How to Form a Nonprofit Corporation in California

Anthony Mancuso

• Publisher: NOLO
• Year: 2019
• ISBN:
  9781413326222
• Edition: 18
• Topic: Business
• Subtopic: Nonprofit Organizations & Charities
• Index: Business

AUDIENCE FOR BOOK:
Anyone who wants to form a nonprofit corporation in California and obtain tax-exempt status under Section 501(c)(3) of the Internal Revenue Code.REASONS TO BUY THIS NEW EDITION

• Explains everything readers need to know to create a Section 501(c)(3) nonprofit corporation in California from start to finish
  
• Provides line-by-line instructions for IRS Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code—the form you need to complete to obtain your 501(c)(3) status
  
• Includes information about the new streamlined federal tax-exempt application, Form 1023-EZ
  
• Explains the California incorporation process—from selecting directors to filing nonprofit articles of incorporation—as well as how to apply for tax-exempt status from the IRS and the state
  
• Includes articles and bylaws for membership and nonmembership nonprofits

CHAPTER

1

Is Nonprofit Incorporation Right for You?

Is Your Group a Nonprofit That Can Use This Book?

Public Benefit Corporations

Religious Corporations

Mutual Benefit Corporations

Benefits of the Nonprofit Corporation

Tax Exemptions

Receiving Public and Private Donations

Protection From Personal Liability

Separate and Perpetual Legal Existence

Employee Benefits

Formality and Structure

Miscellaneous Benefits

The Disadvantages of Going Nonprofit

Official Paperwork

Incorporation Costs and Fees

Time and Energy Needed to Run the Nonprofit

Restrictions on Paying Directors and Officers

Restrictions Upon Dissolution

Restrictions on Your Political Activities

Oversight by the Attorney General

How Nonprofits Raise, Spend, and Make Money

Initial Fundraising

Making Money From Related Activities

Making Money From Unrelated Activities (Unrelated Income)

Making Money From Passive Sources

Your Path to Nonprofit Status

State Law Requirements for Nonprofits

Tax-Exempt Status Under Federal and State Tax Law

Incorporating in Another State—Don’t Fall for It

Qualifying as a Foreign Corporation in California Will Cost You More

Multiple Tax Exemptions

Multiple State Laws

Out-of-State Activities

When Out-of-State Incorporation Makes Sense

Deciding to form a nonprofit corporation will be a big step for you and the members of your group. It will involve more paperwork and government forms, on both the state and federal level, than anyone will like; and you’ll have to conduct your business within the legal framework of various state and federal laws. Fortunately, there are big payoffs to all this work and attention, including the ability to attract donors and grant funds, obtain real and personal property tax exemptions and special nonprofit mailing rates, avoid corporate income taxes, and shield officers and directors from legal liability. Before starting down the path of nonprofit incorporation, however, you’ll want to learn a little more about who can form a nonprofit and the consequences of doing so. In this chapter, we’ll explain:

• the kinds of groups that can—and can’t—form a nonprofit using this book

• the benefits you’ll enjoy as a nonprofit—and some of the disadvantages to choosing this route

• how nonprofits can raise start-up funds and earn money, should they wish to do so

• the process you’ll go through (following the instructions in this book) to incorporate and obtain your tax-exempt status, and

• for those considering incorporating in another state, considerations to bear in mind before doing so.

Is Your Group a Nonprofit That Can Use This Book?

A for-profit corporation can be formed for any lawful purpose. Nonprofit corporations, however, must be established under California law for one of three broad purposes: (1) for the benefit of the public (a public benefit corporation), (2) for religious purposes (a religious corporation), or (3) for the mutual benefit of the members of the nonprofit (a mutual benefit corporation). It’s easy to form a nonprofit corporation in California: Just prepare articles of incorporation that say you are formed for one of these three broad nonprofit purposes and then file your articles with the California Secretary of State. This creates your legal corporate entity. However, having a nonprofit corporation recognized by the California Secretary of State is only your first hurdle. The next important step is to obtain the necessary state and federal corporate income tax exemptions for your nonprofit corporation. To obtain these exemptions, your nonprofit must be formed for one or more specific purposes described in the income tax statutes.

This book has been written specifically for nonprofit corporations that want to qualify for a federal income tax exemption under Section 501(c)(3) of the Internal Revenue Code. This means your nonprofit corporation must be formed for religious, charitable, scientific, literary, and/or educational purposes. If you want to organize as a religious purpose group, we will show you how to form a California religious nonprofit corporation. If you want to organize as a nonprofit to engage in any of the other 501(c)(3) tax-exempt purposes, we will show you how to form a California public benefit corporation. This book is not for groups that want to form a mutual benefit corporation, because mutual benefit nonprofits usually obtain their tax exemption under a subsection of Section 501(c) other than 501(c)(3). It is also not for certain special types of nonprofits (including some public benefit corporations) that do not fall under Section 501(c)(3). (See discussion below, “Special Types of California Public Benefit Corporations,” and “Mutual Benefit Corporations.”)

When thinking about incorporating your nonprofit, consider which purpose you fall under for Section 501(c)(3). Once you know you fall within one of the 501(c)(3) purposes, you can rest assured that this book can help you through the process. First we’ll help you create your corporate entity in California by showing you how to prepare and file articles of incorporation for a public benefit or religious corporation. Then we’ll show you how to obtain your state and federal nonprofit income tax exemptions for 501(c)(3) status.

