When incorporating a new nonprofit, it’s important to consider some legal aspects. The first step is to choose the state where the nonprofit will be incorporated. It’s possible to incorporate a nonprofit in any state, regardless of where its activities will be carried out. Once the state of incorporation is chosen, the next step is to draft and file a certificate of incorporation to formally establish the organization. This article addresses the key issues to think about when incorporating a nonprofit.

Which state should we incorporate our nonprofit in?

When deciding where to incorporate, consider two main factors: (1) where the nonprofit will primarily operate and (2) the complexity or burden of complying with a state’s laws and regulations. Some nonprofits choose to incorporate in the state where they will primarily operate, while others choose a jurisdiction based on its flexibility in structuring internal governance.

Certain states, including New York, California, and Massachusetts, have corporate statutes that limit or dictate governance choices and require regulatory notification or approval for significant transactions, such as mergers, significant asset transfers, or dissolution. On the other hand, states like Delaware have fewer rules about how companies should be managed and approved by regulators. The Attorney General of Delaware doesn’t need to review or approve corporate transactions beforehand, and Delaware’s laws governing corporations are more flexible compared to laws in other states.

Before selecting a state for incorporation, it’s important for the organizers to work closely with a qualified attorney to understand the available options. State nonprofit corporation laws govern many aspects of the governance structure, including the minimum size of the governing board, membership rights and procedures, board election and removal procedures, and processes for managing conflicts of interest or conducting an annual audit. Some state laws may also require regulatory or court approval for major transactions. These requirements can significantly impact the time and money needed for compliance as the nonprofit grows and evolves.  

Are there additional requirements when incorporating in a state where we have no operations? 

If a nonprofit is incorporated in a state where it is not primarily operating (known as the state of legal domicile), it must fulfill additional compliance requirements that would not apply if it were incorporated in its state of legal domicile. However, many nonprofits find these extra requirements manageable and worthwhile because of the advantages of incorporating in a state with a more flexible regulatory approach.

1. The nonprofit must have a registered agent in the state where it is incorporated. The registered agent is responsible for receiving legal mail on behalf of the nonprofit, such as service of process. There are corporate filing services that offer registered agent services for a reasonable annual fee.

2. The nonprofit is often required to file an annual report in its state of incorporation. For example, a nonprofit incorporated in Delaware must submit a Delaware Annual Report by March 1st each year, along with a $25.00 filing fee.

3. The nonprofit must also qualify to “do business” in the state where it primarily operates. This involves making an initial filing with the state and then filing annual reports to maintain its status. 

Nonprofit organizations, regardless of where they are incorporated, must register annually with state charity regulatory offices in order to solicit charitable contributions or hold charitable assets in all applicable states, including their state of legal domicile. For example, a nonprofit incorporated in Delaware, located in New York, and soliciting funds in New York is not subject to most of the governance requirements of the New York Not-for-Profit Corporation Law. However, in addition to registering to do business in New York with the New York Department of State, the nonprofit must also register annually with the New York Attorney General’s Charities Bureau, which regulates charitable solicitation and assets within the state. It’s important to note that many states’ laws exempt hospitals, educational institutions, and religious organizations from the charitable registration requirement. The scope of the exemption, as well as the manner of obtaining it, varies from state to state. 

What provisions are required to be included in our certificate of incorporation? 
What provisions are optional?

The certificate of incorporation is a crucial document that establishes a nonprofit organization’s legal and operational framework. Some states refer to this document as the Articles of Incorporation. It outlines the nonprofit’s purpose(s) and provides basic information about its structure and governance. Careful attention to several key issues is required when drafting the certificate to ensure that the nonprofit is formed correctly, eligible for federal tax-exempt status when sought, and compliant with relevant state and federal laws. 

When creating a certificate of incorporation, the required provisions may vary depending on the state’s laws. However, the following are the standard state-required clauses:

1. The legal name of the organization
2. The name and address of the incorporator
3. The purpose or purposes for which the corporation is formed
4. Designation of the secretary of state as an agent of the corporation for receiving legal documents
5. If the corporation must have a registered agent, the name and address of the corporation’s registered agent in the state
6. Whether the corporation will have members or a statement noting that provisions relating to membership will be in the corporation’s bylaws.

Several states also require the names and addresses of the initial directors to be included in the certificate of incorporation. 

When a nonprofit wants to apply for 501(c)(3) tax-exempt status, there are specific requirements to consider. While a corporation can generally be established for any legal purpose, for 501(c)(3) status, a nonprofit corporation must be organized and operated exclusively for one or more of the purposes described in section 501(c)(3) of the Internal Revenue Code. Meeting the first part of this requirement – the “organizational test” – typically requires a nonprofit to include language in its certificate of incorporation that explicitly limits its corporate purposes. The IRS Form 1023 (the application for 501(c)(3) status) states: Your organizing document must restrict your purposes to those described in section 501(c)(3). 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.

