Forming and Maintaining Charitable Organizations – Cody Walls
|Cody R. Walls, MBA, CPA
Denton Law Firm
555 Jefferson Street
Paducah, Kentucky 42001
Forming and Maintaining Charitable Organizations
There are plenty of articles online discussing how to form a charitable organization. While many will instruct you to form a plan, a mission statement, or even a name that lets the public know what societal benefit you offer, it is all for naught if you don’t properly form and maintain the organization under the strict guidelines set by statutes under the Tax Code, and regulations from the I.R.S.
Charitable organizations require some planning up-front in order to receive their preferential status. While the work in order to receive this status might be expensive as well as intensive, it is with good reason, as charitable organizations receive tax-free status on not only the money donated to their organization, but the money earned through fund-raising activities as well. Additionally, charitable organizations are eligible for several other perks including, but not limited to:
- Exemption from state sales tax
- Eligibility for grants from public and private foundations
- Discounted services: many businesses and government agencies offer lower prices for services provided to charitable organization (including the U.S. Postal Service, as well as legal and accounting firms)
So what is the first step in this mountain load of paperwork? First, like any other business entity, the organization has to be formed. While you can organize essentially as any type of entity, most organize as a corporate entity in order to shield board members and organizers from unwanted legal liability. Since the tax ramifications are a non-issue in a charitable organization, most simply choose to organize as a corporation rather than explore organizing as a Partnership or electing the S-Corp. status. The organizers will simply want to file Articles of Incorporation with the state in which they plan to operate or be based out of.
Next, the organizers should draft bylaws for the organization, setting forth the internal operating procedures. Here is where the organizers can create checks and balances, ensuring the organization will hopefully continue to operate after the original organizers are unable to carry on.
Next, assuming the organization choose a corporate formation, they must follow corporate requirements such as recording minutes and filing annual reports. The organization will want to receive the required tax identification numbers from the Federal government as well as the state government, not only for re-sale or tax free opportunities on expenses, but for payroll reports and tax returns. While the goal is to receive exemption from income tax, the organization will still pay required withholding and payroll tax should they have any paid employees. Additionally, there may be local forms required depending upon where the organization operates and is headquartered. As a note, while the organization will hopefully earn exempt status from income tax, tax returns are still required to be filed with the I.R.S.
After the formation and initial set-up, the application for exemption from tax with the I.R.S. will need to be completed. Most charitable organizations are formed under Section 501(c)(3), for charitable, religious and educational organization, and this article lays out formation and planning for those types of organizations, as opposed to social welfare organizations and other nonprofits or tax-exempt organizations. The application for exemption is a 28-page document to be filed with the I.R.S., Form 1023. Alternatively, if the charitable organization will not exceed $50,000 in gross receipts or have total assets in excess of $250,000, a shorter Form 1023 can be completed, Form 1023-EZ. Relatedly, if the organization qualifies to use Form 1023-EZ, tax returns can be simplified using a condensed version of the required tax form.
So what must a charitable organization’s purpose be in order to qualify? The Internal Revenue Code specifically states that an organization operated “exclusively for religious, charitable, scientific, testing for public safety, literary or education purposes, … to foster national or international amateur sports competition, or for the prevention of cruelty to children or animals” qualifies for exemption. I.R.C. §501(c)(3). Additionally, the term “charitable” has been broadly defined to include a multitude of purposes, including:
- relief of the poor
- relief of the distressed
- relief of the underprivileged
- advancement of religion
- advancement of education or science
- erection or maintenance of public buildings and monuments
- lessening the burdens of government
- lessening neighborhood tensions
- eliminating prejudice and discrimination
- defending human and civil rights secured by law and
- combating community deterioration and combating juvenile delinquency
Tax Information for Charitable Organizations, Internal Revenue Service, irs.gov. https://www.irs.gov/charities-non-profits/charitable-purposes (last visited Dec. 28, 2018).
How long does it take to hear from the I.R.S. to learn if the organization has received an exemption? That all depends on whether the organization applies using Form 1023 or Form 1023-EZ. When using Form 1023, it is not unheard of to take 1 year to hear back from the I.R.S. and learn of their determination, conversely, those who apply using Form 1023-EZ typically hear back within just 1 month.
Once correspondence from the I.R.S. is received, confirming the exemption, maintaining the charitable organization is in most regards the same as maintaining a for-profit business. The organization will file an annual report with the state they were organized in, file a tax return, and file any required payroll or other required tax reports with the relevant taxing authority. Lastly, the organization will maintain records and elect individuals to oversee the organization and hopefully ensure its continued existence for years to come, all the while serving the good of the community.