Non-Profit Corporate Formation

Non-profit organizations provide a wide variety of valuable charitable, educational, and scientific services to people throughout California and the nation. If you are considering forming a non-profit, it is essential to understand the legal and tax implications of how you structure and operate such an organization. It is not simply a matter of opening your doors and accepting contributions.

Forming a Non-Profit Corporation

Although not strictly necessary, most non-profit organizations are corporations. The corporate form provides limited liability protections for the non-profit’s directors, officers, and employees. A non-profit corporation is formed in much the same way as a for-profit business corporation. One key difference is non-profit corporations usually do not have shareholders. The incorporators of the non-profit corporation typically appoint an initial board of directors, and the corporation’s bylaws then specify a procedure for the board to choose its own successors.

Qualifications for Tax-Exempt Status

Once you form a non-profit corporation, the next step is to seek tax-exempt status. The latter is primarily a matter of federal law. While corporations are formed by filing the appropriate paperwork with state authorities (in California, with the Secretary of State’s office), the Internal Revenue Service determines whether or not the non-profit actually qualifies for tax-exempt status.

There are actually more than two dozen types of tax-exempt non-profit organizations recognized by the IRS. Many of these categories only include a small number of groups, however. The most common type of non-profit corporation is what is known as a 501(c)(3) organization. This category includes any non-profit corporate formation exclusively organized for one or more of the following purposes:

• religious;
• educational;
• charitable;
• scientific;
• literary;
• fostering national or international amateur sports competition; or
• prevention of cruelty to children or animals.

The 501(c)(3) classification can be further subdivided into two subcategories: public charities and private foundations. Most non-profits are public charities. The “public” part means these non-profit corporations can solicit tax-deductible contributions from a wide variety of donors. A private foundation, in contrast, is generally controlled by a small group of individuals (such as a family) who finance the majority of the operations.

As noted above, a public charity must be “exclusively organized” for an exempt purpose. It is therefore a good idea to incorporate language into the non-profit corporation’s bylaws or other governing documents expressly stating its exempt purposes. It should also be made clear the non-profit corporation will not engage in any substantial lobbying or political activities, such as campaigning for or against a candidate for elected office. The 501(c)(3) classification does not apply to such “action organizations.” That does not mean a tax-exempt charity may never comment on political matters. For example, a non-profit corporation may publish information about a particular policy area without jeopardizing its tax-exempt status. But the organization may not expend donor funds to, say, lobby Congress to pass a particular bill related to that policy area.

How to Apply for Tax-Exempt Status

The first step toward becoming a recognized 501(c)(3) organization is to have, well, an organization. As noted above, a tax-exempt charity need not be a corporation; it may be a trust or even an “association” of like-minded individuals. But the IRS needs to see some evidence of a formal organization; an individual acting alone cannot be a tax-exempt charity.

Once you have an organization and an exempt purpose, the next step is to file IRS Form 1023, an “application for recognition of exemption under Section 501(c)(3).” (Smaller non-profits can file a simplified form known as a 1023-EZ.) The 1023 application basically provides the IRS with information about your organization and its mission. You will need to provide copies of any organizational documents, as well as information about any officers or employees, including their compensation. You must also disclose any potential conflicts of interest, such as whether you have any business arrangements with individuals related to an officer or director. The application also asks detailed questions about your organization’s finances and activities, including fundraising.

In terms of finances, the IRS requires a non-profit provide at least three years of financial statements. Obviously a newly formed non-profit cannot meet this requirement. In such cases, the IRS requires financial statements for the year the application is filed together with detailed budgets for the next two years.

After the 1023 application is filed, the IRS may send requests for additional information. It may take several months for the IRS to actually grant tax-exempt status. And if the IRS denies your organization tax-exempt status, you may wish to appeal that determination, which can take several more months.

Even after tax-exempt status is granted, your organization will have to comply with annual filing requirements, both with the IRS and state agencies that regulate charitable solicitations. Such compliance can be overwhelming, especially to newer non-profits with little experience in these areas. This is why a qualified California tax attorney can prove invaluable. Whether you are forming a new organization or trying to keep up with the tax filings for an existing charity, contact our offices in San Diego, Los Angeles or Irvine at (619) 595-1655 if you need to speak with an attorney today about non-profit corporate formation.