FREQUENTLY ASKED QUESTIONS: HOW DO I START A NONPROFIT?
The rules governing nonprofit organizations are created by the federal Internal Revenue Service (IRS), the various States, and local Municipalities. They are complicated and they are volatile in that they can change, frequently as a result of economic, political, and social pressures.
Before
you start
There are five steps to follow in establishing a nonprofit organization in Arizona and there are several very good resources that will help you. But before you take any of these steps you must ask yourself two questions:
"Why do I want to start a nonprofit organization
rather than a for-profit organization?"
Either form of organization may be appropriate for providing the service
you wish to perform. And both types of organizations are businesses.
So what is the difference? The following chart summarizes some of
the main similarities and differences:
"Are there other organizations in the community
that do what it is I propose to do?" If so: Is
what I propose different than what any of them already do? Can I
become a program of one of them rather than start a new business?
In the United States there are approximately 1,600,000 nonprofit organizations of which about 800,000 are charities. In Arizona, there are more than 29,000 registered nonprofits of which about 19,000 are currently operating. It is reported that approximately 1500 new nonprofits are started in Arizona each year. Thus there are many others working to make our community a better place for all who live here.
Each of these nonprofit organizations serves a perceived need. In some cases, they are the sole providers of a service; in others, they are among several. It is important to determine whether your proposed program fills a specific niche or whether it may be a duplication. If it is the latter, the chances of developing financial support and clientele may be limited.
It is entirely feasible that your proposed program can be part of an existing nonprofit organization. Such might fill your desire to provide a needed service and it might expand the reach of the existing nonprofit in fulfilling its mission. Your market research should inform you of those potential organizations. Should such a partnership be successful, it is entirely possible that sometime in the future it might serve the purposes of all involved to spin off your program into a separate nonprofit organization. It is worth a serious conversation with those nonprofits to determine what is your best course of action.
In considering whether or not to form a nonprofit it is also important to realize that forming and
maintaining a nonprofit has become increasingly difficult and expensive due to new regulations governing
the sector. What was an extremely simple process now requires a clear mission and core of support. Make this
decision with care. We strongly recommend you study the benefits and disadvantages as outlined by Anthony Mancuso
in How to Form a Nonprofit Corporation NOLO 8th Edition. pp. 9-15
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What
is a nonprofit organization?
Before you go further, you are encouraged to download from the
IRS site both Publication
557 and the Instructions and form for Form 1023.1
Please read these. The information in them is extremely
valuable and will help you make more informed decisions.
Nonprofit organizations represent individual or collective action to address a problem or enhance society in ways other than that provided through governments (federal, state, local) or for individual profit (corporate stockholders, partners, sole proprietors).
Bruce Hopkins, in his book, "Starting and Managing a Nonprofit
Organization: A Legal Guide" quotes the 1973 congressional testimony
of then Secretary of the Treasury, George P. Shultz, who said that
charitable organizations "are an important influence for diversity
and a bulwark against overreliance on big government."2
Thus nonprofits are voluntary organizations with a primary purpose
of serving the public good. They are exempt from federal taxes and
many state and local taxes. This tax-exempt status is supported
by a U.S. Supreme Court decision in which the following appears:
"The State has an affirmative policy that considers these groups
as beneficial and stabilizing influences in community life and finds
this classification [tax exemption] useful, desirable, and in the
public interest."3
Additional rationale for tax benefits is found in a federal court
of appeals decision: "One stated reason for a deduction or exemption
of this kind is that the favored entity performs a public service
and benefits the public or relieves it of a burden which otherwise
belongs to it."4
Some types of nonprofit organizations must evidence that they are
publicly supported by proving they "regularly solicit funds from
the general community." Public support may include government funds.
The IRS has developed various tests to help determine if one meets
these requirements. These are known as the "public support tests."5
Tax-exempt classifications are determined by the federal IRS. There
are 32 different classifications of nonprofit organizations that
receive exemptions from various taxes. Only 9 of these classifications
may offer those who support it with grants and/or donations the
right to declare their contributions as tax deductible. Charities
with a 501 (c)(3) IRS classification comprise the bulk of those
that can offer tax deductibility.6
Nonprofit organizations are not "owned" by anyone. The responsibility
for legal and financial matters rests with its board of directors
which is responsible for overall governance and stewardship. In
some cases, the organization's membership may "control" it by virtue
of its power of vote for those who serve on the board of directors.
