For Nonprofits: Classify your donations correctly

When someone donates money or something else of value to a charity (typically tax-exempt nonprofit, or 501c3), that donation is restricted or unrestricted–a charity’s assets are classified as either with donor restrictions or without donor restrictions.  Charities must know the difference between these terms and what problems might arise with any restrictions, and keep track of donations appropriately.

If I donate $500 to my favorite charity with a statement somewhere (could be written in my donation letter or email, or even on the memo line of a check) that my donation is to be used for a specific purpose of the charity–my gift is to the Humane Society of the United States to fight puppy mills, then my donation must, by law, be used for that purpose, to fight puppy mills.  This is a restricted gift.

If I donate $500 to the United Way with no statement anywhere about what purpose it is to be used, or I state that my donation can be used however the United Way sees fit, then the United Way can use my donation however it determines–operating expenses, any of its programs, etc.  This is an unrestricted gift.

What if a nonprofit that provides assistance with medical bills, raises money through GoFundMe or something similar, for a specific event–a person facing a specific surgery, then that surgery is no longer needed?  Or all of the funds raised aren’t needed–$50,000 was raised but only $30,000 is needed to pay medical bills?  The nonprofit has $20,000 remaining of a restricted gift.  Just because the bills only total $30,000 does not mean that the nonprofit has $20,000 to use as it wishes, since the donors who gave that money did so to pay for that specific surgery.  Your state’s Attorney General would become very interested in what happens to those donations.

If the purpose for the gift no longer exists, it is possible for the charity to remove donor restrictions from a gift/donation.  It can:

  1. Talk to donors.  You can go back to donors, tell them that the purpose for their donation no longer exists and ask them what they would like you to do with their donation, or for permission to put it towards another use.  If you use due diligence in this effort, then the Attorney General might not intervene since their purpose is to protect the public.  Perhaps you would put a notice on your website or Facebook page to reach the specific donors, try to contact them directly, or publish something in the newspaper asking for donors to the campaign to come forward.
  2. Talk to the Court.  It is possible to go to court requesting a modification of the gift’s restriction if the purpose for the gift no longer exists, has become unlawful, impossible to achieve, or wasteful.
  3. Talk to the Attorney General.  If the donations total less than $250,000 and are more than 10 years old, you could provide 60 days’ notice to the Ohio Attorney General of your intention to modify or release the restriction. If the Attorney General does not object, then you can release or modify the restriction–the $20,000 from the GoFundMe surgery campaign could be used for another medical bill, another program, overhead, or whatever the charity determines.

The best advice for nonprofits is to keep detailed financial records of donations and any restrictions that are attached.

If you have any questions regarding donations, charities or anything in this post, email me at julie@juliemillslaw.com.

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

Step #9: Money and People!

You have completed most legal steps to forming your nonprofit, now it’s time to start the steps that help truly launch your organization, i.e., money and people.  Securing funding, forming partnerships—these steps will put your group in a position to accomplish your goals.

  1. Fundraising: know your state’s laws on fundraising that involve gambling or alcohol. Keep detailed financial records of the funds you receive.  If your events involve minors or animals, have waivers and releases ready!  Inquire when you need insurance for events.  Obtain the correct permits and permission from local authorities before your event.  If you are serving or selling food, be sure to check with your local health department and other agencies to see if you need to provide information.  This list is not exhaustive.
  2. Grants: educate yourself, your grant committee if you have one, and others who want to help with grants, on grant writing and the grant application process.  How you present your organization when applying for a grant affects how grant funders view your organization.  They are determining whether to give your group money from the application you submit.  Are your financials in order?  Are your goals and mission clearly described?  Are you organized, which implies trustworthiness with the money they give to you?
  3. Corporate sponsorships: one thing I learned when trying to identify potential corporate sponsors is that you want to look beyond what the corporation does and sells.  For example, animal related nonprofits tend to approach animal-related companies, e.g., pet food, pet supply, pet boarding companies.  This leaves out a potentially large source of funding.  A large contributor to local pet charities in my town is a basement foundation and repair company.  Another large sponsor of animal rescue-related charities in my area is a laptop repair and sales business.  Expand your outreach with companies!
  4. Partnerships: other organizations can be one of your greatest assets. Leverage your contacts in forming partnerships.  The food pantry you start would get much public view if you partner in an event with a group who fills bookbags with food to provide weekend meals for kids who suffer from food insecurity.  Contact organizations who might benefit from your group, and who might provide a benefit to yours.
  5. Media: send the word out to local media about your group, your events. Become familiar with preparing media releases.  Connect with Facebook groups, prepare a content calendar for posting on social media such as Facebook, Instagram, Twitter, Pinterest, etc.

