Last updated: June 2007

The Basics: Creating a Nonprofit Organization
How to Create the Legal Entity
Bylaws and the Roles of Participants
Becoming a Tax Exempt Organization
Registering With the Charitable Trust Bureau
Further Resources

The Basics: Creating a Nonprofit Organization

I am interested in establishing a nonprofit corporation that can receive donations and not pay income taxes. Where should I start?

Most people who want to create a nonprofit organization want to obtain recognition of exemption from income taxes under Section 501(c) (3) of the Internal Revenue Service Code. Organizations that can be recognized as exempt from paying income tax under 501(c) (3) are charitable, educational, religious, scientific, or literary organizations. Most are also entitled to receive donations that may be deductible from the taxable income of the donor. For this reason, recognition of exemption as a 501(c) (3) is very desirable.

There are many steps that must be followed to get this tax-exempt status. Each step in the legal process of establishing a nonprofit corporation and obtaining recognition of income tax exemption under 501(c) (3) will be explained below in detail. But first, it is important for people to understand the differences between a nonprofit corporation and a for-profit corporation. Click on the title below to learn more about whether a nonprofit is right for you.

Is a Not for Profit the Way to Go?

Discussed in greater detail below will be establishing an Illinois nonprofit corporation and getting a federal employer identification number, writing and adopting bylaws, applying to the IRS for income tax exemption and registering with the Attorney General Charitable Trust Bureau. This article will also discuss the relationship between the officers and directors on the board, the staff, and volunteers.

This article is provided for informational purposes only and does not constitute legal advice or the creation of a client relationship. If you are interested in establishing an organization that will be recognized by the IRS as exempt from income taxes under 501(c) (3), you should talk to a lawyer or call the Community Economic Development Law Project (CEDLP) at 312/939-3638.

What are the main differences between a nonprofit corporation and a for-profit corporation? 

• A nonprofit organization is created for educational, charitable, religious, literary or scientific purposes.  A for profit organization is created to make a profit. 
   
• A nonprofit cannot be a sole proprietorship; it must be a corporation or a trust.  A for profit may be a sole proprietorship, a corporation, a partnership, a limited liability company, etc.
   
• A nonprofit corporation is not owned by any one individual or individuals.  A for profit is owned by the individuals who start it. 
   
• A nonprofit is managed and controlled by a board of directors of a least three people, preferably unrelated to one another.  A for profit corporation is managed and controlled by its owners.
   
• Both organizations must have income to survive and cover their expenses.  The income of a nonprofit organization is used to cover all the costs of its programs and excess income is used to further improve or expand those programs.  In a for profit organization the income is used to cover all the costs of its business endeavors but excess income may be used to pay dividends to the owners of the organization.
   
• There are many other differences and if you are thinking of starting a business but don’t know whether it should be a profit or nonprofit, you should consult a lawyer or contact the CEDLP.

How to Create the Legal Entity

How do I create an Illinois not-for-profit corporation?

The first step to creating an Illinois nonprofit is planning.

1. You will need to find other people to work with you and serve on the board of directors.  Illinois law requires at least 3 board members before you incorporate.
    
2. Put in writing what your organization will do, where it will operate, its main purpose, the programs it will operate to accomplish its purpose, its goals and its anticipated funding sources.
    
3. Then choose a name for the organization. Keep in mind that if the name sounds like a for profit business name, the Secretary of State may require you add NFP (Not for Profit) to your name. Words that make a name sound like a nonprofit include "organization", "project", "program", "coalition", "alliance" and "group". Once you choose a name, you can check the Illinois Secretary of State website to see if the name is available. If it is available, and you aren't ready to incorporate, you can reserve the name for 90 days, for a fee of at least $25.00 using the Application for Reservation of Name form. Click the title below to complete and print the form for submission to the Secretary of State's office. If the organization is ready to incorporate there is no reason to reserve the name, just prepare and file the Articles of Incorporation.

Application for Reservation of Name - Form NFP 104.10

How do I incorporate an Illinois not-for-profit corporation?

An Illinois corporation is a legal entity having its own rights, privileges and liabilities separate from the individuals who establish it. An Illinois corporation is formed by filing the Articles of Incorporation form with the Secretary of State of Illinois. Click on the title below to complete and print the form for submission to the Secretary of State's office.

Articles of Incorporation - Form NFP102.10 

To complete this form you will need the following information:

• The name of the organization;
   
• The number of the initial directors and their names and addresses. A minimum of three directors must be listed;
   
• The name of the "registered agent." The registered agent will receive all legal notices sent to the corporation.  If this person moves or leaves the organization, a new registered agent must be provided to the Illinois Secretary of State on the required form. This form is also available at the Secretary of State's website.
   
