10 Essential Steps to Start a Nonprofit (cont’d)

STEP #4: APPLY FOR TAX-EXEMPT STATUS

Step #1 is to develop a mission statement.  Step #2 is to develop your team.  Step #3 is to incorporate with the Secretary of State.  Step #4 is what most people know to do when building a charity–apply for tax-exempt status.

The IRS grants tax-exempt status to nonprofit corporations that are approved.  It’s the federal government’s way of saying “you will be exempt from paying some taxes in exchange for your service to the public good.”  It is also the government’s way of rewarding donors who can deduct their donations from their taxes.  Many recognize the IRS chapter that governs tax exemption for public charities, 501(c)(3).  There are so many myths and misconceptions with tax-exempt status that I could write a 10-post “myth” series on just misconceptions.  I will address these misconceptions below, but first, what is involved in the tax-exempt process?

Once you incorporate with your state’s secretary of state, you obtain an EIN number, you have your team of people, then you file for tax-exempt status with the IRS using form 1023.  Many new organizations will qualify for using the short-form 1023EZ.  There is a fee schedule.  When approved, you will receive a Determination Letter that you will save, and keep on hand to present when requested to organizations and others as proof of your tax-exempt status.

Tax exemption misconceptions to keep in mind:

  1. Your organization is not exempt from paying all taxes.  You are exempt from federal income and unemployment tax, and possibly exempt from some state sales, income and employment taxes.
  2. You are now a public organization.  You are taking public dollars in furtherance of your stated mission, and are to be transparent to the public.  Your tax returns, much of your operations, your board meetings, are to be available to the public (within reason).
  3. You aren’t in charge–you and the board of directors must work together as an organization, not a private, closely-held business.  This is difficult for some to accept when someone has spent a large amount of time developing a charity only to be voted out by its board of directors.  If you want absolute control, become a for-profit business.  You might not have as much access to donations and grants but depending upon your cause, you might still attract donors or sponsorships.
  4. You don’t just “get a [federal] number” and start collecting donations.  You are a business (i.e., nonprofit corporation) and you are now exempt from paying some taxes.  You must operate as a business, observe corporate formalities, observe requirements for maintaining federal tax-exempt status.
  5. As a public corporation (once you receive tax-exempt status), you are scrutinized by both your state’s Attorney General and the IRS to ensure that the public is protected when donating its money to you and other charities.

If you are committed to a cause and to starting a nonprofit, contact me with any questions about formation or applying for tax-exempt status at julie@juliemillslaw.com, or visit http://www.juliemillslaw.com.

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