Starting a Nonprofit: Key Legal Steps You Can’t Afford to Skip

Starting a nonprofit can be an inspiring journey. Whether your focus is advancing social change, promoting social justice, or providing direct service, your organization can positively impact countless lives. However, you must lay a strong legal foundation right from the very start. Even the most well-intentioned nonprofit organizations can run into complications that hinder their mission without having performed the right legal steps from the outset.

In this article, we’ll discuss some key legal requirements and considerations for ensuring that your nonprofit complies with federal and state laws to protect your mission and help you achieve long-term success.

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Defining Your Nonprofit

While for-profit businesses focus on generating revenue to benefit owners or shareholders, nonprofits prioritize a mission-driven purpose. Any surplus revenue a nonprofit earns is reinvested into its mission rather than being distributed as profit to stakeholders.

Nonprofits often focus on charitable, educational, or social welfare missions, and many qualify for tax-exempt status, such as the 501(c)(3) designation. Some common types include:

Charitable Organizations: These focus on providing relief to the underprivileged, advancing education, or combating societal issues like hunger or homelessness. Examples include food banks, shelters, and disaster relief agencies.
Educational Organizations: These nonprofits aim to enhance public knowledge or provide specialized education to various groups. This can include private schools, adult learning centers, museums, or cultural institutions.
Religious Organizations: Often focused on spiritual guidance and community support, these nonprofits include churches, synagogues, mosques, and other places of worship.
Scientific and Research-Based Nonprofits: These organizations focus on advancing research in various fields, such as medical research institutes or environmental conservation groups.
Literary and Artistic Nonprofits: These include organizations that promote and support the arts, such as theaters, galleries, or literary societies that provide public access to creative and cultural experiences.

One of the biggest advantages of forming a nonprofit is the ability to apply for tax exemption under Section 501(c)(3) of the Internal Revenue Service (IRS) code. This status provides two significant benefits:

Tax Exemption: A 501(c)(3) organization is exempt from most federal income tax, meaning that it does not pay taxes on its revenue. This allows more resources to be directed toward the organization’s programs and services.
Tax-Deductible Donations: Donors who contribute to 501(c)(3) organizations can deduct their donations on their federal tax returns, providing a powerful incentive for individuals and businesses to support the nonprofit. This can significantly enhance fundraising efforts and build a sustainable base of financial support.

Achieving 501(c)(3) status requires meeting specific criteria, such as demonstrating that your organization serves a charitable purpose and refrains from political campaigning. The process involves submitting IRS Form 1023 or 1023-EZ and detailed financial and operational plans. Working with a knowledgeable attorney during this process is important to ensuring compliance with all IRS regulations and avoiding delays in obtaining approval.

Choosing the Right Legal Structure

Choosing the proper legal structure when starting a nonprofit is one of your most important decisions. It determines how your organization will be governed, how it can raise funds, and the extent of liability protection for its directors and members.

Most nonprofits register as corporations to gain legal protections and to ensure the ability to apply for federal tax-exempt status. Common structures include:

Nonprofit Corporation: This is the most common structure, offering limited liability for directors and officers and making it easier to qualify for 501(c)(3) status. It is ideal for organizations that plan to seek donations or apply for grants.
Unincorporated Associations: While suitable for smaller groups or short-term initiatives, they lack the legal protections and fundraising flexibility of a nonprofit corporation.
Trusts: These are often used for managing charitable assets or endowments but may have more restrictive governance structures.

The structure and corporate tax exemption you select affect everything from tax benefits to how your nonprofit operates. Most nonprofits fall under the 501(c) umbrella and have their own benefits and limitations:

501(c)(3) – Charitable, Educational, Religious Organizations: This is the most popular type of nonprofit structure. It covers organizations with charitable, religious, educational, scientific, or literary purposes. A 501(c)(3) status offers federal tax exemption and allows donors to deduct contributions from their taxes, making it a good structure for organizations that rely on donations and grants.
501(c)(4) – Social Welfare Organizations: These nonprofits focus on promoting social welfare and can engage in more political advocacy and lobbying than 501(c)(3) entities. However, donations to 501(c)(4) organizations are not tax-deductible, which can limit fundraising options compared to 501(c)(3)s.
501(c)(6) – Trade Associations and Business Leagues: This category is for organizations like chambers of commerce and professional associations. It allows for a focus on promoting the interests of members, but like 501(c)(4) entities, contributions are not tax-deductible.
501(c)(7) – Social and Recreational Clubs: This structure is suitable for nonprofits that are organized for pleasure, recreation, or social activities, such as country clubs or hobby groups. While these organizations can be tax-exempt, they are limited in how they can generate revenue from non-members.
501(c)(8) – Fraternal Beneficiary Societies: These organizations operate under a lodge system and provide life, health, or other benefits to their members. Examples include fraternal orders and mutual aid societies. A 501(c)(8) designation is suitable for groups that focus on both social activities and providing financial support to their members, but it comes with specific compliance and membership requirements.