• The specific purposes for which the organization is being created. You may specifically identify the organization's purposes but if the organization is going to seek recognition of income tax exemption from the IRS it must use the language required by the Internal Revenue Service. Visit the Internal Revenue Service website for more information about the language requirements.  

When completing this form, it is also important to remember:

• For groups seeking recognition of income tax exemption, the limitations imposed by law on tax exempt organizations should be included in the "Other provisions" section of the Articles of Incorporation. 
   
• The signatures on the form must be in black ink and two originals of the form must be filed.  There is at least a $50.00 fee payable to the Illinois Secretary of State.  They will not accept personal checks.
   
• Upon acceptance, the Secretary of State will issue a corporate charter. It may take a few weeks to hear from the Secretary of State's office. If you need to incorporate quickly, there is an expedited process for the Articles of Incorporation but this requires an additional fee.
   
• The Articles of Incorporation must be recorded with the Recorder of Deeds of the County of the main office of the organization.

Once the Articles of Incorporation have been accepted, the organization will receive a letter from the Illinois Secretary of State. The Secretary of State no longer issues certificates of incorporation. The letter provides further direction to the organization, including that the Articles must be recorded with the Recorder of Deeds. Upon receipt of this letter, the organization is an Illinois nonprofit corporation. It is not a tax exempt organization yet. The Illinois Secretary of State cannot and does not grant tax exemption.

I've heard we need a Federal Employer Identification Number (FEIN), what is it and how do we get it?

A Federal Employer Identification Number is a taxpayer number issued by the Internal Revenue Service. It is similar to a social security number for an individual but is used for a business entity. Every legal entity must have a FEIN. An organization seeking recognition of income tax exemption must have a FEIN before submitting its application to the IRS.  Click on the title below to complete and print the form for the FEIN for submission to the IRS.

Application for Employer Identification Number - Form SS- 4

Once you have the FEIN, the organization is recognized as a legal entity by the Internal Revenue Service. Most financial institutions require a corporation to have its FEIN before opening a bank account.

Bylaws and the Roles of Participants

Since there are no owners and no one controls a nonprofit, the board of directors acts as a group to make decisions that are in the best interests of the corporation. The organization’s bylaws guide the board. 

What are bylaws?

Bylaws are the rules and procedures governing how an organization will operate. They establish who has the power to make certain decisions and set forth the process that must be followed in making those decisions, spelling out the relationships between officers, board members, members and staff. Bylaws identify how many people will be on the board, how they will be elected, how long they will serve, how to fill a vacancy, etc. Bylaws also dictate how disputes on the board are to be resolved and help insure that certain decisions and actions of the organization are not the legal responsibility of only a select few persons. The bylaws must be in compliance with the Illinois Nonprofit Business Corporation Act.

How do you develop bylaws?

It is not a good idea to use bylaws that you get from another organization or find on the Internet. The bylaws should be developed specifically to meet the needs of your organization. It is best to have a lawyer write the bylaws to make sure that they are in compliance with state law. Talk to your lawyer, or contact the CEDLP at 312/939-3638. You can also contact CEDLP for further assistance.

Who should be on the Board of Directors?

The board of directors consists of persons who serve as directors of the organization and persons who are the officers of the board. 

The board of directors meets as often as necessary. They may meet once a month, once every other month, or only once a year.  The board does not run the day to day operations of the organization. The directors are responsible for the management of the organization and make most of the major decisions about how the organization will operate.  The bylaws explain who elects the directors, when they are elected, how long they will serve as a director, how to remove a director, etc. See the Illinois Nonprofit Business Corporation Act for additional information.

Who are the officers of the board?

The officers run the board meetings, sign contracts, distribute minutes, etc., and serve at the direction of the Board, usually without compensation.

The officers of a nonprofit board of directors are generally called the President, Vice President, Secretary and Treasurer. The board may decide to call the officers by other titles, such as Chairperson and Vice-Chair, and there may be other officer positions if the directors decide to add other officers. The titles for the officer positions are identified in the bylaws. The President and Secretary should not be the same person. 

The bylaws should contain a job description for each officer, describe how people get elected officers, who elects them, how long they serve and how to remove an officer. One person may hold the position of more than one officer and also be a director. This is common in smaller, new organizations. For example, if the organization has a board of directors with only three people sitting on the board, each person is a director of the organization and each could be an officer. Click on the title below to learn more:

Understanding Board Composition

May the board officers and directors be compensated?

There is nothing illegal about compensating officers and directors for their service to the corporation, but a new nonprofit organization should try to recruit only people willing to serve as volunteers. Funding should be used to support the day-to-day operations of the organization, not the board. Also, the IRS is very concerned about excessive compensation of staff, board directors, officers and employees. For groups seeking recognition of income tax exemption there are many questions on the form about compensation. It is best not to compensate the people serving on the board as officers or directors, but they may receive reimbursement for reasonable expenses. 

If the directors and or officers are compensated, they will lose the possible protections of the Illinois State and Federal volunteer liability protections.

