Starting a Nonprofit: 501(c)(3) Formation and Compliance

What Is a 501(c)(3)?

A 501(c)(3) is an organization that the IRS recognizes as tax-exempt because it operates for charitable, educational, religious, scientific, or other qualifying purposes. The designation comes from Section 501(c)(3) of the Internal Revenue Code.

Tax-exempt status means the organization itself generally does not pay federal income tax on money related to its mission. Equally important, donations to a 501(c)(3) are tax-deductible for the donors — which is a major advantage for fundraising.

Before You Start: Is a 501(c)(3) Right for You?

A nonprofit is not the right structure for every good idea. Consider whether a nonprofit fits your situation:

A 501(c)(3) is appropriate when:

Your primary purpose is charitable, educational, religious, or scientific
You do not intend to distribute profits to any individuals
You need to solicit tax-deductible donations
You want to apply for grants from foundations and government agencies (many require 501(c)(3) status)

A 501(c)(3) may not be right when:

You want to earn a profit and distribute it to owners
Your primary purpose is political advocacy (that is a 501(c)(4))
You could achieve your goals through a for-profit social enterprise or B-Corp
You are one person with a cause but no governance structure

Starting a nonprofit because you think it means you do not have to pay taxes on your income is a fundamental misunderstanding. Nonprofits can and do pay employees, but the organization itself must operate for its exempt purpose — not to enrich its founders.

Step 1: Assemble Your Board of Directors

Every nonprofit needs a board of directors (sometimes called a board of trustees). Most states require at least three directors, and it is best practice to have unrelated individuals — meaning not all family members.

Board members provide governance, strategic direction, and fiduciary oversight. They are not required to donate money, though many do. Look for people who bring relevant expertise: accounting, legal, fundraising, subject matter knowledge, and community connections.

Step 2: Incorporate as a Nonprofit Corporation

File nonprofit articles of incorporation with your state's Secretary of State. This creates the legal entity. The articles must include specific language required by the IRS for 501(c)(3) status:

A statement of purpose limited to one or more exempt purposes under Section 501(c)(3)
A dissolution clause stating that upon dissolution, assets will be distributed to another 501(c)(3) or government entity — not to individuals
A prohibition on private benefit — no part of net earnings may benefit any private shareholder or individual

These provisions are not optional. If your articles of incorporation do not include them, the IRS will reject your tax-exempt application.

Filing fees for nonprofit incorporation range from $30 to $200 depending on the state.

Step 3: Adopt Bylaws

Bylaws govern the internal operations of your nonprofit. They do not get filed with the state but are required by the IRS as part of your application. Bylaws should cover:

Board of directors structure, terms, and election procedures
Officer positions and duties
Meeting frequency and quorum requirements
Committee structure
Conflict of interest policy
Amendment procedures

Step 4: Get Your EIN

Apply for an EIN from the IRS. You need it before you can open a bank account or apply for tax-exempt status. The process is the same as for any other entity — free and available online at irs.gov.

Step 5: Apply for 501(c)(3) Status

This is the big step. You must file Form 1023 (or Form 1023-EZ for smaller organizations) with the IRS.

Form 1023-EZ (Streamlined)

Available if your organization:

Has gross receipts of $50,000 or less annually (projected for the first three years)
Has total assets of $250,000 or less

The 1023-EZ is filed online and costs $275. Processing typically takes 3-6 months.

Form 1023 (Full Application)

Required for larger organizations. The full Form 1023 is detailed and requires:

A detailed description of your activities
Financial projections for three years
Your organizing documents (articles and bylaws)
Information about officers, directors, and key employees
Compensation details
Fundraising plans

The filing fee is $600. Processing takes 6-12 months, sometimes longer.

Tip: Many nonprofits hire an attorney experienced in tax-exempt law to prepare the Form 1023. The investment (typically $2,000-$5,000) significantly increases your chances of approval and reduces back-and-forth with the IRS.

Step 6: State Tax Exemptions

Federal tax-exempt status does not automatically grant state tax exemptions. You typically need to apply separately for:

State income tax exemption — most states require a separate application or registration
Sales tax exemption — many states exempt nonprofits from paying sales tax on purchases related to their mission
Property tax exemption — if the nonprofit owns real estate used for its exempt purpose

Each state has its own application process and requirements.

Step 7: Register for Charitable Solicitation

Most states require nonprofits to register before soliciting donations from residents of that state. This is a separate registration from your tax exemption and typically filed with the state's Attorney General or Secretary of State.

About 40 states have charitable solicitation registration requirements. If you are soliciting donations nationally (through a website, for example), you may need to register in all of them. Unified registration services can help streamline multi-state filings.

Ongoing Compliance Requirements

Running a nonprofit involves significant ongoing compliance:

Annual Federal Filing

Form 990 (gross receipts over $200,000 or total assets over $500,000)
Form 990-EZ (gross receipts under $200,000 and total assets under $500,000)
Form 990-N (e-Postcard) (gross receipts under $50,000)

These are due by the 15th day of the 5th month after your fiscal year ends (May 15 for calendar-year organizations). Three consecutive years of failing to file results in automatic revocation of your tax-exempt status.

State Annual Filings

Most states require annual reports and/or annual charitable solicitation registration renewals.

Governance Requirements

Hold regular board meetings with documented minutes
Maintain a conflict of interest policy and enforce it
Keep compensation reasonable and documented
Ensure activities align with your stated exempt purpose
Avoid prohibited political campaign activity
Limit lobbying activities

The Private Benefit and Inurement Rules

Two rules are absolute for 501(c)(3) organizations:

No inurement: No part of the organization's net earnings may benefit any private shareholder or individual (insiders). This does not mean you cannot pay employees — it means compensation must be reasonable and no one can siphon off profits.

No excessive private benefit: The organization's activities must primarily benefit the public, not private individuals. Some incidental private benefit is acceptable, but it cannot be more than incidental.

Violating these rules can result in excise taxes on the individuals involved, and in extreme cases, revocation of tax-exempt status.

Compensation: Yes, You Can Pay People

A common misconception: nonprofit does not mean no one gets paid. Nonprofits can and should compensate their employees fairly. The requirement is that compensation must be "reasonable" — meaning comparable to what similar organizations pay for similar work in similar locations.

Document how you set compensation. Research comparable salaries. Have the board approve executive compensation. This protects both the organization and the individuals involved.

Bottom Line

Forming a 501(c)(3) is more complex and expensive than forming a for-profit business, but for organizations with a genuine charitable mission, the benefits — tax exemption, donor deductibility, grant eligibility — are substantial. Budget 6-12 months for the full process from incorporation to IRS approval. Invest in professional help for the Form 1023 if your budget allows. And once you have your exemption, take compliance seriously — the IRS can and does revoke tax-exempt status for organizations that fail to file or violate the rules.