Forming a Charitable Tax-Exempt Nonprofit Corporation in California Christian Cañas Staff Attorney Community Development Project Intake: (213) 385-2977 x 200 www.publiccounsel.org Disclaimer: This presentation is intended as a general overview of the issues involved in forming a charitable tax-exempt nonprofit corporation, and is not intended to provide you with specific legal advice. This presentation should not be construed as all-inclusive, nor as the provision of legal services to any individual or entity. Summary of Presentation: What Is a Nonprofit Corporation? Why Form a Nonprofit Corporation? Advantages and Disadvantages How to Form a Nonprofit Corporation How to Apply for Tax Exempt Status For a Nonprofit Corporation Federal Exemption State Exemption Readiness Level and Alternatives -- Is a Nonprofit Corporation the Best Form for My Proposed Project? What is a Nonprofit Corporation? A Separate Legal Entity Organized and Operated for a Recognized Nonprofit Purpose Types of California Nonprofit Corporations Public Benefit Corporation May be formed for public and/or charitable purposes and may not make any distributions of corporate assets. Mutual Benefit Corporation May be formed for any lawful purpose (e.g., Homeowner s Association). Religious Corporation May be formed primarily or exclusively for religious purposes. 1
Legal Structure of a Nonprofit Corporation StatutoryMembers (Optional) Board of Directors Includes Chairperson of Board May also include 3 statutory officers* *Statutory Officers Must Include: Chairman and/or President Secretary, and Chief Financial Officer Nonprofit Corporation Operations Includes: Executive Director and/or CEO Who Supervises Other Employees and Volunteers To Operate Corporation's Day-to-Day Activities Forming a Nonprofit Corporation Advantages Eligible for Income Tax Exemption and Tax Deductible Donations Corporate Agents Generally Not Liable Disadvantages Administrative Burden Limitations on Permitted Activities Costly to Form Fees Name Reservation (optional) $ 10.00 Articles of Incorporation $ 30.00 Federal Tax Exemption Application $750.00 State Tax Exemption Application* $ 25.00 Biennial Statement of Information $ 20.00 Registration with Attorney General $ 25.00 TOTAL $855.00 2
How Do I Form a Nonprofit Corp? Reserve Corporate Name with Secretary of State (optional) Determine Who Will Be Directors and Officers Execute and File Articles of Incorporation with Secretary of State This Forms the New Legal Entity File IRS Form SS-4 to Obtain EIN Draft Corporate Bylaws Set up a Corporate Minute Book Hold First Meeting of Board of Directors Adopt Bylaws Elect Officers File Statement of Information (Domestic Nonprofit Corporation) Within 90 Days Name Your Organization Name Cannot Conflict With Existing Corporations www.ss.ca.gov/business/corp/corp_naav.htm Optional Name Reservation Assemble a Board of Directors Wealth Wisdom Work Will In a Public Benefit Corporation, no more than 49% of the board can be interested persons! Interested means persons who have been compensated for services (other than as a director) during the previous twelve months, and their family members 3
Articles of Incorporation What Are the Articles of Incorporation? The corporation s basic organizational document i.e., the Articles create the corporation. Filing starts the clock running on tax deadlines. What Must The Articles Include? (1) the corporate name; (2) a statement that the corporation is established for public or charitable purposes (or both); (3) the name and address of the initial agent for service of process; (4) a provision dedicating the corporate assets to charitable purposes and restricting the corporation from political campaigning or lobbying. What about filing? The corporation must file Articles with the Secretary of State with a $30 filing fee. CAUTION! When you file articles to form the corporation, you will start the clock running on important tax deadlines. If your organization has not yet begun its activities, you should strongly consider waiting to incorporate (filing the articles) until you are also ready to complete the tax exemption application. Tax ID Number ( EIN ) Every corporation that will apply for federal tax-exemption must file IRS Form SS-4 to obtain an Employer ID number (EIN). EIN is the corporation s tax ID number for all federal tax purposes. There is no separate tax-exempt number Just having an EIN does not mean that the corporation is tax-exempt! Bylaws The Bylaws Establish the Procedures for Governing and Operating the Corporation s Activities. Typical Bylaw Provisions: Number of Directors Time, Place, and Manner of Director Meetings Voting Procedures Director and Officer Duties Committee Structure Amendment Procedures 4
First Board Meeting Initial Board Named in Articles or by Incorporator Board Composition Must Comply with Bylaw Requirements: Number of Board Members Qualifications for Board Membership, if any Board Governs as a Group and Must Vote as Described in Bylaws First Meeting Actions Adopt Bylaws Elect Officers Establish Bank Accounts and Signing Authority Authorize Officers to File Tax Exemption Application Adopt Board Conflict of Interest Policy Board Meeting Minutes Keep Minutes of All Board Resolutions as Evidence of Valid Corporate Action Example of Resolution: RESOLVED, that the bylaws presented at this meeting and attached to these minutes are adopted as the bylaws of the Corporation. Maintain Minute Book In Permanent Corporate Files Other California State Filings Secretary of State: Statement of Information After initial filing, file every two years, or sooner to change information on file Attorney General Registry of Charitable Trusts Must register by filing Form CT-1 within 30 days after receiving or accruing assets http://ag.ca.gov/charities/forms/charitable/ct1-form.pdf File annual report thereafter on Form RRF-1 Employment Development Department Register if any employees will receive wages 5
