By James Gilmer
Nonprofits are held to a high standard of government scrutiny. And that is for good reason! 501(c) nonprofits are exempt from federal income tax, access public funds, and provide donors with a tax deduction on their contributions. To maintain accountability and transparency, and to protect the public, nonprofits must meet various initial and ongoing reporting requirements. Starting with the 501(c) application process, nonprofits must demonstrate that they support a public good and do so in a way that is free from conflicts of interest. In addition to the IRS, various state agencies regulate nonprofits.
Each state has different requirements for nonprofits. This post is part of a series on nonprofit compliance. Our first two posts in the series covered the rules and regulations governing nonprofits in North Carolina and New York. Today’s post covers the specific rules and requirements of California.
Disclaimer: The focus of this post is 501(c)(3) nonprofits, which includes public charities and private foundations. This information is general in nature and will not apply to every organization.
Starting a Compliant 501(c)(3) Nonprofit in California
California is the largest state in the country, and not surprisingly, it is home to the greatest number of nonprofit organizations of any state. In 2013, there were over 144,000 nonprofit organizations registered in California. If you are looking to start your own California nonprofit, do some research first, because an organization may very well already serve the mission you have in mind. Public resources are limited, so you should consider aligning your efforts with an existing organization if at all possible.
If you discover that there is in fact an unmet need in your community and you decide to create a new nonprofit, your goal should be to set up the nonprofit correctly. Prioritizing compliance from the start will help you set up the nonprofit for success. Establishing a 501(c)(3) nonprofit in California includes the following key steps:
- Incorporate a nonprofit corporation with the California Secretary of State. The nonprofit corporation is the legal entity that is recognized by the IRS. As part of the incorporation, you will appoint a registered agent, which is responsible for handling legal documents for the organization. California has three unique types of nonprofit corporations: Public Benefit, Mutual Benefit, and Religious. The fee to incorporate any of these types of California nonprofits is $30. The California Secretary of State has slow processing times, often taking a month or more to approve your incorporation. If you need it faster, their expedite fee is $350, and if your filing gets rejected, you lose the expedite fee and have to pay again when you re-submit your application. Once the nonprofit is incorporated, you must file a Statement of Information with the Secretary of State within 90 days to remain in good standing. The fee for this is an additional $20. Lastly, the California Secretary of State is understaffed, and it is very difficult to get support on the phone. For the process of incorporating alone, it’s best to have professional guidance. Keep in mind that the IRS will review your California articles of incorporation when you apply for your 501(c)(3) tax exemption.
- Obtain a federal EIN from the IRS. Wait until California has processed the articles of incorporation. You can file online with the IRS. As long as you have a Social Security Number (SSN), and there is no duplicate business or nonprofit name in the IRS database, you can get the EIN instantly online. If you get an error, you will have to fax in Form SS-4 and wait about a week.
- Prepare bylaws and policies, which are the internal records that govern the nonprofit organization. They must be consistent with California and IRS requirements. Once you have state-approved articles of incorporation, an EIN, and bylaws, you can open a bank account for the organization. You will also need a conflict of interest policy for the purposes of filing with the IRS, who will review these documents in order to grant your federal exemption. Around this time, you will hold an organizational meeting to ratify the bylaws, appoint officers and directors, and make other key decisions.
- File Form 1023 or Form 1023-EZ with the IRS. This is your application for federal exemption. Form 1023 is a long, arduous form, and also requires you to submit each of the documents above. The filing fee is either $400 or $850, depending on your projected revenue and activities. For years, this was the only form you could file. Form 1023-EZ is a streamlined application that was released in 2014, and can be filed online. The danger with Form 1023-EZ is that many organizations are not eligible to file, or they lack certain requirements, including the 501(c)(3) provisions in their articles of incorporation. The best way to ensure that you are eligible and can obtain a tax exemption is to follow the instructions carefully, or find an expert to manage the process for you.
- File for state franchise tax exemption with the California Franchise Tax Board. California is one of a handful of states where your 501(c) nonprofit is not automatically exempt from state franchise (income) tax. Once you have your exemption from the IRS, file Form 3500A with the Franchise Tax Board, along with a copy of your determination letter. Without filing this exemption, your nonprofit will be subject to a minimum $800 annual franchise tax.
