This post is part of the “Launch It Legally: An Attorney’s Guide to Starting Your Business” series
Most people know that non-profits are legal entities that do not generate profit and that usually have some kind of leadership structure, whether a board or officers. But beyond that, the legal characteristics of non-profits are often a bit mysterious. What exactly are non-profits? How are they formed? And are they the same thing as 501(c)(3)s?
I explain what a non-profit is and how to form one below by outlining some key terms, formation requirements, and tax considerations, with a particular focus on Illinois. If you are looking to form a non-profit yourself, this brief guide will help you transform your idea into an operating entity.
What Is a Non-Profit?
A non-profit is often formally referred to as a “not-for-profit corporation.” That is, non-profits are actually a type of corporation, but unlike traditional “for-profit” corporations that generate revenue for their owners, non-profits are generally formed to serve a public purpose or for a charitable benefit. Any revenue generated by the non-profit is reinvested into the organization instead of being distributed to individuals. Therefore, the non-profit does not have any owners.
In Illinois, non-profits are formed pursuant to the Illinois General Not for Profit Corporation Act of 1986. This act outlines 36 purposes for which a non-profit may be formed, which include charitable, benevolent, educational, civic, political, religious, social, and athletic ends. Like limited liability companies (LLCs) and “for-profit” corporations, not-for-profit corporations shield their directors and officers from personal liability, if operated properly.
Many people associate a non-profit with also being tax-exempt. As with everything tax-related, however, the answer is not that simple: Only certain kinds of non-profits are eligible for tax-exempt status from the IRS, and simply forming a non-profit with your state’s Secretary of State is not enough to also obtain tax-exempt status. There are additional steps that must be taken with the federal government to become tax-exempt, and the process can be somewhat complex (more on that below). It is therefore important to work with an attorney and/or accountant who is familiar with these legal and accounting nuances.
How Do I Form a Non-Profit?
Forming a non-profit is very similar to forming a “for-profit” corporation. The “incorporator” (i.e., the individual who is forming the entity) must complete, sign, and file “articles of incorporation” with the Secretary of State. The articles require certain information, including the following:
- The entity’s name
- A registered agent and registered office
- A purpose (in Illinois, the purpose must fall under one of the 36 rubrics listed in the Not for Profit Corporation Act)
- At least three (but no more than seven) directors
Note that if you want to apply for tax-exempt status with the IRS, the articles of incorporation may require certain specific language. Make sure to consult with a professional advisor to ensure you are completing the articles correctly.
If your non-profit has a charitable purpose and aims to solicit donations, it will most likely need to register with Illinois’ Office of the Attorney General. Information on doing so can be found here.
Who Runs a Non-Profit?
Unlike traditional “for-profit” corporations, a non-profit does not have owners or shareholders. As the entity does not earn a profit, there is no one to whom a profit can be paid.
Yet non-profits do have boards of directors, just as with for-profit corporations,. As noted above, they must have at least three directors in Illinois. Non-profits usually also have officers (e.g., president, vice president, secretary). For small non-profits, such as condominium associations, the directors and the officers may be the same people.
Since there are no shareholders, non-profits do not require a shareholder’s agreement. The main governing document is the bylaws, which delineate the entity’s purpose, powers of the board and officers, and other operational matters for the organization.
Bylaws are not filed in Illinois; only the articles of incorporation are. It is not even required to have bylaws prepared before filing for non-profit incorporation. However, I generally encourage entities to prepare their bylaws along with their articles of incorporation because it sets a strong foundation for smooth operations. Further, bylaws will be needed if the non-profit intends to file as a 501(c)(3).
Isn’t a Non-Profit the Same Things as a “501(c)(3)”?
All 501(c)(3) organizations are non-profits, but not all non-profits are 501(c)(3) organizations. It is extremely important to note that simply forming a non-profit at the state level does not mean the organization has obtained the coveted and important tax-exempt status. If you decide to apply for federal income tax exemption, you must do so after you have been incorporated and after you have received the filed articles of incorporation from the Secretary of State.
Section 501(c)(3) of the IRS Code outlines certain organizations which are exempt from income tax. According to the IRS, “to be tax-exempt under section 501(c)(3) of the Internal Revenue Code, an organization must be organized and operated exclusively for exempt purposes set forth in section 501(c)(3), and none of its earnings may inure to any private shareholder or individual.”
To receive tax-exempt status, the requesting organization must apply directly with the IRS. These applications are very detailed and can be quite lengthy; they provide a comprehensive look into the organization’s structure and programs. You likely will need to show a projected budget, plans for programs and funding, and information regarding the individuals associated with the organization. Given the complexity of these applications, many organizations enlist professional help to structure the application and respond to follow-up questions from the IRS.
Certain non-profit entities are often eligible for state sales tax exemptions. In Illinois, the Illinois Department of Revenue (IDOR) makes a determination based on predetermined criteria. More information on this exemption and the application process to obtain it can be found here.
Where to Start?
It can seem overwhelming at first to embark upon incorporating a non-profit entity, especially as the process can be laborious and confusing at times. There are, however, numerous resources available that can help guide you.
Illinois’ Secretary of State publishes a “Guide for Organizing Not-for-Profit Corporations” that provides step-by-step instructions for forming a non-profit in the state, with particular emphasis on preparing the articles of incorporation. Specifically for charitable organizations, the Illinois’ Attorney General offers a “Checklist for Illinois Charitable Organizations” that can be found on the agency’s resource page for charitable organizations.
Additionally, the IRS has issued a document called “Applying for 501(c)(3) Tax-Exempt Status” that outlines eligibility requirement to become tax-exempt, the major steps in the application process, and the attendant responsibilities that come with tax-exempt status.
As always, I recommend working with a knowledgeable attorney who can guide you through this process, answer your questions, troubleshoot potential concerns, and speak from experience with incorporating entities. It’s likely the best way to move your non-profit from initial paperwork to purpose as a fully operational entity.