Which Structure is Right for Your Organization?

Consider the nature of your nonprofit sector or organization’s activities and how charitable organizations operate within your state. If your mission is purely charitable or educational, a 501(c)(3) might be most appropriate. However, if your nonprofit will engage in substantial lobbying or political activity, a different type of 501c may better suit your needs.

Also, consider how you plan to raise funds. If you plan to rely on donations from individuals or grant-making foundations, a 501(c)(3) status is advantageous since it offers the benefit of tax-deductible contributions. On the other hand, if membership dues or advocacy efforts will drive your revenue, a 501(c)(4) or 501(c)(6) might be a better fit.

Finally, what kind of governance do you plan to have in place? Different structures come with varying levels of governance requirements. For example, 501(c)(3) organizations must maintain strict records and file detailed annual reports with the IRS. Make sure your organization has the capacity to meet these requirements to avoid compliance issues.

Incorporate Your Nonprofit

Nonprofit incorporation is another key legal step in launching your organization as it provides essential protection and formalizes your organization’s existence.

Incorporating a nonprofit creates a separate legal entity distinct from its founders, board members, and staff. It shields the personal assets of your board members, officers, and founders from being used to satisfy the nonprofit’s debts or legal liabilities. It also enhances the trust and confidence of donors, grant-making institutions, and community partners, demonstrating that the organization is serious, stable, and compliant with legal requirements.

The incorporation process varies by state, so check the specific requirements for where your nonprofit will be operating. Overall, you’ll need to:

Research the requirements on your state’s official website to find details about necessary forms, filing fees, and timelines.
File articles of incorporation with the office that handles nonprofit incorporation (typically the Secretary of State). This step is required for 501(c)(3) status.
Draft bylaws, which are documents that outline how your organization will be governed. Bylaws include important details like how you’ll conduct board meetings and voting procedures, and how you’ll handle conflicts of interest.
Consider drafting a separate conflict of interest policy. While not always required by state law, this document is strongly recommended and often necessary for obtaining 501(c)(3) status. It outlines how potential conflicts involving board members or officers will be managed, promoting transparency and accountability.
Find out if your state also requires an initial report or registration with a state charitable organization registry if you plan to solicit donations.

Forming a Board of Directors

Your nonprofit’s board of directors is the governing body of your nonprofit, overseeing the organization’s activities and ensuring legal compliance. Their role extends beyond day-to-day operations, focusing instead on governance, strategic direction, and fiduciary duties. Key responsibilities include:

Strategic Direction: The board helps set the overall strategic vision and long-term goals of the nonprofit, ensuring that its activities align with its mission and values.
Financial Oversight: The board is also responsible for ensuring sound financial management, approving budgets, and reviewing financial reports. This helps ensure resources are used efficiently and transparently.
Executive Leadership: Hiring, evaluating, and, if necessary, removing the executive director or CEO is one of the board’s key functions, ensuring the organization has strong leadership to carry out its mission.
Compliance and Accountability: The board makes sure that the organization complies with federal and state regulations, as well as its own governing documents, such as bylaws and conflict of interest policies.

Most states require nonprofits to have a full board meeting and a minimum number of board members (usually at least 3). These individuals are responsible for setting the direction of your nonprofit and ensuring the organization remains focused on its mission while maintaining financial integrity.

Establishing policies that prevent conflicts of interest among your executive director and board members is also important. You may run into a situation where a board member might have a business that contracts with the nonprofit. This can create a perception—or reality—of self-dealing, which can harm the organization’s reputation and violate legal standards.

Board members who also serve as paid staff or consultants to the nonprofit must ensure that their decisions are made objectively and not influenced by their personal interests. A clear, strong conflict of interest policy that outlines procedures for disclosing and managing conflicts will ensure your board is making decisions in the best interest of the organization without any personal gain.

Drafting Bylaws

When starting a nonprofit, drafting strong bylaws is a vital step for establishing effective governance. Bylaws act as the internal rulebook for your organization, guiding everything from board meetings to decision-making processes to executive staff.

Your bylaws should clearly outline:

Board Meetings: Bylaws should specify the frequency, format, and requirements for board meetings. This section should include details about quorum (the minimum number of members needed to make decisions), notice requirements for meetings, and whether meetings can be held virtually.
Voting Procedures: Establishing voting procedures is crucial for decision-making. Bylaws should outline how votes will be conducted, including who is eligible to vote, how votes will be recorded, and what constitutes a majority for different types of decisions. This section is especially important for major decisions, such as amending bylaws, approving budgets, or electing new board members.
Conflict Resolution: To address potential disputes, bylaws should include a section on conflict resolution. This can specify how disagreements among board members, officers, or committees will be handled, such as through mediation or by a vote of the board.
Officer Roles and Terms: Bylaws should clearly define the roles of key officers, such as the board chair, treasurer, and secretary, including their duties and the length of their terms. This helps ensure continuity in leadership and clarifies the responsibilities each officer holds.

