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Thinking About Starting a Nonprofit? Here’s What You Should Know—Part 2

Posted by Scott Lynett, Esq. | Apr 05, 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. Last week, in part one of this series, we outlined a few of the most critical things you should know about nonprofit startups, and here we'll finish our discussion.

501(c)(3) Tax-Exempt Organizations

Of all nonprofit organizations, 501(c)(3)s are by far the most common. In fact, whether you know it or not, you've likely done business with one or more of these organizations, which include the American Red Cross, the United Way, the Humane Society, and the Salvation Army.

To be tax-exempt under section 501(c)(3), an organization must be organized and operated exclusively for certain exempt purposes. These purposes include charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.

Fulfilling Your Mission

Once you've clarified your mission, you'll then need to determine the type of activities and services you would want your nonprofit to provide. Are you intending to be a fundraising organization that raises money to distribute funds to other operating nonprofits? Or are you going to operate and provide services? If you are going to operate and provide services, what and who will those services benefit?

If you are going to be raising money, will the money you raise be primarily from one or a few donors, or are you going to raise money from the public? If you are going to raise money from just one or a few donors, then you will likely be a private foundation rather than a public charity, which offers different tax benefits to your donors. If you are not sure about these tax implications and whether they matter to you, discuss that with an experienced business lawyer like us.

If you are going to provide services, you'll need to decide what purpose your services will be designed for. For example, will your activities be for religious, scientific, charitable, educational, literary, public safety, or cruelty-prevention purposes?

When operating a nonprofit organization, you will need to create a business entity for your nonprofit, which could take the form of a corporation, trust, or even an unincorporated association. That said, the unincorporated association form is not ideal if you want any liability protection at all. The corporate form provides the most liability protection for the directors of a nonprofit. Using a trust structure is also possible, but it could provide less liability protection for the trustees than a corporation would provide for the directors of the corporation.

Trustees of a trust have a fiduciary duty to the trust beneficiaries, which is a higher standard of care than the board of directors has to the corporation. In addition, corporations can have perpetual life, whereas trusts, in most states, cannot survive indefinitely, due to a rule called the Rule Against Perpetuities. However, 20 states have now repealed this rule, so if you are going to use a trust structure for your nonprofit, make sure the state you are governed by allows for perpetual trusts.

Meet with us, as your Family Business Lawyer™, for support in choosing the entity that's best suited for your nonprofit's particular mission and services.

Filing Form 1023

Once you have formed your entity, you will file Form 1023 electronically with the IRS to establish your tax-exempt status as a 501(c)(3). One exception to this requirement is a church. A bona-fide church (including synagogues, temples, and mosques) that meets 501(c)(3) requirements is automatically considered tax-exempt without having to file Form 1023 for tax exemption.

Depending on your situation, you may be eligible to file a streamlined version of this form, Form 1023-EZ. Instructions for both forms can be found on the About Form 1023 page on the IRS website.

You can file Form 1023 on your own, without the help of a lawyer, but it will be much easier for you if you work with a lawyer, particularly one who has experience with nonprofits. Call us to find out if we can help before you get started.

The Business of the Nonprofit Business

Again, you don't want to launch a nonprofit just to avoid the “business” aspects of running a business. You should form a nonprofit because you are passionate about its mission and want to benefit your community through your organization.

That said, if your nonprofit is going to succeed, you'll still need a head for business, and access to the proper legal, insurance, financial, and tax (LIFT) systems, which form the foundation of any successful company. As your Family Business Lawyer™, we can not only help you get your nonprofit off the ground, but we can also ensure you have the proper LIFT systems in place, so your nonprofit can do the most good for the most people, and you can have a business you truly love.

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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