These days there are so many charitable organizations seeking our time, our services, and our financial support that it might feel like there is already an organization out there for every cause. But many people still have a strong desire to start their own nonprofit organization. Often, I’ll hear from individuals who are looking for ways to fund a passion project and who realize that it’s really difficult to raise more than trivial amounts of money without being a recognized tax-exempt organization. (In a future post, we’ll discuss fiscal sponsorship as an alternative to forming a new entity.) Other people I talk to have an idea for a mission-driven project that could potentially be a for-profit business, a nonprofit organization, or a hybrid social enterprise, but they’re just not sure what all goes into establishing and maintaining a nonprofit entity.
Forming a nonprofit and then gaining (and keeping) the organization’s tax-exempt status is definitely more complicated than starting an LLC or other for-profit business. So what do need to know if you’re considering this path?
Step 1: File Articles of Incorporation
The first step in creating any new business entity is to file articles with the Ohio Secretary of State. For a nonprofit, this should be Articles of Incorporation. We’ll discuss applying for tax-exempt status in a future post, but for now just know that the IRS strongly prefers corporations rather than LLCs. Although it is an option, don’t bother filing articles or organization for a nonprofit LLC with the Ohio Secretary of State. You would just be making an already complicated process more complicated and more expensive.
The Articles of Incorporation will ask for the corporation’s name, where the principal office is located, the purpose of the organization, and the identity of the statutory agent. Occasionally, I’ll see clients who got so specific and flowery with their purpose language, that they write themselves right out of the legal requirements for being recognized as a tax-exempt organization. The IRS provides suggested language that won’t cause problems when you go to apply for tax-exempt status:
[This corporation] is organized exclusively for charitable, religious, educational, and scientific purposes, including, for such purposes, the making of distributions to organizations that qualify as exempt organizations under section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code.
You really don’t need to make it any more complicated than this.
The statutory agent is simply a person or business located in this state who is authorized to receive official notices, whether from the Secretary of State, other government agencies, or sometimes even the courts. I cannot emphasize enough how important it is to keep this information up-to-date with the Ohio Secretary of State. If an important notice is sent to your statutory agent, then the law assumes the organization received the notice and was made aware of its contents. I’ve seen clients lose important legal rights because a notice went to an old statutory agent address that was never updated with the Ohio Secretary of State.
Step 2: Obtain a Federal Employer Identification Number (FEIN)
The FEIN (commonly called a tax ID number) will allow the organization to open a business bank account. The application can be completed online on the IRS website, and except in rare situations, you will receive the tax ID number immediately. The IRS will also mail a confirmation letter, but the physical letter may take several weeks to arrive. While the IRS says that the confirmation letter is not necessary to open a bank account or otherwise begin using the tax ID number, some banks still require a copy of the actual letter. The letter can also provide important information to your accountant if there are any questions about your tax status, particularly if you aren’t sure how you answered some of the questions when applying for the EIN.
Step 3: Draft Bylaws and a Conflict of Interest Policy
Bylaws are the governing document for a nonprofit organization. Much like an LLC operating agreement, the bylaws will dictate how organizational decisions are made and how various responsibilities will be carried out.
While there are many examples of nonprofit bylaws out there, your organization’s bylaws really should be customized to fit your organization’s needs and management style.
In addition to the bylaws, your organization should also go ahead and prepare a conflict of interest policy. (The IRS will ask whether you have one when you apply for tax-exempt status). The conflict of interest policy addresses how the organization will deal with potential conflicts of interest, especially when it comes to making decisions that might financially benefit the organization’s officers or directors. For example, how will the organization deal with a board member who also wants to be paid to provide services? How will the organization make sure that this board member is the right service provider for the organization’s needs and that the board member is not being paid above-market rates for their services just because of their position on the board?
The other area where conflicts of interest are likely to arise is in setting compensation for officers and directors. Your conflict of interest policy should prohibit anyone with a financial interest from voting on a compensation decision. Particularly in newly-formed nonprofit organizations, there is often a mistaken belief that the founder “owns” the nonprofit and can do almost whatever they like with the money the nonprofit raises. The reality is that no one “owns” a nonprofit organization, and you would be jeopardizing your tax-exempt status if you were setting (or even voting on) your own salary or other compensation.
If you follow these steps, you will have a created a nonprofit corporation with the state. However, the state cannot grant tax-exempt status. In the next nonprofit post, we’ll discuss how to apply for tax-exempt status and whether you can save money with the “easy” version of the application.
In the meantime, if you need assistance with forming your nonprofit organization or even deciding if this is the right route for you to take: