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Non-Profit Nuances III: How to Create a Not for Profit Corporation

February 26, 2017

 

 

So, it’s Spring, the season of renewal.[1]  Winter’s chill begins to give way to the warming embrace of new beginnings, much like our New Year’s resolutions taking hold and blossoming into new ways of life.  Perhaps, this “something” in the air is the reason that lately I have been receiving so many questions about nonprofits.  Therefore, I am inspired to give a short talk on the way to give life to a dream to make the world a better place - how to create a nonprofit from scratch.

 

Disclaimer: The following information does NOT constitute legal advice and is only for general educational purposes.  Each situation is different and specific legal issues usually require additional research and investigation, so please do not rely on this article to address a particular legal issue; use this as a starting point to gain a general understanding.  This article, although educational in purpose and substance, nevertheless, might be deemed attorney advertising, and prior results do not guarantee future success.

 

I.  Planning

 

Before I bore you half to sleep with all the legalese, let’s cover a few basics. 

 

You should have a purpose that’s either to help someone or something (children, animals, trees) or benefit “members” of some kind (a professional association, a civic league, a local group of folks in the same neighborhood).  Give some thought to whether you might want to expand the scope of your nonprofit in the future. 

 

Example: If you plan to benefit your neighborhood, will you want to expand to your entire county at some point? If you want to save trees, might you want to engage in other environmental activities once you become viable? Leaving yourself some flexibility at the start could help you avoid some paperwork headaches later on.

 

You also might want to think twice about duplicating existing efforts: for example, if you’re going to raise money to fight a particular disease, is there a reason the much larger and better organized current foundations and charities aren’t good enough? Can you fill some kind of niche they don’t?

 

I’m not saying you can’t.  Maybe there’s a sub-group not well served by existing organizations that you could do better? But if you can’t, consider instead volunteering for an existing organization rather than going through the expense and effort of doing this, as there is potentially a lot of work involved, not only in forming a nonprofit, but also maintaining it.

 

In addition, you will need at least two dedicated friends, a “business” plan (I use that term loosely) for three years (I’m not making that up; if you want to be tax-exempt, the IRS will want to know your planned / estimated finances three years ahead),[2] at least $1,000 for fees,[3] and be ready to fill out a bunch of paperwork.

 

Why Are Non-Profits Often Corporations?

 

In my original blog article of this series I talked about how nonprofits constitute something like close to one trillion ($1T) (yes, T R I L L I O N) in annual GDP, about 10% of the country’s workforce and tens of millions of volunteers.[4]  Fairly heady stuff. 

 

Often, nonprofits are corporations, but also[5] can be an “unincorporated associations”[6] or even “trusts” [7]. Unincorporated associations arise by “operation of law” when two or more people raise money for a temporary specific cause, such as rebuilding a damaged church or funding a school trip. 

 

In other words, you don’t need to do anything special to create them - if you and your friend are raising money for your school program, tada! You’re an “unincorporated association nonprofit.” Often, these unincorporated associations come and go as needed, and are small and spontaneous - in such a case, they only need file with the IRS if they raise more than $5,000.[8] 

 

However, if unincorporated associations raise ‘too much’ money or stick around for awhile, they, like their corporate counterparts, can apply for IRS tax exemption (otherwise, technically, they are subject to taxes, despite their ad-hoc origination and charitable intentions).  Trusts also can be used to raise money for other worthy causes and are relatively easy to create, but have limited flexibility.[9]

 

Incorporated nonprofits have corporate legal protection and maximum flexibility, depending on how they are created and run.  By “corporate legal protection” I mean participants *generally* are more shielded from personal liability for mishaps and missteps. 

 

For example, suppose you are collecting donated furniture for a new charity, and the furniture contains bed bugs and the recipients sue you for the cost to remedy the critters or the damage they cause.  Or if a volunteer gets into a car accident while transporting the furniture, it might be possible to hold the other volunteers responsible - particularly if you all were celebrating your fundraising skills at the local restaurant with a burger and beer. 

 

Another good thing about corporate form is that it can provide a sense of permanency to your venture.  They stay on the books (whether you want them to or not).  They hold assets forever, and those will go to your worthy cause whether or not you lose interest in it.  They provide a legal structure to facilitate longevity for years to come, so that your legacy will live on.  Something to think about anyway.

 

II.  Incorporation on the State Level

 

For the purposes of this blog, I’m gonna go with the corporate form.  But where do they come from?

 

Well, first thing you should know is that almost all corporations are creatures of the State, not the federal government, i.e. with very rare exception, there is no such thing as a “federal corporation.”  The underlying structure of virtually all corporations, no matter what they are, is that they are “incorporated” on the “state” level and every state has their own rules for doing it, although they are, for the most part, fairly similar. 

 

However, there are differences between “for-profit” corporations and “not-for-profit” corporations.  As the name implies, the former are designed to make profits, for their shareholder owners (i.e. if you own 50 of the 200 shares of the corporation, you “own” 25% or a quarter of the corporation and can expect proportional profits).  In New York, “for-profit” corporations have their own set of governing law called the “New York Business Corporation Law.”

 

By contrast, “not-for-profit” corporations (at least in New York State) are organized either for “Charitable” or “Non-Charitable”[10] purposes; either way, it’s not for the profit or self-enrichment of the individual participants (although, for instance, a trade association could promote the economic interests of their membership as a whole).  And, oh, if you’ve done this before and remember New York’s old, “Type A, B, C or D not-for-profits” … well, they’re gone, thanks to the 2013 Nonprofit Revitalization Act.[11]

 

Anyway, you should know that “Charitable” and “Non-Charitable” are not soft and fuzzy words, but have actual legally enforceable meanings: “Charitable” means for “charitable, educational, religious, scientific, literary, cultural or for the prevention of cruelty to children or animals[12] (and yes, I know, part of that definition was circular, but don't blame me, I didn't write the law).

 

“Non-charitable” means “any corporation formed under this chapter, other than a charitable corporation, including but not limited to one formed for any one or more of the following non-pecuniary purposes: civic, patriotic, political, social, fraternal, athletic, agricultural, horticultural, or animal husbandry, or for the purpose of operating a professional, commercial, industrial, trade or service association.”[13]

 

So, what does one do to actually make this happen? In New York, you file the correct paperwork with the State Department of State[14],  which usually takes about seven business days, but can be expedited for additional fees. 

However, the paperwork can be bounced for any number of reasons, including the State doesn’t believe you have an appropriate purpose, you don’t have the correct approvals,[15] you don’t have the minimum number of directors (three), or any number of reasons. 

 

Within that paperwork certain key information will be required, including the general purpose, names of at least three directors, whether it’s a member organization or not, and certain “magic” tax language required by the IRS, depending on the type of nonprofit.  Theoretically, you can include other key limiting or empowering language as well, although many prefer to keep it simple, and if necessary, place that kind of info in the bylaws.

 

Once you do that, you’ll need to hold an organizational meeting,[16] where you will approve the Directors (unless the original ones still wish to serve), pass a set of bylaws,[17] and approve a conflicts of interest policy.[18]  You might also establish a regular meeting schedule for Directors, create a business plan, hire professionals, buy insurance, plan for or rent out permanent office space, etc.  In short, you are now running an organization, so get used to making decisions and planning ahead. 

 

Oh, and definitely TAKE MINUTES.[19]  Look, you don’t have to be Shakespeare, and you aren’t required to transcribe every word said.  That said, you should make sure you notate how formal corporate procedure was followed, record votes, and especially record anyone who dissented (this might protect them from liability if the Board made a poor decision).

 

III.  The Internal Revenue “Service”

 

So, you’re all incorporated on the State level, held your first meeting, and now you can start soliciting money and handing out tax-exempt donations, right? BUZZZZZ.  Wrong answer.  Incorporating is just the first step.

 

Next stop is requesting an Employment Identification Number (EIN #) from the IRS.  Good news: it’s free, and if you do it yourself, you can get it instantly over the web.  Generally, if you have a third party do it for you, the IRS eventually will mail it to you a few weeks later.  Easy enough, if everything were only so.

 

Now, comes the real work.  If you want tax-exempt status, you’ll most likely need to file some flavor of IRS Form 1023 or 1024.  Depending on certain thresholds of how much money you expect to actually raise and handle, you may get off relatively easy and file something like an IRS Form 1023EZ, or if you’re really small, like under $5,000, you might not have to file at all.

 

Depending on attachments, a full blown IRS Form 1023 can start taking on some serious heft.  1023s are used for your typical 501(c)(3) charitable organization.  1024s essentially are for everyone else (think professional associations or civil leagues or … well, the list is kinda long)[20].

 

Even if you file an IRS 1023, and apply for tax-exempt status under 501(c)(3), things get a bit more complicated and weird.  By default, you are classified as a “foundation” which has some disadvantages and some advantages, which I plan to address in a future article. 

 

I feel many people, however, envision more of a “public charity” status, which also has its perks.[21]  If you desire to be a “public charity” you will have to fight a bit for it and work with the IRS to achieve this.  Generally, you need more support and broader board participation.  This is a crucial time in the process you’ll really have to pay attention.

