Forming A Tax-exempt California Nonprofit Corporation
FORMING A TAX-EXEMPTCALIFORNIA NONPROFIT CORPORATIONPrepared by:The Legal Aid Foundation of Los AngelesHousing and Communities WorkgroupRevised 2018
COPYRIGHT 2018 Legal Aid Foundation of Los AngelesAll rights reserved. No part of this publication may be reproduced by any means, electronic orotherwise, or used for any purpose without the express written permission of the Legal AidFoundation of Los Angeles. This publication may be copied and/or distributed by a CaliforniaNonprofit Corporation for the sole purpose of assisting other nonprofit corporations provided noportion of this publication is altered in any reprint and that the name of the Legal Aid Foundationof Los Angeles is not altered or removed.DISCLAIMERThis manual has been prepared by the Legal Aid Foundation of Los Angeles. It is not intended toprovide you with specific legal advice regarding your organization, but rather to give yougeneral information about the incorporation and tax-exempt status application process. If youhave specific questions about your organization, you should consult an attorney.ABOUT USLegal Aid Foundation of Los Angeles’ Housing and Communities Workgroup aims to empowerLos Angeles communities and community-based organizations in their efforts to attack povertyat its roots. The Unit is committed to building clean, safe, and economically vibrantneighborhoods through legal assistance, policy advocacy and community education. Toachieve this goal, attorneys and advocates assist in developing, training, and empoweringcommunity-based organizations and poor and low-income individuals to become activelyinvolved in the community revitalization process.To request our services for your organization, call us at (800) 399-4529 or visit us online atwww.lafla.org.ii
Table of ContentsChapter One: Introduction . 1Chapter Two: Forming A Nonprofit Corporation . 2A.Section A: General Background . 21.Nonprofit vs. For-Profit Organization . 22.Types of Nonprofit Organizations . 2a.Unincorporated Association . 2b.Charitable Trust . 3c.Corporation . 3d.Limited Liability Company . 3e.Fiscal Sponsorship . 23.B.Nonprofit Corporate Forms Under California Law . 3Section B: Formation and Incorporation Process . 4Checklist . 41.Reserving a Name with the Secretary of State . 52.Preparing the Articles of Incorporation . 5a.Required Provisions . 5b.Other Provisions . 6c.Optional Provisions . 63.Executing the Articles of Incorporation . 64.Filing the Articles of Incorporation . 65.Drafting Corporate Bylaws . 7Recommended Bylaws Provisions. 86.Initial Registration with the Secretary of State . 97.Initial Registration with the California Attorney General . 98.Initial Registration with the Employment Development Department . 10Chapter Three: Gaining Tax-Exempt Status . 11C.1.Section A: Types of Exempt Organizations . 11Internal Revenue Code Section 501(c)(3) . 11501(c)(3) Lobbying – Restricted but not Prohibited . 122.Internal Revenue Code Section 501(c)(4) . 133.Differences Between 501(c)(3) and 501(c)(4) Status . 134.Other Organizations Exempt Under 501(c) . 13iii
D.Section B: Procedure for Securing Tax-Exempt Status . 14Checklist . 141.Federal Forms . 152.Submitting IRS Form SS-4, Application for Employer Identification Number . 153.Obtaining Federal Tax Exemption . 15Expediting the 501(c)(3) Process . 164.Obtaining State Tax Exemption . 185.Filing for Local Property Tax Exemption . 206.Sales and Use Tax . 21Chapter Four: Continued Reporting Requirements . 22Checklist . 221.Biennial Report with the Secretary of State . 232.Annual Informational Return with the Internal Revenue Service . 233.Annual Informational Return with the Franchise Tax Board . 244.Annual Report with the Attorney General’s Office . 255.Annual Report to Directors and Members . 266.Changes to the Articles of Incorporation. 27Appendix . iA.Flowcharts .iPre-Incorporation . iIncorporation . iTax Exemption . iiB.Checklists . iiiInitial Set-up .iiiFormation and Incorporation Process . iiiProcedures for Securing Tax Exempt Status . ivContinued Reporting Requirements. vC.Yearly Calendar Deadlines . viiv
CHAPTER ONE: INTRODUCTIONThis manual has been designed by the Housing and Communities Workgroup of the LegalAid Foundation of Los Angeles to provide your organization with basic guidance on forminga nonprofit corporation and gaining tax-exempt status. This manual is not designed to takethe place of legal or technical assistance, but rather to lay out the basic steps to get theincorporation and tax exemption process underway.Although this manual is useful to any organization seeking to incorporate, the emphasis is onorganizations that want to incorporate as Public Benefit Corporations and who want to seek501(c)(3) Tax Exempt Status.This manual is divided into three separate sections:1. The incorporation process2. Gaining tax-exempt status3. Continuing reporting requirementsReview each section carefully. It will be important for your organization to appreciate thedifferences between incorporation and tax-exempt status, as well as to be aware ofreporting requirements.There are two decisions your