Top Legal Considerations for Starting a 501(c)(3) Nonprofit Organization

Starting a 501(c)(3) nonprofit organization can be a rewarding endeavor, allowing you to make a lasting impact on your community. However, establishing and maintaining a successful nonprofit is not just about having a great mission; it involves careful legal planning and compliance with state and federal laws. Understanding the key legal considerations from the outset will help ensure that your organization is structured to thrive in the long term.

Here are the top legal considerations you must address when starting a 501(c)(3) nonprofit organization:

Defining the Purpose of Your Organization

The first legal consideration when forming a 501(c)(3) nonprofit is defining its purpose. The IRS requires that organizations seeking 501(c)(3) status serve one or more of the following purposes:

Charitable
Religious
Educational
Scientific
Literary
Testing for public safety
Fostering national or international amateur sports competition
Preventing cruelty to children or animals

Your organization’s purpose must fit within one of these categories. This is critical because the IRS will evaluate whether your nonprofit’s purpose aligns with these criteria when deciding whether to grant tax-exempt status.

Creating a Legal Structure

Before applying for 501(c)(3) status, you must choose an appropriate legal structure for your nonprofit. The most common and appropriate structure is the nonprofit corporation. Incorporating your nonprofit offers several benefits, including limited liability protection for board members and officers, and a more professional structure for governance and accountability.

You will need to file articles of incorporation with your state’s secretary of state or another business filing agency. These articles must include specific language required by the IRS to ensure that your nonprofit qualifies for 501(c)(3) tax exemption. For example, they should state that your organization is formed for charitable purposes and that, upon dissolution, its assets will be distributed to another tax-exempt entity.

Developing Bylaws

Bylaws are the governing rules of your nonprofit, and they are a critical legal document. They outline how your organization will operate, how decisions will be made, how board members will be elected, and what the responsibilities of officers will be. Although the IRS does not require you to submit your bylaws with your 501(c)(3) application, they are necessary to maintain your nonprofit’s legal structure and compliance.

Crafting comprehensive and clear bylaws is essential for avoiding internal conflicts and ensuring the nonprofit operates effectively. Additionally, many states require nonprofits to submit their bylaws when applying for incorporation or state-level tax exemptions.

Forming a Board of Directors

Selecting the right board of directors is another crucial legal step. A 501(c)(3) organization must be governed by a board that acts as the fiduciary for the nonprofit’s activities and finances. Board members are responsible for steering the organization toward its mission while ensuring legal compliance.

It’s important to understand that board members cannot receive financial benefits from the organization, aside from reimbursement for legitimate business expenses. The IRS imposes strict rules to prevent conflicts of interest and self-dealing. Therefore, ensure that your board of directors includes individuals who are not financially tied to the organization, as this could jeopardize your tax-exempt status.

Applying for Employer Identification Number (EIN)

An Employer Identification Number (EIN) is like a social security number for your nonprofit. It is necessary to open bank accounts, hire employees, and file IRS forms. To obtain an EIN, you must file IRS Form SS-4, either online or by mail. Obtaining an EIN is a straightforward process, but it’s essential to have it before moving forward with other legal steps, such as applying for tax-exempt status.

Filing for 501(c)(3) Tax-Exempt Status

The cornerstone of starting a 501(c)(3) nonprofit is obtaining tax-exempt status. This involves completing and submitting IRS Form 1023 (or Form 1023-EZ, depending on your organization’s size and scope). Form 1023 requires detailed information about your nonprofit’s structure, mission, governance, and financial activities. The IRS will closely review your submission to determine if your organization qualifies for tax-exempt status.

Keep in mind that the application process can be lengthy, sometimes taking several months for approval. During this time, your organization may still operate, but donations will not be tax-deductible for donors until the IRS grants tax-exempt status. Once approved, the nonprofit must annually file IRS Form 990 to maintain its tax-exempt status.

Compliance with State and Local Requirements

In addition to federal requirements, you must comply with state and local regulations when starting your nonprofit. These requirements vary by state but often include:

Registering with the state attorney general’s office if your nonprofit will be soliciting donations.
Obtaining state-level tax exemptions.
Filing annual reports with your state’s business or nonprofit regulatory agency.

Failure to comply with state laws can result in fines, loss of tax exemptions, and even the involuntary dissolution of your nonprofit.

Charitable Solicitation Laws

If your nonprofit will be fundraising, you must also comply with charitable solicitation laws, which vary by state. Most states require nonprofits to register before they can solicit donations. Some states have ongoing reporting requirements, meaning your organization must regularly file financial reports showing how funds are being used. Violating these laws can result in fines or the revocation of your fundraising privileges.

Avoiding Private Inurement and Private Benefit

One of the most critical legal requirements for 501(c)(3) nonprofits is to avoid private inurement and private benefit. In short, no part of the nonprofit’s income or assets can benefit private individuals, such as board members, officers, or other insiders. The IRS is strict about this, and violations can result in heavy penalties or the revocation of tax-exempt status.

Maintaining Compliance After Formation

Forming a 501(c)(3) nonprofit is only the beginning. Ongoing legal compliance is essential to ensure your organization maintains its tax-exempt status and remains in good standing with both the IRS and state agencies. This includes:

Filing annual IRS Form 990.
Keeping accurate financial records.
Ensuring the board of directors meets regularly and adheres to its fiduciary duties.
Complying with employment laws if the nonprofit has staff.

Failure to meet these obligations can result in penalties, including fines or revocation of tax-exempt status.

Final Thoughts

Starting a 501(c)(3) nonprofit requires more than passion and a commitment to your cause. It involves understanding and navigating a variety of legal requirements at both the federal and state levels. Consulting with a 501(c)(3) attorney to help guide you through the legal process can be invaluable in ensuring that your nonprofit is set up correctly, remains compliant, and is able to focus on achieving its mission.