Qualifying as a Charitable Organization
A.1 Formation or Reformation. A qualified charity begins with its formation and organization, usually as a non-profit corporation that is organized under state law. If the organization already exists, its organizational documents may need to be revised or reformed to comply with the requirements of a qualified charity.
A.2 Recognition. The charity’s recognition as an organization that is qualified under IRC § 501(c) begins with an application (IRS Form 1023) that is filed with the Internal Revenue Service with information about the organization and those who will be running it. For an existing entity, that form requires five years of financial information, and for a new entity, it requires three years of projected budgets.
A.3 CPA Involvement. While we can assist, we advise all clients to have a certified public accountant prepare and submit the IRS Form 1023. The CPA’s role will continue to be significant because annual filings with the IRS are required.
B. GETTING STARTED
B.1 Formation. The initial step in having a qualified charitable organization is its formation. A non-profit corporation or a trust can qualify, but a trust is typically used only for private foundations and not for public charities or operating foundations. A non-profit corporation is formed under state law by submitting “articles of incorporation” to the Secretary of State. The articles of incorporation are like the “constitution” of the organization and declare the purpose and intent of the entity.
B.2 Specific Requirements. A non-profit corporation must be formed with specific formalities and requirements.
(a) No Owners. A non-profit corporation does not have owners. No shares of stock are issued. This means that no individual has a financial interest in the organization, and there will be no profits to share with anyone.
(b) Charitable Purpose. Each qualified charitable organization must have an approved charitable purpose. The purpose can be charitable, religious, educational, and/or scientific.
(c) Distribution upon Termination. Upon the termination of a charitable organization, all of its assets must be distributed to one or more other qualified charities.
(d) Prohibited Transactions. Some transactions will be prohibited, depending on the type of 501(c)(3) entity is involved. For example:
(i) With some exceptions, efforts to affect legislation and political campaigns will not be permitted.
(ii) Self-dealing transactions involving major donors can create problems, especially for private foundations.
(iii) Unrelated business taxable income will be taxed, but there are more significant penalties for private foundations.
B.3 Drafting the Bylaws. The bylaws of a corporation supplement the articles of incorporation to direct the governance of the corporation. The bylaws usually provide for the details of how trustees and officers are elected and removed and provide for how decisions for the corporation are made, usually by resolutions adopted at meetings or by written consent of the trustees.
B.4 Selecting the Board. The governing board for a non-profit corporation is called a “board of trustees” or “board of directors”. (We prefer “trustees” to avoid sounding like a for-profit company.) It is important to decide who the trustees will be and how they can be removed and replaced. A succession plan that helps maintain like-minded folks as trustees is essential to avoid losing sight of the founder’s intent and mission. These details are usually found in the corporation’s bylaws.
C. APPLICATION FOR RECOGNITION
C.1 IRS Form 1023. To apply for recognition as a qualified charity under Internal Revenue Code § 501(c)(3) requires the completion and submission of IRS Form 1023. That form contains sections that will apply to all organizations and sections that apply only to specific organizations.
C.2 Eating the Elephant. Filling out IRS Form 1023 may seem like trying to eat an elephant, but it is not so daunting if you just take it a step at a time. As mentioned above, it is good to involve your CPA in the process.
(a) Part I identifies the organization and its contact person.
(b) Part II identifies the organization’s structure.
(c) Part III is a checklist of required elements in the organizational documents.
(d) Part IV is an attachment with a “narrative description” of the organization’s activities.
(e) Part V identifies those who will be paid compensation for services, including officers, trustees, and independent contractors and contains questions regarding financial issues.
(f) Part VI contains some questions relating to benefits provided by the organization to individuals and other organizations.
(g) Part VII asks for a history of the organization if it is not new.
(h) Part VIII asks questions about specific intended activities and affiliations.
(i) Part IX asks for budgetary questions. For existing entities, it wants a 5-year history. For new entities, it asks for three-year projections.
(j) Part X asks for the type of recognition the organization is seeking.
C.3 Schedules and Exhibits. Some of the information requested will be provided or supplemented using schedules and exhibits. For some organizations, these require significant effort, and for others, the schedules simply do not apply.
C.4 Submission. Once the form is complete, it is submitted with the applicable filing fee. The user fee can range from $400 to $850, depending on the organization’s anticipated gross receipts.
An organization can receive recognition as a qualified charitable organization under IRC § 501(c)(3) if it is properly formed (or reformed) and an application for recognition (IRS Form 1023) is completed and submitted. Doing this requires creating a mission statement, assembling the governing board, and creating a budget that will convince the IRS that the organization should be recognized as a qualified charity. If we can help, let us know.
NOTE: This memo provides general information only and does not contain legal, accounting, or tax advice. For brevity, this memo is oversimplified and should not be relied on for any particular situation.
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