All Posts by acnonprofitlaw

Basic Overview of the Process of Incorporating 501(C)3s

If you already know what your nonprofit organization is doing, then you’re already in good shape. You’ll need to file articles of incorporation with the state you’re registering in. A lot of states, like TX and CA, have nonprofit-specific forms that you can fill out online.

After you do that and the articles are approved, your next step is checking the state AG/SOS site for any other forms you need to file. The forms you need to file could be specific to what your organization is doing. So for example, a family foundation in CA will have to pay to register with the state AG’s office, but if you’re starting a church or some other religious organization, they are exempt from those filings.

You should also check your city or county if you need to register for any business licenses too.

Once you complete all the required supplemental filings, you should first write your organization’s bylaws, including coming up with a conflict of interest policy. There’s a lot of templates and examples online, and you can choose whichever one you like. A lot of foundations put theirs online too so you can use that as a reference.

Finally, the 1023 application – applying for tax-exempt 501(c)3s status. There are two main ways to apply – on paper, the 1023 application requires you to list all your financials to date and where you expect the nonprofit to be two or three years down the line. They also ask a lot of questions about the activity you will be engaging in. The turnaround time is typically around 4-6 months but could be longer with a more complicated application.

If you don’t anticipate taking in more than $50k for each of the first 3 years, then you can apply for a 1023-EZ application on the IRS website. It’s a two page, online application and you get a decision within a week and a half to two weeks. I do believe that a lot of 501(c)3s go over the 50k but I actually have not heard of the IRS revoking tax-exempt status for doing so. If you think you’re going to be taking in above $50k in grants or donations, I would do the 1023 full application.

And make sure you file the form 990s every year! They are basically your organization’s tax returns. Even though you may be tax-exempt, these filings are still important as they help the IRS determine if you are in compliance with all tax laws and failure to file can result in significant tax penalties.

Who Makes Decisions in a 501(c)3?

A 501(c)3 nonprofit is essentially a business – one that acts in the public interest and does not need to pay taxes. As such, the decision-making process should be modeled after corporations. So in addition to having officers such as CEO/President, Vice President, you also need a board of directors. 

The board of directors (BOD) will make all the decisions that the CEO/President carries out. It is important for private foundations, as well as public foundations, to have one. Private foundations are usually family-oriented, so this results in a lot of IRS scrutiny of their decisions. Therefore, it is advisable that there be at least 2 disinterested (non-family) members on the board of directors that can make decisions in case the family members on the board might need to recuse themselves. Interested family members include siblings, in-laws, parents and grandparents, cousins, aunts, and uncles. 

The board of directors are responsible for the direction and the actions of the nonprofit. They can vote to remove or replace the CEO, approve projects, and even vote to dissolve the nonprofit. The full scope of duties for the board of directors can be detailed in the organizational bylaws. As such, they are extremely important to the function of an organization and their actions could be closely scrutinized by the IRS. The directors will have to act in the best interest of the nonprofit and not act to enrich themselves or their family. 

In California, organizations are required to have a CEO/President, a chief financial officer, and a secretary. There is no requirement that they all have to be different people. While I generally do not recommend it, there are organizations when all three roles are filled by the same person. The CEO/President runs the day-to-day of the organization as well as carrying out duties tasked by the BOD. The chief financial officer is obviously in charge of the finances. A secretary is, what I believe, the most important job. They are responsible for taking notes and meetings of BOD and officer meetings. This is especially important because the notes will be what the organization and the IRS refers to in the event of an audit.

Avoiding Self-Dealing

The biggest trap that most private foundations fall into is self-dealing. Self-dealing is very broadly defined, but the general definition is officers and directors using foundation funds to enrich themselves or their business. Blatant examples include directly taking foundation funds or donations and putting them into personal accounts. However, there are also less obvious forms of self-dealing. This post will detail them here and how to avoid them. And if certain self-dealing actions are unavoidable, how to avoid being penalized by the IRS. 

One form of self-dealing is steering foundation work and contracts to businesses owned by family. For example, your foundation might need a CPA or attorney. You just so happen to have a brother who owns his own firm, so you pay him to handle your legal or tax affairs. This is an example of self-dealing. A related example is when a director or officer owns – say a printing business – and the foundation contracts with that person’s business to print tshirts and mugs. This is an example of self-dealing in that you are using foundation funds that can indirectly benefit you. By itself, this can draw IRS penalties that can be financial, and in the worst case scenario, result in revocation of tax-exempt status. There are ways to avoid this however. 

First, you should have a policy to deal with instances of self-dealing in your bylaws. This is not mandatory but is very helpful to refer to. The policy should dictate that when deciding on having that brother work on your taxes, or have the officer’s business print your merchandise, that you solicit quotes and selected the lowest quotes possible. Next, it is important to show that the interested person – the one who’s brother owns the business, or the officer – is removed from the decision making process. To the IRS, a group of disinterested parties – those who wouldn’t financially benefit – making the decision will make the choice look more credible. This takes me to my final point, which is to keep copious notes of all meetings, so in the event that the IRS does audit you for self-dealing, you can show that you have taken all the right steps and avoid penalizing.