How to Create a Non-Profit Prior to Obtaining 501(c)(3) Status

Creating a charity or foundation that has 501(c)(3) status involves two legal stages: (i) Formation of the entity under state law, and (ii) applying to the Internal Revenue Service.? With any business, incorporation is the first step. When an organization or individual starts a nonprofit organization, many have the misconception that they must incorporate in the state that they plan to operate, serve, and work in. However, a nonprofit can incorporate in any state of their choosing and apply for authority to conduct business in other states. At Dorf Nelson & Zauderer, we generally advise our clients to incorporate in Delaware, a state with high regulatory flexibility.? In this article, we focus on the advantages of incorporating in Delaware vs. New York.? This article uses the term “nonprofit” to apply to all nonprofit corporations.? However, note that under Delaware law nonprofits are referred as “non-stock” corporations and New York nonprofits are called “not-for-profit” corporations.

New York’s Restrictive Nonprofit Regulations

One of the main differences between New York's and Delaware’s incorporation processes is the laws governing nonprofit organizations. Unlike Delaware, New York has a separate body of law for nonprofit corporations: the New York Not-for-Profit Corporation Law. This body of law works alongside the state’s Charities Bureau within the Office of the Attorney General to regulate nonprofits incorporated in New York.??

Despite New York’s enactment in 2013 of the New York Non-Profit Revitalization Act, which modernized many required governance processes and limited reporting for smaller nonprofits, New York’s regulatory environment can limit a nonprofit’s ability to govern on their own timeline and increase their annual disclosures from cradle to grave.

The New York Not-for-Profit Corporation Law has rules and regulations that govern a nonprofit’s internal governance processes. For example, the Not-for-Profit Corporation Law requires an organization have at least 3 board members, and places restrictions on board chair membership and a director’s age. The laws also require an organization to maintain annual conflict of interest disclosures and to register by filing annual CHAR500 forms.? Additionally, if a New York nonprofit corporation wanted to dissolve outside of the court system, they must follow a multi-step process that involves the New York Department of State, New York State Department of Taxation and Finance, and the Attorney General. New York’s Not-for-Profit Corporation Law requires that a petition be filed with the Attorney General or the New York State Supreme Court to authorize nonprofit corporations wanting to sell, exchange, lease, or dispose any significant amount of their assets. The list of regulations is long and arduous, creating extra work for a nonprofit just to comply with the state’s constraining regulations.?

Despite the rigid statutory guidelines that govern a nonprofit, New York’s strict regulations do provide some benefits for nonprofit organizations. The more arduous legal landscape can be attractive to donors, as governmental oversight offers a sense of security for the funds granted and the manner in which the nonprofit is governed. Further, the annual conflict of interest disclosures provide stability to the board’s organization, and can reduce potential harms to the organization and its donors.?

Why We Advocate for Incorporating in Delaware

Delaware does not have a nonprofit statute.? Rather, nonprofits in Delaware are regulated by? the same statute the governs for-profit corporations: The Delaware General Corporation Law. Incorporating in Delaware comes with none of the above listed requirements and restrictions, allowing new nonprofits to structure their internal processes the way they choose. Incorporation in Delaware is complete after filing a certificate of incorporation for a non-stock exempt corporation through their online portal, and paying the filing fee with the Delaware Secretary of State Division of Corporations. The state also offers other regulatory benefits such as automatic exemption from a variety of state and local taxes for nonprofits that are exempt from federal income tax under Section 501(c)(3).?

In terms of restrictions on an organization’s governing procedures, Delaware only requires one board member for governance and does not require an organization to interact with specific regulatory agencies. Although it is advisable to have not less than 3 directors, when board members resign or are removed, a New York nonprofit would be out of compliance with the law if one or more board members resigns unexpectedly. It can take time to replace board members which can paralyze a New York nonprofit.

Delaware has fewer annual filing requirements for nonprofit corporations and they do not require registration with the Delaware Attorney General or any state approval to make business changes such as mergers, dissolutions, or governing document amendments. Also, dissolving a nonprofit corporation in Delaware only requires that an organization is up to date on their annual tax reports, and approval by a majority vote of the directors.?