organization must initially make. First, do you want to becomea nonprofit corporation? The incorporation process is defined by the California CorporationsCode. Therefore, all the forms and processes discussed in this chapter will be governed byCalifornia law.Next, does your organization wish to seek tax-exempt status? As you may be aware, taxexempt status provides many advantages for an organization. Some of these advantagesinclude no state or federal income tax liabilities, assisting your organization with qualifyingfor certain grants and/or funding and, in some instances, providing your donors with acharitable contribution tax deduction. Tax-exempt status is governed by both state andfederal regulations. Under state law, the Franchise Tax Board establishes filing and reportingrequirements; under federal law, the Internal Revenue Service (IRS) establishes suchrequirements.Not all organizations may choose to undertake these processes. In fact, as will be brieflydiscussed later in this manual, certain types of organizations may not find it appropriate ornecessary to incorporate or to seek tax-exempt status. However, should your organizationchoose to form into a tax-exempt nonprofit corporation, this manual will prove to be avaluable tool in that endeavor.Each chapter of this manual contains a checklist outlining each step of the process. Inaddition, the Appendix contains an overall checklist that can be used as a guide to theincorporation and tax exemption processes.1
CHAPTER TWO: FORMING A NONPROFIT CORPORATIONA. SECTION A: GENERAL BACKGROUND1. Nonprofit vs. For-Profit OrganizationA nonprofit organization is defined by the American Bar Association as a corporation “nopart of the income or profit of which is distributed to its members, directors or officers”. Allnonprofit organizations have three basic characteristics: They are designed from the outset to be nonprofit None of the income or assets may be divided among members, officers, or directors They may only pursue legally defined purposes (i.e., public benefit, educational,charitable or religious)A for-profit corporation, on the other hand, would allow for income and asset distributionand serve very different purposes.2. Types of Nonprofit OrganizationsUnder the California Corporations Code, there are four basic types of legal organizationsthat can be used for nonprofit purposes: the unincorporated association, the charitabletrust, the corporation, and the limited liability company.a. Unincorporated AssociationAn unincorporated association is formed for some purpose other than for profit and isgenerally the organizational structure selected by small local clubs, labor unions andfraternal organizations. Often the association structure is selected if the organization will onlyoperate for a short time period.AdvantagesDisadvantagesEasy to organizeSomewhat vague state regulationsInformalPotential individual director and memberliability for acts and omissions within thescope of their authorityNo incorporation costsMay enter into contractsMay sue or be suedDifficulty in contracting/doing business inassociation’s nameLimited record keeping requirementsDifficulty in raising money/obtaining grantsNet income potentially taxable2
b. Charitable TrustTrusts are generally developed by one person (the trustor), who gives an intermediaryperson (the trustee) legal title to certain property (the trust) for the benefit of another (thebeneficiary).This organizational structure is used for very specific and very limited purposes, for example,tax-advantaged charitable giving.AdvantagesDisadvantagesCan be established and operatedrelatively quickly and inexpensivelyMust register with the Attorney General andis subject to the Attorney General’scontinuing supervisionDoes not have to comply with anystatutorily required formalitiesFounder has the authority to name thetrusteec. CorporationThe corporation is the most common—and probably the best—organizational structure formost nonprofit organizations. It is a legal entity, organized according to prescribed legalrequirements and having specific powers granted by law.AdvantagesDisadvantagesRecognized legal entityCosts of formationClear statutory requirementsNeed to fulfill corporate formalitiesNo individual director or officer liability forgood faith acts and omissions that arewithin the scope of their duties and in thebest interest of the corporation and withinthe exercise of their policy-makingjudgment (California Corporations Codesection 5047.5)Formalized structure, reporting and recordkeeping requirementsPrerequisite from some funding sources toreceiving moneyd. Limited Liability CompanyLimited Liability Companies, often referred to as LLCs, are a hybrid between corporationsand partnerships. Although they offer the limited liability of corporations, they have greaterflexibility and can be structured so that the entity is not subject to corporate income tax.3
