Keeping it Legal: What to consider before starting a new nonprofit October 27, 2012 Nancy Eberhardt, NJ Program Director Pro Bono Partnership Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

What is the Pro Bono Partnership? Free business and transactional legal services for nonprofit organizations through the services of our staff and corporate and private attorney volunteers To be eligible, the organization must be: Nonprofit, tax exempt (or seeking 501(c)(3) status); Primarily serving the disadvantaged and enhancing the quality of life in their neighborhoods; Focusing on health and human services, community development, affordable housing, neighborhood revitalization, environmental protection, or the arts; Providing programs that have a demonstrable impact; and Unable to pay for legal services without significant impairment of program resources. Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Introduction The nonprofit sector is growing quickly But revenue sources are decreasing, especially in this economy! More targeted individual giving and redirected/focused corporate giving Resulting in an environment where it is essential to make a disciplined assessment of whether it makes sense for you to incorporate and apply for tax exemption The Partnership’s experience screening new organizations Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Myth or Reality? Nonprofit and tax exempt mean the same thing (or nonprofit corporations are automatically tax exempt) An organization cannot raise money unless it is tax exempt Every good idea deserves a nonprofit If I am the founder, I can pretty much run the nonprofit the way I want Nonprofits can’t make a profit Being on the Board of a nonprofit is not “serious”, the way being on the Board of a for-profit company is Nonprofits cannot engage in lobbying Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Myth or Reality? (cont’d) Nonprofits cannot pay salaries (or nonprofits can pay any salaries they want to) Nonprofits are exempt from workers’ compensation and unemployment laws I can get a tax deduction for the time/services I give to my nonprofit I can get a tax deduction for use of my space State tax and local property tax exemptions are automatic for a 501(c)(3) organization Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Incorporation and Tax Exemption Becoming a tax-exempt organization is a two-step process First step: Incorporation is a product of state law; obtained by filing a certificate of incorporation or articles of incorporation with the state Second step: Tax exemption is a federal designation for which the corporation applies to the Internal Revenue Service on Form 1023 and asks to be recognized as tax exempt Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Pros and Cons of Incorporating Limited liability Facilitates tax exemption More attractive to funders Perpetual existence CONS State filings Federal filings Maintaining corporate records Observing corporate formalities Must recruit and retain people to carry out responsibilities Perpetual existence Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Organizational Requirements Not-for-profit vs. for profit Bylaws Membership vs. nonmembership Board of Directors/Board of Trustees Officers Staff Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Organization Chart for Nonprofits Elect Hire & Supervise Hires & Supervises Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Incorporating Generally Each state has its own Nonprofit Corporations Act or Nonstock Corporation Act (or some other name) You generally must complete and file a Certificate of Incorporation (sometimes called Articles of Incorporation) with a state agency; agency that handles incorporations and fees vary between states. Usually, must decide: Membership or non-membership Agent for service of process Carefully state your organization’s mission, keeping in mind your intention to apply for federal tax-exempt status Incorporators sign Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Incorporating Generally (cont’d) Other State filing requirements: Usually some kind of consumer protection function within each state. Some states have specific filing requirements depending on type of activities (example: NY nonprofits engaging in educational activities) Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

501(c)(3) Tax Exemption 501(c)(3) is one type of tax-exempt organization Can accept tax-deductible charitable donations Doesn’t pay income taxes; may be exempt from sales, property, and other state and local taxes No private benefit or inurement Registration and reporting requirements Restrictions on lobbying activities Absolute bar on political campaign activities Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

501(c)(3) Tax Exemption (cont’d) Transparency and accountability Organizations that don’t have to apply to have tax exemption Religious organizations that are houses of worship (not just faith-based charities) Organizations under a “group exemption” Organizations with annual gross receipts of not more than $5,000 Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

How to Apply for 501(c)(3) Tax Exemption Obtain a federal tax ID number, EIN, from the IRS (Form SS-4) Complete and file IRS Form 1023 Set out, in detail, information about the organization, including its mission, programs, structure, fundraising program, sources of financial support, and three-year budget $850 filing fee; $400 if annual gross receipts of $10,000 or less IRS is working on “Cyber Assistant” that may result in reduced fees File within 27 months of incorporating to get tax exemption retroactive to the date of incorporation; if more than 27 months, retroactive to date that Form 1023 is filed Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