- Apply for a charitable solicitation license before you solicit any funds. You must register with the Department of Justice, which oversees charitable solicitation and is a branch of the California Attorney General’s office. The initial registration fee is $25, and allows your charity to solicit funds from the public. Most states require you to file for your fundraising license prior to soliciting any funds, but California allows you up to 30 days after receiving assets to register. Nevertheless, California is quite strict on charities that fail to register, so it’s better to be proactive and register up front. Penalties include holding officers and directors personally liable for payment of fines, and revoking your state franchise tax exemption.
- Apply for state sales and property tax exemptions. Nonprofits are not automatically exempt from state sales and use taxes. Certain qualifying organizations are eligible for local property tax exemption. For both exemptions and more information, you can apply through the California State Board of Equalization.
California Nonprofit Compliance
Nonprofits incorporated in California have several ongoing filing requirements. Paying close attention to these requirements will help avoid penalties for noncompliance.
- IRS Form 990. This is a federal return due to the IRS four months and fifteen days after the end of your fiscal year. For organizations whose year ends December 31, your due date is May 15th. If you fail to file this return in three consecutive years, the IRS will revoke your tax exemption. However, if you do not file in a single year, you will not be able to renew your Charitable Solicitation License, or show proof to foundations and donors, who may expect to see this return before they make a gift. There are several versions of the 990, and the form you file depends on your revenue. Small organizations making less than $50,000 in a year can file the 990-N postcard online, which takes just a few minutes. Many organizations file this after their first year, which is dedicated primarily towards initial setup. Medium-sized organizations file a still streamlined 990-EZ, and large organizations prepare the full-length 990.
- File California corporate tax returns. If you have applied for and received your state franchise tax exemption, you will typically file Form FTB 199 or FTB 199N, which are returns for exempt organizations. There is a separate return for unrelated business income (UBI). If your organization is not exempt from California franchise tax, you’ll file the standard corporation tax return along with the minimum $800 tax.
- Renew your charitable solicitation license, which is also due four months and fifteen days after the close of your fiscal year by filing Form RRF-1. The state fee will be based on your contributions, and currently ranges anywhere from $0 to $300. California grants you an automatic 180 day extension, but after that period, you must file or you may face penalties. Charities fundraising in California must submit a 990 and a financial audit if required. If you use professional fundraisers, or receive government grants, you’ll have additional schedules to prepare.
- Meet ongoing department of state obligations. Currently, domestic nonprofit corporations must file a biennial statement of information (biennial report) with the California Secretary of State, and are required to maintain a registered agent located within the state. If you have a corporate registered agent, be sure to renew the service and update any contact information that may have changed. If you use an individual, make sure they are aware of the duties of a registered agent, and if they have moved addresses, file to update the state’s records.
California Compliance for Out-of-State Nonprofits
California is one of the forty-one states that requires charities to register in order to solicit donations from its residents.
Before you ask for contributions from California citizens, make sure you register with the California Department of Justice, which is a branch of the Office of the Attorney General. You will have to renew this registration annually. California is particularly strict when it comes to the use of professional fundraisers and fundraising consultants, as well as organizations receiving government grants. You will have to disclose that information fully as part of your annual registration.
If you fundraise in multiple states, tracking due dates and filing on time are the keys to success. Each state has a unique renewal process and different renewal dates, so be sure to keep good records (and plenty of calendar reminders), or consider using a service company to manage the renewals for you.
Depending on your activities in the state, you may have to obtain a California certificate of authority for the nonprofit corporation (foreign qualify) and appoint a registered agent. The California charitable solicitation application asks for the entity’s California Secretary of State registration number. While not required, qualification may eventually become a requirement for charities soliciting funds in California. Nevertheless, your charity may conduct certain activities that may trigger requirement. Organizations that have employees who are residents or open a physical location within the state are common reasons that can create the need to foreign qualify.
Foreign nonprofit corporations must file an initial statement of information with the Secretary of State within 90 days of qualification. Unlike domestic nonprofit corporations, who file biennially and pay $20, foreign nonprofits file annually, and pay $25 each year.
The Importance of Compliance
While this all seems like a lot of work, and it is, remember that these requirements exist for a reason. Periodically reporting to the IRS and state agencies demonstrates that the organization has not deviated from its mission and that its funds are used responsibly. Staying compliant also demonstrates credibility to your donors and grantmakers. In conclusion, compliance plays an integral part to the sustained success of your organization.
James Gilmer is a compliance specialist for Harbor Compliance, which establishes 501(c) nonprofits and helps them stay compliant. Harbor Compliance assists charities in every state and several countries abroad. James serves on the Board for two nonprofits in Lancaster, Pennsylvania.