AdvantagesDisadvantagesMembers, managers and officers are notpersonally liable for obligations or liabilitiesof the LLC, with the same narrowexceptions (e.g. using LLC as “alter ego”)as corporate shareholders (CaliforniaCorporations Code section 17101)Costs of formationMust pay 800 annual California limitedliability taxLaw is unclear as to whether LLCs can beformed for charitable purposes, State lawrequires a “lawful business activity, whetheror not for profit” (California CorporationsCode section 17002)Flexible structure allowing members toactively participate in management andcontrol of companyVery limited circumstances under whichLLCs can obtain 501(c)(3) tax exemptionCan be structured so that the entity is notsubject to corporate income tax but haspass-through tax status similar to apartnershipe. Fiscal SponsorshipAnother alternative to forming a corporation or gaining independent 501(c)(3) status maybe operating as an informal organization under the legal umbrella of an existing charity.AdvantagesDisadvantagesCan raise grants, contributions, and otherfunds based on the sponsor’s track recordand experienceLoss of control over activities, since ultimateauthority lies with the board of directors ofthe sponsorThe sponsor has fiscal, accounting,personnel, management and other systemsin placeCommunity perception that its activities arethose of the sponsor. The sponsor mayreceive credit for a successful project. Asponsor with a bad reputation may tarnishthe projectCan operate informally, no incorporationcostsAs a small part of a larger organization, theproject may not receive timely andadequate support. Also, the sponsor mightretain a significant portion of the funds forits administrative expenses.The sponsor assumes the risk of liabilityMay be difficult to disengage from thesponsor and continue the project as aseparate corporation.2
3. Nonprofit Corporate Forms Under California LawThe California Corporations Code recognizes three types of nonprofit corporations. Eachtype is governed by separate sections of the California Nonprofit Corporation Law. Thethree types are Public Benefit, Mutual Benefit and Religious Benefit Corporations. Thedifferences are as follows:Public BenefitCorporationMutual BenefitCorporationReligious BenefitCorporationFormed for public orcharitable purposesFormed for any lawfulpurposeFormed primarily forreligious purposesNo distribution of assets tomembers allowed at anytimeDistribution of assets tomembers allowed onlyupon dissolutionNo distribution of assets tomembers allowed at anytimeSubject to strictgovernmental regulationand supervisionSubject to less rigidgovernmental regulationand supervisionSubject to minimalgovernmental controland supervisionGenerally used byfoundations, civic, andsocial service groupsGenerally used byhomeowners associations,fraternal orders, andtrade associationsGenerally used bychurches and otherreligious organizationsThe vast majority of California nonprofits are organized as Public Benefit Corporations.3
B. SECTION B: FORMATION AND INCORPORATION PROCESSChecklistReserve a corporate name with the California Secretary of State (optional butrecommended).Draft and file Articles of Incorporation with the California Secretary of State.Draft corporate bylaws.Complete SI-100, Statement of Information (Domestic Nonprofit Corporation) andfile it with the California Secretary of State.Complete Initial Registration with State Attorney General’s Registry of CharitableTrusts using Form CT-1 or URS v.4.02 within 30 days of receipt of property or assets bycorporation.If your organization will have employees, complete Form DE-1NP, Registration Formfor Nonprofit Employers, and file it with the California Employment DevelopmentDepartment.4
1. Reserving a Name with the Secretary of StateIt is advisable to reserve the name of your organization with the Secretary of State’s officeprior to filing your Articles of Incorporation. This process will help avoid later delays inapproval of the Articles should another corporation already have that name. If you have aprepaid priority account, you may reserve the name by phone. All requests for prepaidpriority accounts, name availability and name reservations must be sent in writing.Prepare the NameReservation Request FormSubmit it to the Secretary ofState http://www.sos.ca.gov/businessprograms/ Forms, Samples & Fees BusinessEntities Corporations Scroll down to find NameReservation Request Form Fee: 10 By mail: Secretary of State, NameAvailability Unit, 1500 11th Street,3rd Floor, Sacramento, CA 95814 Include a self-addressed envelope In person: At the above address or at 300South Spring Street, Room 12513,Los Angeles, CA 90013 In person requests require anadditional 10 handling fee n-requestform.pdf A name will only be held for 60 days2. Preparing the Articles of IncorporationEvery nonprofit organization that wishes to incorporate must file Articles of Incorporationwith the Secretary of State. Articles of Incorporation need not be lengthy or includedetailed information about your organization. Under California law, certain items must becovered in Articles of Incorporation.Specific instructions and forms links:Public Benefit: b.pdfMutual Benefit: u.pdfReligious Benefit: e.pdfa. Required Provisions1. Name, street and, if different, mailing address of the Corporation.2. The following statement:“This corporation is a nonprofit public benefit/mutual benefit/religious benefitcorporation and is not organized for the private gain of any person. It is organizedunder the Nonprofit Public/Mutual/Religious Benefit Corporation Law for charitable[501(c)(3)] or public [501(c)(4)] purposes.”5