Members of nonprofit boards of directors serve without compensation except that they may be reimbursed for expenses incurred as part of their voluntary service. Boards of directors are responsible for assuring that the organization adheres to the principles of "no private inurement," and the avoidance of "private gain" and "conflicts of interest." These important principles are explained in the resources listed in this FAQ.
Nonprofit organizations may make a profit – as long as
that excess of income over expenses is returned to the organization
in pursuit of its mission. The expenses may include compensation
paid to employees – as long as it is in accordance with
community standards for the same work, thus avoiding issues
of "private inurement" and "private gain."
Nonprofit organizations must file annual federal tax information
reports, called Form 990. As of January 1, 2009 all nonprofits must file annual 990 forms. It should
be noted that Forms 990 that have been filed with the IRS are made
available to anyone over the Internet and a copy of such must be
provided anyone who asks.7 Additionally,
Arizona – and most states – requires annual registration as a charity
along with a financial statement.
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What
a nonprofit organization is
not :
There are certain precepts that a nonprofit organization must maintain
in order to assure its tax-exempt status and the ability to offer
tax deductibility to its donors. A nonprofit organization may not
distribute profit to individuals in their private capacity. Charities
must be organized and operated so that "no part of…[its]
net earnings…inures to the benefit of any private shareholder
of individual."8 They may not solicit
or receive contributions directly for specifically named individuals.
They may not offer opportunities for private gain to any of its
directors, trustees, officers, or key employees. As an organization
governed by a board of directors, no one person may hold control.
Nonprofits are held to the highest standards of public trust; they
may not keep secret their standard annual tax information reports
(IRS Form 990).
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Five
step process
Thoroughly researched
business plan with market analysis. See www.boardsource.org
for information on governance and strategic planning. A basic plan
will consist of, minimally, the following components:
- Mission of potential organization
- Description of service or product
- Need or marketability of service or product
- Analysis of marketplace including full descriptions of real
or potential competition
- Cost projections over 5 year period
- Income projections over 5 year period
- Expertise needed to perform service or product projections
- Board of directors
- Biographies of you, the board of directors, and other key people.
Be sure to note expertise in service, program, management, and
governance.
Financial support in the forms of grants and donations can be very
difficult to obtain in the first few years. In addition to keen
competition from well-established nonprofits, new organizations
must prove their market niche, expertise, and stewardship of resources
before many funders and donors will help support
them. Therefore, a thoroughly researched business plan is essential.
State Incorporation (fee is charged)9
Register with the Arizona Corporation Commission. This incorporates
your organization as a nonprofit. You do not need to incorporate
but there are multiple reasons to do so including protection from
personal liability.10 You may access
the information and the forms you need via Internet: http://www.cc.state.az.us
A similar process will be required in any other state; information
is available via each state’s website or Mancuso’s "How
to Form a Nonprofit Corporation in all 50 States."
Note: In Arizona while you are preparing to start a nonprofit, you
may – in advance – reserve the name you have created
for your organization. The Secretary of State and the Corporation
Commission offices have registration of trade name forms.
Obtain EIN
The Employer Identification Number (EIN) is the equivalent of your
corporation’s federal ID number, similar to your own social
security number. The form for obtaining this number is SS-4, available
over the Internet at www.irs.gov.
The easiest and quickest way to obtain the number is to apply online from the IRS website www.irs.gov
and type "EIN" in the upper search box. Then click "Go to open a page that lists links to EIN-related Web pages." You should see a link to the online EIN application.11 http://www.irs.gov/businesses/small/article/0,,id=102767,00.html.
You will need this number for banking and for the next step.
File IRS Form 1023
This is the final step in obtaining your tax-exempt status; it
can take up to 6 months depending upon the IRS office through which
you must file. This form requires considerable attention. Each time
the form is returned to you for further information or clarifications,
the time for receiving your exemption is extended thus it is advisable
to ask legal counsel versed in nonprofit law to review the form
after you complete it but before you send it in.
BEFORE you complete this form, you are urged to review any of the
following references and/or to read carefully Publication 557 and
the Instructions for completing Form 1023 available over the Internet
from the IRS site www.irs.gov.
Look for information on Tax-Exempt Organizations. Your business
plan will provide you valuable information for completing the form;
part of the requirements are your income projections over the next
4 years. (Remember to familiarize yourself with the Public Support
requirements.) Upon acceptance you will receive a Letter of Determination.
Be sure to permanently file the original; copies will be requested
by various agencies and funders.
