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)

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.

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

Welcome to the third in a series of ten posts discussing what you should do to start a nonprofit.  You have your mission statement, you’ve assembled your team.  Now, it’s time to take your first formal, legal step–incorporate with the Secretary of State as a nonprofit corporation.

My posts regard Ohio, but these steps are similar in most states.  Be sure to check the rules and law in your state.  Articles of Incorporation are filed with the Secretary of State to form a corporation.  With nonprofit corporations, your articles must address issues important to the IRS, including conflict of interest and dissolution matters.  It is important to note that filing articles with the Secretary of State does not make your organization tax exempt, and donations are not tax deductible to the donor.  For an nonprofit corporation to become tax exempt, it must apply for tax-exempt status with the IRS, which will be addressed in a subsequent post.

The Articles of Incorporation are relatively easy to complete and file.  In Ohio, articles can be filed online.  You need to submit your name, address of the organization, designate a statutory agent to receive legal mail, and the names of your incorporators.  Once your articles are accepted, you will receive a charter number as an official corporation.

If you would like assistance filing articles of incorporation for a nonprofit corporation, email me at julie@juliemillslaw.com, or contact me through http://www.juliemillslaw.com.  I can help get your nonprofit started so you can fulfill your mission!

Starting a business in Ohio

The first of the year typically brings clients wanting to begin the new year by starting a business.  I enjoy working with people who want to pursue their dreams, whether it is working for themselves, or turning a hobby into income, or providing a product or service to others.  In addition to filing forms and preparing organizational documents, my role as your attorney is to take all steps necessary to protect you and your assets from personal liability.

The necessary actions in starting a business in Ohio will vary according to what type of business you’re starting.  Basic steps include:

This list is not exhaustive.  If you have employees, you should contact the Ohio Bureau of Worker’s Compensation and the Ohio Department of Job and Family Services to determine any steps you need to take.  Certain businesses will need to obtain special licenses and permits, particularly if your business involves preparing and selling food.

If you want to discuss starting your own business, contact me at julie@juliemillslaw.com.  It is never too late to become an entrepreneur in business-friendly Ohio.

Top 4 Pervasive Myths about Nonprofits

Everyone knows about nonprofits—they are groups or organizations that help.  Some organizations help people, some have a mission to help animals or the environment, and some are formed to help communities or society.  As common as nonprofits are, there are a few myths about nonprofits that are just as common, and that I dispel with clients on a regular basis.

MYTH #1: Nonprofits can’t make a profit.  (Or, shouldn’t make a profit.)  This myth is, in my opinion, the most common and the most detrimental.  Nonprofits can make a profit, and those that are run well do make a profit.  If a nonprofit breaks even, or loses money every year, it won’t be around long at all.  The word “nonprofit” is a misnomer–nonprofits can make a profit; what matters is what is done with the profit.

A nonprofit is like a for-profit business except that profits can’t be distributed to any private individual.  With for-profit corporations, profits are distributed typically through dividends to shareholders.  Nonprofits belong to the public, and profits come back to the organization so it can fulfill its mission in helping the public, not to private individuals.  This leads to the second common myth…

MYTH#2: Nonprofit directors, officers and staff can’t be compensated.  To the contrary, nonprofit employment makes up about 10% of private employment in the United States.  Much discussion and controversy surround how much the director of a nonprofit should make.  Naturally, people want to donate money to an organization to help its cause, not to excessively compensate its director or officers.  The key with compensation is for it to be “reasonable.”  For nonprofits with the financial means to compensate its director (desirable to attract qualified people—see Myth #1), a very general rule to determine “reasonable compensation” is that director compensation should not exceed 10% of revenue.  A salary of $200,000 would likely be considered reasonable for a nonprofit with $2 million in revenue.

MYTH#3: Donations to nonprofits are tax deductible.  If the nonprofit has received tax-exempt status from the IRS, then a donor can take a deduction on his or her taxes.

