A version of this article used to live here as a guest post. Look, it got some things wrong, and it’s been changed. What follows is how I walk clients through starting a nonprofit in Texas.
The question I get most isn’t “how do I file.” It’s “my business wants to do good – can I set up a nonprofit alongside it, and how closely can they work together?” Occasionally that means “can I use a charity to dodge taxes” (no). Usually it’s sincere. Either way, the same six issues come up.
“Nonprofit” is a state-law label. “Tax-exempt” is a federal one. You need both, and one doesn’t get you the other.
The Texas piece is a certificate of formation filed with the Secretary of State (currently Form 202; the fee is $25 as of this writing). That gives you a Texas nonprofit corporation with no tax exemption of any kind. It owes federal income tax and Texas franchise tax like any other corporation until you do something about it.
The federal piece is an application to the IRS for recognition under Section 501(c)(3), on Form 1023 or, for small organizations, the shorter 1023-EZ. The user fee is a few hundred dollars, and the wait runs from a few weeks (EZ) to several months (long form).
Then you go back to the state. With your IRS determination letter in hand, you apply to the Texas Comptroller for franchise tax and, where it applies, sales tax exemption. That’s a separate application.
When someone tells me they “started a 501(c)(3) last year” and can’t produce a determination letter, they usually stopped after the Texas filing.
Form 202 is built to create a valid Texas corporation, not to satisfy the IRS. The IRS generally wants two things in the certificate of formation itself: a purpose clause limited to exempt purposes (charitable, religious, educational, and so on) and a dissolution clause sending any leftover assets to another exempt organization or the government, never to the founders.
File a generic Form 202 and the Secretary of State will accept it, the IRS will bounce it, and you’ll be filing a certificate of amendment and restarting the clock. Before filing, that’s a wording change. After, it’s an amendment and a new wait.
Your bylaws should also cover no private inurement, no substantial lobbying, no campaign activity, and a conflict-of-interest policy. Form 1023 asks about each.
The old article said Texas requires “at least three non-related directors.” Half right.
Texas generally requires at least three directors, plus a president and a secretary. It does not, to my knowledge, require that the directors be unrelated. You, your spouse, and your brother-in-law can be the whole board as far as the Secretary of State is concerned.
The IRS cares a great deal, though. A board of relatives or paid insiders signals “private benefit.” Form 1023 asks about relationships among directors, and a related board is a common reason for extra scrutiny. Not an automatic denial – but if you want a smooth application, keep a majority of the board independent. It’s also just good governance – you want a board that can tell the founder no.
The old article said the agent must be “an accountant or, most commonly, an attorney.” That isn’t a requirement.
Every Texas entity needs a registered agent: a person or business with a physical Texas street address who agrees to receive lawsuits and official notices. That can be any Texas resident (a director, a volunteer, you) or a business registered in Texas. The corporation can’t name itself, and the agent has to consent in writing. Many nonprofits pay a commercial agent service a modest annual fee so the address never changes; many just name the founder. Either approach works. What doesn’t work is naming your buddy who moves to Oklahoma eighteen months later – notices go to an empty address, and you can lose a lawsuit you never knew about. More on the role in my piece on DBAs and LLCs; the rules are the same.
The old article said employees earning under $100 a year don’t pay income tax. I don’t know where that came from.
The exemption belongs to the organization. Employees pay income tax on wages like anyone, and the nonprofit withholds payroll tax like any employer (501(c)(3)s are generally exempt from federal unemployment tax, and that’s about it). Founders and directors can be paid reasonable compensation for real work, approved by disinterested directors and documented. Overpay an insider and the “excess benefit” penalties land on the individual.
The ongoing calendar, generally, as of this writing:
The IRS requires an annual Form 990, 990-EZ, or 990-N postcard regardless of size. Miss three years in a row and the exemption is revoked automatically.
The Secretary of State may request a periodic report (Form 802) of directors, officers, and agent – not annually, and generally not more than once every four years. Ignore the notice and the corporation can be involuntarily terminated.
Once the Comptroller grants franchise tax exemption, there’s generally no annual franchise report. Sales tax is separate: your exemption covers purchases for the exempt purpose, not sales you make. Sell t-shirts at a fundraiser and you’re generally a seller collecting tax, with some specific exceptions (Texas gives exempt organizations a limited number of tax-free sale days per year), so ask before assuming the exemption covers a sale.
Texas also does not generally require charitable solicitation registration, unlike many states. A few categories (certain law enforcement, public safety, and veterans groups) have their own rules, and soliciting in other states brings their rules along.
Your company can donate to the nonprofit, sponsor its events, lend it space, and let employees volunteer on the clock. The nonprofit can hire a for-profit, including yours, for services.
What it can’t be is a division of the business, a marketing arm, or a place to park revenue. Every transaction between the two has to be arm’s length, fair to the nonprofit, documented, and approved by the independent directors with the interested one out of the room. Your company billing the charity above market, or the charity’s programs steering customers to your business, is private benefit, and the consequences run from excise taxes on the insiders to revocation. A written agreement between the entities, priced at or below market, keeps it legal.
Last thing, which the old article got right underneath the invented statistics: a nonprofit needs a funding plan before it needs a certificate of formation. The filing fees are the cheap part. Bookkeeping, insurance, and several months of waiting on the IRS before you can promise donors a deduction cost more. A business lawyer can set the entity up correctly, but the funding plan has to come from you.
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