The instructions for Form 1023 state that it is generally enough to limit a nonprofit’s purposes by referring to section 501(c)(3) to meet the organizational test under section 501(c)(3). The IRS gives an example of an acceptable purpose clause as follows: The organization is exclusively organized for charitable, religious, educational, and scientific purposes under section 501(c)(3) of the Internal Revenue Code or corresponding sections of any future federal tax code.            

Alternatively, a nonprofit organization’s certificate of incorporation can fulfill the organizational test by specifying a particular charitable purpose. If this approach is chosen, nonprofits should be cautious in crafting a purpose description that does not overly restrict the organization’s ability to effectively pursue its broader charitable goals.

According to Form 1023 instructions, the nonprofit’s certificate of incorporation must ensure the permanent dedication of its assets to a section 501(c)(3) purpose. In the event of dissolution, a 501(c)(3) tax-exempt nonprofit must distribute its assets for an exempt purpose described in section 501(c)(3), or to the federal, state, or local government for a public purpose. In some states, nonprofits can rely on state law to establish the permanent dedication of assets for exempt purposes. 

Form 1023 instructions offer the following example of an acceptable dissolution clause: 

Upon the dissolution of this organization, assets shall be distributed for one or more exempt purposes within the meaning of section 501(c)(3) of the Internal Revenue Code or corresponding section of any future federal tax code or shall be distributed to the federal government, or a state or local government, for a public purpose.

Nonprofits may want to include a provision setting forth the statutory limitations or prohibitions applicable to 501(c)(3) nonprofits regarding lobbying and political campaign activities. 

How long does it take for the certificate of incorporation to be filed? 

States may take anywhere from a few days to a few weeks from the submission date to file the certificate of incorporation. The speed of incorporation is another factor that may influence the decision of where your nonprofit should incorporate. It is easier and faster to incorporate in some states than others. Many states offer expedited filing for an additional fee, including 24-hour, same-day, or even 2-hour expedited filing.

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501(c)(3) Charitable Organizations

Purposes
501(c)(3) organizations operate exclusively for charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.  For purposes of section 501(c)(3), the term charitable is used in its generally accepted legal sense and includes:

• Relief of the poor, the distressed, or the underprivileged
• Advancement of religion
• Advancement of education or science
• Erecting or maintaining public buildings, monuments, or works
• Lessening the burdens of government
• Lessening neighborhood tensions
• Eliminating prejudice and discrimination
• Defending human and civil rights secured by law
• Combating community deterioration and juvenile delinquency

Public Charity vs. Private Foundation
Every 501(c)(3) organization is classified as either a private foundation or a public charity. Private foundations and public charities are primarily distinguished by the level of public involvement in their activities. Public charities normally receive a significant portion of their financial support from the general public or governmental units and interact more with the public. 

A private foundation is typically funded by a single person, a family, or a company. Private foundations are subject to stricter operating restrictions because they are less open to public scrutiny than public charities. They are subject to certain excise taxes for failure to comply with those restrictions.  

Private foundations are further classified between private non-operating foundations and private operating foundations. The main difference is that private operating foundations actively “operate” or conduct their own charitable programs. Because of this major difference, private operating foundations are subject to the same regulations as public charities on a few key matters, which are generally more favorable than the rules applicable to non-operating foundations.

Lobbying
Lobbying is any attempt to influence legislation, including acts, bills, resolutions, or ballot initiatives by Congress, state legislatures, local councils, or similar governing bodies.

A public charity is not permitted to engage in substantial legislative activities. If lobbying activities are substantial, a 501(c)(3) organization may fail the operational test, risk losing its tax-exempt status, and, in certain cases, be liable for excise taxes.

Like public charities, private foundations will jeopardize their 501(c)(3) status if lobbying is a substantial part of their activities. However, private foundations are subject to a significant excise tax on their lobbying expenditures, such that the excise tax generally acts as a lobbying prohibition for private foundations.  A limited exception to this lobbying prohibition, known as the “self-defense” exception, applies if the communication addresses legislation that affects the foundation’s existence, powers and duties, tax-exempt status and/or deductibility of contributions.

Political Campaign Activities
All 501(c)(3) organizations are prohibited from directly or indirectly participating in or intervening in any political campaign on behalf of (or in opposition to) any candidate for elective public office.  Prohibited political campaign activities include any statements made by or on behalf of the organization in favor of or in opposition to any candidate for public office and contributions to political campaign funds.  Violating this prohibition may result in denial or revocation of tax-exempt status and the imposition of excise taxes on the organization.

