Starting a Non-Profit? Here are a Few Simple Tips on Filing for 501(c)(3) Status

The other day, I was enjoying my morning in a 4-star (Yelp) café and overheard a conversation between two young men at the adjoining table. They appeared to be just out of business school – judging by their wearing of obviously freshly-purchased shirts sporting known MBA programs . They discussed a range of topics, mostly about being new in DC. Towards the end of the exchange (at least, the part I heard) they had moved on to how to start their own nonprofit. One thing, however, was clear: their MBA did not prepare them to start a formal tax-exempt organization – at all.

One of these promising individuals maintained that it was important to retain the services of a lawyer to in order to start a nonprofit, ideally one who is willing to perform the work pro bono.

“Step one is we gotta find a lawyer. Gotta be pro-bono,” the more confident of the two proclaimed.

“Pro-bono is key,” the other agreed.

This man had a rather broad definition of what ‘pro-bono’ services were, up to and including casual conversations over coffee. Any informational interview he had, including a couple that I’m pretty sure took place on the phone, counted as pro-bono support in his eyes. But he needed more pro-bono. I guess he was hooked. The first one is always free.

Starting a nonprofit requires many things: a vision, a desire to fill an unmet need in the world, or possibly just having too much money and not enough to spend it on. It does not, however, require a lawyer, pro-bono or otherwise. That being said, given some of the information floating out there, one cannot be blamed for thinking otherwise. The process of acquiring your 501(c)(3) classification can appear to be intimidating and complicated, and I certainly do understand the desire to find someone willing to take that off your plate for you, especially at no cost. If you can find someone to do it for you that’s great but you should make sure they know what they’re doing. Most lawyers have never filed a 1023 whereas the team at the Unfunded List, (we have zero law degrees and very little formal education in accounting) has successfully filed the 1023 form for half a dozen different organizations. This process is very doable for even a one-person operation if you understand the following going into the process:

  1. You have one shot to get it right

First, the good news: the IRS will be looking to accommodate you. You aren’t going to be treated like you are applying for a grower’s license for recreational marijuana. As long as you give correct and viable information on your 1023, you’re going to get the 501(c)(3) classification.

The IRS’s frequently asked question page does an excellent job of covering pretty much every question a prospective 1023 filer will have: https://www.irs.gov/charities-non-profits/frequently-asked-questions-about-form-1023

You can also call the IRS and ask them your question directly. IRS Tax Exempt and Government Entities Customer Account Services can be reached at (877) 829-5500 (a toll-free number).

The bad news: the IRS will take their sweet time approving you if you make mistakes or are disorganized on your first 1023 submission. Is there a discrepancy that needs correcting? Does your dissolution of assets plan need clarification? If the IRS comes to you with follow-up questions on your application, it will cost six months to a year to re-start and complete the process even if you eventually do provide satisfactory answers to them.

Delays in obtaining your exempt status could be crippling. I am assuming that you do not have several years to wait before you can begin your work. That’s why it’s essential be prepared and accurate the first time around. Even if you did find a pro-bono lawyer who knew what he or she was doing that lawyer would still be using information that you provided. It makes no difference if you provide inaccurate information to an attorney or if you put that same inaccurate information on the form yourself – the IRS is going to notice.

  1. Understand the paperwork you’ll need to have before applying

Every organization needs an employer identification number (EIN) at the federal level. Obtaining this is very simple and can even be done over the phone. This page on the IRS site spells it out for you: https://www.irs.gov/charities-non-profits/obtaining-an-employer-identification-number-for-an-exempt-organization

Beyond that requirements vary based on your mission. Is your organization community-based? Then you will need to be registered as a not-for-profit corporation in your respective town/city before you can submit a 1023. If you want to fundraise in multiple states, then you will have to be legally registered to do so in those states.  Most also require a state employer identification number for tracking taxes and potential employees. Unfortunately, all of these state regulations will vary. Figuring out the various state regulations that pertain to your specific organization will likely be the most complicated part of this. The good news is that your local or state government wants these fees and wants you to be registered. It should not be difficult to call city hall or the secretary of state’s office to figure out their requirements.

