No Need To Wait – Advice for New Nonprofits
This article on Generocity.org about Seed Philly finally getting 501(c)(3) status got me thinking about some common misconceptions about nonprofits, 501(c)(3)s and other tax-exempt organizations. Specifically, this part: “[Seed Philly CEO Brad Denenberg said] that the IRS was not responsive when it came to figuring out when the organization could expect official nonprofit status. And without that certainty, it is very difficult to even begin seeking funders, Denenberg said”. It kills me that Denenberg had trouble finding funders, because, if you understand a little nonprofit tax law, there was absolutely no reason to wait.
Before I can explain why Seed Philly – which does some awesome work encouraging start ups in Philly – didn’t need to wait for the IRS to approve their 501(c)(3) application, I need to explain the difference between a non-profit corporation and a 501(c)(3) tax-exempt organization. A nonprofit corporation is any corporation organized specifically for a purpose other than making profits, and it is an entity created under state law. You could run any business as a nonprofit corporation; it simply means that you cannot pay dividends to the nonprofits “members” (which are analogous to a for-profit’s shareholders) – before Enterprise bought it, PhillyCarShare was a nonprofit corporation.
That said, most nonprofits are organized to be a tax-exempt charitable organization under Section 501(c)(3) of the Internal Revenue Code. (There are other types of tax-exempt organizations as well, like fraternal groups, political organizations, co-ops and veterans groups, but 9 times out of 10, when someone says “nonprofit” they mean a 501(c)(3) charitable organization).
Nonprofit corporations, by themselves, do not get any sort of tax benefits. When they have 501(c)(3) status, however, they get two huge benefits: (1) they don’t have to pay federal incomes taxes, and (2) donations to them are tax deductible for the donors.
Note how I said “when” they have 501(c)(3) status: a charitable organization’s tax-exempt status “relates back” to its incorporation date if it applies for 501(c)(3) status within 27 months of incorporation. In other words, you can start a nonprofit today, and then wait two years form now send in your 501(c)(3) application, which then takes two years to process, and all of the donations you got in the intervening four years would be tax deductible.
Admittedly, this isn’t ideal for many donors. First off, who wants to file amended tax returns a few years down the line? More importantly, its not always guaranteed that your application will be approved (that said, over 99% are approved, so its not exactly a long-shot) But there is a simple solution to those problems: a fiscal sponsorship.
A fiscal sponsorship is an arrangement where a 501(c)(3) charitable organization will accept donations on behalf of another group’s mission. Fiscal sponsorships are commonly used by non-profits that have applied for 501(c)(3) status but are waiting for the IRS to process the application. (By the way, the IRS is backlogged and is taking on average well over a year to process applications.) While the new non-profit waits, it can still raise funds by directing its donors to make their checks out to the fiscal sponsor. The fiscal sponsor, in turn, hands those funds over to the new non-profit.
Now, Seed Philly might have had other reasons for waiting, and fiscal sponsorships aren’t for everyone (many fiscal sponsors charge administrative fees and demand some control over the sponsored organization’s activities). But it would be a shame if they held off fundraising simply because they were waiting on bureaucracy.
Because I’m an attorney, I need to say this: this article does NOT contain legal advice. If you want to incorporate a nonprofit, apply for 501(c)(3) status or enter into a fiscal sponsorship, you should probably consult an attorney. If you can’t afford one, you should check out Philly VIP, which tries to pair folks with pro bono attorneys. Seriously, this stuff can get complicated quick (I didn’t even mention state tax laws and “institutions of purely public charity”, which, for arcane and asinine reasons, are not necessarily the same as 501(c)(3) charitable organizations).