 

Once you surmount those hurdles, you’ll have some annual requirements, like filing the IRS Form 990, and some other requirements, and making financial information available (such as the original application, tax returns, and possibly individual donor contributions).[22] 

 

Many nonprofits deal with disclosures by posting them online.[23]  Failure to comply can result in penalties and possibly suspension or loss of your tax exempt status.  In any event, you can expect to wait several months or more for an “IRS Determination Letter” declaring whether or not you’re tax exempt (but if you take care of this within 27 months of your creation, tax-exempt status is retro-active).

 

IV.  Back to the State

 

If you’re not the type to rest on your laurels while you’re waiting for the IRS, you can get a start on other parts of the process.  If you’re going to hold charitable assets or solicit money in New York, you’ll most likely need to register with the New York Attorney General.  If you’re not raising that much money (less than $25,000 a year) you can request an exemption from registration. 

 

But ... you are not permitted to solicit money until you register with them, so do it.  Registration usually takes a few weeks (or more).  The nice thing is that you can register even before you are approved by the IRS, just include your IRS 1023 / 1024 application.  Eventually, you will want to apply for exemptions from the New York sales tax, and corporate franchise tax, and possibly some others.  Being a nonprofit is great when it comes to avoiding taxes!

 

V.  Continuing Obligations

 

Guess what? You’re gonna have a fair amount of responsibilities going forward.  Among them will be: regular board meetings and minute keeping to keep your corporate status.  Annual filings with the IRS.  Annual filings with the NYS Attorney General and possibly other State tax departments.  Paperwork to donors who will need proof of donations.[24]   Other things as well no doubt, especially if you take on employees, or apply for government grants, etc.

 

Conclusion

 

As I said, nonprofits contribute enormously not only to the good causes to which they are dedicated, but also to the economy as a whole.  They are inextricably woven into the framework of our society; a patchwork quilt enmeshed into the very fabric of everyone you know and don’t know. 

 

Your participation in your chosen worthy activity, especially at such a high level of involvement and sophistication, will shield someone or something from harm, nurture it, and with your own efforts, make the world a better place.  So, don’t let a few paperwork requirements get in your way; it’s only a test of your resolve.  Pass the test, and take your rightful place in the world as a doer of great deeds.[25]

 

***

 

[1] “A Prayer In Spring” by Robert Frost.  http://poetry.about.com/library/weekly/blfrostspring.htm?_ga=1.244471296.485538097.1488847990.

 

[2] https://www.irs.gov/charities-non-profits/form-1023-required-financial-information.

 

[3] Currently, estimated about $75 for New York State incorporation incorporation and about $850 for the IRS, plus potentially others.

 

[4] https://www.lanerlegal.com/single-post/2016/07/08/NonProfit-Nuances-The-Three-Duties-Care-Loyalty-and-Obedience.

 

[5] https://www.irs.gov/charities-non-profits/application-process.

 

[6] http://www.nolo.com/legal-encyclopedia/what-an-unincorporated-nonprofit-association.html.

 

[7] http://smallbusiness.chron.com/use-trust-nonprofit-37683.html.

 

[8] https://www.irs.gov/charities-non-profits/charitable-organizations/organizations-not-required-to-file-form-1023.

 

[9] http://money.howstuffworks.com/economics/volunteer/starting-a-charity/charitable-trust.htm.

 

[10] N-PCL, §201.

 

[11] In 2013, New York passed the Not for Profit Revitalization Act and abolishing the old Type A, B, C and D classifications, and simplified it into charitable and non-charitable.

 

[12] N-PCL, §102(3a-b).

 

[13] N-PCL, §102(9a).

 

[14] By the way, this is obviously not the same as the United States Department of State.  Remember the 50 States are their own mini-sovereign governments, and they need a department to handle general administrative duties like licensing professionals, overseeing corporate recognition, and maintain records, etc.  https://www.dos.ny.gov/about/aboutus.html.

 

[15] N-PCL, §404.

 

[16] N-PCL, §405.

 

[17] N-PCL, §602.

 

[18] N-PCL, §715a.

 

[19] N-PCL, §621.

 

[20] https://www.irs.gov/pub/irs-pdf/f1024.pdf (see the top of Part I).

 

[21] https://www.irs.gov/charities-non-profits/eo-operational-requirements-private-foundations-and-public-charities.

 

[22] https://www.irs.gov/charities-non-profits/public-disclosure-and-availability-of-exempt-organizations-returns-and-applications-public-disclosure-requirements-in-general.

 

[23] https://www.irs.gov/pub/irs-pdf/p4221pc.pdf.

 

[24] https://www.irs.gov/charities-non-profits/substantiating-charitable-contributions.

 

[25] https://www.youtube.com/watch?v=mxOMCH6rapU (enjoy!).

 

***

 

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