www.probonopartnership.org copyright 2012 pro bono partnership. all rights reserved. no further use,...

www.probonopartnership.orgCopyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution

or publication is permitted without express written permission of Pro Bono Partnership.

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Keeping it Legal: Keeping it Legal: What to consider before What to consider before starting a new nonprofitstarting a new nonprofit

October 27, 2012

Nancy Eberhardt, NJ Program DirectorPro Bono Partnership



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What is the Pro Bono Partnership? Free business and transactional legal services for nonprofit

organizations through the services of our staff and corporate and private attorney volunteers

To be eligible, the organization must be:

– Nonprofit, tax exempt (or seeking 501(c)(3) status);

– Primarily serving the disadvantaged and enhancing the quality of life in their neighborhoods;

– Focusing on health and human services, community development, affordable housing, neighborhood revitalization, environmental protection, or the arts;

– Providing programs that have a demonstrable impact; and

– Unable to pay for legal services without significant impairment of program resources.



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Introduction The nonprofit sector is growing quickly But revenue sources are decreasing, especially

in this economy! More targeted individual giving and

redirected/focused corporate giving Resulting in an environment where it is

essential to make a disciplined assessment of whether it makes sense for you to incorporate and apply for tax exemption

The Partnership’s experience screening new organizations



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Myth or Reality? Nonprofit and tax exempt mean the same thing (or nonprofit

corporations are automatically tax exempt)

An organization cannot raise money unless it is tax exempt

Every good idea deserves a nonprofit

If I am the founder, I can pretty much run the nonprofit the way I want

Nonprofits can’t make a profit

Being on the Board of a nonprofit is not “serious”, the way being on the Board of a for-profit company is

Nonprofits cannot engage in lobbying



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Myth or Reality? (cont’d)

Nonprofits cannot pay salaries (or nonprofits can pay any salaries they want to)

Nonprofits are exempt from workers’ compensation and unemployment laws

I can get a tax deduction for the time/services I give to my nonprofit

I can get a tax deduction for use of my space

State tax and local property tax exemptions are automatic for a 501(c)(3) organization



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Incorporation and Tax Exemption

Becoming a tax-exempt organization is a two-step process

• First step: Incorporation is a product of state law; obtained by filing a certificate of incorporation or articles of incorporation with the state

• Second step: Tax exemption is a federal designation for which the corporation applies to the Internal Revenue Service on Form 1023 and asks to be recognized as tax exempt



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Pros and Cons of IncorporatingPROS Limited liability

Facilitates tax exemption

More attractive to funders

Perpetual existence

CONS State filings

Federal filings

Maintaining corporate records

Observing corporate formalities

Must recruit and retain people to carry out responsibilities

Perpetual existence



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Organizational Requirements

Not-for-profit vs. for profit

Bylaws

Membership vs. nonmembership

Board of Directors/Board of Trustees

Officers

Staff



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Organization Chart for Nonprofits

R em ain ingS taff

(P a id a n d U np a id )

Executive D irector

D irectors/T rustees

M em bers(if a p p lica b le )

Elect

Hire & Supervise

Hires & Supervises



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Incorporating Generally Each state has its own Nonprofit Corporations Act or

Nonstock Corporation Act (or some other name)

You generally must complete and file a Certificate of Incorporation (sometimes called Articles of Incorporation) with a state agency; agency that handles incorporations and fees vary between states.

Usually, must decide:

• Membership or non-membership

• Agent for service of process

• Carefully state your organization’s mission, keeping in mind your intention to apply for federal tax-exempt status

• Incorporators sign



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Incorporating Generally (cont’d)

Other State filing requirements:

• Usually some kind of consumer protection function within each state.

• Some states have specific filing requirements depending on type of activities (example: NY nonprofits engaging in educational activities)



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501(c)(3) Tax Exemption 501(c)(3) is one type of tax-exempt organization

Can accept tax-deductible charitable donations

Doesn’t pay income taxes; may be exempt from sales, property, and other state and local taxes

No private benefit or inurement

Registration and reporting requirements

Restrictions on lobbying activities

Absolute bar on political campaign activities



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501(c)(3) Tax Exemption (cont’d)

Transparency and accountability

Organizations that don’t have to apply to have tax exemption

• Religious organizations that are houses of worship (not just faith-based charities)

• Organizations under a “group exemption”

• Organizations with annual gross receipts of not more than $5,000



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How to Apply for 501(c)(3) Tax Exemption

Obtain a federal tax ID number, EIN, from the IRS (Form SS-4)

