Establishing a 501(c)(3) Organization in California

What is a nonprofit organization?

Nonprofit 501(c) organizations are formed for one of three purposes: public benefit, religious purposes, or mutual benefit of its members (e.g. clubs and groups) [1]. Nonprofit means that no individual or private stakeholder can profit from the organization’s earnings [2]. That’s not to say that nonprofits cannot and do not make money, only that profits earned are used for the organization's benefit and operating expenses [1]. Nonprofits are also prohibited from making any attempts to influence legislation or be involved with any other political activity [2].

There are a number of 501(c) subsections, but this discussion will be focused on 501(c)(3) nonprofits. The Internal Revenue Service (IRS) refers to these as charitable organizations. Many formed for the purpose of environmentalism and/or conservation fall under this “public benefit” category. Under California law, this encompasses organizations formed for scientific, educational, literary, charitable, and/or religious purposes [1].

What are the benefits of 501(c)(3) status?

This is a unique status in that it not only benefits the organization, but the public and private sources who make contributions to the organization. These nonprofits qualify for state and federal tax exemptions. In California, they can also qualify for county and personal property tax exemptions. There are a number of other miscellaneous benefits including discounted postal, advertising, purchasing, and membership costs and also participation in local, state, and federal incentive programs [1].

Donors benefit from contributing to 501(c)(3) organizations because they are able to claim tax deductions on their donations [1]. This increases the organization's chances of attracting public and private donations and grant funds, arguably making 501(c)(3) the most desirable nonprofit status [1]. In fact, many tax-exempt government entities and private charities and foundations are only allowed to donate to other 501(c)(3) organizations [1]. It’s an attractive scenario for all parties involved.

How do I establish a 501(c)(3) in California?

The Internal Revenue Code section requirements are the same for all organizations, regardless of locality. However, each state has their own requirements and processes for establishment. Here are the steps one must take to form a tax-exempt, conservation focused nonprofit organization in California: 

1. Choose initial director(s). Emily Chan and Gene Takagi with the Neo Law Group in San Francisco point out that the articles of incorporation do not require a listing of initial director(s) [3]. Instead, it's possible to appoint director(s) after the corporation's name is selected and articles have been filed [3]. However, I believe it is prudent to formulate an initial board of directors to collaborate on the name selection, preparation, and filing of the articles of incorporation. Chan and Takagi also note that although California law requires a minimum of one director on a nonprofit board, it would be much less likely to be granted 501(c)(3) status with only one [3]. Neo Law Group, who specializes in nonprofit corporations, find that the majority of California's nonprofits have between 3-25 directors [3]. All 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" [3].

2. Choose your corporation's name. This may seem too obvious to mention here, but choosing a name is more difficult than one might assume. The corporation's name must be relevant and appropriate. California law requires that the name is not too similar to existing corporation names, that it is not misleading in any way, and that it does not infringe on anyone's trademark rights or intellectual property [3]. Chan and Takagi recommend comparing potential names with existing names listed on the Secretary of State (SoS) website. Once a name has been determined, they also recommend submitting a Name Reservation Request to the SoS to hold the chosen name while the next steps are being completed.

3. Form a purpose(s) statement. The formation of a purpose(s) statement isn't listed individually by Chan and Takagi, but I find its importance warrants a separate listing here. The nonprofit's purpose needs to be focused enough that the organization has a clear and specific mission, but broad enough to leave room for the mission to evolve without requiring amendments to the articles later on [3]. Chan and Takagi note that the stronger the purpose(s) statement, the more likely the organization stays on track after the initial founders are no longer involved [3]. The formulation of purpose(s) is a significant step; it will influence the course of the nonprofit's future and should not be taken lightly.

4. Prepare and file articles of incorporation. Completion of this step results in the legal formation of the corporation. This is required of all nonprofits in California pursuant to Corporations Code Section 5000 [4]. The articles of incorporation specify the nonprofit's name, purpose(s), the responsible party (person open to receive official correspondence and legal action), and limitations on corporate powers [3]. If an initial board of directors was not already established, these articles can be completed and signed by a single "incorporator" [3]. If directors were already chosen and named in the articles, they must be signed by all parties [3]. There are templates for articles of incorporation available on the California Secretary of State's website. If the director(s) have not already been selected, they would need to be appointed by the "incorporator" through written action before moving on to the next step [3].

5. Prepare bylaws. Bylaws help to ensure sound governance to all stakeholders (corporation directors and officers, government entities, donors, etc.) [3]. According to Chan and Takagi, these should address a variety of provisions, including but not limited to:

• the nonprofit's mission
• how directors are chosen (e.g. majority vote)
• the corporation's officers and their duties - California law requires a president or chair, a secretary, and a treasurer or chief financial officer
• how often meetings are called and how the board is notified of meetings
• how the board can take an action (e.g. majority vote)
• how meetings are conducted
• reporting guidelines
• authorizations of board and non-board members (e.g. acting authorities vs. recommendations only)
• conflict of interest policies - required for IRS Application of Exemption under Section 501(c)(3)
• the level of indemnification for directors, officers, and other agents

This is a step for which many corporations will seek counsel to ensure their structure, processes, and member rights are sound, thorough, and legal [3]. Counsel can be formally secured or guidance can be obtained free of charge from documents created by pro bono law firms like Public Counsel, a Los Angeles, CA firm. They provide an annotated form of bylaws for public benefit nonprofits in California [3]. It's updated as needed and is a great option to identify the corporation's fundamental provisions without having to hire an attorney [3]. 

