It happens to me all the time. A client calls and says he or she wants to start a “501(c)” for a new charity. It’s a common error and one that I do not mind clearing up for the client and for your readers, so here it goes:
What the client is really asking for (in most instances) is to create an entity under state law (typically a non-profit corporation), and to then prepare and complete an application to the IRS to designation that non-profit entity a tax-exempt organization under Section 501(c) of the Internal Revenue Code. Make sense now? No? Allow me to elaborate then.
Establishing a non-profit entity is pretty simple. We prepare Articles of Incorporation or Organization and file these with the Minnesota Secretary of State in order to establish the legal entity. We also prepare bylaws that control the governance of the nonprofit corporation and miscellaneous resolutions that address other housekeeping type matters such as officers and directors, banking resolutions and the adoption of several necessary policy statements (conflict of interest, record retention and whistleblower policies being the main ones). This typically costs around $500, including in that figure the $70 filing fee that the Secretary of State collects when the Articles of Incorporation or Organization are filed.
What we will have accomplished by taking these steps is to create a separate legal entity for non-profit activities. This is not yet a tax exempt entity, however. Instead, the non-profit status simply means that the entity’s purposes do not include making a profit for the benefit of its owners (the raison d’être for a for-profit entity). This means that the nonprofit still files tax returns, still pays taxes on any revenue in excess of its expenses, and that contributions to the entity are not tax deductible by the donor and are taxable income for the non-profit entity. None of this represents an issue if the venture will never make a profit (that is, have earnings or income that exceed its costs) and if the entity is not dependent upon donations for its operations.
In order to qualify as tax-exempt, an organization must apply to the Internal Revenue Service and seek a formal determination of exemption. Not all non-profit entities will qualify as tax-exempt; generally, only those entities that are engaged in the activities described in Section 501(c) of the Internal Revenue Code will receive that designation from the IRS. Among the types of organizations and activities that do qualify for tax-exempt status are those that (i) are organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, (ii) that foster national or international amateur sports competition (but only if no part of its activities involve the provisions of athletic facilities or equipment), or (iii) promote the prevention of cruelty to children or animals.
The process of applying for tax exempt status (that is, to become a 501(c) organization) is complex and I recommend that you work with an experienced CPA or tax practitioner to ensure that the extensive IRS application (IRS Form 1023 – you may find this at http://www.irs.gov/) is filled out correctly. The IRS receives hundreds of 501(c) applications each year, and considers them on a state-by-state, rotating basis. The time period for receiving approval is, therefore, quite unpredictable - if your application is received just before the applications from your state make it to the top of the IRS’s stack, then you might hear back from the IRS quite quickly. If your application is received, however, right after your state had its turn, you will be behind the applications from the 49 other states! Therefore, it is critical that your application be correct and complete – you would not want to have the application rejected due to an error and have to start your application process (and waiting period) all over again.
If you would like more information about nonprofit or tax-exempt organizations, please send me an email at roger.stahl.esq@gmail.com.