Corporation Basics

You don’t have to understand all there is to know about corporations in order to follow this book or form your nonprofit. But there are a few basic concepts you’ll want to have under your belt as you go through the process. Here they are, with special emphasis on any differences between for-profit corporations and nonprofits:

• A corporation is a separate legal entity. A corporation is a legal entity that allows a group of people to pool energy, time, and money for profit or nonprofit activities. It acquires legal existence after its founders comply with their state’s incorporation procedures and formalities. The law treats a corporation as a separate “person,” distinct from the people who own, manage, or operate it. The corporation can enter into contracts, incur debts, and pay taxes. Corporations are either for-profit (business corporations) or nonprofits.

• For-profit, or business, corporations versus nonprofits. Business corporations can be formed for any legal purpose. They can issue shares of stock to investors in return for money or property, or services performed for the corporation. Shareholders receive a return on their investment if dividends are paid or if, upon dissolution of the corporation, any corporate assets remain to be divided among the shareholders after payment of all creditors. Nonprofits, on the other hand, generally cannot issue shares of stock or pay dividends under state law (unless they are some type of hybrid such as consumer or producer co-ops). The federal tax code also prohibits 501(c)(3) tax-exempt nonprofit corporations from paying dividends or profits to their members or other individuals. When a 501(c)(3) tax-exempt nonprofit corporation dissolves, it must distribute its remaining assets to another tax-exempt nonprofit group.

• In-state and out-of-state corporations. Corporations formed in California are known in California as “domestic” corporations. Corporations formed in other states, even if physically present and engaging in activities in California, are called “foreign” corporations. For example, a corporation formed in California is a domestic corporation as far as California is concerned, but a foreign corporation when considered by other states. At the end of this chapter, we give you more information on doing business outside California and deciding whether to incorporate in another state.

Public Benefit Corporations

Under state law, public benefit corporations are corporations formed for a “public purpose” or “charitable purpose.” Most groups forming public benefit corporations also want to qualify for Section 501(c)(3) status. These groups usually organize for one of the specified purposes under Section 501(c)(3)—charitable, scientific, literary, or educational. All of these 501(c)(3) purposes are considered “charitable” purposes under California law. For example, a school or educational facility would organize as a California public benefit corporation formed under state law for “charitable” purposes but its 501(c)(3) purposes would be “educational.” The public purpose classification under state law is for groups that want to form civic league or social welfare public benefit corporations (see discussion below on civic leagues and social welfare groups). Don’t worry—we show you how to fill in your articles so you put in the right purposes under California law and also satisfy the federal and state tax exemption requirements.

Religious Corporations

Just as the name indicates, religious corporations are formed primarily or exclusively for religious purposes. These groups can qualify as religious organizations under both state incorporation law and Section 501(c)(3). You need not set up a formal church to form a religious nonprofit corporation; these groups can have a general religious purpose. For example, a group organized to promote the study and practice of a particular religion could incorporate as a religious nonprofit corporation. It is unlikely that the California Secretary of State’s office, where you’ll file your articles of incorporation, will question whether your religious activities are genuine. This type of debate is more likely to occur (if it occurs at all) when you apply for your state or federal tax exemptions.

Special Types of California Public Benefit Corporations

This book covers the incorporation of California public benefit and religious nonprofits that want to obtain their tax exemption under Section 501(c)(3) of the Internal Revenue Code. There are several other types of California public benefit corporations that obtain tax exemption under other sections of the Internal Revenue Code or that must meet special state law requirements. Below, we list several of the most common types of these special California nonprofit corporations. If you plan to form one of these special nonprofits, you’ll need to do your own research or get legal help to form your corporation—this book does not cover the incorporation of these special groups. (See “Where to Go for Help for Non-501(c)(3) Nonprofits,” below.)

• Civic leagues and social welfare groups. Civic leagues and social welfare groups are formed as California public benefit corporations and seek their exemption from federal corporate income taxation under Section 501(c)(4) of the Internal Revenue Code. Because this book covers only nonprofits exempt under Section 501(c)(3) of the Internal Revenue Code, you won’t be able to use this book to incorporate these types of public benefit corporations. (See “Special Nonprofit Tax-Exempt Organizations,” in Appendix B, for a list of organizations that qualify for tax-exempt status under a subsection of 501(c) other than Subsection 3.)

• Medical or legal service corporations. These are nonprofit corporations operated to assume or defray the cost of medical or legal services. These corporations may be organized as California public benefit corporations or mutual benefit corporations. Special provisions of the California Corporations Code apply (see California Corporations Code §§ 10810–10841).

• Humane societies. A humane society, formed to prevent cruelty to children or animals, can be formed as a California public benefit corporation. The Department of Justice must perform a criminal history check on all incorporators and issue a certificate before the secretary of state will accept the articles of incorporation for filing (California Corporations Code §§ 10400–10406).

Mutual Benefit Corporations

This book is not intended for mutual benefit corporations. Unlike public benefit corporations and religious corporations, these groups usually qualify for tax-exempt status under a subsection of 501(c) other than 501(c)(3).

Examples of mutual benefit corporations include trade associations, automobile clubs, and social groups, such as tennis clubs. Chambers of commerce, boards of trade, and mechanics’ institutes, which are generally formed to promote trade and commerce, can organize as mutual benefit corporations or as regular, for-profit corporations. Cooperatives, comprising producers or consumers organized for their mutual benefit, can also qualify as mutual benefit nonprofits with special added restrictions ap...