executive director
Center for Non-Profit Corporations
Seeking to Start a Non-Profit? Part I: Choosing the Right Slot
Every Presidential candidate seems clear on one fact: America is a nation filled with a generous and giving spirit. As obligatory as pressing flesh and kissing infants, no campaign stop is complete without citing at least one donating individual who is offering his time and wealth for the benefit of others. This humane beneficence has always been the strength of our nation, and it even gains appreciation in our country’s tax codes.
In 2006, the IRS recorded over 1.5 million 501(c)(3) non-profit organizations, including public charities, private foundations, and others ranging from horticultural groups to chambers of commerce. This marks a whopping 36.2 percent rise from the previous decade. Over the next ten years, the IRS estimates another half-million will embrace this giving spirit and establish some entity for the public good. How well they serve and meet their goals will depend on how effectively they organize as they start today.
Ms. Linda Czipo, executive director of the Center for Non-Profit Corporations has worked with the organization for 21 of its 25 years. She has shepherded thousands of Garden State groups through their launch pangs. And along the way, she’s made clear scores of misconceptions.
“The term ‘non-profit’ is actually quite confusing,” Czipo explains. “Federally, it has no legal meaning. In New Jersey law, however, non-profit is legally defined as ‘an organization to advance community interest without any personal financial gain.’” The startup non-profit has choices. They need not fall blindly into some legal or tax classification. Rather, with a little awareness, they can position their organization in the category of best advantage.
* Non-profit or Not? Many well-meaning folks are struck by some strong social need. With the best of intentions they assume that forming a non-profit organization is the sole and best way to address the problem. But Czipo suggests there are several alternate routes. “Before rushing to establish, it’s best to check the competition. There are thousands of charities out there. Why not first see who might be responding to your concern?” she says. If your aim is close, or within another group’s parameters, maybe you can join on as a project leader and expand the existing group’s horizons.
* Public & Private. The IRS in its infinite complexity boasts more than 25 classifications of non-profits. More generally, non-profits are divided into three categories: public charities, private foundations, and non-profit common-purpose groups (discussed below.) Public charities are groups that receive typically at least one-third of their income from the public or a governmental arm. Most, but not all, may qualify for the IRS’s 501(c)(3) tax exempt status. They may foster scientific exploration, child safety, mental health, the environment, museums, or a theater group. In New Jersey, 32 percent of public charities aid human services, and another 20 percent are aimed at enhancing education.
Private foundations differ primarily in the source of their funding, e.g. a family trust set up for some public benefit. They are subject to different laws, but most also can gain 501(c)(3) status.
Legally, both public charities and public foundations cannot distribute earnings, or pay dividends. They may make a profit - something devoutly to be encouraged - but all of those earnings must be plowed back into the organization toward its stated mission. They may advocate for a cause e.g. Mothers Against Drunk Driving; they may even meet and urge their position with legislators. But they cannot be connected with registered lobbyists and they very much must avoid any involvement in partisan politics, either by donation or endorsements. (Things get a bit blurry on this last issue, but it is best to err here on the side of caution.)
If your startup organization opts to operate as either a foundation or charity, it’s best to go on and apply to the IRS for 501(c)(3) tax exempt status. Charities with over $5,000 in gross receipts must apply. If neither classification fits your mission, consider the non-profit groupings below.
* The Coveted 501(c)(3). An organization may apply for tax exempt status using IRS form 1023, “Application for Recognition of Exemptions.” The IRS also suggests applying for an Employer Identification Number (EIN) at the same time, even if , as yet, you have no employees. Help with these forms can be found online: www.irs.gov/charities/article. Publications 557,4220, and 1635 also explain qualifying guidelines and more.
Once obtained, 501(c)(3) status allows the charity or foundation to collect tax deductible donations, and be exempt from federal, and by extension in most cases, state taxes. They also qualify for a sales tax exemption and lower, non-profit mailing rates. It is an excellent non-profit tax category, but scarcely the only one.
* Other Non-profits and Spinoffs. Non-profits other than charities and foundations, tend to be money-holding organizations, formed for some common purpose. An athletic club or a fraternal order may form itself into an entity, collect necessary dues, and their invested funds will still qualify them for non-profit status. Here again, choosing the right classification offers varied benefits.
A civic league or social welfare organization, e.g. the Main Street Improvement Association, like a charity, may be formed for the public good, and might qualify for either 501(c)(3) or 501(c)(4) status. Choosing 501(c)(4) will make their donations no longer tax deductible. However, it would free them from the 501(c)(3) no-lobbying leash laws. They can freely join with registered lobbyists, and within certain restrictions involve themselves in partisan politics.
Trade and professional organizations, such as Smithville Real Estate Association, or Chamber of Commerce, may offer their members the benefit of 501(c)(6). In this case, contributions, while not tax deductible in Schedule A, may be deducted as business expenses. Social and recreational clubs, falling under 501(c)(7) may gain the tax exempt status for their funds, provided pleasure, not profit, is their sole mission. Clubs under such status may not discriminate against any person based on race or color.
An existing entity, such as a school, library, hospital or church which is tightly bound by governmental or organizational strictures in fund raising techniques, may seek to spin off a separate non-profit. These can prove a substantial funding source. It establishes a separate board whose sole mission is to raise funds, thus freeing up the extant governing board from this duty. Basically, the same tax qualification rules apply. Just beware, that as executive director you are now harnessing two boards and they may not always want to go in the same direction.
* To Incorporate or Not? The pros and cons of incorporation for both non and for profit companies are very similar. First is the cost. Filing and various services will require $115 for incorporation in each state the charity operates. Add to that New Jersey’s mandated certified audit for non-profits grossing over $250,000 annually, and a host of time-taking reporting requirements.
Also non-profit corporations must have a board of at least three trustees, all over age 18. (No, you can’t include your infant children.) This entails a loss of control which may not suit an individual seeking to run the show on his own.
Yet if the time and filing costs can be met, there are certainly advantages to incorporating. All New Jersey non-profits are exempt from corporate income tax. Tax exemptions may be obtained on property. Incorporation also acts as a legal buffer, protecting personal assets from creditors or lawsuits. But definitely the greatest advantage of incorporating is that it elevates your organization in donors’ eyes. People feel safer, and companies feel more familiar giving to an incorporated non-profit.
The choices are many and barely brushed over here. But once an organization decides where to stand, regarding law and taxes, it can begin to take strides forward into fulfilling its mission. Biz4
Linda Czipo is a Jersey lady whose charitable interests were fostered early on. She grew up in West Caldwell watching her teacher mother spend long hours laboring for a host of volunteer causes. Czipo attended Rutgers University, earning a bachelors in political science. Upon graduating in 1984, she went to work for the New Jersey Commission for Hunger. Twenty one years ago, she joined the New Jersey Center for Non-Profit Corporations in New Brunswick, all the while continuing her legislative advocacy for non-profits. Since 2000 she has served as the Center’s executive director.
