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Thinking About Starting a Nonprofit? Here’s What You Should Know—Part 1

Posted by Scott Lynett, Esq. | Mar 29, 2022 | 0 Comments

Starting a nonprofit organization can be a great way to give back to your community, while working for a cause you are passionate about. That said, if you are starting a nonprofit simply to avoid some of the more unsavory aspects of running a business, you should seriously reconsider.

As the founder of a nonprofit, you will still be “in business,” and you'll have to deal with many of the same things for-profit business owners face when running their companies. The main difference is, when running a nonprofit, you'll be working in service to your mission, rather than in service to yourself or to the other owners of your business—and that's because there are no “owners” of nonprofits!

Ownership is just one of many unique aspects involved with starting a nonprofit, and there are several other important factors you should consider before launching your own organization. Here we've outlined some of the most critical things you should know about nonprofit startups.

What is a nonprofit?

The term “nonprofit” typically refers to an organization that works to serve a public purpose, as opposed to serving for the financial benefit of a particular person, entity, or corporation. As such, traditional nonprofits are organized around a shared mission, social cause, or community need, and they work to provide some sort of public good.

Note that a nonprofit organization is distinct from a “not-for-profit organization” or NFPO. In contrast, a NFPO does not need to provide for the public good and can be organized solely to benefit its members or a community. Here we're going to solely focus on nonprofit organizations, but look for a future post on NFPOs.

You can think of your nonprofit as a business that has no owners or shareholders. And a nonprofit does not pay taxes like a regular business would, either. However, a nonprofit is still a business in the sense that it needs to bring in money, it has expenses, and the money that it brings in has to be sufficient to cover the expenses.

This is where the term “nonprofit” can be confusing. Despite the term, nonprofits can and do earn a profit—they wouldn't be able to survive otherwise. However, unlike for-profit businesses, nonprofits don't distribute their profits to their members as personal income. Instead, a nonprofit's excess revenue goes toward furthering the organization's mission, whether that's growing the organization, paying employees, supporting fundraising, or supporting other nonprofits with a similar mission.

What's more, as long as you don't violate any rules against self-dealing by overpaying yourself or by commingling your personal assets with those of the nonprofit, one of your organization's expenses can include paying yourself a salary to run the nonprofit. So even though your nonprofit's purpose is to further your chosen mission, rather than benefiting yourself personally, that doesn't mean you can't pay yourself a reasonable salary.

Clarifying Your Mission

The starting point for all nonprofit organizations is to clarify your mission. Clarifying your mission is about defining and quantifying the cause, problem, or issue your organization wants  to address. Similar to a for-profit business, this involves researching whether there is a sufficient demand for the services your nonprofit would provide. And if there is sufficient demand, you must determine what kind of market already exists for those services. As with any business, there is serious competition in many nonprofit sectors for a limited amount of funding.

If your nonprofit is going to succeed, you'll need to ensure that your organization is properly positioned and well equipped to fulfill this demand. As you are doing your research, survey the field to find out whether anyone or any organization is already doing what you want to do. If you find an already established organization that shares your mission, then your time, energy, attention, and money might be put to better use by joining or collaborating with them, rather than duplicating their efforts.

Setting up a nonprofit

In the U.S., the IRS recognizes 29 different types of nonprofit organizations, the most common type being a 501(c)(3), which we'll cover in detail below. Outside of 501(c)(3)s, there are 501(c)(5)s, which include labor unions, and 501(c)(4)s, which include social welfare organizations, and 501(c)(7)s, which include social and recreational clubs. In all cases, the organization begins with a business entity, which can be set up in a few different ways (more on that below) depending on state law.

As mentioned earlier, the “ownership” of a nonprofit can be somewhat confusing. No person or group of persons can own a nonprofit. Instead, once incorporated, the newly created nonprofit organization is a separate legal entity from its incorporators, directors, officers, and employees. A nonprofit corporation owns all assets of the business. And because there are no owners, nonprofits are typically managed by a board of directors or by its members.

The tax status of your nonprofit is determined by a filing to the IRS, which happens with IRS  Form 1023, which we'll discuss in-depth in next week's article. As with all business entities, the entity is formed under state law, while the tax status is determined at the federal level.

Similar to other businesses, incorporating a nonprofit follows a few general steps:

  1. Choose the name of your nonprofit.
  2. Incorporate your entity through your state.
  3. Apply for your IRS tax exemption.
  4. Apply for your state tax exemption, if applicable.
  5. Prepare bylaws.
  6. Appoint directors.
  7. Hold a meeting of the board.
  8. Obtain necessary licenses and permits.

Next week, in part two of this series, we'll complete our discussion of what you should consider when starting a nonprofit organization.

We offer a complete spectrum of legal services for business owners and can help you make the wisest choices on how to deal with your business throughout life and in the event of your death. We also offer you a LIFT Your Life And Business Planning Session, which includes a review of all the legal, insurance, financial, and tax systems you need for your business. Schedule online today.

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