Complete and file IRS Form 1023• Set out, in detail, information about the organization,

including its mission, programs, structure, fundraising program, sources of financial support, and three-year budget

• $850 filing fee; $400 if annual gross receipts of $10,000 or less

• IRS is working on “Cyber Assistant” that may result in reduced fees

• File within 27 months of incorporating to get tax exemption retroactive to the date of incorporation; if more than 27 months, retroactive to date that Form 1023 is filed



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External Oversight of Tax-Exempt Organizations

IRS• Compliance and reporting requirements

• The IRS recently revoked tax-exempt status for over 385,000 organizations for failure to a Form 990 for three consecutive years [IRS Data Book 2011]

State Attorneys General



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External Oversight of Tax-Exempt Organizations

Other State agencies (e.g., Departments of State and Taxation)

Public

Media

Grantmakers

Sarbanes-Oxley legislation



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Is Incorporation/Tax Exemption Right for You? Ask These Questions:

1. Do your purposes fit within 501(c)(3)?

2. Is your mission clearly articulated?

3. Is there a profit motive?

4. Is there a need for your services?

5. Are other organizations doing what you want to do? Locally? If so, how will your activities differ?

6. Whom do you plan to benefit? Many, or just a few?

7. Who is involved with the organization?

(continued…)



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Ask These Questions (cont’d):

8. Where will you get your $$? Do you have identified sources of funding?

9. Do you have only a short-term project?

10. Do you have a need for privacy?

11. Do you plan to do more than an insubstantial amount of lobbying, or engage in any political campaign activities?

12. Do you have the personality needed to work under the direction of a board and timely file required reports with government agencies?

13. Do you have any experience working with/for a nonprofit organization?

14. Can you afford it?

15. Have you considered alternatives to incorporation and tax exemption?



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1. Do your purposes fit within 501(c)(3)?

IRC Section 501(c)(3)

• The organization must be “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition…, or for the prevention of cruelty to children or animals”

“Charitable” covers a wide variety of objectives, including:

• Relief of the poor and distressed or of the underprivileged

• Lessening the burdens of government

• Lessening neighborhood tensions

• Combating community deterioration



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1. Do your purposes fit within 501(c)(3)? (cont’d)

Other purposes may not qualify under 501(c)(3), but the organization may still qualify as tax exempt under another subsection of Section 501. However, donations to these groups are likely not deductible as charitable contributions. For example:

• 501(c)(4) – civic leagues and social welfare organizations (e.g., a block association)

• 501(c)(6) – business leagues (e.g., Chamber of Commerce)

• 501(c)(7) – social clubs



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2. Is your mission clearly articulated?• Important as a basis for exemption, continuing focus,

organizational documents, public relations, and accessing funding

3. Is there a profit motive?

• 501(c)(3) status requires that “no part of the net earnings…inures to the benefit of any private shareholder or individual”

• This is the “nondistribution constraint”

• Compensation must be “reasonable” – sanctions if violated

• Upon dissolution, all assets must be distributed to other 501(c)(3) organizations or to the government for public purposes



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4. Is there a need for your services?

• Have you done a needs assessment?

• Could you operate as a program of an existing organization?

5. Are other organizations doing what you want to do? Locally? If so, how will your activities differ?

• Will you be duplicating already available services?

• Is there limited funding for such services?



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6. Whom do you plan to benefit? Many, or just a few?

• Can’t establish a 501(c)(3) to benefit just one person or a few people

7. Who is involved with the organization?

• How many board members do you have? • What is their ongoing commitment to the organization?• Are they all family and/or friends? • Do they represent the public? • What skill(s) does each person bring to the organization? • Is someone good at/fond of administrative/organizational

tasks? • Are there others who will help in non-board member roles?



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8. Where will you get your $$? Do you have identified sources of funding?

• Fees? Donations? Government? Corporations?

• Must be able to articulate this on Form 1023

• Some funders are reluctant to fund start-ups

• Do your volunteers have the skills to fundraise?

• Is the organization sustainable?

9. Do you have only a short-term project?

• If so, might be better to use a fiscal sponsor or work as a program of an existing agency



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10. Do you have a need for privacy?

• 501(c)(3) “public charities” are accountable to the public and full disclosure is mandated in some circumstances

• Form 990 annual informational tax returns – must disclose information such as compensation of key employees and corporate governance policies; must make copies of Form 990 available on demand; also likely posted online

• The list of donors filed with the annual Form 990 does not have to be disclosed by a 501(c)(3) public charity

• Annual reports filed with state authorities



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11. Do you plan to do more than an insubstantial amount of lobbying, or engage in any political campaign activities?