External Oversight of Tax-Exempt Organizations IRS Compliance and reporting requirements The IRS recently revoked tax-exempt status for over 385,000 organizations for failure to a Form 990 for three consecutive years [IRS Data Book 2011] State Attorneys General Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

External Oversight of Tax-Exempt Organizations Other State agencies (e.g., Departments of State and Taxation) Public Media Grantmakers Sarbanes-Oxley legislation Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Is Incorporation/Tax Exemption Right for You? Ask These Questions: Do your purposes fit within 501(c)(3)? Is your mission clearly articulated? Is there a profit motive? Is there a need for your services? Are other organizations doing what you want to do? Locally? If so, how will your activities differ? Whom do you plan to benefit? Many, or just a few? Who is involved with the organization? (continued…) Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Ask These Questions (cont’d): Where will you get your $$? Do you have identified sources of funding? Do you have only a short-term project? Do you have a need for privacy? Do you plan to do more than an insubstantial amount of lobbying, or engage in any political campaign activities? Do you have the personality needed to work under the direction of a board and timely file required reports with government agencies? Do you have any experience working with/for a nonprofit organization? Can you afford it? Have you considered alternatives to incorporation and tax exemption? Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

1. Do your purposes fit within 501(c)(3)? IRC Section 501(c)(3) The organization must be “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition…, or for the prevention of cruelty to children or animals” “Charitable” covers a wide variety of objectives, including: Relief of the poor and distressed or of the underprivileged Lessening the burdens of government Lessening neighborhood tensions Combating community deterioration Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

1. Do your purposes fit within 501(c)(3)? (cont’d) Other purposes may not qualify under 501(c)(3), but the organization may still qualify as tax exempt under another subsection of Section 501. However, donations to these groups are likely not deductible as charitable contributions. For example: 501(c)(4) – civic leagues and social welfare organizations (e.g., a block association) 501(c)(6) – business leagues (e.g., Chamber of Commerce) 501(c)(7) – social clubs Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

2. Is your mission clearly articulated? Important as a basis for exemption, continuing focus, organizational documents, public relations, and accessing funding 3. Is there a profit motive? 501(c)(3) status requires that “no part of the net earnings…inures to the benefit of any private shareholder or individual” This is the “nondistribution constraint” Compensation must be “reasonable” – sanctions if violated Upon dissolution, all assets must be distributed to other 501(c)(3) organizations or to the government for public purposes Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

4. Is there a need for your services? Have you done a needs assessment? Could you operate as a program of an existing organization? 5. Are other organizations doing what you want to do? Locally? If so, how will your activities differ? Will you be duplicating already available services? Is there limited funding for such services? Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

6. Whom do you plan to benefit? Many, or just a few? Can’t establish a 501(c)(3) to benefit just one person or a few people 7. Who is involved with the organization? How many board members do you have? What is their ongoing commitment to the organization? Are they all family and/or friends? Do they represent the public? What skill(s) does each person bring to the organization? Is someone good at/fond of administrative/organizational tasks? Are there others who will help in non-board member roles? Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

9. Do you have only a short-term project? 8. Where will you get your $$? Do you have identified sources of funding? Fees? Donations? Government? Corporations? Must be able to articulate this on Form 1023 Some funders are reluctant to fund start-ups Do your volunteers have the skills to fundraise? Is the organization sustainable? 9. Do you have only a short-term project? If so, might be better to use a fiscal sponsor or work as a program of an existing agency Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

10. Do you have a need for privacy? 501(c)(3) “public charities” are accountable to the public and full disclosure is mandated in some circumstances Form 990 annual informational tax returns – must disclose information such as compensation of key employees and corporate governance policies; must make copies of Form 990 available on demand; also likely posted online The list of donors filed with the annual Form 990 does not have to be disclosed by a 501(c)(3) public charity Annual reports filed with state authorities Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

11. Do you plan to do more than an insubstantial amount of lobbying, or engage in any political campaign activities? A 501(c)(3) cannot have a “substantial part” of its activities consisting of attempts to influence legislation Section 501(h) Election on IRS Form 5768 A 501(c)(3) is prohibited from participating in campaign-related activities – supporting or opposing a candidate for public office 12. Do you have the personality needed to work under the direction of a board and timely file required reports with government agencies? If no, starting a nonprofit may not be right for you Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