Who are the employees of a not-for-profit corporation?

The first employee hired is usually the Executive Director, hired by the Board of Directors. Other employees are either hired by the board, or the board can delegate this authority to the Executive Director. The Executive Director runs the operations of the organization subject to the direction of the board of directors. The staff, including the Executive Director, are employees of the organization and are responsible for implementing the policies of the board and making decisions in accordance with those policies. Volunteers serve at the direction of staff or the board.

Becoming a Tax Exempt Organization

Now that we have established an Illinois Nonprofit Corporation, are we exempt from paying income taxes and are people able to make deductible donations?

No. Most Illinois nonprofit corporations are not exempt from paying income taxes unless they apply to and receive recognition of exemption from the Internal Revenue Service. The IRS makes these decisions based upon information it receives from nonprofit corporations submitted to it on IRS Form 1023.

What is Form 1023?

To be recognized as a 501(c) (3) tax exempt organization, the organization must file Form 1023 with the IRS. Click on the titles below to print the form for submission to the IRS.

Application for Tax Exempt Status - Form 1023
Instructions for Form 1023 

Most Illinois nonprofit corporations are not exempt from paying income taxes unless they apply to and receive recognition of exemption from the Internal Revenue Service. The IRS makes these decisions based upon information it receives from organizations submitted to it on IRS Form 1023. 

Why do we want to qualify to be a tax-exempt organization?

Tax exempt organizations do not pay federal or state income tax on related income. But, they may be taxed on income received from an "unrelated" business activity. Tax exempt organizations are not exempt from employee tax, real estate tax or sales tax unless specifically exempted after applying to the Illinois Department of Revenue.

If the organization qualifies as a 501(c) (3) exempt organization, donations to the group may be a tax deduction for the donor.

How do we qualify as a 501(c) (3) charitable or educational organization?

The group must show the IRS that it is organized and operated exclusively for an exempt purpose. Exempt purposes are defined by the Internal Revenue Code as religious, charitable, scientific, testing for public safety, literary, or educational purposes, or for the prevention of cruelty to children and or animals.

As a public charity, the organization must provide a broad public benefit to a charitable class through direct aid to individuals or by providing services that benefit the community. 

Examples of charitable services include relief of the poor, social welfare to lessen neighborhood tensions, eliminate prejudice and discrimination, combat community deterioration and juvenile delinquency, defend human and civil rights.

How do we show the IRS that we are organized exclusively for an exempt purpose?

A nonprofit corporation submits its organizing document to the IRS with Form 1023. A corporation’s organizing document is its Articles of Incorporation. The Articles must contain language that limits the organization’s purposes to those authorized for groups recognized as exempt under Section 501 (c) (3). 

The Articles of Incorporation must also include a prohibition on private inurement. The Articles must provide that the organization will not distribute any part of the net earnings of the corporation to the benefit of any director, officer, member or employee of the corporation, or any private individual except that reasonable compensation may be paid for services rendered to or for the corporation affecting one or more of its purposes.  

The Articles must state that the organization will not engage in significant legislative lobbying and there must be a ban on all political campaign activity. Finally, there must be a dissolution clause in the Articles that permanently dedicates the organization’s assets to exempt purpose activities. 

How do we show the IRS that we are operated exclusively for an exempt purpose?

The IRS will review a number of things. Form 1023 asks for a narrative description of past, present and planned activities. Here you explain the “who, what, where, when, why and how” of the organization. The description you provide is critical and must show how the organization will address the exempt purpose for which it was created. Form 1023 also asks over thirty questions about “Compensation and other Financial Arrangements With Your Officers, Directors, Trustees, Employees, and Independent Contractors.”  Your answer to these questions will assist the IRS in determining that the organization does not further personal interests or benefit private interests and that its assets and income are not or will not unjustly enrich board members, officers, employees, etc.

Form 1023 also asks the group whether it will engage in political activity and whether it will attempt to influence legislation. If the organization engages in political campaign activity it will not qualify for recognition of exemption as a 501(c) (3) organization. However, 501(c) (3) organizations may engage in lobbying activities on a limited basis. If your organization expects to engage in lobbying, it may file IRS form 5768, the "Section h" election. This allows an organization to track its lobbying expenditures and know exactly how much of its revenue it can spend on lobbying without jeopardizing its exempt status. Consult an attorney if your organization will engage in lobbying, or contact the CEDLP at 312/939-3638.

Organizations must also identify and explain all plans for fundraising. If the application is from a new organization, it must submit a current year budget and projected budgets for two years. The organization is not held to these amounts, but the IRS filing fee will be based upon the projections. If the applicant has been in existence four or more years, it must provide the actual budgets for the four years. If the organization has been in existence more than one year, but less than four years, it must provide the actual revenue and expenses for the years it has been in existence and projections for financial reporting for a total of three years. See pages 8 and 9 of Form 1023 and the instructions for more information.

