A Step-by-Step Guide
Congratulations. You've got an idea for making the world a better place, and you want to start a nonprofit as the means to do so. The good news is that starting a California nonprofit isn't that hard to do if you have a sound plan, the right team, and sufficient startup capital.
The bad news is that running a successful nonprofit is not easy. You'll need to think through exactly how you will bring value to the public, obtain funds, attract staff and/or volunteers, build a board of directors, and comply with the laws that regulate nonprofits. Your answers to these questions will determine whether you should start a nonprofit or consider alternatives. More on these points later in this article.
Questions to consider:Determine the name of the corporation
A nonprofit is typically formed as a corporation and its name can be a valuable asset. In California, a corporation name may be adopted if the name is not the same as or too similar to an existing name on the records of the California Secretary of State, or if the name is not misleading to the public. You can check the current database of existing names in the business search page on the Secretary of State website. You can also reserve a name for 60 days by mailing in a Name Reservation Request. You must also make sure the name does not infringe on another person’s trademark rights. This is not always easy to determine, but a good start includes running a trademark search on the U.S. Patent and Trademark Office database and a simple Google search. For some founders, it may also be important to confer with intellectual property counsel to help ensure they are not infringing on another’s rights and to protect their name from being used by other parties.
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A corporation is legally created with the filing of the articles of incorporation. Articles of incorporation typically identify:
(a) The organization’s name;
(b) Purpose or purposes of the nonprofit;
(c) Agent for service of process -- that is, a person whose name and address are identified and who can receive lawsuits and other official correspondence and other matters; and
(d) Any limitations on corporate powers.
The articles of incorporation are typically signed by an "incorporator," which can be just one person but may also be signed by the initial board of directors if they are named in the articles.
There is a template you can fill in and print on the Secretary of State’s website. This is a good starting point but does not provide guidelines or advice on every important consideration. For example, there is no guidance on specific purpose statements.
A word on specific purpose statements: A broad specific purpose statement provides room for the organization’s mission to evolve without requiring an amendment to the articles of incorporation. It and may also make it easier to comply with charitable trust laws that require charitable funds be used consistent with the specific purpose of the organization at the time such funds were originally acquired. If, instead, you adopt a narrow purpose statement such as "to restore and maintain Pomponio State Beach," you can't use funds to restore any other beaches, but the statement would provide a stronger mission anchor to help ensure that your organization stays on a specific course after the founders have left.
For additional information on this issue, read Starting a Nonprofit: Articles of Incorporation and Specific Purpose Statements.
More about the agent for service of process: It is also important to understand that the agent is responsible for receiving lawsuits and possibly other important legal documents on behalf of the organization and making sure those documents reach the President or other authorized officer in a timely manner. If the agent fails to do so (e.g., fails to have his or her mail checked regularly while away for an extended period) the organization could face negative consequences such as losing a default judgment for not showing up to defend a lawsuit. An organization can identify an individual as agent or may elect to pay for a corporate agent, which may be preferred if there is no person willing to accept this responsibility or if privacy concerns are an issue (the agent’s street address will be a matter of public record).
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If the initial directors are not named in the articles of incorporation, the incorporator can and should appoint the board through a written action.
Under California law, a nonprofit board may be composed of as few as one director, but the IRS is unlikely to grant 501(c)(3) status to a nonprofit with only one director and most nonprofits have anywhere between three and 25 directors.
These directors should understand their duties and responsibilities to act with reasonable care and in the best interests of the organization while providing direction and oversight over the organization’s activities, finances, officers, and legal compliance. BoardSource offers valuable resources on nonprofit corporate governance, including these Ten Basic Responsibilities of Nonprofit Boards. We recommend also looking at the Board Source website for more information and resources about boards, many of which are free.
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A corporation’s bylaws typically address, at a minimum, fundamental provisions related to the management of the activities and affairs of the corporation. Bylaws should provide guidance to the board and reassurance of sound governance practices to government authorities, funders, and other interested stakeholders.
Bylaws typically contain specific provisions detailing:
(a) The purpose or mission of the nonprofit;
(b) How directors are elected or otherwise selected (e.g., by majority vote of directors at the annual board meeting);
(c) How the board may take an action (e.g., by majority vote of directors);
(d) How board meetings are called and noticed (e.g., six times per year with 14 days advance notice by email);
(e) How board meetings are conducted (e.g., the chair of the board presides);
(f) The officers of the corporation (a president or chair of the board, secretary, and treasurer or chief financial officer are required by California law);
(g) The duties and responsibilities of each officer;
(h) The authorization of board and non-board committees (e.g., committees tasked to act with the authority of the board versus committees that can only make recommendations);
(i) The level of indemnification provided by the corporation to protect its directors, officers and other agents; and
(j) The reports due to directors (e.g., financial reports).
If the nonprofit has voting members, the bylaws will also need to contain additional provisions regarding member rights and processes. Nonprofits considering a voting membership structure may want to first discuss such structure with a lawyer, particularly if they do not expect their members to actively participate in meetings and regularly exercise their voting rights. Public Counsel provides an Annotated Form of Bylaws for a California Nonprofit Public Benefit Corporation.