Incorporating in Delaware does, however, require that corporations have a “registered agent” which serves as a local address for the nonprofit corporation for services of process. There are many organizations located in Delaware that can act as your registered agent. We recommend Harvard Business Services, which has an annual fee of less than $100.? The organization can then file to do business in other states of its choosing.? In New York, that would mean filing for Authority to do Business in New York. Obtaining authority in New York is not a hindrance on nonprofit activity, as it only requires the filing of one application with the New York Department of State and the payment of a filing fee. Delaware’s registered agent requirement does impose an additional fee on organizations, but it decreases their workload and maintenance requirements over time.?

If a client chooses to pursue incorporation in Delaware, the following is an outline of the steps required to obtain a 501(c)(3) classification.

1. Choose a director for your organization. As stated above, Delaware requires at least one director on your board.
2. Choose a name for your Delaware nonprofit corporation. The name cannot be the same name as another business entity already on file with the Delaware Department of State. You can check which names are already used on: https://icis.corp.delaware.gov/Ecorp/EntitySearch/NameSearch.aspx Additionally, the name must include one of the following: "Association," "Corporation," "Company," "Club," "Fund," "Foundation," "Incorporated," "Institute," "Society," "Syndicate," "Union," "Limited"; or "Corp.," "Co.," "Inc.," "Ltd."
3. Appoint a registered agent. This is an individual or corporation that agrees to accept legal papers on behalf of the non-profit in the situation that they are sued. The agent must have a physical street address in Delaware.
4. Prepare and file your non-profit certificate of incorporation. To create the nonprofit entity, you must file a Certificate of Incorporation for an Exempt Corporation with the Delaware Department of State.?This certificate of incorporation must include:

• The name of your nonprofit?
• A statement stating that the corporation will not have any capital stock.?
• The conditions for membership if applicable, and the name and mailing address of the incorporator.
• The name and street address of the corporation's registered office in Delaware and its registered agent in Delaware for service of process.
• The purpose of the corporation, including the following statement that is required for nonprofits: “This Corporation shall be a non stock corporation.”

To receive tax-exempt status from the state of Delaware and the IRS, certain specified language must be added to the certificate:?

• A statement of purpose that meets IRS requirements.?
• A dissolution provision that offers the organization’s assets to the government or another 501(c)(3) organization if dissolution occurs.
• Statements ensuring that your nonprofit will not engage in prohibited political and legislative activities or activities unrelated to its exempt purposes.

5. Prepare bylaws for your Delaware non-for-profit. After filing the articles of incorporation mentioned above, a new corporation must create bylaws that comply with Delaware law. Such bylaws contain procedures and rules that a corporation will follow for electing officers and directors, holding meetings, and provisions to change the bylaws. These bylaws are internally used in the nonprofit, and do not need to be filed with Delaware.?

6.?Hold an organizational meeting of the board of directors, during which the board may

• Approve the bylaws
• Elect directors and appoint officers
• Approve initial transactions, for example, a corporate bank account and set an accounting period and tax year

7. Obtain an Employer Identification Number (EIN) from the IRS. An EIN is a unique, nine-digit number assigned by the IRS to identify your nonprofit. The EIN number is required to apply for 501(c)(3) status, open a corporate bank account, and submit 990 returns to the IRS.?

8. File an Annual Report. In Delaware, all exempt corporations must file an annual report to the Delaware Division of Corporations. Along with submitting the report, there is a $25 franchise fee. The annual report is filed online, no later than March 1st. A notification to complete this is sent to all registered agents of Delaware in December.

Assuming that you have been incorporated in Delaware after following steps 1-8, you can then obtain Delaware state and federal tax exemptions.?

Prepare and File with the IRS Form 1023 federal tax exemption application. It is required to complete Form 1023 if a corporation wants to receive federal tax-exempt status from the IRS. Once an organization obtains 501(c)(3) tax-exempt status from the IRS, it is automatically exempt from Delaware corporate income tax along with the gross receipts tax on the sales of most goods and services. Additionally, nonprofit corporations are excused from various business license fees and various state and local property taxes. Delaware does not require nonprofits to register to fundraise within the state of Delaware but, if a nonprofit wants to conduct business and fundraising in another state, they may have to follow reporting and filing obligations in that state.

This article is a general overview of requirements for the formation of nonprofit corporations and is not meant to be legal advice. If you have any questions regarding anything in this article, please feel free to contact me at Dorf Nelson & Zauderer LLP.