Forming a nonprofit corporation and getting tax-exempt status are two separate steps. In California, you first file articles of incorporation for a nonprofit corporation with the Secretary of State, then apply to the IRS for recognition of 501(c)(3) status on Form 1023 (or the shorter Form 1023-EZ, if eligible), and separately apply to the California Franchise Tax Board for state exemption. Charities must then keep up annual federal and state filings, including the Form 990 series, to keep their exemption.
Founders of charities often assume that incorporating as a nonprofit makes the organization tax-exempt. It does not. Here is how the process works for a California charity and the ongoing requirements that come with it.
Step 1: Form the Nonprofit Corporation
Most California charities are organized as nonprofit public benefit corporations. The organization files articles of incorporation with the California Secretary of State. For 501(c)(3) purposes, the articles should include:
- A purpose clause limiting the organization to charitable, educational, religious, scientific or other exempt purposes.
- A dissolution clause dedicating assets to another exempt purpose if the organization dissolves.
- Statements required by California law for public benefit corporations, including the dedication of assets to charitable purposes.
The organization is formed only in its home state. If it later operates in other states, it may need to register there as a foreign nonprofit and comply with their charitable solicitation rules. After incorporating, the board adopts bylaws, appoints officers, adopts a conflict of interest policy and obtains an Employer Identification Number (EIN) from the IRS. California also requires an initial Statement of Information and periodic updates.
Step 2: Apply for Federal Tax Exemption
To be recognized as a 501(c)(3) organization, most charities file an application with the IRS. Applications are filed electronically through Pay.gov, and a user fee applies; check the IRS website for the current fee.
Form 1023
The full Form 1023 asks for detailed information about the organization’s structure, governing documents, activities, compensation arrangements, relationships with insiders, fundraising and finances. Key parts include:
- Confirmation that the organizing documents contain the required purpose and dissolution clauses.
- A detailed narrative of past, present and planned activities, including who will benefit and how.
- Compensation and financial arrangements with officers, directors, trustees and highly compensated employees, and any family or business relationships among them.
- Information about political and lobbying activities, fundraising, gaming, foreign activities and relationships with other organizations, and whether the organization is succeeding to another organization’s activities or assets.
- Financial data: actual results for completed years and projections for newer organizations, as specified in the instructions.
- Classification as a public charity or a private foundation.
Form 1023-EZ
Smaller organizations may be eligible for the streamlined Form 1023-EZ. Eligibility depends on financial limits, including projected annual gross receipts not exceeding $50,000 in each of the next three years, actual gross receipts not exceeding that amount in each of the past three years, and total assets not exceeding $250,000, as well as other criteria in the IRS eligibility worksheet. Some types of organizations cannot use the EZ form. Because the form is short, the organization should still make sure its documents and activities would satisfy a full review.
Timing
Filing within 27 months after formation generally allows exemption to be recognized back to the date of incorporation. Late filers may receive exemption only from the date of filing unless relief applies.
Step 3: Obtain California Tax Exemption
Federal exemption does not automatically exempt an organization from California franchise and income tax. The organization applies to the Franchise Tax Board, typically using a streamlined submission based on its IRS determination letter or a full application. Other California steps commonly include:
- Registering with the Attorney General’s Registry of Charitable Trusts shortly after first receiving assets, and filing annual renewals.
- Seeking property tax exemption where the organization owns or uses property for exempt purposes.
- Complying with charitable solicitation and fundraising rules, including rules for commercial fundraisers.
Step 4: Keep Your Exemption
Tax-exempt organizations do not pay federal income tax on income related to their exempt purposes, but they must file annual information returns:
- Form 990-N (e-Postcard) for organizations with small gross receipts.
- Form 990-EZ or Form 990 for larger organizations, depending on gross receipts and assets.
- Form 990-PF for private foundations.
Returns are generally due on the 15th day of the 5th month after the end of the organization’s fiscal year, and an extension is available. An organization that fails to file required returns for three consecutive years automatically loses its federal exemption. California has its own annual filings with the Franchise Tax Board, the Registry of Charitable Trusts and the Secretary of State.
Charities must also respect the core limits on 501(c)(3) status:
- No private inurement or excess benefit. Compensation and transactions with insiders must be reasonable, and excess benefit transactions can trigger penalty taxes.
- No political campaign activity for or against candidates for public office.
- Limited lobbying, which must not be a substantial part of the organization’s activities.
- Unrelated business income may be taxable and reportable.
Governance Matters
A nonprofit’s directors owe fiduciary duties to the organization. Good governance includes an independent board, documented approval of compensation and insider transactions, a conflict of interest policy, and accurate minutes. Contracts with vendors, grantors and sponsors should be reviewed carefully, since they often contain restrictions on how funds may be used. See our post on contract review.
The Takeaway
A California charity needs three things: a properly drafted nonprofit corporation, IRS recognition of 501(c)(3) status, and California exemption and registrations. Getting the organizing documents right and staying current on annual filings protects the exemption and the organization’s reputation with donors.
Frequently Asked Questions
Does forming a nonprofit corporation make it tax-exempt?
No. Incorporation creates the entity under state law. Federal 501(c)(3) status requires a separate IRS application in most cases, and California exemption requires a separate filing with the Franchise Tax Board.
Who can use Form 1023-EZ?
Smaller organizations that meet the IRS eligibility criteria, including limits on projected and past annual gross receipts of $50,000 and total assets of $250,000. Some types of organizations are not eligible and must file the full Form 1023.
When is Form 990 due?
Generally by the 15th day of the 5th month after the end of the organization’s fiscal year. An extension is available, and failing to file for three consecutive years results in automatic loss of federal exemption.
Does a California charity need to register with the Attorney General?
Generally yes. Charities holding assets for charitable purposes in California typically register with the Attorney General’s Registry of Charitable Trusts and file annual renewals.
How Sutter Law Can Help
Sutter Law helps founders with entity formation, including nonprofit articles and bylaws, and can serve as outside general counsel on governance and contracts. Contact us for a free consultation.
This article is general information, not legal advice. Reading it does not create an attorney-client relationship.