6. Hold a board of directors meeting and record actions taken. The first board meeting should elect officers, approve the bylaws and the conflict of interest policies, establish a fiscal year, approve the establishment of a bank account and budget, approve the application of state and federal exemptions, approve the reimbursement of startup expenses, and approve the compensation of the CEO and CFO [3]. Minutes should be created in order to record the actions taken by the board [4].

7. Set up a corporate records and bookkeeping system. One of the drawbacks for nonprofit organizations is the requirement of extensive record keeping, so it's vital to develop an organized and efficient systems early on [1]. The articles of incorporation, bylaws, and meeting documents should be filed and maintained [4]. Once the 501(c)(3) is up and running it will also be a requirement to manage additional records such as accounting procedures, tax documentation, and financial and activity reports [1]. It would be useful to have a tax advisor, bookkeeper, or other tax or legal specialist on the board [1]. However, it is quite possible in the early stages and even for smaller, established nonprofits to utilize an outside accountant or related professional to maintain the organization's books and records [1]. 

8. Obtain an Employer Identification Number (EIN). An EIN is issued by the IRS for the sole purpose of tax administration [5]. It is required for all nonprofits to obtain an EIN, regardless of whether or not they have employees. The EIN is applied for by the organization's responsible party [3]. The application can be completed online and the ID number is generated upon completion.

9. File the California Charitable Trust (CT) initial registration, Form CT-1. This is done with the California Attorney General's Registry of Charitable Trusts. This registration is required by California law for nonprofit public benefit corporations [3]. This step is time sensitive and must be completed within 30 days of incorporation [3]. The initial submission requires the articles of incorporation and bylaws and later, the IRS determination letter of tax-exempt status [3]. The Charitable Trust registration must be renewed annually.

10. File the California Statement of Information, Form SI-100. This is done with the Secretary of State. This is another time sensitive step that must be completed within 90 days of incorporation [3]. California law requires nonprofit public benefit organizations to submit this form every other year [3]. The initial submission identifies the organization's address, officers, and responsible party and future filings are intended to keep the information current [3]. 

11. File IRS Form 1023. This is the Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code and it is filed with the IRS. Smaller nonprofits can file the streamlined application with Form 1023-EZ, but either way, this step is considered to be the most daunting in the formation of a tax-exempt nonprofit organization [3]. 

This form requires a comprehensive description of the nonprofit's structure; compensation and other financial arrangements for board members, employees and independent contractors (if applicable); members and other organizations that may receive benefits; history; statement of revenue and expenses (actual and/or projected); and specifics for past, present, and future activities [3]. All of this information must be extremely detailed. For instance, the activities section addresses what the activities are; who conducts them; when, where, and for how long they've been or will be conducted; how they serve to support tax exemption; and how they have been or will be funded [3]. It's an in-depth inquiry which further emphasizes the importance of an organized record keeping system (step 7). 

This is also the most costly application in the process, ranging from $400.00 to $850.00 [1, 3]. The turnaround time is between three to four months if the application is correct and complete, but a great deal longer if there are any omissions or errors [3]. The application consists of 11 Parts and 8 Schedules, so while you might be in a hurry to establish your tax-exempt status, it's important to be thorough, accurate, and to make use of IRS tools before and during the completion of the 1023 and 1023-EZ forms to avoid delays. If all goes as planned, your application will be approved and you'll receive your federal determination letter in a few short months. Do not forget to submit this letter to the California Attorney General's Registry of Charitable Trusts (step 9) once it's received.

12. Apply for California tax exemption with Form 3500A. Pursuant to California Revenue & Taxation Code section 23601d, federally tax-exempt nonprofits also qualify for state tax exemptions [3]. This is done with the California Franchise Tax Board (FTB). Form 3500A is free to file and can only be completed once you've received your 501(c)(3) determination letter [3]. Once approved, your status is retroactive to the date of your federal tax exemption [3]. If you don't want to wait for your federal determination letter, you can complete the more complicated Form 3500 for a fee [3]. 

Conclusion

Establishing a 501(c)(3) organization may not be an easy process, but it's necessary for organizations like the Conservation Biology Institute (CBI) and many others that strive to make a positive impact on biodiversity and environmental processes. For more details, check out Attorney Anthony Mancuso's book: How to Form a Nonprofit Corporation in California. You should also visit the California Secretary of State's "Domestic Nonprofit Corporation - Filing Tips" page and the IRS "Small to Mid-Size Tax Exempt Organization Workshop" found here. 

Please note that the steps I've outlined are used to create a "domestic" nonprofit, meaning it is located within the state of California. Out-of-state organizations are considered "foreign" and, like CBI which is based out of Oregon, require additional steps and/or separate forms to operate in California. Check with California's Secretary of State, Attorney General's Registry of Charitable Trusts, and Franchise Tax Board for foreign nonprofit requirements.

Resources

1. Mancuso, A. (2019). How to form a nonprofit corporation in California. Berkeley, CA: Nolo.

2. IRS. (2019). Exemption Requirements - 501(c)(3) Organizations. Retrieved August 11, 2019, from https://www.irs.gov/charities-non-profits/charitable-organizations/exemption-requirements-501c3-organizations

3. Chan, E., & Takagi, G. (2018). How to Start a California Nonprofit. Retrieved August 11, 2019, from https://calnonprofits.org/resources/starting-a-california-nonprofit#incorporation

4. Nolo. (2014, November 14). How to Form a California Nonprofit Corporation. Retrieved August 11, 2019, from https://www.nolo.com/legal-encyclopedia/forming-nonprofit-corporation-california-36053.html

5. IRS. (2019). Apply for an Employer Identification Number EIN Online: Internal Revenue Service. Retrieved August 11, 2019, from https://www.irs.gov/businesses/small-businesses-self-employed/apply-for-an-employer-identification-number-ein-online