How long is the turnaround time at the IRS? According to Anthony Mancuso, How to Form a Nonprofit Corporation, 8th edition (2007) p 198 the IRS should inform you that they received the application within three weeks. While the turnaround time for completion of review of your Form 1023 is normally about 2 months, you may have to wait three to six months. It is possible to request an expatiated filing by submitting a written request along with the application. Successful reasons can include an impending grant deadline, providing disaster relief, delay of prior application.
Register with State (fees may be charged):
Before charities may solicit contributions they must file with
the Arizona Secretary of State -- and annually in September thereafter.
Your latest Form 990 must be attached. Most states require a similar
process.12 Instructions and forms are
available over the Internet http://www.azsos.gov/business_services/filings.htm
There are additional requirements if you hire contract solicitors.
The Arizona Corporation Commission requires the filing of an annual
report each year. The forms will be sent to you. Your latest Form
990 must be attached. Go to www.cc.state.az.us
for information over the Internet.
Registration with the Arizona Department of Revenue is required
to obtain tax exemption. Contact the Department to determine if
you are exempt from sales tax. www.revenue.state.az.us
If you will be employing persons, register with the state unemployment
insurance bureau. Information and forms are available at https://www.azdes.gov
Note: You will need to complete numerous forms
for various regulatory agencies. It is your responsibility to research
and know these. Some of these are referenced below:
- You may also wish to apply for a nonprofit mailing permit from
the US Postal Service. http://www.usps.com/businessmail101/misc/nonprofitApplication.htm.
- Obtain directors and officers liability insurance. Go to www.nonprofitrisk.org
for information about risk management and insurance.
- Understand if you need special licenses or permits for your
specific area of service. Professionals and accrediting agencies
will be helpful.
- Contact your county assessor to determine if you might qualify
for property tax exemption. Most nonprofits do not qualify.
- Seek assistance in establishing accounting processes and procedures.
Understand the rules for filing the IRS Form 990 which is a public
document.
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Five
topics to know for your success
Each of the following topics is essential to your success. Information
about them is available at the various resources listed below. In
addition, the Center on Nonprofit Leadership & Management at
ASU offers 10 – 15 hour courses through its Professional Development
program. Please see the schedule posted on this site.
- Governance: what are legal responsibilities of boards of directors;
how do they operate
- Financial Management: what are the basic accounting and audit
requirements; how to develop and read nonprofit financial statements
- Program Knowledge: how to evaluate programming and evaluate
for effectiveness.
- Resource Development: how to develop donor relationships that
lead to effective fund raising; foundation and corporate fund
raising.
- Nonprofit Law and Ethics: what specific laws to know and how
to understand and make decisions that are ethical and sound.
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___________________________________________________
Notes
- http://www.irs.gov.
- Hopkins, Bruce, Starting and
Managing a Nonprofit Organization: A Legal Guide, 3rd ed., Wiley
Nonprofit Series, John Wiley & Sons. 2004. Chapter 1 p.7.
- Hopkins, Bruce, Starting and
Managing a Nonprofit Organization: A Legal Guide, 3rd ed., Wiley
Nonprofit Series, John Wiley & Sons. 2004. Chapter 1 p.7.
- Hopkins, Bruce, Starting and
Managing a Nonprofit Organization: A Legal Guide, 3rd ed., Wiley
Nonprofit Series, John Wiley & Sons. 2004. Chapter 1 p.7.
- Mancuso, Anthony, How to Form
a Nonprofit Corporation in All 50 States, 8th ed., NOLO Press.
2007. Chapter 4 p.61-69
- IRS, Publication 557.
- http://www.guidestar.org.
- Hopkins, Bruce, Starting and
Managing a Nonprofit Organization: A Legal Guide, 3rd ed., Wiley
Nonprofit Series, John Wiley & Sons. 2000. Chapter 5. p.56
- Some of the resources below
are specific to Arizona, Visit your state website, usually www.state.xx.us
(xx=postal abbreviation for your state), and search for similar
deparments and/or tax-exempt and/or nonprofit
- Hopkins; Mancuso.
- Hopkins, Bruce, Starting and
Managing a Nonprofit Organization: A Legal Guide, 3rd ed., Wiley
Nonprofit Series, John Wiley & Sons. 2000. Chapter 2; Mancuso,
Anthony, How to Form a Nonprofit Corporation in All 50 States,
4th ed., NOLO Press. 2002. Chapter 2.
- Mancuso, Anthony, How to Form
a Nonprofit Corporation in All 50 States, 4th ed., NOLO Press.
