Starting a 501(c)3

My goal for this post is to generally outline how we formed a 501(c)3 corporation as the legal entity for Legs Mis. I'm sharing this because I believe if you have an idea to start a nonprofit, you should just go for it. The process takes time and a little bit of money, but it is not difficult.

As this is not really the point of Legs Mis, this post will be a work in progress as I focus my time on more relevant subjects. For now, I will just outline the steps we took to form the 501(c)3. Keep in mind that we did this in Texas. The process for other states may differ slightly.

Texas RioGrande Legal Aid (TRLA) provides some great resources for free on their website here. Much of the information below comes straight from them.

Step 1(a): Develop Your Idea

Obviously, if you want to start a nonprofit, you will need an idea of what it will do and why. But before proceeding, you should spend a lot of time thinking about this idea and build it out by starting with these questions:

• What is the primary purpose? What community will it serve? What need(s) will it address?
• Are there existing organizations that already serve the same or a substantially similar purpose?
• Do you expect to have strong commitment from participants? What areas of expertise will be required for success?
• How will you raise money? What are the major expenses you expect in the first 3 years? How much funding will be required to sustain the organization?

Step 1(b): Is 501(c)3 the Right Way to Go?

It might not be necessary, or desirable, for your organization to be a 501(c)3. In fact, incorporation is not even necessary in some cases. Do your own research on this one, as your purpose will determine which way to go.

To qualify for federal tax-exemption under Section 501(c)(3), a nonprofit must be organized and operated exclusively for one or more of the following purposes: religious, charitable, scientific, testing for public safety, literary, educational, or the prevention of cruelty to children or animals. It cannot be organized for the purpose of financial profit for its members or directors, although they can be paid a reasonable compensation for their work.

Step 2: Recruit the Initial Board

In order to file the Certificate of Formation, you must have at least three board members. So, you will need to have at least that many to get the ball rolling. This is probably one of the most difficult aspects of starting a nonprofit: recruiting like-minded people to join your effort. Joining the board is a significant commitment, and most people already wish for a 25-hour day. Target individuals that bring something to the table, whether it is their character or experience. You will need both.

Step 3: File Certificate of Formation

The Certificate of Formation is filed with the Secretary of State to form the nonprofit entity. It is a public document. In Texas, this can be filed online at https://direct.sos.state.tx.us/

For the entity to be eligible for 501(c)3 status it requires some specific language:

• Purpose Clause - purpose should not be so narrow that it unduly limits the nonprofit’s activities, but not so broad that it prevents the nonprofit from obtaining 501(c)(3) exemption from the IRS. All that is required is: “The Corporation is a nonprofit corporation organized for exclusively charitable, scientific, religious, and educational purposes within the meaning of section 501(c)(3) of the IRC of 1986, as amended.”
• Dissolution Clause – a statement that upon dissolution of the nonprofit, any remaining assets will be distributed to other organizations exempt under Section 501(c)(3). Example: "Upon the dissolution of the corporation, assets shall be distributed for one or more exempt purposes within the meaning of section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code, or shall be distributed to the federal government, or to a state or local government, for a public purpose."
• Inurement Clause – a statement that no part of the earnings of the nonprofit shall inure to the benefit of individual members
• IRS Clause - a general statement that the corporation may not take action that would be inconsistent with the requirements for tax-exemption under Section 501(c)(3)

Step 4: First Board Meeting: Adopt Bylaws and Elect Officers

The bylaws are the rules governing the internal structure and internal management of the corporation. The bylaws, along with the Certificate of Formation, are the “governing documents” of the organization. State law requires certain provisions to be part of the bylaws, but most provisions are optional. The law often provides that “unless the certificate or bylaws state otherwise, then…” What that means is that, when the certificate and bylaws (the governing documents) are silent, State law governs by default. However, when the bylaws are not silent, the bylaw provisions apply, provided they do not conflict with the certificate or state law.
Some of the important issues in drafting the bylaws include:

• leadership
• meetings
• quorum and voting
• financial controls
• committees
• actions without a meeting
• fiscal year
• amendment procedures

In addition to adopting the bylaws, the board must elect at least a president and secretary, and if seeking 501(c)3 status, vote to authorize the preparation and filing of the application. Some other actions that may be important to vote on during the first board meeting include:

• Appoint members of committees
• Authorize purchase of corporate record books
• Fix the location of the principal office
• Select a bank or banks and authorize the opening of an account
• Authorize check signers
• Authorize payment or reimbursement of incorporation and filing expenses
• Authorize the filing of state tax-exemption applications
• Appoint a registered agent for service of process (if the agent named in the Certificate of Formation will not continue to serve in this capacity)
• Select an insurance broker and authorize the purchase of general liability and property insurance, bonding, director’s and officer’s liability insurance, and employee fringe benefits such as medical insurance and retirement plans
• Select an accountant or auditor
• Authorize obtaining a nonprofit mailing permit to use special bulk nonprofit rates

Step 5: Apply for Federal Employer Identification Number (EIN)

Apply for an EIN by filing IRS form SS-4. This can be done online here. It only takes a few minutes.

Step 6: Apply for Federal Tax Exempt Status under Section 501(c)3

There are two types of application, based on organization size. Organizations with assets of $250,000 or less and annual gross receipts of less than $50,000 can submit form 1023EZ, a shorter form for small organizations. Organizations with more than $50,000 in annual gross receipts must file the standard form 1023.

The application is done online. Learn more on the IRS website here. Even the EZ form takes a bit of time to fill out, and the review process can take 2-3 months once the application is submitted.

Bonus: Apply for State and Local Tax Exempt Status

This is taken straight from the TRLA:

Nonprofit corporations are subject to all state taxes that for-profit corporations are subject to, including sales/use, franchise and hotel occupancy tax, unless the nonprofit corporation obtains an exemption from the Texas Comptroller of Public Accounts. The easiest method for obtaining state tax-exemption is by first obtaining federal tax-exemption. To apply for state exemption based on the federal exempt status, complete Form AP-204.20 Include a copy of the exemption determination letter issued by the IRS, including any addenda. The organization name on the IRS letter must match the organization’s legal name as listed in the Certificate of Formation.

Organizations engaged primarily in charitable activities may be eligible for a local option property tax-exemption. The availability of the exemption is at the option of local taxing authorities. Before an organization can apply for the exemption, the Texas Comptroller’s office must verify that the nonprofit organization is a statewide charitable organization engaged primarily in charitable activities. Complete and submit along with a copy of the Comptroller determination to their local appraisal district.