Each day, a need in the community is identified that is not already being met or a problem arises that requires public attention, funding and non-financial support to solve. Sometimes, these problems are so large that individuals consider creating a separate organization to solicit public backing. Forming a non-profit provides an organization with the ability to receive certain tax privileges, including exemption from federal corporate income taxes and limited protection from creditors and courts. In addition, these organizations provide potential donors with the benefit of making tax-deductible contributions and the reassurance that the non-profits will use their contributions for the services, programs and needs identified by the organizations, rather than into the pockets of the nonprofits’ organizers. However, establishing a non-profit organization is not as easy as filing out a simple form. Rather, it requires consideration of a broad range of daily requirements for which organizers must be vigilant to uphold.
According to the Urban Institute’s Center on Nonprofits and Philanthropy, since 2002, there has been an increase in the number of non-profit organizations registered for tax-exempt status with the Internal Revenue Service (IRS), including charitable, educational and religious organizations, and professional and civic associations. To qualify for exemption from paying taxes and eligibility to receive tax-deductible donations, a charity must meet the requirements of Section 501(c)(3) of the Internal Revenue Code. Additionally, they must be “organized and operated exclusively for exempt purposes,” and none of their earnings may be used “to benefit private shareholders or individuals.”
The first step in forming a non-profit organization should begin with consultation with legal and tax advisors that are well-versed in the non-profit domain. These professionals can help organizers navigate through the complex issues required to form a qualifying legal entity and set up the processes and procedures to ensure ongoing compliance with state and federal laws and the requirements related to grants and donor-specific restrictions.
Forms, Forms and More Forms
Becoming a 501(c)(3) organization begins with a mountain of paperwork. After selecting an organizational structure, recruiting and electing a board of directors and holding an initial meeting to prepare and adopt bylaws under which the organization will operate, the organization must file certificates of incorporation as a trust, corporation or association with the states in which they are based. They must also file Form SS-4 to obtain an Employer Identification Number (EIN) and may be required to file Form 2848, Power of Attorney and Declaration of Representative, to authorize the founder or another appointed individual to represent the organization.
To be recognized under federal law as a tax-exempt entity, the organization must apply to the IRS for recognition of exemption as a 501(c)(3) using Form 1023, a lengthy, 11-section form that requires disclosure of explicit details about the organization and proof that it satisfies all requirements under the law. Engaging an accountant can expedite the process. Alternatively, organizations expecting to receive less than $50,000 in donations for each of the following three years may qualify to complete a streamlined and simplified Form 1023-EZ online, which they may file electronically.
No matter which form an organization files, the result of their efforts will be a determination letter from the IRS that hopefully grants them all the benefits of a 501(c)(3) entity. Receiving such notice may take months and may require the submission of additional information. Before and during this waiting period, applicants should continuing moving forward to file all of the forms and registration required by the states in which they operate to receive tax-exemption status, including exemption from sales and/or property taxes. They should also file federal tax returns, even if they have not yet received a determination letter from the IRS.
Ongoing Financial Responsibilities
Federal and state laws require non-profit organizations to meet a rigorous set of standards to maintain their legal status as tax-exempt entities. An organization should invest in a well-qualified accountant from the onset to generate and maintain the accounting records and implement strong internal control policies to ensure transparency and accurate financial reporting. Sound internal controls and separation of duties within the controls are vital in preventing fraud and improper accounting, such as the allocation of funds, which can cause compliance issues with a grant or a donor-restricted funds. Once the accounting systems are in place, start-up organizations on limited budgets may avail themselves to affordable programs that simply assist in data entry and automate basic reporting processes.
Each year, 501(c)(3) organizations are required to file a federal tax return, IRS Form 990, Return of Organization Exempt From Income Tax. Once completed, these forms become public record. Because they tell outsiders about an organization’s history, its mission, its finances and its plans for the future, these forms are often used by potential donors to assess an organization and help in the process of deciding whether they wish to contribute to its cause. As a result, organizations should provide as much detail as possible and pay special attention to the allocation of expenses. These details help potential donors determine the effectiveness of the organization, which may be calculated as the portion of each contributed dollar to the organization’s mission.
Audits
Audits are an important part of the financial responsibilities non-profits must meet in order to provide sound financial information to its potential grantors and donors. Audits demand a significant investment of time and resources. However, their benefits to the organizations are far greater than their costs, considering that audited financial statements increase the credibility and accuracy of the organization’s financial statements. Moreover, they provide assurance regarding the presentation of the organization’s functional expenses, which, in turn, provide information about the efficiency of the use of funds collected.
For organizations with limited funding and personnel, audits may help identify internal control weaknesses and material misstatements. Audits may also assist in the preparation of documentation required by the board of directors or by funding agencies and donors. For example, when organizations seek federal or state funding, they must follow certain government guidelines. Once government funding is obtained, there are usually continuous guidelines from the government agency requiring, among other items, a compliance audit performed by a certified public accountant (CPA). The non-profit should weigh the time and financial costs of an audit with the benefits of the added funding and increased potential to attract new donors. Sometimes, granting agencies will allow non-profits to forgo an audit for a less costly financial statement review, which will provide a lower level of assurance.
Whether it be preparing financial statements, conducting audits, compilations and reviews or simply helping to understand their rights and responsibilities under the law, organizations should turn to experienced accountants to guide them through the complicated process of applying for and maintaining non-profit status.
The advisors, accountants and auditors with Berkowitz Pollack Brant have deep experience helping private foundations, hospitals, religious organizations and other tax-exempt organizations to enhance operations while meeting rigorous compliance requirements and tax obligations.
About the Author: Tabitha Branch, CPA, is a senior manager with Berkowitz Pollack Brant’s Audit and Attest Services practice, where she provides audit, accounting and consulting services to non-profit organizations and businesses in highly regulated industries. She can be reached in the Miami CPA’s firm’s office at 305-379-7000 or via email at info@bpbcpa.com.
The post The Taxes of Starting and Maintaining a Non-Profit by Tabitha Branch, CPA appeared first on Berkowitz Pollack Brant Advisors and Accountants.