By Zachary S. Kester, Executive Director and Robert Miller, Program Officer, Charitable Allies
Starting a new nonprofit can be fun and exciting. You are beginning a journey to help your community in the best way you know how. You see an issue and you are stepping in to fill the void. But, it can also be scary and intimidating.
The world of nonprofits and tax-exemption is complex and highly regulated. There are a seven simple questions (with explanations below) that you can ask to assess if you are ready to start a nonprofit and to begin making a change in the world.
- Will you serve a “charitable class?”
- Do you have a charitable “program?”
- Can you feed and care for an organization?
- Can you fund the startup?
- Do you have an anticipated budget?
- Have you developed a funding plan?
- Do you have a board?
If you answered “yes” to four or more of these questions, then you might be ready to start your nonprofit. However, if you answered “no” to four or more, you will want complete more planning before you are ready to change the world.
The above questions are common questions any nonprofit needs to answer. They cover the basic ground work and decisions that need to be made before you are ready to start your nonprofit. Some of the rationale behind these questions is provided below.
1. Will you serve a “charitable class?”
A charitable class is the group of people who can properly receive assistance from charitable organizations. They have to be sufficiently large or indefinite so that aiding them provides a benefit for the community as a whole. For example, an organization created and operated solely for the benefit of one person or one specific disaster event would generally not qualify for tax-exemption as a charitable organization. However, an organization created and operated to benefit all victims of a particular disaster type would qualify. In the end, you must ensure that you are serving a “charitable class” or you will lose your charity and tax-exempt status.
2. Do you have a charitable “program?”
One of the biggest questions that tends to face nonprofit founders is how to provide help to the people in most need. You will need to decide exactly how you want to help and figure out a set of programs that will allow you to achieve that goal. This can be the most daunting part of starting a nonprofit, but it is also one of the most important. It is your job to decide which way works best for you and your target community.
More specifically, you need to be able to answer the “who, what, when, where, and how” of your charitable program in order to adequately answer the form required by the IRS for it to recognize your organization as a charity under Internal Revenue Code §§ 501(c)(3) and 509(a). Code § 501(c)(3) requires that tax-exempt charities be organized and operated exclusively for (1) religious, (2) charitable, (3) scientific, or (4) educational purposes, among others (collectively “charitable purposes”). These “W” and “H” questions help the IRS assess whether your organization qualifies.
The “who” question is largely answered by the question above about serving a “charitable class.” The “when” and “where” questions also tend to be relatively easy. You need to determine a location or locations for your services. Will you have a single location where all of your services will happen? Will you have a central location, but perform most of your services on-site at specific events? Will you essentially roam around the service are without any central location? Whatever the case, you need to know where you will perform your charitable program. When the events take place is equally important. Do you have annual, quarterly, monthly events? Or do you perform your services daily or weekly? In any case, you need to decide when you will perform your charitable program and be able to communicate this effectively to the IRS.
The “what” and the “how” questions are much more important and much more difficult to answer than the others. The “what” is part of the description of the charitable program itself. This is a description of the services you will provide to those in need. Do you want to feed the hungry, house the homeless, or cure the sick? It is your decision what services you will provide and there are an incredible number of ways to provide assistance to those in need.Finally, the “how” question must be answered. This is the other part of the description of the charitable program most commonly understood to be the services performed by charities. If the “what” is to feed the hungry, then the “how” could be to open a soup kitchen or a donation center for food to send to homeless shelters. In general, the “how” is the way in which you will perform the “what.”
The U.S. Department of Treasury and IRS have set forth numerous rules and regulations about activities that are for “charitable purposes.” Once you can answer the “who, what, when, where, and how,” then you will be much, much closer to starting your nonprofit than before.