• A 501(c)(3) cannot have a “substantial part” of its activities consisting of attempts to influence legislation

• Section 501(h) Election on IRS Form 5768

• A 501(c)(3) is prohibited from participating in campaign-related activities – supporting or opposing a candidate for public office

12. Do you have the personality needed to work under the direction of a board and timely file required reports with government agencies?

• If no, starting a nonprofit may not be right for you



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13. Do you have any experience working with/for a nonprofit organization?

• Funders will look at your experience

• Experienced board or staff available?

14. Can you afford it?• Filing fees?

• Insurance?

• Startup costs?

• Overhead/administrative costs (e.g., wages)?

• Annual accounting fees?



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15. Have you considered alternatives to incorporation and tax exemption?

(A) Become a program of another organization

Pros:• Able to concentrate on and build your program

• Do not need to deal with fundraising, administrative, or organizational issues

Cons:• Lack of control

• Lack of identity



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15. Have you considered alternatives to incorporation and tax exemption? (cont’d)

(B) Fiscal Sponsorship

• An existing 501(c)(3) organization (the “Sponsor”) may financially support an unrelated organization (the “Project”) as long as doing so furthers the Sponsor’s exempt purposes

• Funders donate to the Sponsor, which reports the income, controls the administration of funds and the Project’s activities, and is responsible for recordkeeping and reporting to IRS and state agencies on behalf of the Project

• Sponsor may charge a reasonable fee for its administrative services



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(B) Fiscal Sponsorship (cont’d)

• Good idea for new groups; allows them to focus on developing their programs

• Often temporary/short-term arrangements – can be an interim step on the road to incorporation and tax exemption

• Many different ways to structure a fiscal sponsorship. A written agreement is recommended and can be tailored to the needs of each Sponsor and Project



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(B) Fiscal Sponsorship (cont’d)

• Choose the fiscal sponsor carefully – investigate it to make sure it is well run.

• For questions to ask, see the National Network of Fiscal Sponsors’ Guidelines for Comprehensive Fiscal Sponsorship, at www.tides.org/fileadmin/user/NNFS/NNFS-Fiscal-Sponsorship-Guidelines-for-Comprehensive.pdf



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Ingredients for Success Clear Mission

“Market” Niche – need for organization

Business and Budget Planning

Adequate Sources of Funding

Strong Administrative Skills

Committed Board Members

Committed Volunteers

Appropriate Staff



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Resources IRS website offers online training on a wide range of subjects

relevant to maintaining tax-exempt status: www.stayexempt.org

IRS Publication 557 explains the process of applying for tax-exempt status: www.irs.gov/pub/irs-pdf/p557.pdf

Center for Nonprofit Management booklet “Get Ready, Get Set! What You Need To Know Before Starting a Nonprofit”: www.cnmsocal.org/images/downloads/startinganonprofit_getreadygetset.pdf

Center for Non-Profits booklet “Thinking of Forming a Non-Profit? What to Consider Before You Begin”: www.njnonprofits.org/ThinkingOfFormingDesc.html

BoardSource booklet “Starting a Nonprofit Organization”: www.boardsource.org/dl.asp?document_id=17



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Resources (cont’d)

American Bar Association “Tool Kit” that outlines the process of completing the IRS Application for Tax Exemption: www.npaction.org/resources/tetk.pdf

Foundation Center’s tutorial on starting a nonprofit: http://foundationcenter.org/getstarted/tutorials/establish

Information on other charities:

• GuideStar: www2.guidestar.org

• Charity Navigator: www.charitynavigator.org

The Pro Bono Partnership website contains many publications:www.probonopartnership.org/Pages/Publications/all-publicationsfaqs-x



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Resources (cont’d)

Resources for Developing a Business Plan:

• SCORE: www.score.org/business_toolbox.html and www.score.org/resources/search/all/283%2C263

• U.S. Chamber of Commerce Small Business Nation: www.uschambersmallbusinessnation.com/toolkits/start-up

• U.S. Small Business Administration: www.sba.gov/category/navigation-structure/starting-managing-business/starting-business

• Many states have pro bono services for start-ups – check the state and local bar associations, local law schools, and your state’s Nonprofit Association.



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Please Note IRS Circular 230 Disclosure: To ensure compliance with

requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

This presentation is provided as a general informational service to clients and friends of the Pro Bono Partnership. It should not be construed as, and does not constitute, legal advice on any specific matter, nor does this presentation create an attorney-client relationship. You should seek advice based on your particular circumstances from an independent legal advisor.

www.probonopartnership.org copyright 2012 pro bono partnership. all rights reserved. no further use,...

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