What is a Nonprofit Organization?

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1 Chapter Six Page 50

2 What is a Nonprofit Organization? A nonprofit organization (NPO), also known as a not-for-profit organization, is a business entity that uses surplus revenue to achieve a goal that benefits the common good rather than distributing them as profits or dividends to employees. A nonprofit organization is allowed to make money, but any surplus revenue must be used to further the cause of the organization by paying for supplies, advertisement, expansion, or staff. Profits are not allowed to be used on any member for personal reasons, or to raise the pay of any individual staff member. Money can still be made but excess profits may be constrained or restricted. In contrast, a for-profit organization has no limit to the amount of money they can make, but must pay taxes on those profits; NPO s are almost always tax-exempt. Furthermore, if a for-profit goes out of business its assets can be liquidated and the proceeds distributed to owners and shareholders personally, but if a non-profit goes out of business all of its capitol must be given to another NPO or charity. What are the benefits? Becoming a non-profit organization is a lengthy and difficult process, but wields significant benefits. California has the highest number of non-profit organizations at nearly 230 thousand active non-profits. These benefits include tax exemption on most taxes, low or zero interest on business bank accounts as well as avoiding the need to pay taxes on any interest earned in the account, qualifying for public and private grants and donations, and legal protection. However these benefits do come with some responsibilities such as the need for continuous and accurate record keeping of income, payments, and documents. Page 51

3 Become a Nonprofit Organization Becoming a Nonprofit Organization can be done, but requires organization and multiple legal steps to be taken. Completing these tasks within a timely manner is to the benefit of your group, and by staying on top of deadlines and finances your Neighborhood Association can become a non-profit organization within a year. The process of becoming a non-profit can start before or after a Neighborhood Association is established, but reaching for NPO status after making a Neighborhood Association can be easier as many of the necessary items you may have already created for your association. The Following is a detailed list of steps the all need to be completed in order to be recognized as a nonprofit. We recommend you hire a legal consultant to help complete these tasks as many require excellent skills with law and organization. Name 1. When creating a Neighborhood Association a name is required by the city of Sacramento, so by getting an approved organization name from the IRS you only have to decide on a name once for the city. a. A name may be used only if it is not the same or too similar to an existing name on the records of the California Secretary of State or if is not misleading to the public. b. Apply for the name you ve chosen at the state filing office website ( and filling out the Name Availability Inquiry Letter. or Phone requests cannot be made. c. Once a name your organization likes is available you can reserve it for a small fee of $10.00 for 60 days or until you have filed your Articles of Incorporation. d. Fill out and send in your Articles of Incorporation ( along with the required fees. ($30-100) Page 52

4 Mission Statement 2. Nonprofit organizations are made to benefit the public or meet a specific goal. That means you need to create a concise mission statement that describes the name, purpose, goals and location of service that your NPO provides in one or two sentences. Here is an example of what one might look like for a Neighborhood Association: Example Mission Statement: The River City Neighborhood Association is a nonprofit organization, based in the heart of Downtown Sacramento, created to improve the lives of its residents and businesses. We strive to reduce crime, pollution, and blight, while increasing education, infrastructure, and community within the downtown area. Hire Legal Assistance 3. Hiring an attorney with 501(c)(3) experience will assist you when filing legal documents like Article of Incorporation and bylaws. Go to the State Bar of California ( There you can find an attorney with experience in non-profit law to assist you. File All Necessary Documents 4. Articles of Incorporation protect board and staff from legal liabilities incurred by the organization, making the corporation the holder of debts and liabilities instead of individuals. The specific requirements are determined by each state. You can obtain the information you need to proceed with this step from your state Attorney General s office or your Secretary of State's office. These official documents may have different names in different states. You may see names like "corporate charter," "trust instrument" or "articles of association." Apply for a federal employer identification number. Regardless of whether or not you have employees, nonprofits are required to obtain a federal Employer Identification Number (EIN), which is also referred to as the federal ID number. Page 53

5 Create your Financial Structure 5. Hire a certified public accountant (CPA). Consider the following factors: a. Look for an accountant who has experience with organizations like yours. Someone who's never worked with a 501c3 may not have the experience to handle the nuances of the process. b. Make sure that you feel comfortable with the person. The person should reliable, should listen to your concerns and should respond to requests as soon as possible. c. Choose a firm that matches the size of your nonprofit. If you're a small 501c3, then choose a CPA who works alone or a small firm. For large nonprofits, choose a large firm with a good reputation. d. Take time to make your choice. Look for referrals and references and interview different candidates so that you make the best choice from a pool of available accountants. Develop a Financial Structure 6. Hire a certified public accountant (CPA). Consider the following: a. Look for an accountant who has experience with organizations like yours. Someone who's never worked with a 501c3 may not have the experience to handle the nuances of the process. b. Make sure that you feel comfortable with the person. The person should reliable, should listen to your concerns and should respond to requests as soon as possible. c. Choose a firm that matches the size of your nonprofit. If you're a small 501c3, then choose a CPA who works alone or a small firm. For large nonprofits, choose a large firm with a good reputation. d. Take time to make your choice. Look for referrals and references and interview different candidates so that you make the best choice from a pool of available accountants.[1] Page 54

