By Cliff Ennico
“I am trying to start a nonprofit organization to raise money for a local institution that has lost its state funding due to budget cuts.
I formed a limited liability company (LLC), which went through without difficulty, but I am having trouble obtaining tax-exempt status from the IRS. I filed the application (Form 1023) a while back, but they keep asking for more and more information which takes me a long time to pull together.
Can you please tell me what I’m doing wrong here, and why do they make it so hard for people to do good?”
Lately it seems like everybody’s forming nonprofit organizations, and the IRS is being overwhelmed with requests for certification as a “public charity” under Section 501(c)(3) of the Internal Revenue Code. I understand they are receiving 20 to 30 applications a day at their processing office in Louisville, Kentucky, and the wait time for approval (even if your application is perfect) can be as long as six months.
The fact that you are getting requests for additional information means either that your application wasn’t complete when it was initially filed, or the IRS isn’t buying your charitable purpose and is “burying you in paperwork” so that you will eventually withdraw your application and save them the trouble of rejecting you.
Here are some of the most common reasons the IRS holds up your application.
They Prefer Corporations. While legally there’s no reason a charitable organization can’t be formed as an LLC, the IRS does prefer that you be formed as a nonstock or not-for-profit corporation, quite simply because most applicants for tax-exempt status are corporations and they understand them better. Every state has a detailed statute spelling out the rights and duties of board members, directors, officers and other key players in not-for-profit corporations, while the rules for nonprofit LLCs are still evolving. Consider converting your LLC into a nonprofit corporation – a fairly easy procedure in most states.
Your Charity Might Not be “Public” Enough. It sounds as if your organization may not be benefiting the general public, as is required for a Section 501(c)(3) charitable organization. Section 501(c) allows tax exemption for over 30 different types of organizations, and you may want to review them with your attorney to see if another subsection might be a better “fit” (see Chapter 4 of IRS Publication 557, available online at www.irs.gov/publications/p557/ch04.html). Keep in mind, however, that you will not be able to accept tax-deductible donations unless you are a “public” charity under Section 501(c)(3).
Your Activities Are Not Specific Enough. The IRS is not comfortable with vague generalities. Your Articles of Organization should specify clearly and in detail exactly what types of activities the organization will conduct to further its exempt purpose. Since your principal purpose is raising funds for another (hopefully tax-exempt) organization, your application needs to spell out exactly what fund-raising activities you will conduct, who you will solicit for donations and government grants, and what specific activities you will fund.
If the organization you want to support is not a Section 501(c)(3) public charity, you may not be eligible for tax-exempt status at all. Check the IRS’ “Exempt Organizations Select Check” database (www.irs.gov/Charities-&-Non-Profits/Exempt-Organizations-Select-Check) and make sure the organization’s name appears there.
Your Organizational Documents are Incomplete. Your LLC Articles of Organization need to contain specific language required by the IRS relating to:
- The fact that all profits will be applied to fulfill the organization’s exempt purpose;
- The fact that the organization cannot engage in political activity (with certain limited exceptions); and
- How funds will be distributed when the organization ceases its activity.
If your organizations has been in existence for a while, the IRS may also want to see copies of all board resolutions you have adopted to date.
Your Financial Projections Don’t Go Far Enough into the Future. Under a recent amendment to Form 1023, a startup charity must project income, expenses, assets and liabilities for the next three fiscal years (increased from two years). Failing to provide the third year of projections can lead to time-consuming delays in the approval process.
You Forgot to Attach Your “Policy” Documents. The IRS requires all 501(c)(3) exempt organizations to adopt two policies:
- A “compensation policy” showing how the salaries of the organization’s officers and directors will be determined; and
- A “conflict of interest policy” showing how the organization will handle financial transactions with its officers, directors and other related parties.
There are numerous sample policy documents available online (a typical compensation policy can be found at www.publiccounsel.org/tools/assets/files/CompPolicy.doc, while sample conflicts of interest policies can be found at www.nonprofitrisk.org/advice/samples/ConflictPolicy.doc).
To find out exactly why the IRS is giving you the runaround, you should retain an attorney to help you clean up the application and re-submit it to the IRS along with a “power of attorney” form (IRS Form 2848) so the IRS will contact your attorney directly if they have any further questions.
Cliff Ennico (email@example.com) is a syndicated columnist, author and host of the PBS television series ‘Money Hunt’. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com. COPYRIGHT 2016 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC. @