What is an advance ruling?

 If your organization has been in existence for less than one full tax year or has been in existence but has not received any funding, it will not be able to demonstrate that it is a public charity and must request an advance determination. The advance ruling determination is a determination by the IRS that, based upon the information submitted, the organization is tax exempt pursuant to Section 501(c) (3) as a public charity or a private foundation. Most organizations prefer to be public charities because they are subject to fewer requirements about disbursing their funds than a private foundation. The advance determination letter from the IRS is evidence of this decision. The IRS does not issue a tax exempt number. 

After a set period of time, identified in the Determination Letter, the organization must report all its revenue sources and expenditures to the IRS. The IRS will then issue a final determination letter. If the organization is requesting an advance determination letter, it must sign a waiver of the statute of limitations.  This waiver is incorporated into Form 1023.

What is the user fee?

The user fee is based upon the organization's actual or projected budget. It is paid to the IRS with the 1023 application. The user fee must accompany the application for exemption. If the wrong fee is submitted or no fee is submitted, the IRS will return the application. The user fee is nonrefundable. The following fees apply:

• Organizations with anticipated revenues in excess of $10,000, averaged over the first four years of the organization’s existence, must pay at least $750;
• Organizations anticipating less than $10,000 must pay at least $300.

What is the process for submitting the application to the IRS?

The application and other documents should be submitted in the order specified on the IRS Application Checklist. Click on the title below to view the IRS Application Checklist.

Internal Revenue Service Application Checklist

Make sure that the FEIN and the organization's name are prominently displayed at the top of each page. Attach the Articles of Incorporation, the bylaws if they have been adopted and any printed material about the organization. Also, place the user fee on top of the package. The fee paid must be consistent with the financial information provided.

What happens after we send the application to the IRS?

Within approximately two weeks, you should receive a letter from the IRS acknowledging that it received the application. This letter will provide you with a document locator number and a timeframe for receiving a response. At the end of the timeframe indicated in the letter, if you have not received any correspondence from the IRS, call to find out what happened to the application.

The response you receive from the IRS will either be a determination letter or a letter requesting additional information:

• If you receive a determination letter, your organization will have been recognized as exempt from income taxes as a 501(c) (3) organization. The letter will explain the nature of the exemption, the public charity/private foundation status and additional on-going requirements.
   
• If you receive a letter requesting additional information, you will need to reply quickly or request an extension. Two week extensions are routinely granted. If you don't understand the questions, call the person identified on the IRS letter and discuss the questions. They are helpful.

If we received our determination letter, are we exempt from paying all taxes?

No, the only taxes the organization does not have to pay are federal and state income taxes. The organization must continue to pay real estate taxes, employment taxes and sales taxes. The Illinois Department of Revenue grants real estate tax and sales tax exemption to certain charitable organizations, however, you must apply directly to the Illinois Department of Revenue for these exemptions.

Registering With the Charitable Trust Bureau

Can we seek funding now?

Before soliciting or holding charitable funds, the organization must register with the Illinois Attorney General's Charitable Trust Bureau.

What form do we use to register?

To register with the Illinois Attorney General’s Charitable Trust Bureau, go to the Illinois Attorney General's website or click on the titles below to complete and print the forms for submission to the Illinois Attorney General's office.

Charitable Organization - Registration Statement - Form CO-1 - charity organizations
Charitable Organization - Financial Information Form - Form CO-2 - new organizations
Charitable Organization - Registration Statement - Form CO-1 and Illinois Charitable Organization Annual Report - Form AG990 - organizations that have been in existence for more than eight months
Instructions
 
Here are some important facts to remember about registration:

• Charitable organizations that solicit funds and hold funds, in excess of $4,000.00, must register under both the Charitable Trust Act and the Solicitation for Charity Act.  At least a $15.00 registration fee is required.
   
• Failure to register prior to soliciting funds in Illinois may subject the organization to late registration fees.
   
• If the organization is going to begin soliciting or holding charitable funds before receiving its determination letter from the IRS, when it files its application with the Illinois Attorney General, it must submit an explanation of why it does not yet have recognition of exemption.
   
• After the organization registers it will receive a letter from the Illinois Attorney General with a CO (Charitable Organization) number. It must maintain this number and every year will have to file AG990 with the Illinois Attorney General.

Further Resources

Where can I go for more information?

There are many on-going rules and requirements and reports that must be filed by a tax exempt Illinois Not for Profit Corporation. It is important that your board be familiar with these requirements. Failure to understand them may jeopardize the tax exempt status and or the corporate status of the organization. Contact your attorney or for additional information, contact the CEDLP at 312/939-3638. Also, see the Illinois Secretary of State publication "A Guide for Organizing Not-for-Profit Corporations.”

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