A nonprofit is a state entity.  Donations to a nonprofit are tax deductible only if the nonprofit has received federal tax-exempt status from the IRS, designated most commonly as a 501(c)(3) charity (donations to some 501(c)(4) organizations and organizations under other IRS sections are tax deductible but are less common).  If a nonprofit does not have tax-exempt status, either as a 501(c)(3) or other organization, donations to it are not deductible to the donor.  People see “nonprofit” and often assume donations are automatically tax exempt.  If you plan to claim a deduction on your taxes, check if the nonprofit has tax-exempt status from the IRS first.

MYTH #4: Tax-exempt nonprofits do not pay taxes.  Tax-exempt nonprofit organizations do not pay federal taxes, sales tax and property taxes.  They do, however, pay employee taxes (Social Security and Medicare) and, in some situations, pay income tax.

If you would like to form a tax-exempt nonprofit organization, contact me at julie@juliemillslaw.com.

The IRS begins scrutinizing tax-exempt organizations more closely

Charitable organizations, typically recognized as 501(c)(3) organizations, are beholden to the public financially and otherwise, which is one of the trade-offs for being exempt from paying most taxes.  The IRS and the Attorney General in each state ensure that tax-exempt organizations are acting, in a very broad and general sense, “reasonably.”  Focus is generally put upon compensation of key people (directors, officers), and private inurement (benefiting privately).  Tax exempt organizations need to review their practices because, in my opinion, when the IRS announces “closer scrutiny,” audits are forthcoming.

Read this article to learn more about what the IRS will be scrutinizing, and steps for your organization to take:

https://www.benefitslawadvisor.com/2018/03/articles/irs/irs-announces-heightened-scrutiny-for-tax-exempt-entities/

Can our group hold fundraisers?

Yes.  Really, you can do anything you want.  The question is, should you?

I had a parent of a scout-like troop ask if the group should become a nonprofit in order to hold fundraisers.  The answer depends upon who the group will benefit, what does the group want to offer donors, among other considerations.

  1. A nonprofit is a state-formed entity.  To gain tax-exempt status (group does not pay certain taxes such as federal income tax; donors can take a deduction for donation on their taxes), the nonprofit needs to file for exemption with the IRS.  The typical status you see is a 501(c)(3) charity.
  2. A tax-exempt nonprofit can only be formed to benefit the public (generally).  For example, such an organization can be formed to fight childhood cancer, but cannot be formed to fund just Timmy’s cancer treatments and medical bills, even if you give away any “leftover” funds.
  3. Anyone can fundraise (note that your state’s Attorney General will want to know if you fundraise, likely regardless of whether or not you are a nonprofit, or tax exempt).  The issue is what is offered to a donor.  “Donations are tax deductible” can be offered only if you have tax-exempt status.  You could hold a spaghetti dinner to benefit Timmy above, but if you are not tax exempt, you cannot say to donors that their donations are tax deductible.
  4. Becoming a tax exempt nonprofit is not something to consider unless you are ready to essentially run a business.  You must first incorporate with your state, then apply for tax exempt status with the IRS.  In Ohio, a nonprofit must have a minimum of 3 board of directors, must file articles of incorporation, should have organization bylaws, hold regular meetings and keep corporate minutes.  A nonprofit is a corporate entity (C-corp, LLC, etc.), and by applying for tax-exempt status with the IRS, you are asking the federal government to exempt your corporation from paying certain taxes.

For smaller groups who still want to become tax exempt, the IRS has shortened their application by introducing the form 1023EZ a couple of years ago, see http://www.irs.gov.  For information on forming nonprofit organizations in Ohio, see http://www.sos.state.oh.us/sos/upload/publications/busserv/Nonprofit.pdf.  Also, read what the Ohio Attorney General has to say about nonprofits:  http://www.ohioattorneygeneral.gov/Business/Services-for-Charities.