3. The name and California street address of the corporation’s initial agent for serviceof process.4. A statement describing the specific purpose of the corporation.5. If the corporation wishes to be federal and state tax-exempt as a 501(c)(3)organization, specific statements must be included which:a. Dedicate its assets to a 501(c)(3) organization upon dissolution;b. Prohibit the corporation from engaging in political campaigns and restrictlobbying activity; andc. Specify being “organized and operated exclusively” for 501(c)(3) purposes.b. Other ProvisionsIn addition to the required provisions, certain other provisions will not be effective unlessthey are stated in the Articles of Incorporation:1. A provision limiting the duration of a corporation’s existence to a specific date.2. If the corporation is formed under the authority of a parent organization, a provisionmust be included which gives authority for dissolution to the parent organization andprovides for the assets to go to the parent organization upon dissolution.c. Optional ProvisionsThese provisions are not formally required, but may be included if your organization sochooses:1. The names and addresses of the initial directors (a drawback to including thisinformation is that each initial director must sign as an incorporator).2. A statement that the corporation shall or shall not have members.3. The number, or a required minimum and maximum number, of directors.3. Executing the Articles of IncorporationEach incorporator must sign the Articles of Incorporation. The incorporator(s) can be thedirector(s), an attorney, or someone in the attorney’s office, like a paralegal.4. Filing the Articles of IncorporationSubmit the Articles of Incorporation and enclose a check for 35.00 payable to theSecretary of State to cover the 30 filing fee and 5 certification fee:6
By Mail:Secretary of StateBusiness Entities Filing UnitP.O. Box 944260Sacramento, CA 94244-2600A certified copy will be returned in approximately 7-8 weeks. If you want an additionalcertified copy, enclose a check for 41 or 41.50 to cover the 30 filing, 10 certification feefor 2 certified copies, and the copying fee of 1 if the Articles are on one page or 1.50 if ontwo pages.In Person:Secretary of State Office1500 11th Street, 3rd FloorSacramento, CA 95814If filing in person, take a separate check for 15.00 for special handling fees, payable to theSecretary of State.****IMPORTANT NOTE****Once the Secretary of State has endorsed and filed Articles of Incorporation, acorporation continues to exist until dissolved. Dissolving a public benefit or religiouscorporation requires at minimum:1. A California Attorney General letter that waives objections to distribution of itscorporate assets or confirms that no corporate assets exist; and2. Filing a Certificate of Dissolution with the Secretary of State.Dissolution of a mutual benefit corporation requires the California Attorney General toapprove—or a superior court to decree—the distribution of its charitable assets. Therefore,you should not file Articles of Incorporation unless you will seek tax-exemption andactively pursue your stated purposes. If the corporation is inactive and/or suspended, itwill need a revivor certificate from the Franchise Tax Board before it can dissolve.5. Drafting Corporate BylawsIt is highly recommended that your organization draft corporate bylaws and have themapproved by the board of directors and/or membership. In fact, your organization musthave bylaws in order to file for tax-exempt status. Bylaws function as the operatinginstructions for conducting the business of the corporation. Bylaws serve three mainpurposes:1. Regulate the internal practices and procedures of the organization;2. Define the relationship, duties and limitations of the members, if any; and3. Define the power, duties and limitations of directors, officers, and other agents.Bylaws also serve a practical necessity by helping to resolve future disagreements amongboard members regarding organizational operations.7
Recommended Bylaws ProvisionsThe California Corporations Code Sections 5151 and 5152 describe the generalrequirements for bylaw provisions. At a minimum, bylaws should include the following:1. Location of principal office;2. Time, place & manner of calling membership, director, & other committeemeetings;3. The number, qualifications, duties, and powers of directors;4. Quorum requirements at all mentioned meetings;5. Appointment and authority of committees;6. Appointment; duties, and compensation of officers;7. The voting authority of the Executive Director (if applicable);8. Hiring, termination, duties, and how compensation will be determined for staff;9. Method of determining members (if applicable);10. Reporting requirements, annual reports, financial reports;11. Dues (if applicable);12. Fiscal Year;13. Amendment and conflict of interest procedures;14. Other items that may be specific to your organization’s needs.8