Separately articulated policies commonly supplement the bylaws in addressing key governance and management issues. For example, although not required by federal tax law, it is considered to be a best practice for any nonprofit to have an adopted conflict of interest policy. Additionally, a nonprofit must describe its policy regarding conflicts of interest in the IRS Form 1023. Accordingly, it would be advantageous for most nonprofits to adopt a policy similar to the sample policy provided in Appendix A (page 25) of the Instructions to Form 1023.
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The board should take the following actions:
(a) Adopt the bylaws and conflict of interest policy;
(b) Elect officers;
(c) Adopt a fiscal year (such as a year ending December 31 or June 30);
(d) Approve establishing a bank account;
(e) Approve applying for federal and state tax-exempt status;
(f) Approve reimbursement of startup expenses (if applicable); and
(g) Approve the compensation of the executive director (CEO) or the treasurer (CFO) (if applicable).
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This annual registration is required for the majority of nonprofit public benefit corporations and must be filed within 30 days after receipt of assets. The CT-1 Form and Instructions are available online. The corporation’s articles of incorporation and bylaws should be included in the initial filing. The Form 1023 application and federal determination letter (Step 9) should be submitted upon receipt of the determination letter to complete the filing.
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The Statement must initially be filed within 90 days of the date of incorporation. This biennial filing requirement, which identifies the organization’s address, principal officers, and agent for service of process, can be filed online or by mail. (You can find information and instructions on completing the Statement of Information here.)
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Completing the Form 1023 application for exempt status under Internal Revenue Code (IRC) Section 501(c)(3) may be the most challenging part of the startup process. It is a legally-driven and comprehensive inquiry covering 11 Parts and 8 Schedules. Luckily, in 2013 the IRS added new tools and instructional videos to their website to help you understand and file it correctly.
A critical section for careful completion is Part IV, Narrative Description of Your Activities, which asks: for each past, present, or planned activity, include information that answers the following questions.
Form 1023 also requires information regarding (a) organizational structure; (b) compensation and other financial arrangements with officers and directors, and certain highly paid employees and independent contractors; (c) members and other individuals and organizations that receive benefits from the organization; (d) organizational history (e.g., an organization that was spun off or previously fiscally sponsored by another organization may need to complete an additional schedule as a successor organization); (e) specific activities; and (f) actual and/or projected statement of revenues and expenses (which should be consistent with any identified activities).
Part X is designed to determine the organization’s classification as either a private foundation or a public charity. Public charity status is generally the more favorable tax status, but requires an organization to meet certain requirements. For most organizations, this means passing a public support test over a five-year measuring period. For organizations that will receive a large bulk of their support from few sources over their first five years, monitoring and managing of the public support ratio may be critically important. Public Charity Status Simplified (a little) is a helpful online resource from Insight Center for Community Economic Development.
The filing fee for Form 1023 is currently $850 for all but the smallest organizations.
The IRS may typically take 3-4 months or longer to process a Form 1023 application for exempt status. However, the waiting period may be much longer if the application contains errors, omissions, or other information that require additional development by a special IRS department. The IRS application process is further explained on its Where Is My Exemption Application page.
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10. Apply for California tax exemption with the California Franchise Tax Board (FTB) and receive an affirmation of exemption letter from the FTB.
Organizations with a 501(c)(3) federal determination letter can request California affirmation of tax exemption under California Revenue & Taxation Code section 23701d from the FTB by filing Form 3500A along with a copy of the IRS determination letter. The FTB will recognize the organization’s exemption from state income taxes as of the federal effective date. An organization that does not have a 501(c)(3) federal determination letter is otherwise required to file the more complicated Form 3500 for state income tax exemption (there is an instruction booklet available for this form). There is no fee for Form 3500A and a $25 fee for Form 3500.
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Although the majority of nonprofits are set up without the help of lawyers, it's easy to make mistakes that become costly to correct later (such as unwisely creating voting membership structures, adding unlawful provisions to template bylaws, violating the commerciality doctrine, etc.). We recommend having experienced professionals involved -- such as attorneys, board members with nonprofit incorporation experience, and experienced consultants. Don't discount the value of a knowledgeable attorney. You can find a list of firms and consultants who are CalNonprofits members in the Professional Directory online. (Search for "Starting a Nonprofit and Staying Compliant.")
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Now that you know how to start a California nonprofit, you should thoughtfully consider whether this is the right choice for your ideas and for the public benefit. There may be other ways to carry out your dreams, including working under the umbrella of an existing nonprofit. See Alternatives to Forming a Charitable Nonprofit. One often overlooked alternative is fiscal sponsorship, a relationship that may allow a group to house a charitable project within an existing nonprofit with the ability to spin it off at a later date. For more information on fiscal sponsorship, see Fiscal Sponsorship Basics from the Bar Association of San Francisco.
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ABOUT THE AUTHORS: Emily Chan and Gene Takagi
Attorneys Emily Chan and Gene Takagi wrote this guide for the California Association of Nonprofits as part of their pro bono work.
Emily Chan, an associate with the NEO Law Group, was recognized as the 2012 Outstanding Nonprofit Lawyer – Young Attorney by the Nonprofit Organizations Committee of the American Bar Association. Gene Takagi is managing attorney of the NEO Law Group, an adjunct professor at the University of San Francisco, and contributing editor of the Nonprofit Law Blog.