Information about grant writing, fundraising, partnerships and related topics could fill a book.  The information above should serve to get you started in launching your organization’s work.  I’m happy to answer any questions–contact me at julie@juliemillslaw.com.

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

STEP #8: WAYS TO LOSE YOUR TAX-EXEMPT STATUS

Most charities rely on donations to operate.  To attract donations, nonprofits will pursue tax-exempt status from the IRS so they can tell donors that their donations are deductible from their taxes.  People generally recognize the IRS code, 501c3, as an indicator that their donations are deductible.  Tax-exempt status makes it possible to secure grants, and makes the organization attractive to corporations and business who want to donate, for “good will” reasons and/or to receive a deduction off taxes.  Losing your tax-exempt status can be a huge blow to a charity, both financially and to the charity’s reputation.  Becoming knowledgeable on ways to lose tax-exempt status is crucial in running a tax-exempt nonprofit.

The federal government grants your organization tax-exempt status if you agree to certain behavior.  The government is saying, “we won’t make you pay certain taxes, but you now owe the public certain things (disclosure and accountability), and you must not do certain things.”  Not following the rules means that the IRS could revoke your organization’s tax-exempt status.

How to jeopardize your tax-exempt status:

  1. Inurement,” or private benefit.  First, as you read the definition of inurement, know that any amount can jeopardize tax-exempt status.  Second, inurement means to “benefit.”  The prohibition against inurement means that there shall be no using income or assets of a tax-exempt organization to unduly benefit an individual or organization that has a close relationship with the tax-exempt organization.  The inurement prohibition is absolute.  Assets and income are to be used to further the organization’s mission, period.
  2. Unrelated Business Income (UBI).  If your organization runs a business that produces income for your organization, but the purpose of the business is unrelated to your organization’s mission, then the organization is subject to tax on its income from the business.  If your tax-exempt organization provides clothing for shelters and low-income families, and receives income from a thrift store it runs, it is unlikely there would be a risk for UBI.  If your organization is a pet rescue and receives income from a nail salon business, the rescue might have UBI.
  3. Political campaign activity.  As with the inurement prohibition, any amount of political campaigning in support or opposition of a candidate is prohibited and could result in loss of 501c3 (tax exempt) status.  I counsel nonprofit clients that the organization can’t engage in political activity regarding a candidate, but can generally support or oppose an issue.  The tax-exempt “clean oceans” organizations can oppose a ballot initiative to ease pollution restrictions, for example.  I caution to proceed carefully, since tax-exempt status can be revoked if political activity is deemed to be “substantial,” and there are tests the IRS uses to determine this.

Guard your organization’s tax-exempt, 501c3 status.  Having to reapply is cumbersome if you lose this status, and it might give donors a reason to donate their money to an organization who has not behaved in ways that result in losing this designation.

If you have any questions about getting, maintaining, or losing tax-exempt status, email me at julie@juliemillslaw.com.

 

 

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

STEP #7: EDUCATING YOUR BOARD

When I see articles on starting a nonprofit I rarely see “educate your board” yet this step is crucial.  Educate about what?  Why?

Educate about what? Inform about liabilities board members might face, educate about their duties and rights, educate on actions that could jeopardize the organization, particularly its tax-exempt status .  This list is not exhaustive.

Why?  Board members need to know what they are required to do, what laws govern their actions, how they can unwittingly get into trouble, among other reasons “why.”  In some situations, although uncommon, board members can face personal liability.

People have good intentions when forming a nonprofit that will pursue a charitable cause.  There are legal responsibilities and potential liabilities if you don’t do what you are supposed to as a board member.  Unfortunately, awareness of these duties and liabilities often comes after there’s an issue.