3. Can you feed and care for an organization?
Another major part of starting a nonprofit is ensuring that you can provide for the feeding and care of an organization. This includes creating a budget, looking at start-up costs and operating costs, working out a funding plan (more on that below), getting insurance, and any other number of issues that will arise when starting and operating a nonprofit and/or various tax exemptions and other privileges. This also includes a number of different filings that need to be done every year to maintain your status as a nonprofit. This is the area where we, at Charitable Allies, see the most issues with nonprofits. This issues are often left on the back burner too long and are not given enough attention until they catch fire.
The first issue that you must be prepared to deal with the filing of your Form 1023 with the IRS to qualify as a tax-exempt charity. This is an extensive filing that requires a lot of time and attention to complete accurately and timely. Additionally, there are several other filings that charities can make that will exempt them from sales and use tax, unemployment insurance, and get a reduction in postage for bulk mailings.
Secondly, nonprofits are required to file annually a number of different documents. Most nonprofits must submit some type of the Form 990, which is an annual “tax” information return, to the IRS depending on their size. A major consequence of failing to file a required 990 is that after three consecutive years of failing to timely file, then your nonprofit will lose its tax-exempt charity status.Additional annual filings include an annual report to your states’ department of revenue, business entity reports to the secretary of state, and notice of any changes in address, registered agent, etc. of the nonprofit with the relevant authority, e.g. the Attorney General.
A third major consideration of most nonprofits is charitable solicitation issues, which affect 39 states. The main way this is resolved is through CSR or Charitable Solicitation Registration. Failing to comply with this can result in anywhere from a couple hundred to thousands of dollars of fines. If you plan on fundraising, you need to ensure that you will be in compliance with the regulations by registering, usually prior to beginning your fundraising.
Finally, nonprofits must be aware of any donation requests and receipts issues, charitable gaming or sweepstakes issues, employment concerns, and potentially necessary insurance coverage. In the end, nonprofits have issues that concern more than just where to get funding and how to help the people in most need. Nonprofits and their founders need to be aware of these issues and ensure that their organization has a plan in place to effectively feed and care for the organization.
4. Can you fund the startup?
Funding a startup nonprofit can be difficult. Common ways to fund a startup nonprofit is through self-funding or through donations or grants. The most common source of funds for a nonprofit organization is individual donations. These donations can be of two types: cash donations or in-kind donations. Cash donations are transfers of funds directly to the organization whereas in-kind donations are most other types of donations, including goods, services, expertise, or cash equivalents.
Additionally, nonprofits can receive grants. restricted grant designated for a startup project for one of our clients.These grants can either be awarded by the government or other foundations. However, grants should be a lesser focus than individual donations. Oftentimes, these donations or grants can be restricted for specific purposes. As a nonprofit law firm, Charitable Allies has often been the recipient of a donation or
Another possible source of funding for nonprofits is through a fiscal sponsorship, or a fiscal sponsor-sponsee relationship. This is a formal arrangement where a current nonprofit, commonly a community foundation. According to Fiscal Sponsorship: a 360 Degree Perspective, Trust for Conservation Innovation, “[a] fiscal sponsor is a nonprofit organization that provides fiduciary oversight, financial management, and other administrative services to help build the capacity of charitable projects.” In other words, a fiscal sponsor can be a “home” for a startup nonprofit looking for funding even if it lacks tax exempt status. This method can be very useful for new nonprofits because the fiscal sponsor will often take on a number of responsibilities that new nonprofits might struggle with on their own, including receiving and administering contributions, dealing with some of the operating issues of a nonprofit, etc. On the other hand, this does seem to be a method of funding that is decreasing both in popularity and opportunity to find willing “homes.”
There are a number of ways to fund a startup nonprofit, including donations, grants, and a fiscal sponsorship, but if you cannot find enough funding for a startup nonprofit, then it might be better to work with an existing organization or charity to accomplish your charitable goals.
5. Do you have an anticipated budget?
When creating a budget it is important to understand what resources you will need to perform your stated objectives, what these resources will cost, and where you will get those resources. An important note when dealing with an anticipated budget for nonprofits is that sometimes nonprofits can get some resources donated by other organizations or get discounts on some of the resources they will need.
