Steps in Forming a Tax-Exempt Organization

June 6, 2016

I’ve had a few clients asking me lately about the right way to go about forming tax-exempt organizations. A lot goes into choosing the right entity type and I’d be happy to talk to you about it in detail. For now, however, I want to outline the basics of the formation of a public charity or private foundation. Again, keep in mind that I intend this list to serve as a general reminder of some of the things that need to be considered when forming such an organization and it is certainly not a complete or comprehensive guide to formation or maintenance. Read on and understand the what goes into the process and then call your lawyer.

Phase 1: Choosing the right entity

There are many different types of organizational structure for a business and only certain businesses and causes are a good fit for an NPO. The laws of your state govern the establishment of all of these organizations and it’s up to you to decide whether you want to pursue forming an association, corporation, trust, or LLC. A lawyer whose practice focuses on non-profits and business formation will be able to discuss your goals and plans for the prospective organization and help you determine whether or not a non-profit is right for you. Other possibilities include for-profit companies, donor-advised funds, and fiscal sponsorships. Forming a non-profit creates heavy responsibility and cumbersome reporting requirements. This is why you want to be sure that the NPO is right for you.

Phase 2: Forming and registering your entity

This may seem like a no-brainer, but oftentimes people forget that in order to have a non-profit, tax-exempt organization, you must first have an organization. In order to establish an entity that will eventually be granted tax-exempt status you must follow all of the rules of incorporation in your state. This generally means that you will reserve your business name and file for appropriate certificate of incorporation. On top of making sure that all of the state law requirements are met in the state you and your attorney have chosen, you and your lawyer should make sure that your organization’s statement of purpose generally follows the language in Section 501(c)(3) of the Internal Revenue Code so that the organization can more easily qualify for tax-exemption later. After all of the documents are filed and accepted your new corporation will need to hold a meeting, elect officers, and adopt policies and bylaws.

Phase 3: Double checking your corporation

At this point, make sure that all of your bases are covered and your new corporation is ready to go. There are other clauses that are considered best-practice for inclusion in the bylaws across the nation, but may be mandatory in your state’s charity regulations (such as a Conflict of Interest Policy, Whistleblower Policy, etc.). Additionally, double check to make sure you have set up a bank account, obtained an Employer Identification Number (it’s like a social security number for your business), and filed an Application for Authority if you are operating in a different state than the one in which you registered.

Phase 4: Applying for tax-exemption

Within 27 months from the formation of your organization, file your application for tax-exemption. If your 501(c)(3) is going to be very small for the foreseeable future, your attorney may recommend the faster and less expensive form 1023 EZ (and eligibility worksheet). Otherwise you will take the time to work through the 1023 or 1024 with your lawyer. This can be time-consuming so give it the attention it deserves. You’ll need to plan out your budget for the next three years and establish a narrative describing your entire program. Once your organization receives a favorable determination from the IRS, you’ll repeat the application for tax-exempt status in your local jurisdiction at the state level.

Phase 5: Maintaining ongoing compliance

Public charities (501(c)(3)) and private foundations alike will continue to report their financials using Form 990, 990-T, and the appropriate state filing documents. Directors of the exempted organization will also need to ensure that the corporate formalities are scrupulously observed from year to year. These are merely the threshold requirements. It is highly advisable that you speak with an attorney who can help you monitor requirements such as minimum distribution requirements, conflict procedures, operational procedures, and activity limitations.

I can’t stress enough how much time, money, energy, and potential heartache a good attorney (who is respectful of your time and money) will save you. Use this resource to put the structure in place to go do some good.