You have an idea to start a nonprofit organization that will further a cause dear to your heart, such as environmental protection, sheltering the homeless, or promotion of the arts. What are the steps that you need to take to get your new nonprofit organization off the ground?
Formation of the Nonprofit
Certificate of Incorporation
Before you can draft and file the Certificate of Incorporation with the Secretary of State, there are several decisions that you and the other founders will need to make, including:
- The name of the company
- The purposes of the company
- Whether the company will have members
- The individuals who will serve on the initial board of directors
- The individuals who will serve as the officers, including the president, secretary, and treasurer
- The location of the company’s registered address
- Whether the company will seek tax-exempt status with the Internal Revenue Service
The Certificate of Incorporation must contain specific text to be eligible for filing, and if the organization intends to seek tax-exempt status, there are also a number of provisions that must be added to comply with federal tax law.
Employer Identification Number
Once the Certificate of Incorporation has been filed, the company must obtain its federal employer identification number from the IRS. This is done by completing the online SS-4 application. The employer identification number, or EIN, will be used by the company on its tax forms, to open a bank account, pay employees, solicit funds from the public and apply for grants from the government and private entities.
Organizational Meeting of the Board of Directors
The next step is for the company to hold its first board of directors’ meeting, known as the “organizational meeting,” where the board appoints the company’s officers, adopts the company’s Mission Statement, approves the opening of the company’s bank and investment accounts, and adopts the bylaws and appropriate company policies that are either recommended or in some cases, required by law or regulation. Alternatively, in lieu of holding the organizational meeting, the initial members of the board of directors may sign a unanimous written consent to pass all of the actions that are taken at the organizational meeting.
Although not legally required, it is a good idea for the foundation to adopt a mission statement that focuses the board, officers, employees and volunteers on its goals, activities, and the needs of its stakeholders and others whom the organization serves. As the organization’s priorities, services and activities naturally evolve and morph over time (sometimes called “mission creep”), the mission statement should be regularly updated. This ensures that the board of directors has made a definitive decision about the direction of the organization, rather than operating under a situation where the organization conducts its activities haphazardly and without a clear direction of its overarching goals. An annual review of the mission statement is the best way for the organization to maintain its priorities, and ensure that its activities remain in compliance with the requirements of its tax-exemption, its bylaws, its board policies and the needs of its membership and other stakeholders.
The bylaws are similar to a constitution, identifying the rules of the company’s governance and how the board of directors will be elected. Since the board of directors provides an oversight role for the nonprofit, and appoints the officers and determines the chief executive’s salary, it is critical that the founders of the nonprofit consider, in a well-thought-out manner, how the board of directors will be appointed.
In New York state, there are two options for electing the board of directors. If the company has members, then the members are typically responsible for electing the board on an annual basis (this is one of the members’ only key functions with respect to the company’s operations). If the company does not have any members, then the board of directors elects itself each year. This situation is known as a “self-perpetuating board,” and the board election is usually held by a majority of the board members at the annual meeting. This is how board members can be voted out and new members can be added each year. Often there is a nominating committee that keeps track of any term limits, vacancies and resignations in order to find appropriate replacements as board members rotate off of the board for various reasons.
The bylaws also contain the rules for holding the company’s board and member meetings, including who calls and chairs the meetings, as well as identifying notice and quorum requirements. The bylaws typically include a detailed description of the role of each of the company’s officers, which are appointed by the board of directors annually.
The bylaws should include an indemnification provision that provides for the company to cover any officers’ or directors’ attorneys’ fees and other defense costs in the event that any of the board members or officers are sued because of their role with the company. It is possible to be sued just by virtue of deciding to join a nonprofit board – despite that the board member or officer did nothing wrong individually. An indemnity provision protects board members and officers in this situation and is often helpful in attracting quality individuals to a nonprofit’s board of directors.
There are a number of company policies that are either advised for nonprofit organizations or are required by law. The policies are approved by the board of directors, usually at the organizational meeting of the board, to ensure that it complies with various laws, regulations and ethical requirements. The standard policies include the following:
- Conflict of Interest Policy
- Whistleblower Policy
- Public Disclosure Policy
- 990 Review Policy
- Document Retention Policy
- Political Activities Prohibition Policy
- Executive Compensation Policy
- Fundraising Policy
- Investment Policy
In addition to these standard policies, a foundation’s board should evaluate the activities of the nonprofit organization and analyze which regulations apply to the company’s purposes and operations. From this information, the company should develop appropriate “special purpose” policies that help ensure that the organization acts in compliance with the not-for-profit corporation laws, the Internal Revenue Code and associated IRS regulations, memorandums and field guidance, as well as the requirements of the state’s attorney general, who typically governs the operations of nonprofit entities, especially in connection with fundraising from the public. The IRS inquires about the existence of many of these policies on the IRS form 990, which is filed annually by tax-exempt organizations and is available to the public.
For example, for an organization that acts as the United States “friends of” organization to an overseas nonprofit foundation (for purposes of fundraising in the United States to donate to projects or companies in foreign countries), it should implement board policies that require that the company ensure that any foreign organizations to which the nonprofit donates is equivalent to a United States tax-exempt entity and operates for charitable, scientific, educational or artistic purposes; that the funds donated by the nonprofit will not be used for political activities and other prohibited activities; and that before any funds are donated to organizations in foreign countries, the nonprofit will enter into a written contract with the foreign donee mandating the receipt of periodic reports on the use of the funds. These policies should address all of the requirements in the applicable Internal Revenue Code regulations.
After the company has been appropriately set up, with a foundation of rules and procedures that help guide the company and maintain regulatory compliance, the nonprofit foundation’s board should consider whether the foundation should apply for federal tax-exemption. The organization’s eligibility for tax-exemption is based on its activities, and whether it will operate for charitable, educational or other tax-exempt purposes.
Under section 501(c)(3) of the Internal Revenue Code, in order to obtain a federal tax-exemption an organization’s activities must be charitable, religious, educational, scientific, literary, involve testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. According to the IRS, this 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, and combating community deterioration and juvenile delinquency.”
Loss of Governing Control
While obtaining a federal tax-exemption has numerous benefits, it also has its downsides. A key disadvantage of forming a nonprofit organization is that the founders remain at risk of losing control over the organization that they started and funded. It is even possible for a founder that serves as the executive officer of a charitable organization to be fired and completely cut out of the organization that they founded. Various strategies can be employed to minimize the possibility of this happening, but there are no guarantees.
New York State Registrations
For companies located in New York, in addition to filing the Certificate of Incorporation with the New York Secretary of State to incorporate the nonprofit organization, the foundation must register with the New York State Attorney General’s Charities Bureau. This entails completion of the CHAR410 using an online platform and uploading the company’s organizing documents. To obtain an exemption from the payment of New York sales tax and corporation franchise taxes, charitable organizations must submit the ST-119.2 and CT-247 to the NYS Department of Taxation and Finance.
Operating a charitable foundation can be a rewarding and enriching experience, with the possibility of enhancing our enjoyment of our work-life while bringing about positive results that not only benefit ourselves but the community that surrounds us. A strong legal structure helps a nonprofit’s board keep the company focused, ethical, and on track. This can be one of the strongest indicators of future success in fulfilling the organization’s mission.
Claudia Pollak, Esq. is a nonprofit attorney based in New York.