Businesses operate to make money, which means paying taxes and taking on certain liabilities. Nonprofit organizations, on the other hand, get tax breaks and liability protections. To start a nonprofit, you'll need to apply for tax-exempt status with the IRS, which means meeting a list of requirements that apply specifically to not-for-profits in the U.S.
What Is a Nonprofit?
Before you apply for a federal tax exemption, you'll first need to understand what the IRS sees as a nonprofit. The IRS tax code for tax-exempt status, labeled 501(c)(3), defines a nonprofit as organizations that are "charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition and preventing cruelty to children or animals."
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A nonprofit doesn't enjoy tax benefits until the IRS has reviewed and approved its application, which is submitted as Form 1023. Tax exemption applications must go through Pay.gov, a site set up for making certain payments. Achieving nonprofit status through your state does not grant you tax-exempt status with the federal government. You'll still have to apply to the IRS and wait for approval.
Starting From Scratch
The first step in starting a nonprofit is determining the need. You'll want to have a solid business plan in place, which means proving there's a demand for your organization's services and how you'll meet that demand. Do careful market research into charitable organizations in the same space to identify where your new nonprofit will fit.
Once you have your business model outlined, you'll have to file paperwork to incorporate at the state level before requesting 501(c)(3) status with the Internal Revenue Service. You'll also need to draw up articles of incorporation and choose your leadership team, including board members who will champion your nonprofit from the start.
For-Profit Business to Nonprofit Organization
Converting a for-profit business into a nonprofit can be tricky. Whether you're running a startup or a longstanding large corporation, you'll have to make sure your business meets the requirements to be classified as a nonprofit corporation. Before you get started, look at both local and federal requirements and make sure you have the documentation necessary to prove your business qualifies.
As with a new nonprofit, switching to a nonprofit means going through your individual state's process of gaining nonprofit status. You'll also then go to Pay.gov and request 501(c)(3) status. You can find instructions on Form 1023.
It's also important that you fully understand what you'll be giving up by making the move. Public charities must be open to constant scrutiny, especially if you'll be engaging in fundraising activities. You'll also be answerable to a board of directors in many of the major decisions you make, and that loss of control can be tough for some business owners.
To start a nonprofit, you'll need to apply for tax-exempt status with the IRS, which means meeting a list of requirements that apply specifically to not-for-profits in the U.S.
Profits and Salaries
Finances are an important part of running a nonprofit. Your nonprofit's books are subject to audit, so it's important for a nonprofit startup to avoid any conflicts of interest or questionable spending. Legal advice can help, as can bringing on board members and employees with prior experience in the nonprofit sector.
But things can get tricky when it comes to compensation. A nonprofit needs at least a few good employees, but you'll have to meet the definition of your compensation being reasonable and not excessive while also paying enough to be competitive in your job market. Your executive director's salary should be approved by the entire board, and regular salary reviews should be part of your board meetings.
One misconception about various types of nonprofits is that they can't make a profit. The internal revenue code allows for your nonprofit small business to bring in more money than it spends. The key is that you put those funds back into your organization rather than your personal bank account.
Running a tax-exempt organization can help you make a difference in the world. If you organize it correctly, you won't have to pay federal or state taxes on the funds your business brings in, but it's important to operate in accordance with tax laws to maintain your 501(c)(3) status. Many nonprofits work with experts who specialize in nonprofit finances to ensure they remain compliant.
- American Bar Association: How Nonprofits Obtain and Maintain Their Nonprofit Tax Status
- IRS: Exempt Purposes - Internal Revenue Code Section 501(c)(3)
- IRS: Applying for Tax Exempt Status
- Pay.gov: Streamlined Application for Recognition of Exemption Under Section 501(c)(3)
- Council of Nonprofits: State Filing Requirements for Nonprofits