonprofit Corporation: The minimum number of people required varies by state (ranges from 1-3 people in most of the states). For state wise requirements see:
STEP 4: ARTICULATING VISION, MISSION, OBJECTIVE & BUDGET for the organization
IRS requires all nonprofit organization to submit a purpose statement & budget for at least four years.
Drafting the vision, mission and objective statement is easy, if the purpose for starting the organization is clearly established.
The budget of a nonprofit organization shows its projected expenses and revenues for a given time period. Thus it is essentially recording of the organization’s plans in quantifiable money terms. See: Drafting a startup nonprofit budget.
STEP 5: CHOOSING A NAME FOR THE NON-PROFIT
Each state prescribes separate words to be added as suffix of prefix to the name of the proposed organization. See: State wise naming requirements
All states have prescribed separate norms for naming of non-profit organizations. See: Rules for naming a nonprofit organization.
STEP 6: OBTAINING THE FEDERAL EMPLOYER IDENTIFICATION NUMBER
EIN is the organization’s identification number with the federal authorities. EIN is a nine-digit number assigned to corporations, partnerships, sole proprietors, trusts and other entities for tax filing and reporting purposes. The EIN is required even if an organization does not have employees. Obtaining the E.I.N is compulsory before applying for Income tax exemption status with the IRS. Some states make it mandatory to obtain the EIN even before applying for Incorporation. U.S Nonprofit Organizations can apply and obtain E.I.N online almost immediately.
Alternatively, organizations can apply for the EIN by filling and mailing across or faxing FORM SS-4 to the IRS office.
STEP 7: DRAFTING THE ORGANIZATIONAL POLICY DOCUMENTS
Organizational Policy documents to be drafted include: Board manual, Board attendance policy, Conflict of interest policy, Code of ethics policy, Record keeping policies, Document retention policy, Personnel (Staff) Policies and Procedures & Whistleblower policy
While these are not mandatory, IRS recommends and treats organizations with these documents favorably when assessing the tax exemption application (Form 1023). Adopting a Whistle blower policy is mandatory for all nonprofit organizations as per Sarbanes Oxley Act of 2002. IRS form 990 also requires nonprofits to give an undertaking that they have adopted a whistleblower policy.
STEP 8: PRE FORMATION ORGANIZERS MEETING
The state laws provide for the minimum agenda and the process for conducting the first and subsequent meetings of the organization. The founders/organizers of the organization should create an agenda for the first meeting well in advance. The organizers must give a notice of such meeting by mail to the initial board members (if decided). The notice must state the time, place and agenda of the meeting. The Common agendas for the first meeting are:/strong>
To approve the name of the organization
To approve reserving of the name and the expenditure incurred therein.
To approve filing of the articles of incorporation & its expenditure
To approve appointment of registered agent
To approve filing for the EIN
To adopt board manual, code of conduct, whistle blower policy, conflict of interest policy, personnel policies and others.
STEP 9: APPOINTING THE REGISTERED AGENT (Corporations only)
The registered agent (also called the ‘resident agent’) is a person identified by the corporation to receive all legal notices and documents on behalf of the corporation. A resident agent is a corporation’s official contact individual and address. Accordingly, the agent receives service of process for lawsuits, notices, demands and any acts as a liaison with the Secretary of State and other regulatory agencies, and forwards any court notices and state reports to the organization.
The registered agent is generally required to sign an undertaking by most of the states agreeing to carry on this responsibility by making himself available at the registered office of the corporation. If an organization does not have a valid street address of the state where it wants to incorporate, it can appoint ‘commercial registered agents’ who act as registered agent for organizations in return of a small annual fee.
The registered agent must have a valid street address of the state where he/she is acting as the resident agent at all times.
Appointing a registered agent is must for corporations. Unincorporated associations formed in 11 states where the UUNAA has been adopted may or may not appoint registered agents. In other 39 states, appointing a registered agent is not possible for unincorporated associations.
STEP 10: DRAFTING THE ORGANIZING DOCUMENT (ARTICLES OF INCORPORATION/ASSOCIATION)
/strong>The organizing document is the principle document that evidences the legal existence of the nonprofit organization. Depending upon the structure of the proposed organization, the organizing document is called by different names. An Unincorporated Association is formed under ‘Articles of Association’ while an Incorporated organization is formed under ‘Articles of Incorporation‘
There are no prescribed formats for Articles of Association but each state has prescribed formats for Articles of Incorporation. (See state wise: Articles of Incorporation format).
A nonprofit organization comes into a formal legal existence on the date on which its organizing document is executed.
The article of Incorporation/Association must include IRS prescribed clauses to the Articles in addition to the respective state wise requirements.
STEP 11: DRAFTING THE ORGANIZATION’S BYLAWS
Bylaws are a set of resolutions that the board adopts to govern the organization structure and its operations. Bylaws are second only to the articles in terms of their authority in that they govern the day to day functioning of the organization.
Nonprofit corporations are not required to file their bylaws with the Secretary of State. Nevertheless, many nonprofit corporations choose to file their bylaws with the Secretary of State. Bylaws filed with the Secretary of State are subject to public disclosure.
The bylaws are fairly easy to amend and do not have to be perfect in order to file for 501(c)(3) tax-exempt status with the Internal Revenue Service (IRS).
STEP 12: FILING FORM 1023 (OR FORM 1024) WITH IRS
Nonprofit organizations with an expected gross contribution receipt of USD 5000 or more are required to apply for tax exemption determination with the IRS within 27 months of its formation date. Religious organizations and a select few educational organizations are exempted from this requirement.
In order to obtain the IRS determination letter, the nonprofit organization must meet the exemption eligibility norms of IRS.
STEP 13: APPLY FOR STATE SOLICITATION REGISTRATION WITH THE STATE AG OFFICE
As per the laws, every nonprofit organization is required to get itself registered with the state A.G Office if it exceeds the fund raising limit of the state This step is required before the newly formed nonprofit organization can start raising funds within a state. States have prescribed the maximum fund raising limits beyond which this registration is compulsory.
Nonprofit organizations planning to raise funds in several states may instead apply for a multi state filing.
A nonprofit organization enjoys several benefits that a for profit company cannot. However these benefits comes at the cost of greater reporting requirements with state and federal authorities. (See: Advantages/Disadvantages of Nonprofit organization)
The legal framework in which nonprofits operate in U.S. can at best be described as evolving. The restrictions and reporting requirements grow manifold when the organization starts employing people. (see: NPO employment related laws).
Nonprofit organizations are also required to report their financials with the state and federal authorities at periodic intervals besides a need to get their books of account audited. Therefore the founders must equip themselves or hire professional accountants to handle these requirements before they actually get down to start a nonprofit organization.
Given these restrictions and requirements, nonprofit organizations are often found struggling to address the common start up problems.
New start up often try to bypass these restrictions by operating as a fiscally sponsored organization for the first few years until a need for a full fledged operations is felt.
The entire process of starting a nonprofit organization takes around 3-5 months time. Applying for IRS determination and registration with the state A.G office are the two most time taking aspects of starting a nonprofit organization. (2-6 months). All other processes to start a nonprofit organization can be completed in 1-7 days time.