6 Develop a budget 7. Creating a budget is often one of the most challenging tasks when creating a nonprofit organization. A budget is the expression, in financial terms, of the plan of operation designed to achieve the objectives of an organization. New organizations may start the budgeting process with their accountants by looking at potential income and then figuring out how much money they have to spend. Develop a record-keeping system 8. Legally, you must save all Board documents, including minutes and financial statements. You'll have to preserve your important corporate documents, including board meeting minutes, bylaws, Articles of Incorporation, financial reports and any other official records. You should contact your appropriate state agency for more information on what records you are required to keep in the official files. Develop an accounting system in partnership with your CPA. 9. Nonprofits are accountable to the public, their funders (contributors), and, in some instances, government granting bodies. a. You have to establish a system of checks and balances when establishing the organization s accounting practices. Make sure that your system meets your current and future needs. b. The organization needs to open a bank account and decide whether to use the accrual or cash method of accounting. The difference between the two types of accounting is when revenues and expenses are recorded. i. In cash basis accounting, revenues are recorded when cash is received and expenses are recorded when they are paid (no matter when they were actually invoiced). ii. In accrual basis accounting, income is reported in the fiscal period it is earned, regardless of when it is received, and expenses are deducted in the fiscal period they are incurred, whether they are paid or not. Page 55

7 Apply for Federal & State Tax Exempt Status as a Private Foundation 10. Apply for recognition of tax-exempt public charity status. You'll need to fill out either Form 1023 or 1024, which is an application. Publication 557 will provide detailed instructions for filling out either form and will let you know which one, 1023 or 1024, your organization needs to file. a. Submit financial statements for the current year as well as budgets for the next 2 years in Part XI of Form b. If an attorney is representing you, fill out Form 2848 to designate power of attorney. c. Either can be obtained from your local IRS office or the IRS website. The filing fee will depend upon the size of your organization s budget. This application is an important legal document, so seek the assistance of an experienced attorney or certified public accountant (CPA) when preparing it. 11. Send your forms to one of the following addresses: a. Internal Revenue Service P.O. Box Covington, KY b. Internal Revenue Service 201 W. Rivercenter Blvd. Attn: Extracting Stop 312 Covington, KY 41011[3] File for state and local tax exemption. 12. In accordance with state, county and municipal law, you may apply for exemption from income, sales and property taxes. Contact the State of California Franchise Tax Board, your county or municipal Department of Revenue, local Departments of Revenue and your county or municipal clerk s offices for information on how to apply for exemption in your state or municipality. Page 56

8 Organizing your Corporation After Receiving your letter of Determination 13. Draft Bylaws. Bylaws are simply the rules of how the organization operates. Although bylaws are not required to file a 501(c)(3) status, they will help you in governing your organization. a. Bylaws should be drafted with the help of an attorney and approved by the board early in the organization's development b. Depending on who you use to assist in the process, some firms require that your bylaws are sent to the IRS. Form a Board of Directors 14. Forming a board requires careful though and extensive recruitment efforts. a. Draft bylaws. Bylaws are simply the "rules" of how the organization operates. Although bylaws are not required to file for 501(c)(3) status, they will help you in governing your organization. Bylaws 15. Bylaws should be drafted with the help of an attorney and approved by the board early in the organization's development. a. Depending on who you use to assist in the process, some firms require that your bylaws are sent to the IRS. Fulfill Charitable Solicitation Law requirements 16. If your organization s plans include fundraising, be aware that many states and a few local jurisdictions regulate organizations that solicit funds within that state, county or city. a. Usually compliance involves obtaining a permit or license and then filing an annual report and financial statement. b. Contact the state Attorney General s office, the state Department of Commerce, state and local Departments of Revenue and county or municipal clerk s offices to get more information. Page 57

9 Apply for a Nonprofit Mailing Permit 17. The Federal Government provides further subsidies for nonprofits with reduced postage rates on bulk mailings. a. If your organization s plans include fundraising, be aware that many states and a few local jurisdictions regulate organizations that solicit funds within that state, county or city. b. Usually compliance involves obtaining a permit or license and then filing an annual report and financial statement. c. Contact the state Attorney General s office, the state Department of Commerce, state and local Departments of Revenue and county or municipal clerk s offices to get more information.[5] Page 58

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