The purpose of nonprofit organizations is generally to improve quality of life for others at a community, local, state, national, or even global level. These organizations are not dedicated to private or financial gain but to the advancement of public interest.

Laws Governing Nonprofit Organizations

Nonprofit organizations are governed by state and federal law but do not have a statutory federal meaning. Most states allow nonprofits to form for any purpose provided that it is legal and that profits are not distributed to members of the organization.

To receive favorable tax-exempt status and other benefits, however, the nonprofit's purpose must be approved by the Internal Revenue Code (IRC).

All funds earned by a nonprofit organization must be used to further its mission. However, paid staff can be hired to manage the organization's activities.

Creating a Nonprofit Organization

When creating a nonprofit organization, you should first define its specific purpose. What do you hope to accomplish by starting this organization? This can be anything from creating a neighborhood club or promoting the work of local artists to tackling major issues such as homelessness, health care, and hunger.

Once you define the purpose of the organization, you can come up with a descriptive name, determine whether you'll be able to file for tax-exempt status, and seek potential candidates for the board of directors. You may want to consult with a tax professional about qualifying as a 501(c)(3) tax-exempt organization.

Writing a Nonprofit Mission Statement

A mission statement outlines a nonprofit organization's purpose. It should include elements such as:

  • The market or target audience you are planning to serve.
  • The type of service or product you plan to provide to this market.
  • The aspects of the organization that distinguish it from other product and service providers in that market.

Filing Articles of Incorporation

To form a nonprofit organization, you must file articles of incorporation with the state where you plan to be located. It's important to pay specific attention to the purpose clause. The IRS will carefully review this section to determine whether your organization qualifies for tax-exempt status. They also provide organizations with recommended language to use in this section.

You can download a template from the secretary of state website for your articles of incorporation. You can also attach separate pages if you need to provide more information. For example, you should make sure to detail the mission and purpose of your organization. The descriptive language you develop for the articles can also be used for your nonprofit bylaws.

Advantages of Forming a Nonprofit

Nonprofits are exempt from paying certain taxes, which can create substantial cost savings. This includes federal income tax provided the organization qualifies for tax-exempt donations based on IRS guidelines. Those who donate to a qualifying nonprofit can deduct these itemized donations on their tax returns.

Tax-Exempt Status

Several dozen business categories can qualify as tax-exempt nonprofit organizations with the IRS. Most of these are not subject to federal corporate income tax, including but not limited to the following:

  • Charitable organizations
  • Labor unions
  • Social clubs
  • Professional associations
  • Civic leagues
  • Fraternal organizations

Certain groups may receive additional privileges or be subject to activity limitations and/or disclosure and reporting requirements. Some organizations may be classified as nonprofits by state law but not meet the IRS criteria for tax exemption.

Organizations that qualify for 501(c)(3) status with the IRS are exempt from federal income tax and receive donations that are tax-deductible for the donors. An organization must pass both the operational and organizational tests to achieve 501(c)(3) categorization. The organization test means that the nonprofit's formation documents must limit its activities to only those permitted by the IRS for tax-exempt organizations. Its activities must also comply with these guidelines to pass the operational test.

Most qualifying organizations are either private foundations or public charities. The purposes of these organizations may include but are not limited to the following:

  • Religious
  • Scientific
  • Public safety-oriented
  • Charitable
  • Literary
  • Sports
  • Cruelty prevention

Examples include day care centers, museums, churches, theaters, and many other types of organizations.

Organizations that do not pass both tests can sometimes qualify for tax-exempt status, but donors may not deduct donations to these organizations on their tax returns.

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