An anticipated budget is equally as important for determining whether your organization passes the “public support” test and is a public charity rather than a private foundation. The IRS requires four years of actual, anticipated, or estimated budgets in order to assess your organizations charitable status. There are massive benefits to being a public charity instead of a private foundation that includes being fully tax-exempt.
A public charity is a charity which either provides an inherently public service (such as a church, hospital, public education or governmental unit) or which is a publicly supported organization; this latter category is divided between organizations supported by exempt function income (Internal Revenue Code § 509(a)(2)) or which receive substantial support from the general public or a governmental unit (IRC §§ 509(a)(1) and 170(b)(1)(A)(vi)).
There are two tests used by the IRS to determine if an organization is a publicly supported organization, but only one of them must be met to be classified as such. First, if the organization receives no more than one-third of its support from gross investment income and more than one-third of its support from contributions, membership fees, and gross receipts from activities related to its exempt functions, then it qualifies as a publicly supported organization. The other test is that if the nonprofit receives a “substantial support” in the form of contributions from publicly supported organizations, governmental units, and/or the general public, then it is a publicly supported organization. Under §§ 509(a)(1) and 170(b)(1)(A)(vi), “substantial support” means 33⅓ percent or more of the charity’s support must come from either of the two acceptable sources to be considered publicly supported.
Ensuring that you have an anticipated budget that is as accurate as possible and meets the “public support test” is a must for most nonprofits be recognized as an organization with tax-exempt status.
6. Have you developed a funding plan?
The key here is sustainability. It is a common misconception that nonprofit means that you cannot make a profit, but that is not true. A nonprofit can, and should, make a profit, but nonprofits cannot distribute those profits to its “owners” or other “insiders.” This is commonly called the “nondistribution constraint.”
Indeed, if you do not have a margin for profits, then it will be hard for the nonprofit to survive and continue to carry out its mission. fundraising regulations with which you must comply.Not all nonprofits require fundraising, but many do. If you decide that you need to conduct fundraising keep in mind that there are certain
Many nonprofit founders know about fundraising and other typical ways to raise money for their organizations. However, it is less well-known that nonprofit organizations can in fact generate revenue through the services they provide. This is called program service revenue and is defined as revenue received by an organization while charging for the services for which it received tax-exemption. Examples include tuition received by schools, admissions received by an art museum, and patient payments for medical services at a hospital. But, it is important to prevent your activities from becoming too “commercial” or risk losing your tax-exempt status. Just remember the key to developing a funding plan is sustainability so that your organization can survive and thrive.
7. Do you have a board?
Lastly, you need to have a board of directors for your nonprofit. A typical board of directors has either three or five members, a majority of whom are unrelated, depending on the state in which you operate. Unrelated simply means that the members cannot be related to you or each other by blood, marriage, or business. You can have some related board members, but then usually you must have additional members to out vote the related members. Additionally, board members need to have certain level of business experience and skill, which could include having a lawyer sit on the board, but they also need to have a certain personality type or traits to fit with you and your nonprofit. When choosing board members ensure that you educate them properly about their role within the organization and their duties to the organization. Failing to educate them properly can result in disastrous consequences for your organization that could include expensive liability. Once you have the proper number of board members, you are one step closer to starting your nonprofit.
There is a lot of work that goes into starting a nonprofit, but with these 7 questions as a guide, you will be able to figure out easily what you want to do with your nonprofit and how to get there.
With highly experienced legal and training personnel, Charitable Allies provides all manner of legal and educational services for boards, officers, management and staff of myriad charities throughout the sector. From basic one-time questions about a single matter to training for boards and officers to complex reorganization or merger of activities, Charitable Allies is your go-to cost-effective provider of legal services to nonprofit organizations.
Contact Zac Kester, executive director, at 317-333-6065 or email@example.com with any questions.