Toby Mathis, Esq. answers some common questions about nonprofits, including how to register and fund nonprofits.
Updated August 27, 2020
Before we get into the specifics related to registering a nonprofit, let’s first zoom out and think about entity planning in a more big-picture way. With any entity, regardless of whether it’s for-profit or not, there are three main levels that must be addressed: the state level, the third-party level (the face of the business that interacts with investors, lenders, and, in the case of nonprofits, donors), and the level of the federal government.
With that in mind, there are 29 different flavors of nonprofits. What many of us think of first when we hear “nonprofit” is only one of these 29 flavors: the 501(c)(3). This particular flavor of nonprofits includes charitable organizations, such as religious, educational, scientific, and other organizations with charitable missions. This is important because a hallmark of the 501(c)(3) organization is the ability to accept donations. Furthermore, when someone donates to a 501(c)(3), that donation amount entitles the donor to a tax write-off.
When it comes to registering a nonprofit organization, we already know there are three areas that must be addressed: the state, third parties, and the federal government. Before filing with the state, however, it’s important to first check with the other two areas that must be addressed. How do third parties want to see your nonprofit, and how does the federal government want to see your nonprofit? All three need to work in concert. So, with the state, it’s best to use what the federal government prefers.
In the Tax Code, 501(c)(3) organizations can be either trusts or corporations. In most cases, we’ll go with the plain vanilla nonprofit corporation. That’s what we’ll file with the state. 501(c)(3)s also have bylaws that note there are no shareholders. Instead, charitable nonprofits are run by their directors only and are not inured to any shareholders’ private benefit.
Next, apply for an EIN with the federal government. Then, put all this together with a plan to create an exemption application, called a 1023, for tax-exempt status. Submit this application to the federal government, then wait.
If this sounds complicated: it is. When you’re familiar with this process, you can know what to anticipate and how to bolster the comprehensiveness of your application to streamline the efficiency of this process and enhance the likelihood of acceptance. If you’ve never done this before, though, then yes: it is complicated. It’s not an easy or intuitive process.
This is why it’s useful to use a professional to set-up your nonprofit corporation. Keep in mind that, after exemption status is accepted by the federal government, it will relate back to the date the organization was filed. You have 29 months from the date you apply for exemption to obtain it and have it relate back.
I filed for exemption and was denied. Am I out of luck?
Put simply: if you’ve been denied tax-exempt status, there was something deficient in your application. Declines are almost always the result of someone not knowing what they’re doing. The vast majority of applications, in fact, will be declined.
I would highly encourage you to work with a professional to ensure your application is accepted the first time around. At Anderson, we’ve been doing this for twenty years and have created over 3,400 nonprofits. It’s not unusual for us to sometimes see the IRS come back with questions, but we’ve never received a decline.
Can I start a nonprofit with no money?
We often associate nonprofits with the super rich (think the Bill & Melinda Gates Foundation, the Clinton Foundation, etc.). However, this is not always the case. Oftentimes, the opposite is true.
Once you register your 501(c)(3), you now have the ability to accept donations. These donations are tax-free to your nonprofit and tax deductible to donors. That’s what we call a win-win.
Furthermore, once you have registered your 501(c)(3) and your exemption has been approved, you can solicit donations from foundations and other grant-giving entities. By law, foundations must give away 5% of their assets to nonprofits. As a 501(c)(3), you can access these funding options.
Ultimately, don’t feel like you must be super rich to start a nonprofit. This is not the case. More than anything else, you need to be passionate about what you’re doing. If you’re considering setting up a nonprofit only for the tax benefits, I would advise you to think again.
What qualifies as a 501(c)(3)?
To qualify as a 501(c)(3), the organization must conduct activities that benefit society. Basically, if the organization conducts activities that could be the realm of the government, then it will most likely qualify. One common example I see among my clients is residential assisted living. This is an example of qualifying activity.
How are nonprofit employees paid?
In short: nonprofit employees are paid just like employees of for-profit companies: W-2 income. Yes, this income is taxable. Furthermore, salaries must be “reasonable.”
Don’t let this deter you. Many people hold the misconception that you can’t receive much in compensation when working for a nonprofit. This is not necessarily correct. The standard is what is “reasonable,” and our measure for “reasonable” is fair market compensation.
Additionally, your nonprofit can still provide ancillary benefits beyond W-2 income, including contributions to tax-deferred vehicles, like certain retirement plans, and accountable plans. When you pull a salary out, though, it will be no different than a for-profit salary. You will pay tax on the salary when you receive it.
If you’re considering starting a nonprofit for your passion project, reach out to the experienced professional Advisors at Anderson for a complimentary consultation. We can provide structuring guidance and answer your questions about how to make the most of nonprofit power. To take advantage of a free, no-obligation consultation, schedule online or call us at 800.706.4741.