You Want to Start a Charity – Now What?

You Want to Start a Charity – Now What?

An exempt charitable organization, also known a 501(c)(3) organization, must operate exclusively for charitable purposes. It must serve the public interest rather than a private interest, and the activities that it is engaged in must further its exempt purpose. The organization must be created for one of the following purposes:

• Religious.
• Charitable.
• Scientific.
• Testing for public safety.
• Literary or educational.
• Fostering national or international amateur sports competition.
• Preventing cruelty to children or animals.

When creating a not-for-profit entity, you must first create a legal entity under your state’s law. The entity must be a trust, corporation or association. Every state has its own requirements on what is required to create a not-for-profit entity, which may differ from the requirements to create other types of entities. The IRS website provides a listing of contact information, website and phone number, for each state – State Nonprofit Incorporation Forms and Information.

Non-profit status is a state concept that may convey benefits such as exemption for state sales, income and/or property taxes. Tax-exempt status is a federal tax law concept. Being a non-profit at the state level does not automatically make the entity tax-exempt at the federal level.

Once your organization has been created as a not-for-profit entity under your state’s law, you will then want to apply for federal tax-exempt status in order to make donations to your organization eligible for tax deductions on the donors return. Tax-exempt status will excuse your organization from paying income taxes on its income from charitable purpose activities and will only pay income taxes at a reduced rate on any unrelated business income it may have. Filing for federal tax-exempt status is done by submitting Form 1023 with the IRS. You will need the following documents as part of that filing:

• Employer identification number (EIN). Here is the link to the IRS website to apply for an EIN – Apply for an Employer Identification Number Online.
• Organizing or enabling documents signed by a principal officer, such as articles of incorporation, articles of organization for limited liability company or declarations of trust.
• Bylaws, if they have been adopted by your organization.

In order for your organization to obtain tax-exempt status from the first day of operation, you need to file Form 1023 within 27 months of the end for the first month it was organized. You can operate as a tax-exempt organization while waiting for approval from the IRS, but your donors will not have assurance that their contributions to your organization will be deductible until your application is approved. If the application is approved, donors’ contributions made while the application was pending will qualify as charitable deductions; however, if the application is denied, the contributions will not be deductible on donors’ income tax return, and the organization will be responsible for filing federal and state income tax returns.

Every state has its own regulations regarding fundraising as well as soliciting donations. These include requiring registration of your organization, special rules when using the services of a paid solicitor or fundraising counsel, gaming activities and financial reporting. Every state is different, so you will need to make sure to check with each state in which you plan to solicit funds or hold fundraising activities. Here is a link to the National Association of State Charity Officials. It contains a link to each state’s charities website.

Once you have your tax-exempt status, you certainly don’t want to lose it. Here are five ways you can jeopardize your organization’s tax-exempt status:

• Private benefit/inurement – Tax-exempt organizations cannot serve substantial private interests, nor can they permit assets or income to accrue to insiders. An insider is also known as a disqualified person and is defined as officers, directors, key employees, founders, certain family members and entities more than 35% owned by a disqualified person. Examples of inurement include payment of dividends, unreasonable compensation and transfer of property for less than fair market value. An excise tax can be assessed on a person who receives excess benefits and also on the organization’s managers. The excise tax may be assessed instead of, or in addition to, revocation of tax-exempt status.
• Lobbying/legislation – Lobbying is defined as activities intended to influence foreign, national, state or local legislation. Although certain tax-exempt organizations are permitted to expend funds for lobbying, 501(c)(3) organizations are only permitted a limited amount of lobbying expenditures and excessive amounts can result in loss of tax-exempt status.
• Political campaign intervention – Your organization cannot make statements for or against a political candidate. Your organization also cannot incur expenses related to the participation in a political campaign. Political campaign intervention activities will not only result in the imposition of a two-tier excise tax on the political expenditures but can result in the loss of your tax-exempt status. Although 501(c)(3) organizations are allowed to expend a very limited amount on lobbying expenditures, expending so much as one dollar towards a political campaign could result in the loss of your exempt status. Be very careful.
• Operating for a non-exempt purpose – A public charity cannot conduct more than an insubstantial amount of non-exempt activity without jeopardizing its tax-exempt status. A common type of non-exempt activity is conducting an unrelated trade or business. Unrelated business income (“UBI”) is considered income from a trade or business that is regularly carried on and not substantially related to your organization’s tax-exempt purpose. Common types of UBI include advertising, sale of merchandise and services. There are some exceptions to the rule which includes the activity being run by volunteers, for the convenience of its members, selling donated articles and income from traditional bingo games. Simply because the proceeds from the activity are used for an exempt purpose does not mean that the activity contributes significantly to the organization’s exempt purpose and, therefore, does not exclude that activity from unrelated business income tax. Organizations with $1,000 or more of UBI are required to file Form 990-T and pay income taxes on their UBI.
• Filing requirements – Most public charities are required to annually file one of the following forms: Form 990, 990-EZ or 990-N (e-postcard) or if a private foundation, Form 990-PF. Failure to file for three consecutive years will result in automatic loss of your tax-exempt status. Religious organizations are exempt from these filing requirements.

Donors cannot claim a tax deduction for any single contribution of $250 or more unless the donor obtains contemporaneous, written acknowledgement of the contribution from the donee organization. Therefore, you will need to provide donors with written acknowledgment for all donations of $250 or more. The written acknowledgement needs to contain the name of the recipient, the amount of cash donated or a description, but not a value, of any property other than cash contributed. If the donor receives something of value in return for the contribution beyond a de minimis threshold, the organization should describe and give a good faith estimate of the nature and value of the goods or services it provided. If the organization did not provide goods or services in return for the contribution, it should provide a statement to that effect.

In conclusion, there are many rules and pitfalls involved in creating and running a public charity. This article contains some information to help you get started. It is not intended to be an all-inclusive list of everything you need to know. If you need more information regarding this topic visit Withum’s Not-for-Profit and Education webpage or contact your WithumSmith+Brown, PC, professional, a member of Withum’s Not-for-Profit and Education Services Group or e-mail us at [email protected].

	Lisa Galinsky, CPA, CVA 732-842-3113 [email protected]

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To ensure compliance with U.S. Treasury rules, unless expressly stated otherwise, any U.S. tax advice contained in this communication is not intended or written to be used, and cannot be used, by the recipient for the purpose of avoiding penalties that may be imposed under the Internal Revenue Code.