Forming and Protecting a Tax-Exempt Nonprofit Corporation

If you’re ready to start your own nonprofit corporation and do some good in the world, then the first thing you need to understand is that not all nonprofit corporations are tax-exempt. To claim tax-exempt status for your new corporation, you’ll need to meet certain requirements — on top of the requirements that all nonprofit corporations must meet. Here’s a step-by-step guide to the process you must follow to successfully launch your new tax-exempt nonprofit corporation.

Step one: make a plan

Most nonprofit corporations seeking federal tax-exempt status will want to do so by qualifying for Section 501(c)(3) status with the IRS. To qualify as a 501(c)(3) corporation, IRS Publication 557 says that your organization must be “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports, or prevention of cruelty for children or animals.” Thus, it’s important to confirm that your corporation’s activities will fall into one of these categories before you go any further in the process.

You’ll also want to investigate your state’s requirements for forming a nonprofit, as these can be somewhat different from the federal requirements. For example, in New Jersey, 501(c)(3) organizations must register with the New Jersey Charities Registration Section (with a few exceptions among religious and educational institutions). You’ll likely also want to apply for an exemption from New Jersey sales and use tax.

Step two: prepare your corporate documents

To form any corporation, you’ll need to prepare a certificate of incorporation along with a few other organizing documents. IRS Publication 557 includes a sample articles of incorporation that you can use as a template for your own organization. However, nonprofit corporations incorporated in New Jersey (and in certain other states as well) need to include special nonprofit provisions in their articles of incorporation. You’ll find these provisions in the New Jersey Public Records Filing for New Business Entity form. While it’s possible to prepare your own articles of incorporation, you’d be advised to at least have an experienced lawyer check over the documents and confirm that they are drafted correctly.

Step three: file your federal paperwork

Once your incorporation paperwork is in order, you’ll need to get a Federal Employer Identification Number (FEIN) before you can proceed any further. The FEIN is your company’s equivalent of a Social Security number, and you’ll need it in order to apply for federal tax-exempt status, open a bank account, and conduct numerous other activities. Fortunately, acquiring this number is easy — in most cases you can apply online and get your FEIN immediately.

Next, you’ll need to fill out either Form 1023 or Form 1023-EZ to apply for recognition of 501(c)(3) tax-exempt status from the IRS. If you qualify to use the EZ version of the form, by all means do so — the main version of Form 1023 is 28 pages long and can be quite a headache to fill out. Fill out the eligibility worksheet in the instructions for Form 1023-EZ to see if you qualify. You’ll find a checklist at the end of Form 1023 that you can use to confirm you’ve completed all the necessary steps before filing this form — a wise precaution, since you definitely won’t want to have to go through the whole thing twice.

Step four: file your state paperwork

In New Jersey, any properly incorporated and operated nonprofit corporation is automatically exempt from state corporation business taxes. You will, however, need to register your organization with the New Jersey Charities Registration Section. You’ll probably also want to get your nonprofit corporation exempted from sales and use taxes; you can do so by completing Form REG-1E, Application for ST-5 Exempt Organization Certificate, and sending it in along with your certificate of incorporation, a copy of your bylaws, and a copy of your 501(c)(3) determination letter from the IRS.

In some cases, you may need to complete even more paperwork to meet New Jersey requirements for tax-exempt nonprofit corporations. For example, if your organization buys or sells any real estate you’ll need a letter of exemption from New Jersey corporation business tax, which you can request from the Regulatory Services Branch. And if you plan to hold raffles or other games of chance, you must first register with the New Jersey Legalized Games of Chance Control Commission. Your best bet is to consult with a lawyer with experience in your state’s incorporation process to be sure that you’ve met all the requirements.

Step five: maintain your tax-exempt nonprofit status

Once you’ve finally completed the somewhat torturous process of getting tax-exempt status from the IRS and your state Division of Taxation, the next challenge is keeping that status. First, you must meet the basic corporate operating requirements: follow the rules you laid down in your articles of incorporation and your bylaws; hold regular meetings of the Board of Directors and keep minutes; maintain complete and well-organized financial records; clearly separate personal and business transactions by setting up a separate bank account and credit card for your organization; and file Form 990 or Form 990-EZ as required by the IRS.

On top of that, you must meet the requirements for operating a 501(c)(3) organization. For example, your organization must stick to activities related to its stated purpose. If it earns business income through other activities, this income will be subject to the unrelated business income tax. Also, 501(c)(3) organizations are expected to be public entities, so it’s important to have multiple, diverse funding sources. If you don’t meet this requirement you may be forced to reorganize your corporation as a private foundation. Finally, you will likely also have annual filing requirements with your state Division of Taxation (this is certainly the case in New Jersey).

The process for getting and keeping tax-exempt nonprofit status is certainly a hassle, but the rewards can be well worth it. Simply setting up a nonprofit organization is far less complicated, but such organizations will still be required to pay federal taxes and possibly state ones as well — which will likely take a hefty bite out of their revenues. By taking the additional steps necessary to get your nonprofit organization tax-exempt status, you’ll have that much more revenue available to spend on making the world a better place.

Michael is an attorney specializing in entertainment law and a professionally-trained actor. He is a partner in the law firm of DeBlis Law.