Board member responsibilities, in general (can be in addition to state law requirements):

  1. Duty of Care: duty to exercise reasonable care when he or she makes a decision for the organization. Reasonable care is what an “ordinarily prudent” person in a similar situation would do.
  2. Duty of Loyalty: A board member must never use information gained through his/her position for personal gain and must always act in the best interests of the organization.
  3. Duty of Obedience to the Mission: A board member must be faithful to the organization’s mission.  He or she cannot act in a way that is inconsistent with the organization’s goals. The board member is trusted by the public to manage donated funds to fulfill the organization’s mission.

Board members should have bylaws in place that govern the functioning of the organization.  They should be apprised of potential legal pitfalls that could impact them or the organization.  There should be short primers provided on open records laws, aka “Sunshine Laws,” and how they impact board meetings and public attendance; a primer on insurance, waivers and releases for events, protocol to be followed if someone is injured at an organization event; fundraising do’s and don’ts, liability with alcohol at fundraisers; political activity and what is permitted; among many other topics relevant to nonprofits.

Sitting on the board of a charitable organization can be rewarding, and board members do have a responsibility to educate themselves on what liability they could face.  Moreover, nonprofits should educate their boards on personal and organizational liability so board members can act accordingly, and avoid making decisions that unknowingly put themselves or the organization at risk.

If you have questions about board member liability, contact me at julie@juliemillslaw.com.

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

STEP #6: ADDITIONAL FILINGS; APPLICATIONS; REGISTRATIONS

Depending upon the nature of your nonprofit or what activities you undertake for fundraising–e.g., bake sales, pet bakery sales, bingo tournaments, etc.–you might be required to register with other agencies or organizations.  For many nonprofits, it’s highly recommended that you register with certain organizations.  The listings below are often specific to Ohio, so be certain to check with your state’s agency or organization for registration information.

Places where you might be required to register:

Places where you might decide to register; information you might need:

For information about where you should register, email me at julie@juliemillslaw.com.

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

You created a nonprofit corporation under your state’s corporation laws.  You presented your nonprofit corporation to the IRS and requested tax-exempt status.  Congratulations, you just received your Determination Letter from the IRS that grants your nonprofit tax-exempt status!  You are a 501(c)(3) tax-exempt, nonprofit organization.  By this time, you are probably ready to start soliciting donations from the public, who you’re certain will be anxious to contribute to your worthy cause.  Are you finished with the applying, registering, filing, etc?  No!

STEP #5: REGISTER YOUR CHARITY WITH THE ATTORNEY GENERAL

In Ohio, a charity that solicits donations from the public must register with the Ohio Attorney General.  Ohio law requires such registration, and other states likely have similar charitable registration laws.  At this point, my clients are often tired of registering, filing, and applying, and some tax-exempt nonprofits actually overlook this important step in the process.

It helps to see the big picture with many legal processes.  Here, you create an entity in your state to do business, whether it’s for-profit or nonprofit.  As a nonprofit, you want to attract donors, so you decided to offer them a tax deduction for their donation by asking the IRS for permission to do that–having your nonprofit become tax exempt.  Since you are asking the public for their money, the attorney general enters the picture as the agency in charge of protecting the public.  To protect people about to donate their money, the attorney general ensures that charities in its state are legitimate.  There are many unscrupulous people who use fake charities to attract donations and the attorney general is tasked with protecting people from giving money to scams.  Fake charities tend to mimic the name or mission of popular charities, particularly veteran organizations, breast cancer charities, and charities that pop up after disasters.

In Ohio, the Ohio Revised Code requires charities to register with the Ohio Attorney General, and to file annual registration statements.  There are charities that are exempt from this requirement.  If your organization contracts with a professional fundraiser or solicitor, parts of the Ohio Revised Code govern your contractual relationship–in other words, special attention is paid to these arrangements.  Certain disclosures need to be made to the public for any organization asking the public to donate, and records of all fundraising activity need maintained for 3 years whether you hire a professional fundraiser or not.

Clients sometimes wonder at this point why all of this work is needed when they just want to “do good.”  There is much initial work involved, and annual registrations and other actions must be followed, but the main reason clients must follow these steps is to make sure that people are giving money to legitimate causes.

If you have any questions about registering your Ohio charity with the Ohio Attorney General, email me at julie@juliemillslaw.com. 

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.