How to Form a Non-Profit Organization

Doing charitable work is an important aspect of many people's lives. As the first part of this series of articles discussed, you can always do something to help your community by donating money toward or volunteering to spend time with your favorite cause. However, for those who want to do something more, creating a new charitable organization to address the needs you care about most can be incredibly fulfilling.

Don't fool yourself, though. Setting up a charity involves a lot of hard work. Just getting your organization off the ground will require not only your labor but also the efforts of many other volunteers who share your vision. You'll need to identify resources in your community that are available to help you. You'll need to find other people who want to work with you toward your common goals. And although it's perhaps the hardest thing about working with a charity, you'll need to find interested donors to provide financial support.

In addition to their desire to improve their communities, donors want to take full advantage of tax provisions that allow them to deduct their charitable contributions. To make sure no one abuses these provisions, the IRS requires all non-profit organizations that want to collect tax-deductible contributions to file paperwork requesting tax-exempt status. Furthermore, most states mandate that you provide additional information to state agencies to ensure that the funds you collect are going toward the charitable purposes that you created your organization to support. This article goes into these legal requirements in more detail to help you avoid pitfalls that can later threaten your organization's survival.

Helping the IRS help you
Tax-exempt status is crucial for your charity. Not only does tax-exempt status give your donors the ability to deduct contributions on their individual tax returns, but it also makes sure that your organization won't be treated as a taxable business association with the accompanying income tax liability.

To obtain tax-exempt status, you need to file Form 1023 with the IRS. In completing the form, it's important to understand the statutory requirements that the IRS must follow in evaluating charities. Specifically, your charity must be organized and operated in accordance with its charitable purposes. It must not participate in political campaigns, use assets in a way that benefits the charity's insiders, or operate any sort of trade or business that's unrelated to the charity's primary mission. Failure to follow any of these guidelines at any time can result in your organization not receiving tax-exempt status or in having the organization's tax-exempt status revoked.

In addition to these limitations, a non-profit organization must fall into one of the permissible categories of public charities to qualify for tax-exempt status. Churches, schools, and hospitals all qualify as public charities without regard to their sources of funding. However, any organization that receives substantial funding from grants and donations from members of the public can be considered a public charity. Specifically, you must obtain at least one-third of your funding from grants and donations to meet the public charity requirements.

Of course, when you're starting out, you won't have historical information to provide to the IRS. In such cases, the form's instructions allow you to make good-faith estimates of budget-related figures, including funding sources and expenditures. Along with financial information, you must provide written descriptions of your organization's purpose, structure, activities, and compensation of employees, along with a list of members and affiliated organizations. Unless your organization already qualifies based on actual financial figures, you'll want to obtain a provisional determination of status, also known as an advance ruling. This will give your organization up to five years to meet the public support qualifications of a public charity.

Once you've gathered all of the necessary information, you'll need to send it to the IRS service center specified in the instructions. After the IRS has processed your submission, you'll receive a letter granting your application or requesting additional information. If your request is granted, make sure to keep the IRS letter readily accessible, since donors may want copies of the letter to support the tax deductions they take on their returns.

State compliance
Most states regulate charitable activity within their jurisdiction. To protect your charity and its volunteers, you'll probably want to incorporate your charity as a non-profit corporation under state law. The documents necessary for creating a non-profit corporation are often very similar to those required of regular for-profit business. You'll generally work with a state department, such as the office of the secretary of state, to have your organization recognized as a not-for-profit business. However, on top of all the requirements that all corporations must face, your charity may also be supervised by another government official, such as the state attorney general. Because it's so easy for fraudulent individuals and groups to solicit contributions in the name of a nonexistent charitable cause, states often give the attorney general significant power to require members of charitable boards of directors to follow their fiduciary duties to the public by appropriately using funds for permissible purposes.

Ongoing responsibility
Once you've gotten your non-profit organization formed, you're not done. Most tax-exempt organizations must file annual reports with their state of incorporation, as well as with the IRS. IRS Form 990 is used to report yearly financial results to substantiate your charitable status. States vary in the level of detail required of charities filing annual reports.

In general, meeting the requirements for forming and maintaining your non-profit's tax-exempt status isn't difficult. The primary challenge is learning about all the requirements at the outset. The most common problem that charitable organizations face is failing to meet one of the requirements for formation. Because it often takes months or years for state and federal authorities to discover your oversight, it may be too late to fix the problem by the time it's discovered. By making sure you meet all of the initial requirements, you can avoid a sticky problem further down the road.

One of the most important aspects of running a charitable organization is fund-raising. The next article in this series discusses some of the tasks involved in documenting charitable contributions in a manner that will allow your donors to obtain the tax benefits they want.

For further charitable Foolishness:

The Motley Fool is committed to helping charities. Through its annual Foolanthropy campaign, The Motley Fool and its members support a number of worthy charitable organizations whose missions span the globe. Stay tuned for more information on Foolanthropy 2006 beginning on Oct. 16, when we begin the call for nominations..

We're proud to have Hilton Family Hotels (NYSE: HLT  ) as a partner in the Foolanthropy 2006 campaign.

Fool contributor Dan Caplinger has worked with charities large and small. He doesn't own shares of Hilton. The Fool's disclosure policy is always in your best interest.


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