Of course, there will be expenses associated with everything along the way. At the very least, you want to have a few hundred dollars available in order to become incorporated as a not-for-profit entity and cover the associated application fees. Depending on your mission and the various levels of paperwork (local, city, state, federal), you may need a few thousand before all is said and done. There are a few shortcuts; certain states have lower registration fees for getting incorporated and will allow you to file with them even if your operation is out-of-state.

Beyond the various registrations, there are important documents that you will need to compile and work through with your founders and board before submitting anything.  The most basic are the organization’s Articles of Incorporation and Bylaws.  There are some great templates for these online, but you should also check your state’s business filing sites for information regarding specific provisions that need to be included for that region.  Does the treasurer need to be a resident of the state? Do you need a physical address or will a PO Box suffice? How many founding board members are required?

  1. Be wary of fiscal sponsorship with few exceptions

On the surface, fiscal sponsorship seems like an appealing option for organizations looking to make an impactful launch. Under this approach, you’d partner with a larger organization whose mission aligns with yours to get administrative help and use their tax-exempt status in exchange for a percentage of the money you raise.

The problem with fiscal sponsorship is that it only makes sense if you are looking to implement a time-sensitive, one-off project. If you are producing a play and only plan to do it once; need to raise support for a disaster-stricken community; or if you’re a professional athlete looking to distribute excess income, then fiscal sponsorship might make sense. Even still, you should be very cautious about which sponsor you partner with as some of them overcharge to the extent that you actually receive very little of what is raised. A well-known example of this is United Charitable Programs. I cannot think of an instance where it would make sense to work with them. For the cost of applying to UCP you could pay for your own 1023 application and probably cover the cost of an accountant to help you with it.  Other programs, like Fractured Atlas, are great partners for the right groups but even they come with fees and other costs not incurred when filing yourself. Some fiscal sponsors provide additional support – like fundraising, insurance, or other administrative services – that may be essential to you as you form your organization.

If you are trying to start a 501(c)(3) organization with a long-term mission and growth plan, however, there are aren’t many advantages to fiscal sponsorship. First, you will submit just as much paperwork and pay the same amount of money arranging the sponsorship as you would if you filled out the 1023 yourself. Furthermore, a percentage of your funds will now be taken by the sponsoring organization, which has more negative consequences if you are looking for long term development rather than a temporary project. Putting on my donor hat for a moment, I can say confidently that I would be very unlikely to make a grant to an organization operating under fiscal sponsorship because I know the sponsor would be taking a piece of my donation.

In the end, if you’re committed to the long-term success and independence of your organization, it’s best to go it alone when submitting a 1023 then be tied to a sponsorship. If you do decide on fiscal sponsorship – make sure you’re not making that decision for simple expedience.

  1. If you’re going to hire help – hire an accountant and not a lawyer.

This is a tax form after all. Some people fill out their own taxes but when they need help they hire an accountant. Hiring a lawyer to do your taxes might work out for you but it would likely be a coincidence. Even if it does work out, you would have been better off hiring an accountant who specializes in non-profit taxes. Someone who regularly files 990s and conducts audits for non-profits will be far more aware of the potential pratfalls of a new non-profit than a lawyer who is just trying to get credit for their pro-bono hours.

Even though the Unfunded List team had experience in this there were still some elements that confused us since it wasn’t something that we did on a regular basis.  To complicate matters,  because we wanted to form in D.C. there were a number of local issues we knew nothing about. We hired the D.C.-based accounting firm, Raffa, P.C., and worked with Frank Smith the head of their nonprofit division. Our application was accepted and approved and took just over 2 months. See our full application by clicking the link here. Feel free to use it as a starting point for your own application.

Disclaimer: The information in this blog post (“post”) is provided for general informational purposes only, and may not reflect the current law in your jurisdiction. No information contained in this post should be construed as legal or accounting advice from Unfunded List or the individual author, nor is it intended to be a substitute for legal counsel on any subject matter. The author is neither a lawyer nor an accountant.