One of the first legal steps in forming a nonprofit is incorporation, and this is also one of the most common areas that individuals make mistakes it the formation process. The Articles of Incorporation need to be properly submitted without omitting language that the IRS requires to qualify for tax-exempt status, such as a clear statement of the organization’s nonprofit purpose and a dissolution clause specifying the distribution of assets to another nonprofit upon dissolution.

Bylaws serve as the organization’s governing document, outlining how it operates and makes decisions. Using generic or boilerplate Bylaws often results in governance disputes or noncompliance with state and federal requirements. For example, failing to include provisions for electing board members, resolving conflicts of interest, or handling dissolution can lead to operational and legal challenges.

Board members and staff are often connected to donors or beneficiaries, which can lead to potential conflicts of interest. Failing to adopt and enforce a conflict of interest policy can result in unethical decisions, legal disputes, loss of public trust, and potential legal issues with the IRS and respective state agencies. Additionally, nonprofits are required by the IRS to disclose conflicts of interest when applying for tax-exempt status.

A common misconception is that forming a nonprofit automatically grants tax-exempt status. Many organizations fail to apply for federal tax exemption under Section 501(c)(3) or other relevant sections of the Internal Revenue Code. Without this designation, the organization may be subject to federal income tax and ineligible to receive tax-deductible donations. Another common mistake is using the simplified Form 1023-EZ without ensuring the organization meets the eligibility criteria, leading to potential rejection or revocation of tax-exempt status later.

Many states require nonprofits to register before soliciting donations. Failing to register with the appropriate state authority, often the Attorney General or respective Secretary of State, is a common mistake. This error can lead to fines, penalties, or even being barred from fundraising in a state. Organizations soliciting donations in multiple states often neglect to register in all applicable jurisdictions, further complicating compliance.

Nonprofits are required to file annual reports with the IRS (e.g., Form 990) and state agencies (Annual Report with the Tennessee Secretary of State and Charitable Solicitation Renewal). Failure to meet these deadlines can result in penalties, fines, or the loss of tax-exempt status. Smaller nonprofits often assume they are exempt from these filings, which is false. Keeping a calendar of reporting deadlines and hiring professional help can prevent missed filings.