Federal Tax Exemption What Does it Mean to be Tax-Exempt? Subject to a few exceptions, nonprofit corporations with federal tax exemption are NOT taxed by the IRS on income received! How Does a Nonprofit Corporation Obtain Federal Tax-Exemption? The IRS will recognize tax-exemption if a corporation qualifies under a specific exempt category defined by the Internal Revenue Code. The most commonly used tax-exempt classification is 501(c)(3). To be treated as tax-exempt under 501(c)(3), a corporation must generally file an application with the IRS. 501(c)(3) Organizations To Gain 501(c)(3) Status, a Corporation Must Be Organized and Operated for One of the Following Exempt Purposes: Charitable Religious Scientific Literary Educational Prevention of Cruelty to Children or Animals Charitable 501(c)(3) Organizations Qualifying Purposes Relief of the Poor Lessening the Burdens of Government Lessening Neighborhood Tensions Elimination of Prejudice and Discrimination Defense of Human and Civil Rights Combating Community Deterioration and Juvenile Delinquency Examples Homeless Shelter Affordable Housing Developer Community Health Care Clinic Job Training Program for Low-Income Individuals Child Care Center Domestic Violence Shelter Youth Services Organization 6
Special Characteristics of 501(c)(3) Organizations Donors may deduct contributions from taxable income. Must be organized and operated exclusively for exempt purposes. Must irrevocably dedicate assets to exempt purposes. Cannot confer excessive financial benefits on insiders (i.e., directors, officers, members of their families) or other disqualified persons (i.e., persons in a position to exercise substantial influence over organization). Cannot provide substantial private benefits to ANY individual. Cannot support or oppose candidates for political office and may not devote a substantial part of its activities to lobbying. Public Charity or Private Foundation Status? IRS divides all 501(c)(3) charities into two types: 1. Public Charity: Supported by Broad Public, or from Fees for Charitable Services 2. Private Foundation: Supported by One or a Few Private Individuals or Private Foundations Private foundations are subject to limitations and excise taxes and are not eligible for some foundation grants operating charities try to avoid this! IRS will grant advance ruling as public charity if qualifying budget is submitted on Form 1023 Must submit financial information after 5 years for final letter! How Do I Obtain 501(c)(3) Status? File IRS Form 1023 Tax-Exemption Application Form Application Fee ($300/$750) Remember! Generally, Form 1023 must be filed within 15 months of incorporation (with automatic extension up to 27 months) Exemption is generally retroactive to date of incorporation 5 year advance ruling period for public charities 7
IRS Form 1023 Provide Complete Description of Activities WHY? Show that organization s activities will serve exempt purpose, and Show that organization will actually conduct activities Caution: IRS has denied exemption if description is too vague to prove that activities are exempt. Form 1023: Program Development For each program activity, figure out the following: Why does it further exempt purpose? Who conducts it? What is it? When is it conducted? Where is it conducted? How is it funded? % of total time/$ spent on it? Form 1023: Budget Current year plus 2 year (detailed) Form 1023: Sample Budget Expenditures Year Estimate Compensation of officers and directors $ 0 Other salaries & wages $ 50,000 Rent $ 15,000 Insurance $ 4,000 Accounting/Professional Fees $ 5,000 Utilities $ 2,000 Postage $ 2,000 Fundraising Costs $ 2,500 Other programmatic operational $ 50,000 & administrative costs (attach itemized list) TOTAL $ 130,500 This is only a sample expenditure budget that does NOT reflect many costs your organization may incur. 8
Form 1023: Sample Budget Revenue Year Estimate Individual Donations $ 25,000 Foundation/Corporate Grants $ 40,000 Government Grants $ 50,000 Annual Year-End Solicitation $ 15,000 Annual Fundraising Dinner $ 5,000 Fees for Charitable Services $ 3,000 TOTAL $138,000 This is only a sample revenue budget that may not accurately reflect the funding sources available to your type of organization. Form 1023, cont d IRS Will Scrutinize Relationships With: Founders Board Members Officers Major Donors Highly-Compensated Employees or Consultants Other Private/For-Profit Persons IRS May Not Approve Exemption if Application Shows Risk of Private Benefit or Private Inurement IRS Wants to See Conflict of Interest Policy State Tax Exemption Exemption from California income and franchise tax requires separate filing to State of California State exemption categories generally mirror federal categories How Do I Obtain State Tax Exemption? After Jan 1, 2008 Send IRS determination letter to Franchise Tax Board with Form 3500A Note: you will not receive a letter from FTB Or: File Form 3500 with FTB For Charitable Organizations, Fill Out Section 23701(d) of Form 3500 Pay Filing Fee ($25) 9
What Are Some Alternatives to Forming a New Corporation? Join/Volunteer With an Existing Nonprofit Fiscal Sponsorship by Existing Nonprofit For-Profit Entity? Factors To Consider Size and Scope of Proposed Programs Resources Available to Comply With Filing Requirements and Laws Cost of Formation versus Cost of Alternatives Existing Volunteer or Employment Opportunities What Is Required By Potential Funding Sources? Could This Be A For-Profit Business? Don t Believe the Myths! Incorporation and tax exemption will not automatically generate grants or donations Often, grantmakers want to see a track record before giving any money Grant resources are limited Not all nonprofits generate enough revenue to pay salaries Other Issues to Consider Fundraising Laws and Regulations Nonprofit Business Activities Other Taxes May Still Apply Helpful Resources Long Beach Nonprofit Partnership (562) 290-0018 www.lbnp.org Foundation Center www.fdncenter.org Southern California Grantmakers www.socalgrantmakers.org Idealist.org Volunteermatch.org Guidestar.org Community Partners (213) 346-3200 www.communitypartners.org Nonprofits Insurance Alliance of California (800) 359-6422 www.niac.org Clearinghouse for Volunteer Accounting Services (805) 495-6755 www.cvas-usa.org/ 10