How to Start a Nonprofit: The Rules and Rewards

Nonprofit organizations often come from the heart.

They can begin with a goal of addressing a social or community issue or need. Making money may not be on the priority list. But you can still set up your nonprofit in ways that help keep costs down, particularly taxes. You can then direct more funds toward achieving your organization’s objectives.

Steps to take to start your nonprofit

• The first step is to register your nonprofit in the state where you want to incorporate. An organization called the National Association of State Charity Officials has information on filing requirements for charitable organizations in different states. The U.S. Small Business Administration also has information on the state agencies where you can file papers of incorporation.

• Once you’ve registered your nonprofit, you must file IRS Form 1023, which is the formal request that the IRS recognize you as a 501(c)(3) organization eligible for tax exemptions under this rule.

• If you are going to ask an attorney or some other party to represent you on matters related to your application with the IRS, you also need to fill out and submit Form 2848. Take note: NerdWallet provides info on money-saving online legal services that provide access to lawyers at a lower cost.

• You also will have to fill out and submit IRS Form 990, or “Return of Organization Exempt From Income Tax.”

• Timing is an important consideration. According to IRS rules, you must file for nonprofit tax-exempt status by the end of the 27th month after your organization is legally created, which means when your group is formally incorporated.

• The application can be a long and tedious process, so you'll need patience. The IRS will have a tax specialist go over your application and may ask for more information. But if your nonprofit passes the test, you will get a “determination letter” recognizing your tax-exempt status.

Overview of nonprofits

Now that you know the basic steps, let’s take a step back.

There are different kinds of nonprofits:

• They can be charitable organizations, such as a group that runs a homeless shelter or an enterprise that wants to build and maintain parks in a low-income neighborhood.

• They can be educational institutions, including schools, museums, day care centers or youth sports organizations.

• They can be religious organizations, such as churches, mosques, synagogues and temples.

Because your nonprofit is supposed to be doing work for the public good, your organization can enjoy a host of cost-saving benefits, mainly tax exemptions from federal, state and local governments.

But you must comply with IRS rules and other requirements, including that your organization’s income and assets not be used to benefit private investors or parties.

What registering as a nonprofit does for you

Registering allows you to take advantage of those cost-saving benefits. The rules and regulations vary by state, so check the requirements in yours. The previously mentioned National Association of State Charity Officials has good advice.

You may be required to submit other documents, beyond your bylaws and standard incorporation papers, related to your nonprofit status in some states, according to the National Council of Nonprofits, a nationwide network of U.S. nonprofit organizations.

For example, your nonprofit will be required to file a written “conflict of interest” policy, which states that your organization’s members, particularly officers and directors, are required to disclose any potential conflict related to the nonprofit’s affairs.

The benefits of 501(c)(3) status

After registering your nonprofit, applying for this IRS status grants your organization certain tax benefits. The classification is based on Section 501(c)(3) of the tax code, which is why nonprofits are sometimes referred to as 501(c)(3) groups.

Having this IRS classification can help in several ways:

• Your nonprofit will be exempt from paying federal income taxes on earnings. For example, if your organization holds a fundraising event — say, a concert or a community auction — you won’t have to worry about taxes on the money you raise.

• You organization will be able to accept tax-deductible contributions, which obviously will help you attract more donors and donations.

• Some nonprofits will be exempt from paying certain employment taxes.

• Some states and local governments also grant tax exemptions to groups with 501(c)(3) status.

• Your nonprofit could get discounts from the U.S. Postal Service on mail services.

Your responsibilities as a 501(c)(3) nonprofit

On the other hand, these tax and other benefits come with responsibilities.

You’ll be expected to keep detailed and comprehensive records of your activities, particularly your finances. For example, your nonprofit will be required to make its annual tax returns available to the public for inspection.

And we’re not just talking about having them on file in a box stored in the office basement. The IRS requires you to ensure these documents are readily available at your organization’s office during regular business hours, according to an IRS publication on applying for nonprofit tax-exempt status.

Then there are restrictions on your nonprofit’s activities.

For example, your organization will be prohibited from taking part in the political campaigns of candidates for local, state or federal office. Your nonprofit also cannot engage in lobbying efforts meant to aid the interests of a private shareholder or individual.

There also are strict rules related to compensation, especially for officers and directors. Nonprofits are expected to pay their executives “reasonable” but “not excessive” compensation, according to the National Council of Nonprofits. To figure out what that means, your nonprofit is expected to go through a review process involving an independent body.

How to finance your nonprofit

Foundations and donors

Most organizations rely on nonprofit grants and financial support from foundations and donors. The National Council of Nonprofits offers information and tips on how to secure funding. There also are state associations of nonprofits that offer both information and services, including workshops on fundraising.

Online lenders

Online small-business loans are another option for nonprofits. Bluevine offers accounts receivable financing to small businesses that sell products or services to other businesses, or B2B firms. But the company also offers financing to nonprofits that have invoices due in one to 12 weeks from other companies, Ed Castano, Bluevine vice president of marketing, tells NerdWallet. (Read our review of Bluevine.)

» MORE: Best business credit cards for nonprofits

Setting up for success

Nonprofits have played an increasingly important role in society. Setting one up in response to a need in a community is a worthy endeavor. And the good news is the IRS and other agencies have rules that make it easier for nonprofits to survive and thrive.