Tax-Deductibility and other Characteristics 
Donations to 501(c)(3) organizations are tax-deductible, though the deductibility limits vary between public charities and private foundations (and generally are more generous for public charities). In addition, 501(c)(3) organizations are generally exempt from state income tax exemption and state sales tax exemption (although some states only grant sales tax exemption to a narrow subset of 501(c)(3) organizations).  501(c)(3) organizations are also generally eligible for the nonprofit mail rate, which provides a significant discount. 

Applying for Tax-Exempt Status
Organizations seeking 501(c)(3) tax-exempt status must file the Form 1023 or Form 1023-EZ.  Churches that meet the requirements of IRC Section 501(c)(3) are automatically considered tax-exempt and are not required to apply for and obtain recognition of tax-exempt status from the IRS, although many churches choose to apply for tax-exempt status to obtain the certainty of the IRS’s determination. A written IRS determination can also simplify applying for other benefits, like state tax exemptions.

501(c)(4) Social Welfare Organizations

Purposes
501(c)(4) organizations must be operated exclusively for the promotion of social welfare.  The tax regulations specify that an organization operates exclusively to promote social welfare if it is primarily engaged in promoting the common good and general welfare of the people of the community.

Lobbying
501(c)(4) organizations may engage in unlimited lobbying related to their exempt purposes without jeopardizing their tax-exempt status.  This ability to engage significantly in lobbying activities is a key reason many organizations choose the 501(c)(4) designation.

Political Campaign Activities
501(c)(4) organizations can engage in political campaign activities if not the organization’s primary activity. 

Tax-Deductibility and other Characteristics
Donations to a 501(c)(4) organization are not tax-deductible. In addition, the names and addresses of donors do not need to be disclosed to the IRS in its annual Form 990 filing.  By contrast, all 501(c)(3) organizations must disclose their donors to the IRS in their Form 990 filings, and information about private foundation donors is made publicly available by the IRS.  Some organizations may also choose to seek 501(c)(4) status (especially as an alternative to 501(c)(3) private foundation status) if their donors do not need the benefit of tax-deductibility of their donations, and they would benefit from the more flexible rules applicable to 501(c)(4) organizations.

Applying for Tax-Exempt Status  
Organizations seeking 501(c)(4) tax-exempt status must file the Form 8976 Notice of Intent to Operate Under Section 501(c)(4), generally within 60 days of its formation. In addition to submitting Form 8976, organizations operating as 501(c)(4) organizations may also choose to file Form 1024-A to request recognition of tax-exempt status. Submitting Form 1024-A does not relieve an organization of the requirement to submit Form 8976.

501(c)(6) Business Leagues

Purposes
501(c)(6) organizations include business leagues, chambers of commerce, real-estate boards, and boards of trade.  A business league, which is perhaps the most common type of 501(c)(6) organization, is an association of persons having a common business interest, the purpose of which is to promote such common business interest and not to engage in a regular business of a kind ordinarily carried on for profit. Business leagues include trade associations and professional associations. To be considered exempt, a business league’s activities must be devoted to improving the business conditions of one or more lines of business as distinguished from performing particular services for individuals. 

Lobbying
501(c)(6) organizations may conduct unlimited lobbying to further their exempt purposes without jeopardizing their tax-exempt status.  An organization that engages in these activities must give its members notice of amounts of membership dues allocable to nondeductible lobbying expenditures; failure to provide such notice may subject the organization to a proxy tax on the amount of the expenditures.

Political Campaign Activities
501(c)(6) organizations are permitted to engage in political campaign activities if they are not the organization’s primary activity.

Tax-Deductibility and other Characteristics
Donations to a 501(c)(6) organization are not tax-deductible. 

Applying for Tax–Exempt Status
Organizations seeking 501(c)(6) tax-exempt status must file the Form 1024 with the IRS. 

Keep in mind that organizations engaging in lobbying and political campaign activities may also be subject to federal, state, and, in some cases, local lobbying registration and disclosure reports, depending on relevant factors, including the amount spent on the activities, whether lobbyists are retained, and the locations of such activities.  

Choosing the Classification of Your Organization

It is critical to correctly determine which tax-exempt status is most appropriate based on your organization’s key objectives.  Failure to apply for and obtain the correct tax-exempt status may subject an organization to unanticipated regulatory burdens and constraints and leave it unable to accomplish its essential goals.  While seeking reclassification of an organization’s tax-exempt status is possible, it can be a slow and complex process. As such, it is best to apply for the most strategically beneficial tax-exempt status from the outset.

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