6. Initial Registration with the Secretary of StateWithin 90 days after filing Articles of Incorporation, all nonprofit corporations must file aStatement of Information (Domestic Nonprofit Corporation) with the California Secretary ofState. Details for completing the form are explained on the reverse side of the form.Prepare the SI-100Statement of InformationSubmit it to the Secretary ofState http://www.sos.ca.gov/businessprograms/ Forms, Samples & Fees BusinessEntities Corporations Scroll down to find Statement ofInformation - Nonprofit (Form SI100) Fee: 20 Copy fees: 1 for the first page, 0.50for each attachment page For certified copies, an additional 5per document Online: https://businessfilings.sos.ca.gov By mail: Secretary of State, Statement ofInformation UnitP.O. Box 944230Sacramento, CA 94244-2300 In person: 1500 11th StreetSacramento, CA 95814 http://bpd.cdn.sos.ca.gov/corp/pdf/so/corp so100.pdf7. Initial Registration with the California Attorney GeneralInitial registration with the California Attorney General’s Registry of Charitable Trusts isrequired within 30 days after receiving assets. To register, an organization must submit FormCT-1. If it intends to solicit funds in other states, the Unified Registration Statement (URSv.4.02), which most states requiring registration accept, may be used. A copy of theorganization’s Articles of Incorporation and Bylaws, and a registration fee of 25, must alsobe included. The initial registration fee applies to all charities registering with the AttorneyGeneral's Registry of Charitable Trusts for the first time regardless of gross revenue or assets.Prepare the CT-1 FormSubmit it to the AttorneyGeneral http://www.oag.ca.gov/charities/forms Scroll down to find CT-1 InitialRegistration Form charities/charitable/ct1-form.pdf Fee: 25 Check payable to Department ofJustice By mail: Registry of Charitable TrustsP.O. Box 903447Sacramento, CA 94203-4470 URS v.4.02: www.multistatefiling.org/urs webv402.pdf9
8. Initial Registration with the Employment Development DepartmentIf your organization plans to hire employees, you will need to register with the CaliforniaEmployment Development Department.Prepare the DE-1NPSubmit it to the Secretaryof State http://www.edd.ca.gov/forms Click on Payroll Taxes - Formsand Publications Scroll down to find DE-1NP No fee By mail: Employment DevelopmentDepartmentAccount Services Group MIC 28P.O. Box 826880Sacramento, CA 94280-0001 www.edd.ca.gov/pdf pub ctr/de1np.pdfGenerally, a charity that has employees is treated like any other business for the purpose ofemployment law. The following guides provide more information about the employmentrelationship and duties of an employer: California Employment Development Department 2018 California Employer’s Guidehttp://www.edd.ca.gov/pdf pub ctr/de44.pdf IRS Publication 15, Employer’s Tax Guide (Circular E)https://www.irs.gov/pub/irs-pdf/p15.pdf National Council of Nonprofit Associations Sample Employee -handbook-national-council-of-nonprofits10
CHAPTER THREE: GAINING TAX-EXEMPT STATUSC. SECTION A: TYPES OF EXEMPT ORGANIZATIONSA nonprofit organization is not automatically exempt from state or federal taxes. To berecognized as tax-exempt, an organization must satisfy certain requirements and file forexemption with each taxing authority. The first step in the process is determining what typeof tax-exempt status suits your organization’s missions and goals.1. Internal Revenue Code Section 501(c)(3)501(c)(3) exempt status is the most common form selected. Organizations qualifying for501(c)(3) status do not pay income tax and donations received are generally taxdeductible by the donor, which makes soliciting donations somewhat easier. To qualifyunder 501(c)(3), the corporation’s stated purpose must be one or more of the following:religious, charitable, scientific, educational, or preventing cruelty to children or animals.The
3. Nonprofit Corporate Forms Under California Law The California Corporations Code recognizes three types of nonprofit corporations. Each type is governed by separate sections of the California Nonprofit Corporation Law. The three types are Public Benefit, Mutual Benefit and Religious Benefit Corporations. The differences are as follows:
Public Charities F ederal tax law provides tax benefits to nonprofit organizations recognized as exempt from federal income tax under Inter nal Revenue Code (IRC) Section 501(c)(3). The IRC requires that tax-exempt organizations must comply with federal tax law to maintain tax-exempt status and avoid penalties.
Applying for Tax-Exempt Status Overview Course Page 1 – Welcome to the Applying for Tax-Exempt Status Course This course is presented by the Tax Exempt & Government Entities division’s Exempt Organizations office. Page 2 – Introduction . Leagle: I’m Leagle, the EO Eagle, a
2. 501 (c)(3) Applying for 501(c)(3) Tax-Exempt Status, F. ederal tax law provides tax benefits to nonprofit organizations recognized as exempt from federal income tax under Section
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