Starting a nonprofit in Texas: the order of steps that protects your 501(c)(3)

Two separate steps: forming under Texas law, then applying for exemption

Starting a nonprofit in Texas happens in two stages. First you organize the entity under state law, most often by filing a certificate of formation for a nonprofit corporation with the Texas Secretary of State. Then you apply to the IRS for recognition of exemption under section 501(c)(3), and separately to the Texas Comptroller for any state tax exemptions. The Secretary of State's own instructions make the point directly: a nonprofit corporation is subject to state franchise tax and federal income tax unless an exemption is granted.

The order matters because the documents you file at formation shape the exemption application. I help boards navigate the IRS, the Texas Comptroller and the Secretary of State when deciding what type of nonprofit to form and which exemption to pursue, and in my experience, structuring the organization correctly before applying is crucial to its success. This guide is general information, not legal or tax advice for your organization; talk to a licensed Texas attorney and a tax professional before you file.

Decide what kind of organization you are actually creating

Most people equate nonprofit with 501(c)(3), the exemption for charitable, religious, educational and scientific organizations. But IRS Publication 557 describes many 501(c) categories, and a trade group, a social club or a homeowners association may belong in a different one with different rules. Choosing the wrong category leads to a rejected application or, worse, an exemption that does not fit what the organization really does.

Charitable organizations must also be classified as either public charities or private foundations. The two have very different rules for funding, governance and reporting, and the life cycle of either involves many filings, reports and dealings with regulators. Founders who plan to fund the organization mostly from one family or one donor should understand the private foundation rules before they file anything.

Write a one-page description of what the organization will do, who it will serve, where the money will come from and who will make decisions. That page is the foundation for every later document, and it quickly shows whether 501(c)(3) is the right fit or whether another structure suits the plan better.

Incorporated or unincorporated: the Texas choice

Not every nonprofit organization is filed with the Secretary of State. Many choose to incorporate, which creates a nonprofit corporation under the Texas Business Organizations Code. Others operate as unincorporated nonprofit associations, which the code describes as three or more members joined by mutual consent for a common nonprofit purpose. An unincorporated association may, but is not required to, file a statement appointing an agent to receive legal papers.

For most groups that will hold money, sign contracts, hire staff or seek significant donations, incorporation offers a clearer structure and better liability protection for the people involved. Small informal groups sometimes start unincorporated and incorporate later. I help boards weigh the two, because the right answer depends on the group's size, activities and plans.

The formation documents that the IRS will read later

The Texas form for a nonprofit corporation is Form 202, and the Secretary of State lists its filing fee as $25. The form allows a general purpose such as any lawful purpose, but the Secretary of State warns that the Tax Code or the Internal Revenue Code may require a more specific purpose statement as a basis for tax-exempt status, and that the form does not include the additional provisions the Comptroller or IRS may require. It directs filers to IRS Publication 557 and Comptroller Publication 96-1045 before completing the form.

In practice, that means the certificate of formation should be drafted with the exemption application in mind: a purpose clause that matches the exemption you will seek, and provisions on how assets are distributed if the organization dissolves. The bylaws, which are not filed with the state, should set out how directors are chosen, how conflicts of interest are handled and how decisions are made. Getting these right at formation avoids amending documents in the middle of an IRS review.

• Certificate of formation with an exemption-ready purpose clause
• Supplemental provisions on distribution of assets at dissolution
• Bylaws covering directors, officers, meetings and voting
• A conflict of interest policy adopted by the board
• Minutes of the organizational meeting
• An employer identification number from the IRS

Applying to the IRS for 501(c)(3) recognition

With the entity formed and the governing documents adopted, the organization applies to the IRS. The IRS offers two applications for 501(c)(3) status: Form 1023, the standard application, and Form 1023-EZ, a streamlined version for organizations that qualify. According to the IRS, Form 1023 applications must be submitted electronically at Pay.gov.

The application asks detailed questions about the organization's activities, governance, finances and relationships with insiders. The answers must match the governing documents and the organization's real plans. Vague or inconsistent answers invite follow-up questions and delay. This is also where the public charity or private foundation classification is addressed, so the decisions made in the earlier steps carry through.

How long the process takes, and what you can do while you wait

Founders always ask how long this takes. The honest answer is that it varies, and the parts you control are the preparation and the quality of the application. State formation is usually the quick step. The IRS review takes longer and depends on the form used, the complexity of the organization and whether the IRS comes back with questions. A complete, consistent application is the best way to avoid delay.

While the application is pending, the organization can usually operate, but founders should be careful about what they tell donors regarding deductibility and should keep meticulous records from the first day. Use the time to build the board, adopt policies, set up bookkeeping and plan the first year's program. When the determination letter arrives, the organization should already be running the way it described itself to the IRS.

If the IRS asks follow-up questions, answer them promptly, completely and consistently with what you already filed. Those questions are a normal part of the process, not a sign of failure, and a well-prepared organization can usually address them without changing its plans.

State exemptions are a separate application

A federal determination does not automatically exempt the organization from Texas taxes. Exemption from state franchise tax and sales tax is handled through the Texas Comptroller, as the Secretary of State's instructions note. Boards should plan for that application once the federal status is settled, and keep the determination letters with the organization's permanent records.

Organizations operating in Dallas may also run into local requirements for events, fundraising or property, depending on their activities. Those vary by activity and location, so ask your advisors what applies to your plans rather than assuming the state and federal approvals cover everything.

Keeping the exemption once you have it

Winning exemption is the beginning, not the end. Exempt organizations file annual information returns with the IRS, and the IRS states that organizations that do not file for three consecutive years automatically lose their tax-exempt status. A missed or improper filing can put the exemption at risk, and losing it can create problems for donors who claimed deductions in reliance on it.

Good governance is the other half. Boards that meet, keep real minutes, follow their bylaws and manage conflicts of interest are in a far stronger position when a regulator, donor or grantor asks questions. If a bank or grantor asks for audited financial statements, the guide on what an audit request means explains that process. My guide on the yearly upkeep for a Texas entity covers the state-level habits that apply to many organizations as well.

• File the annual IRS information return on time, every year
• Keep the Secretary of State's records current, including the registered agent
• Hold board meetings and keep minutes that reflect real deliberation
• Review conflicts of interest and related-party transactions
• Keep donor acknowledgments and grant records organized

Where founders usually go wrong

The most common mistake is filing the state certificate with a generic purpose, assuming that makes the organization tax exempt, and starting to accept donations as if it were. Another is building the board entirely from family members or close friends without thinking about conflicts of interest and how the IRS will view insider relationships. A third is choosing a category or classification without understanding the rules that come with it.

I also see founders who obtain exemption and then let governance slide: no meetings, no minutes, no annual filings. The organization looks fine until a grant application, an audit request or an IRS notice exposes the gaps. Fixing those problems after the fact is usually harder than setting up good habits at the start.

How I help boards get started

When a founder or board contacts me, we start with the mission, the people involved and how the organization will be funded. From that conversation I can advise on the type of organization, the exemption to seek, and whether to incorporate. I then prepare the formation documents and bylaws with the exemption application in mind, and coordinate with the organization's accountant on the tax side.

I work from One Campbell Centre in Dallas and advise nonprofits and associations on formation, governance and compliance. If you are comparing advisors, my guide on questions to ask a business attorney before hiring applies to nonprofit counsel too. My approach is straight talk counsel: the board should understand its own documents well enough to govern the organization confidently, without creating liability for its directors and officers.

Questions people ask me