If you’ve got a desire to serve others and a way to turn that passion into a business, then starting a nonprofit could be a great idea. More than 1.5 million nonprofits are registered with the Internal Revenue Service and contribute more than $1 trillion a year to the U.S. economy. Just like with any business, there’s a lot that goes into starting a nonprofit—from registering the business to developing a board of directors and keeping track of compliance requirements. Here’s what you need to know.
What’s a nonprofit?
Like the name implies, a nonprofit is an organization that’s created for a purpose other than making money. Nonprofit organizations serve the public interest, so any surplus earnings generally go to supporting the nonprofit’s mission. For-profit organizations, on the other hand, may have a mission to do good, but they go into business for the express purpose of generating income for its founders, shareholders, and employees.
The IRS has many ways of classifying “nonprofits,” and public charities made up 60% of the nonprofits registered with the agency in 2016. Public charities fall under tax code section 501(c)(3), which includes organizations created for educational, charitable, religious, scientific, literary, safety-oriented, amateur sports-related purposes, or cruelty-prevention purposes. The American Red Cross, National Foundation for Credit Counseling, and the ASPCA are just a few examples of this type of nonprofit.
Pros and cons of setting up a nonprofit
Setting up your organization as a nonprofit could be a good option if you’re looking to fulfill a social purpose. But you’ll need to evaluate the benefits against the trade-offs:
- Tax benefits: Organizations that qualify as public charities under the 501(c)(3) code can apply for federal tax-exempt status. After establishing this exemption, the nonprofit is usually exempt from similar state and local taxes, too, along with certain employment taxes.
- Access to grants and donations: Charitable nonprofits are typically eligible to receive public and private grants, making it easier to get operating capital. Plus, individuals and companies may also deduct charitable contributions they make to your organization.
- Limited liability: Directors and officers are usually not personally responsible for the nonprofit’s debts and liabilities. However, employees and board members can’t use the corporation to shield illegal or irresponsible acts.
- Cost: There are fees associated with registering the nonprofit and applying for incorporation and tax exemption. You also might need to pay for an attorney or accountant to help you navigate the complicated regulations.
- Record keeping: To maintain your exempt status, your nonprofit will need to keep detailed records and submit annual filings to the state and to the IRS by stated deadlines.
- Shared control: Nonprofits are subject to federal laws, state regulations, and their own bylaws that limit personal control. Compared to other business setups, founders and employees have a diminished role and a board of directors typically determines policy.
- Public scrutiny: Nonprofits work toward the public interest, so they’re required to make state and federal filings open to the public.
How to set up a nonprofit
If you’ve decided to start a nonprofit, you’ll need to designate it as such from the beginning—it won’t be possible to switch to a nonprofit setup later on. The process below takes you through the basic steps, but you may find additional help by looking up your state association of nonprofits and checking out nonprofit startup resources by state.
Step 1: Build a solid framework
- Consider hiring a consultant: Nonprofits are organized under state law, and each state defines this type of organization differently. Some founders hire attorneys, accountants, or other consultants to make sure the nonprofit is set up correctly from the get-go.
- Write a mission statement. A mission statement communicates your nonprofit’s purpose, what groups it serves, and how it will serve them. This can guide and support your nonprofit’s future decisions and actions.
- Draft a business plan. Your nonprofit’s business plan explains how it will turn its mission into a reality, and it can help when you’re looking for startup capital. The plan should include a market analysis, a description of your nonprofit’s services and products, its marketing and sales strategy, financials (including revenue sources), and goals.
- Develop your board. Your board of directors will have a variety of roles and legal responsibilities, so it’s important to recruit people who fit the organization well. You’ll need to determine the best size of the board, ideal traits of a board member, and details such as training and compensation. Over time, your board may change and grow.
Step 2: Incorporate your nonprofit
Many charitable nonprofits decide to incorporate to take advantage of the tax benefits. To become a 501(c)(3) organization, your nonprofit must be organized as a corporation, trust, or unincorporated association. Here’s a simple overview of what the process involves:
- Choose a business name that’s legally available in your state and file for an Employer Identification Number (EIN).
- Prepare and file your articles of incorporation with your state’s corporate filing office along with the required fee. You’ll typically go through your secretary of state’s office.
- Create a set of bylaws that dictates how your corporation will be operated.
- Appoint a board of directors and hold the first meeting.
- Apply for any permits and licenses you’ll need to operate your organization in your state and local area.
Step 3: File for 501(c)(3) tax-exempt status
Incorporating your nonprofit simply establishes the business with the state. Next, you can move on to applying for tax-exempt status with the IRS. You’ll need copies of your articles of incorporation, financial documents, and your EIN. The IRS will also charge a user fee, which is either $275 or $600, depending on whether you need to file Form 1023 or Form 1024-A. Organizations applying for tax-exempt status must complete this step within 27 months from the date of incorporation.
Once you submit the application, it may take the IRS a few months to return its decision, depending on whether the agency has questions. Once the IRS finalizes your tax-exemption status, it will further classify the nonprofit as a private foundation or public charity.
Step 4: Ongoing compliance
Once you establish and incorporate your nonprofit and file for exemption, the real paperwork begins. Nonprofits must keep records to follow compliance laws on the federal, state, and local level. IRS publications 4221-PC, 4221-PF, and 557 can help you understand federal guidelines, but an attorney may also help you stay on top of local regulations.
- Recordkeeping: Tax-exempt nonprofits will need to keep books and records detailing its financial and nonfinancial activities, such as how it receives revenue.
- State annual report: Nearly every state requires businesses to file an annual report, which is a simple document that ensures the business’s information is accurate and up to date.
- Federal filing requirements: Most exempt organizations must file Form 990, Form 990-EZ, or Form 990-PF with the IRS, along with certain schedules that may be required for the organization. The form shows your nonprofit’s finances, activities, governance processes, directors, and key staff—and it’s public record. Organizations with gross receipts of $50,000 or less may instead submit an annual electronic notice using Form 990-N.
- Unrelated business income tax: If an exempt organization receives $1,000 or more from an unrelated trade or business during the year, it must also file Form 990-T and may need to make quarterly estimated tax payments on the income.