Ready to Start a Nonprofit?

Seven Questions to Know if you are Ready to Start a Nonprofit

A white question mark on a blue background

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. You are joining more than 1.5 million registered in the U.S., according to the National Center for Charitable Statistics (NCCS). Wondering if you’re ready to start a nonprofit? 

The world of nonprofit organizations and tax-exemption is complex and highly regulated. The terms “public charity,” “nonprofit” organization, and “tax-exempt” all have very specific definitions under federal tax and state corporate law and are only somewhat synonymous.

Here are seven simple questions (with explanations below) that can help you assess if you are ready to start a nonprofit and to begin making a change in the world.

  1. Will you serve a “charitable class?”
  2. Do you have a charitable “program?”
  3. Can you feed and care for an organization?
  4. Can you fund the startup?
  5. Do you have an anticipated budget?
  6. Have you developed a funding plan?
  7. 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 groundwork and decisions that need to be made before you are ready to start your nonprofit. Some of the rationales behind these questions is provided below.

1. Will you serve a “charitable class?”

A charitable class is a group of people (or other, defined group such as endangered animals or wildlife habitat, i.e.) who can properly receive assistance or programming from charitable organizations. They have to be sufficiently large or indefinite so that aiding them provides a benefit for the community as a whole. 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. Additionally, organizations created to operate a little league or run a local museum would also qualify. In the end, you must ensure that you are serving a “charitable class” or you will not be considered to be a proper charity.

2. Do you have a charitable “program?”

One of the biggest questions that tend to face nonprofit founders is how to provide help to the target population. 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 you will enact your program 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. This is where you will decide if you want to feed the hungry, house the homeless, or cure the sick. Or instead you might want to support the arts or build schools. When you apply to the IRS for recognition of tax exemption, you will need to have a concrete plan to present. As a founder, it is your decision what services you will provide and there are an incredible number of ways to provide assistance and support.

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 the nonprofit. If the “what” is to feed the hungry or support the arts, then the “how” could be to open a soup kitchen or a donation center for food to send to homeless shelters or run a nonprofit theater. 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 comply with reporting and record-keeping obligations?

Another major part of starting a nonprofit is ensuring that you can provide for the feeding and care of an organization by complying with the filing, reporting, and record-keeping obligations of the organization. This includes a number of different filings that need to be done every year, quarter, etc. to maintain your status as a tax exempt, charitable nonprofit organization. This is the area where we, at Charitable Allies, see the most issues with nonprofits.  These 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, is 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 nonprofits 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 loses its tax-exempt “nonprofit” 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 or Secretary of State.

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, professional solicitation registrations (different from CSR), commercial co-venture rules, charitable gaming licensures (for raffle, bingo, pull-tabs, among others), sweepstakes regulations, 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. Keep in mind that you’ll need to have enough for any materials you’ll need to run your program, as well as administrative costs like the IRS filing fee to file for tax exempt status, which can range from $245 to $600. Common ways to fund a startup nonprofit is through self-funding, donations or grants. The most common source of funds for a nonprofit organization is individual donations. According to the NCCS, individual donations accounted for 72 percent of all contributions received in 2014.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. These grants can either be awarded by the government or by charitable or private foundations. However, grants should be a lesser focus than individual donations. See the explanation to Question 5 below, for more information on why it matters. Oftentimes, donations or grants are restricted for specific purposes. As a nonprofit law firm, Charitable Allies has often been the recipient of a restricted donation or restricted grant designated for a startup project for one of our clients.

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, agrees to serve as an incubator of sorts for a charitable program that is operated by other persons. 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,” usually in exchange for an administrative fee.

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 major benefits to being a public charity instead of a private foundation, including 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.

Ensuring that you have an anticipated budget that is reasonably accurate and meets the “public support test” is a must for most nonprofits to be appropriately recognized as an organization with tax-exempt status.

6. Have you developed a longer-term 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, have revenue that exceeds its expenses, but nonprofits cannot distribute that excess to its “owners” or other “insiders.” This is commonly called the “non-distribution constraint.”The phrase “no margin, no mission” reflects this reality well; if you do not have a margin (i.e., net revenue), then it will be hard for the nonprofit to survive and continue to carry out its mission. Not all nonprofits require fundraising, but many do. If you decide that you need to conduct fundraising, keep in mind that there are certain fundraising regulations with which you must comply.

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/insurance payments for medical services at a hospital.

But, it is important to prevent your activities from becoming too “commercial” and ensure that any revenue generation comes from an activity that is related to the charitable purpose(s) or your organization will 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. The exact minimum number depends on the state in which the nonprofit operates. “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 that can out-vote the related members.Additionally, board members need to have certain level of relevant experience and skill, which could include having a learned professional such as a lawyer, accountant, marketing expert, or someone with deep knowledge in your programming areas sit on the board, but they also need to have a certain personality type or traits to fit with you and your organization. When choosing board members, ensure that you educate them properly about their roles within the organization and their duties to the organization because 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 seven 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. And once you’re ready to begin learning about the planning phases and the legal process, check out our article Everything You Need to Know About Starting a Nonprofit. 

Attorney Zac Kester provides generalist and strategic nonprofit legal and consulting services. He holds a Master of Laws, a post-law school advanced degree, in which he studied the unique needs of tax-exempt nonprofit organizations. His legal and consulting career has focused on nonprofit organizations.

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.