Nonprofit Law Basics: How Do I Form a 501(c)(3) Nonprofit Corporation?
If you want to start a nonprofit, you should first understand that “501(c)(3)” tax-exempt status and “nonprofit” corporate status are two different things.
Nonprofits are often organized and operated as both nonprofit corporations and tax-exempt entities. They are distinct processes. And there are many specific rules and obligations to follow.
- Nonprofit Corporation. A “nonprofit” refers to a type of enterprise; Texas law defines a “nonprofit corporation” as a corporation in which no part of its income is distributable to a member, director, or officer of the corporation. [Texas Business Organizations Code, Section 22.001(5)]. A nonprofit corporation may be created for any lawful purpose, or purposes permitted by the BOC. Some key points:
- No person owns the nonprofit corporation or has an interest in its property.
- Nonprofit corporation status refers to incorporation status under state law. Filing a Certificate of Formation (or Articles of Incorporation) with the Secretary of State creates a nonprofit corporation.
- There are many state law rules and regulations that a nonprofit corporation must follow.
- Not all nonprofit corporations are entitled to exemption from state or federal taxes.
- A nonprofit corporation is created by filing a certificate of formation with the secretary of state in accordance with the Texas Business Organizations Code.
Tax-Exempt Organizations & 501(c)(3)s
- Tax-Exempt Status. Tax-exempt status means that your organization is exempt from paying certain taxes.
- Tax-exempt status from the IRS exempts a nonprofit from paying corporate federal income tax on income generated from activities that are substantially related to the purposes for which the group was organized.
- Designations such as 501(c)(3) relate to federal tax provisions only. There are many federal tax code requirements that a tax-exempt organization must follow.
- The organization will owe corporate federal income tax on income unrelated to its tax-exempt purposes, called unrelated business income (UBI). UBI is income generated from routine business activities not substantially related to the entity’s tax-exempt purposes. Learn more about UBI here.
- In Texas, state law allows various types of organizations to be exempted from paying sales tax, hotel occupancy tax, property tax, and, if incorporated, franchise tax.
- A nonprofit organization, whether incorporated or not, can decide whether or not it wants to apply for tax-exempt status.
How to Form Your Nonprofit Corporation that has 501(c)(3) Tax-Exemption
We have outlined ten steps to set up a nonprofit corporation that is tax-exempt:
1: Make a Plan. Decide if you really need to start another nonprofit, or if your philanthropic ideas can be utilized in an already-existing entity. Make a plan, do your research, create a team.
2: Select a Name.
3: Recruit a Board of Directors. Who should serve on an initial board of directors? How many do we need?
4: Form a State Nonprofit Corporation – Prepare the Certificate of Formation. State steps to become a “nonprofit corporation.”
6: Draft Bylaws that govern the operations of the nonprofit. What are bylaws?
9: Prepare the 1023 Federal Tax-Exemption Application [to get 501(c)(3) Status]. This is the 501(c)(3) “tax-exempt” part.
10: Apply for State Exemptions & Other Permits, including sales and use taxes, property tax exemptions, charitable solicitation permits, and more.
If you need information regarding tax provisions or how they might affect a state certificate of formation, you should contact a nonprofit attorney or the Internal Revenue Service. In many states, such as Texas, the Secretary of State’s form to obtain nonprofit corporate status meets minimum state law requirements, but does not include any additional statements that the IRS might require for tax-exempt status.
The Cullinane Law Group works exclusively with the nonprofit sector. We help set up and maintain strong and legally compliant nonprofits that have solid bases for long-term success. We provide risk management and offer practical solutions for sound nonprofit governance. We help nonprofits, foundations, religious organizations, and social entrepreneurs throughout the United States who seek to create positive change.
Cullinane Law Group: Nonprofit Law Basics: Nonprofit Corporation vs. Tax-Exempt Organization
To learn more about the rules and procedures for obtaining a federal tax-exempt status, read IRS publication 557: “Tax Exempt Status for Your Organization.”
To learn more about the rules and procedures for obtaining a state tax-exempt status, read the FAQs at the Texas Comptroller of Public Accounts, Tax Exempt Organizations Section: Frequently Asked Questions About Exemptions.
Learn more: How to Become a Nonprofit Corporation
Learn more: How to Apply for Tax-Exemption with the IRS