Your bylaws should be written using clear and concise legal language to avoid ambiguity that could lead to misinterpretations or disputes. Vague or overly complex language can create confusion, making it difficult for board members or staff to understand their duties and responsibilities. Well-drafted bylaws should strike a balance between being detailed enough to provide guidance and flexible enough to adapt to the organization’s evolving needs.

Working with a nonprofit attorney to draft or review your bylaws is highly recommended as they can help ensure that the document complies with state and federal regulations while clearly reflecting your nonprofit’s specific governance needs.

File for Federal and State Tax Exemptions

One of the most important steps when starting a nonprofit is filing for federal and state tax-exempt status. Obtaining 501(c)(3) status from the IRS grants your organization significant tax benefits, including exemption from federal corporate tax and eligibility for tax-deductible donations. To apply, you’ll need to submit IRS Form 1023 or the shorter Form 1023-EZ, depending on the size, charitable purpose, and complexity of your nonprofit.

In addition to federal tax exemption, many states also offer state-level tax exemptions for nonprofits, such as sales tax, state tax, or property tax exemptions. You’ll need to file the necessary state tax forms to ensure that your nonprofit complies with both federal and state tax laws. The sales tax exemption process can be complex, so we recommended closely monitoring deadlines and compiling required documentation.

Obtaining Business Permits and Licenses

Depending on your location and the nature of your nonprofit’s activities, you may need to obtain several different permits and licenses to operate, such as:

General Business License: Most localities require a general business license for any organization operating within their jurisdiction, including nonprofits. This license allows your nonprofit to conduct business legally in the city or county where it is located.
Charitable Solicitation Permit: If your nonprofit plans to raise funds through donations, many states require a charitable solicitation permit, also known as a fundraising license. This permit allows you to solicit donations from the public and ensures compliance with state regulations around charitable giving. Failure to obtain this permit can result in fines and penalties.
Event Permits: If your nonprofit plans to host events, such as fundraisers, fairs, or educational workshops, you may need special event permits from your local government. These permits often regulate aspects like noise levels, crowd size, and parking arrangements.
Health and Safety Permits: Nonprofits that serve food, such as soup kitchens or community events, may need health permits from the local health department. These permits ensure compliance with food safety regulations and help protect the health of those you serve.
Zoning Permits: If your nonprofit will operate from a physical location, such as an office, community center, or shelter, you may need to obtain zoning approval. Zoning permits ensure that your intended activities comply with local zoning regulations for the area.

It’s a good idea to consult with local legal services or government offices to ensure you’ve met all permit and license requirements. A lawyer experienced in nonprofit law can help identify all the permits and licenses your organization needs based on its activities and location. They can also assist in the application process and ensure that you meet all legal obligations before launching operations.

Establishing Strong Financial Systems

Nonprofits must establish and maintain sound financial systems to maintain transparency, manage resources effectively, and build trust with donors and stakeholders. One of the first steps in setting up your nonprofit’s financial system is to maintain separate accounts for nonprofit finances. This means keeping the organization’s funds distinct from the personal finances of board members, staff, or founders. This practice is not just a matter of good bookkeeping—it’s mandatory for maintaining legal compliance and transparency.

To ensure accurate record-keeping, timely reporting, and easy access to financial data, consider using accounting software tailored for nonprofits or working with a qualified accountant who understands the financial needs of tax-exempt organizations. A professional can assist with setting up financial systems, managing payroll, ensuring compliance with IRS regulations, and preparing required forms like the IRS Form 990.

Seek Legal Guidance

Understanding the legal requirements for starting a nonprofit can seem overwhelming, but you don’t have to go it alone. Consulting with a legal professional well-versed in the laws affecting nonprofit incorporation and tax exemption can help you avoid costly mistakes and ensure that your nonprofit complies with all applicable laws.

At Chisholm Law, we provide comprehensive legal services tailored to nonprofits of all sizes. Our experienced attorneys understand the complexities of nonprofit law, helping them secure 501(c) tax-exempt status, build strong legal entities, and establish solid governance structures. Whatever nonprofit you choose to form, our legal guidance and experience can help you build a strong foundation for success.

Start Your Nonprofit With Chisholm Law Today

Starting a nonprofit is an exciting opportunity for social entrepreneurs to make a difference, but it requires careful attention to legal requirements. Every step matters, from nonprofit incorporation and forming a board of directors to securing tax exemptions and complying with charitable solicitation laws.

Chisholm Law understands the unique legal needs of nonprofits. Our legal team is here to help you navigate every step, from your nonprofit idea to securing initial funding to filing for tax exemption. Contact us today to set up your free consultation and ensure that your nonprofit complies with all legal requirements and sets you up for long-term success.

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