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Starting a Nonprofit (501(c)(3) Status)

How a nonprofit is formed under state law, how it gets federal tax exemption as a charity, and the rules it must follow to keep it.

Informational only - this is not legal advice. These definitions explain general legal vocabulary in plain English. They are not advice about your situation, reading them creates no attorney-client relationship, and the law differs from state to state and changes over time. For advice you can rely on, speak to a lawyer licensed in your state.

Looking for a lawyer rather than a definition? Skip to the state-by-state list of Business Organizations law firms.

What it means

Starting a charitable nonprofit involves two separate steps that people often confuse. First, the organization is created under state law, usually as a nonprofit corporation, by filing articles of incorporation with the state and adopting bylaws and a board of directors. Second, it applies to the IRS for federal tax exemption under section 501(c)(3) of the Internal Revenue Code, on Form 1023 or, for eligible small organizations, the shorter Form 1023-EZ. Exemption requires that the organization be organized and operated exclusively for charitable, religious, educational, scientific or similar purposes; its founding documents must limit its purposes accordingly and dedicate its assets to charity if it dissolves. State income, sales and property tax exemptions, and state registration to solicit donations, are separate again.

A 501(c)(3) organization is classified as either a public charity or a private foundation, depending mainly on how broadly it is supported; private foundations face extra excise taxes and restrictions. Donors to either can generally deduct contributions. In exchange, the organization accepts real limits: no part of its net earnings may benefit insiders (private inurement), compensation must be reasonable, it may not participate in any political campaign for or against a candidate, and lobbying must be no more than an insubstantial part of its activities, or within the limits of an elected expenditure test.

Keeping the exemption means filing an annual return in the Form 990 series, which is public, and the IRS automatically revokes the exemption of an organization that fails to file for consecutive years set by statute. Directors owe the organization duties of care and loyalty under state law (see fiduciary duties), and conflict-of-interest and document-retention policies are expected on the application. A group that does not need tax-deductible donations may be better served by another form, such as a 501(c)(4) social welfare organization or an ordinary business.

Where this comes from

Internal Revenue Code, 26 U.S.C.: exemption, § 501(c)(3); public charity and private foundation classification, § 509(a); deductibility of contributions, § 170(c)(2); lobbying expenditure election, §§ 501(h), 4911; annual returns, § 6033(a); automatic revocation, § 6033(j); excess benefit transactions, § 4958. Treasury Regulations: organizational and operational tests, 26 C.F.R. § 1.501(c)(3)-1(b)-(c). IRS Forms 1023, 1023-EZ and 990 series; IRS Publication 557, Tax-Exempt Status for Your Organization. Formation and director duties: the nonprofit corporation act of the state of incorporation (for example the Revised Model Nonprofit Corporation Act, adopted in part by many states).

When people hire a lawyer for this

A business or nonprofit lawyer can draft articles and bylaws that meet the IRS organizational test, prepare the exemption application, and set up governance that avoids the private-benefit and political-activity problems that cost organizations their status. Help is especially worthwhile if founders will be paid, if the organization will buy from or rent to insiders, if it will run a business activity, or if it plans advocacy. Many bar associations and law school clinics assist small community nonprofits at low or no cost.

Worried about the cost? A lawyer can be hired for one part of a case only (limited-scope representation), may be paid from what a claim recovers (contingency fee), or may be free through a pro bono program or legal aid; a court can also waive its own filing fees.

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Part of the LawyerLand plain-English legal glossary. Definitions are written from primary sources - statutes and court rules - and each entry states the authority it rests on, or says plainly when the doctrine is state law with no national rule.

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