13. Do you have any experience working with/for a nonprofit organization? Funders will look at your experience Experienced board or staff available? 14. Can you afford it? Filing fees? Insurance? Startup costs? Overhead/administrative costs (e.g., wages)? Annual accounting fees? Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

15. Have you considered alternatives to incorporation and tax exemption? (A) Become a program of another organization Pros: Able to concentrate on and build your program Do not need to deal with fundraising, administrative, or organizational issues Cons: Lack of control Lack of identity Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

15. Have you considered alternatives to incorporation and tax exemption? (cont’d) (B) Fiscal Sponsorship An existing 501(c)(3) organization (the “Sponsor”) may financially support an unrelated organization (the “Project”) as long as doing so furthers the Sponsor’s exempt purposes Funders donate to the Sponsor, which reports the income, controls the administration of funds and the Project’s activities, and is responsible for recordkeeping and reporting to IRS and state agencies on behalf of the Project Sponsor may charge a reasonable fee for its administrative services Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

15. Have you considered alternatives to incorporation and tax exemption? (cont’d) (B) Fiscal Sponsorship (cont’d) Good idea for new groups; allows them to focus on developing their programs Often temporary/short-term arrangements – can be an interim step on the road to incorporation and tax exemption Many different ways to structure a fiscal sponsorship. A written agreement is recommended and can be tailored to the needs of each Sponsor and Project Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

15. Have you considered alternatives to incorporation and tax exemption? (cont’d) (B) Fiscal Sponsorship (cont’d) Choose the fiscal sponsor carefully – investigate it to make sure it is well run. For questions to ask, see the National Network of Fiscal Sponsors’ Guidelines for Comprehensive Fiscal Sponsorship, at www.tides.org/fileadmin/user/NNFS/NNFS-Fiscal-Sponsorship-Guidelines-for-Comprehensive.pdf Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Ingredients for Success Clear Mission “Market” Niche – need for organization Business and Budget Planning Adequate Sources of Funding Strong Administrative Skills Committed Board Members Committed Volunteers Appropriate Staff Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Resources IRS website offers online training on a wide range of subjects relevant to maintaining tax-exempt status: www.stayexempt.org IRS Publication 557 explains the process of applying for tax-exempt status: www.irs.gov/pub/irs-pdf/p557.pdf Center for Nonprofit Management booklet “Get Ready, Get Set! What You Need To Know Before Starting a Nonprofit”: www.cnmsocal.org/images/downloads/startinganonprofit_getreadygetset.pdf Center for Non-Profits booklet “Thinking of Forming a Non-Profit? What to Consider Before You Begin”: www.njnonprofits.org/ThinkingOfFormingDesc.html BoardSource booklet “Starting a Nonprofit Organization”: www.boardsource.org/dl.asp?document_id=17 Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Resources (cont’d) American Bar Association “Tool Kit” that outlines the process of completing the IRS Application for Tax Exemption: www.npaction.org/resources/tetk.pdf Foundation Center’s tutorial on starting a nonprofit: http://foundationcenter.org/getstarted/tutorials/establish Information on other charities: GuideStar: www2.guidestar.org Charity Navigator: www.charitynavigator.org The Pro Bono Partnership website contains many publications: www.probonopartnership.org/Pages/Publications/all-publicationsfaqs-x Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Resources (cont’d) Resources for Developing a Business Plan: SCORE: www.score.org/business_toolbox.html and www.score.org/resources/search/all/283%2C263 U.S. Chamber of Commerce Small Business Nation: www.uschambersmallbusinessnation.com/toolkits/start-up U.S. Small Business Administration: www.sba.gov/category/navigation-structure/starting-managing-business/starting-business Many states have pro bono services for start-ups – check the state and local bar associations, local law schools, and your state’s Nonprofit Association. Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.

Please Note IRS Circular 230 Disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein. This presentation is provided as a general informational service to clients and friends of the Pro Bono Partnership. It should not be construed as, and does not constitute, legal advice on any specific matter, nor does this presentation create an attorney-client relationship.  You should seek advice based on your particular circumstances from an independent legal advisor. Copyright 2012 Pro Bono Partnership. All rights reserved. No further use, copying, dissemination, distribution or publication is permitted without express written permission of Pro Bono Partnership.