2002. Chapter 8. pg 148.
- http://www.azsos.gov/business_services/filings.htm
Related
Resources
Education,
Training & Assistance:
- Arizona
State University Lodestar Center for Philanthropy and Nonprofit
Innovation http://nonprofit.asu.edu
- "How
to start anonprofit"; offered semi-annually; includes
review of forms and Federal and State processes.
- 16
courses, 12-16 hours each, on topics of importance to nonprofit
leadership and management; can lead to the Certificate
in Nonprofit Management
- Lodestar
Center for Philanthropy & Nonprofit Innovation at ASU nonprofit.asu.edu
- Area
community colleges and professional and trade associations
offer a variety of courses on nonprofit management issues throughout
the year. These are often published in school catalogs and
through mailings distributed to nonprofit organizations.
- The
Arizona Community Legal Assistance (ACLA) program provides
free legal assistance (non-litigation) to new and existing
charitable community organizations in the health and human
service area. Contact: Phoenix - 602-258-3434, ext. 247; Tucson
- 520-623-9465.
Publications:
- Hopkins,
Bruce, Starting and Managing a Nonprofit Organization: A Legal
Guide, 3rd ed., Wiley Nonprofit Series, John Wiley & Sons.
- Mancuso,
Anthony, How to Form a Nonprofit Corporation in All 50 States,
4th ed., NOLO Press.
Websites:
- Arizona
Corporation Commission www.cc.state.az.us go
to Corporations. Find Checklists, Instructions, Forms on left.
Click on Domestic Profit and Nonprofit Corporations. Follow
instructions.
- Arizona
Department of Employment www.de.az.gov Go
to Unemployment, then to Employer's UI Tax Handbook. You
are looking for information on who must provide and pay for
unemployment insurance and how to register.
- Arizona
Department of Revenue www.revenue.az.gov Go
to Non-Profit Organizations for Publication 501 explaining
which nonprofits are exempt from sales tax.
- Arizona
Department of Revenue www.revenue.az.gov/esa/uitax/emp.asp for
unemployment insurance information and forms.
- Arizona
Secretary of State www.azleg.state.az.us/ars/44/06552.htm You
are looking for Arizona Statute 44-6552.
- BoardSource www.boardsource.org type
in How to Start a Nonprofit in Search window. Also
search this site for information on governance and
strategic planning.
- Foundation
Center fdncenter.org/learn/faqs/html Includes
FAQ section on how to start a nonprofit.
- Guidestar www.guidestar.org Posts
all Forms 990. A good reference for better understand
this important reporting form.
- Grand
Valley State University, "How
To Start a Nonprofit," www.gvsu.edu/philanthropy.
- Internal
Revenue Service www.irs.gov go
to left column and select Charities & Nonprofits; go to left
column and select Forms & Publications, then to Forms & Publications
by number; search for SS-4, Publication 557, and Form 1023.Miller,
Steven T. Director of Exempt Organizations at IRS, article, "Easier
Compliance Is Goal of New Intermediate Sanction Regulations."
- Internal
Revenue Service www.irs.gov/pub/irs-tege/m4958art.pdf.
- National
Alliance for Nonprofit Mailers www.nonprofitmailers.org/news.html for
information and assistance in obtaining
a permit.
- Nonprofit
Risk Management Center www.nonprofitrisk.org for
information about how to assess your needs and types of insurance.
- Miller,
Steven T. Director of Exempt Organizations at IRS, article, "Easier
Compliance Is Goal of New Intermediate Sanction Regulations." Internal
Revenue Service http://www.irs.gov/pub/irs-tege/m4958art.pdf
(This
list of questions regarding "How Do I Start a Nonprofit?" has been developed by the many persons and organizations seeking assistance from the Lodestar Center for Philanthropy and Nonprofits Innovation. We invite you to add your questions and reactions through the" Ask the Nonprofit Specialist" section of the center's
website so that we might improve and expand these FAQ. Updated,
revised 2-09 RD, PFL)
Please note that websites frequently change
and while we endeavor to keep links current, some might not
work. When you encounter such a problem you can help us by
sending an e-mail to robert.duea@asu.edu so that we might
investigate and make changes to our information and links.
Copyright © 2010
Arizona Board of Regents for and on behalf of the ASU Lodestar
Center for Philanthropy and Nonprofit Innovation, College
of Public Programs, Arizona State University. All rights
reserved. No part of this publication may be reproduced,
stored in a retrieval system, or transmitted in any form
or by any means, electronic, mechanical, photocopying,
recording or otherwise, without the express written permission
of the ASU Lodestar Center, except for brief quotations in
critical reviews.
Last updated: 05/10/2010
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