Stan Hutton - Nonprofit Kit For Dummies

Entire volumes have been written about IRS regulations and laws pertaining to nonprofits. But don’t worry — we just want to give you an overview of some facts that may help you decide whether starting a 501(c)(3) nonprofit organization is your best choice.

IRS regulations can change from year to year, so be sure to look at the most recent version of IRS Publication 557 for the latest information.

Nonprofits can’t campaign to support or oppose the candidacy of anyone running for an elected office. However, the stipulations on lobbying for specific legislation are less clear. In the following list, we break down the rules so that you know what you can and can’t do, depending on which type of nonprofit you set up:

Social welfare organizations and labor unions, 501(c)(4): These organizations have more leeway when it comes to legislative lobbying than 501(c)(3) organizations do. They can engage in political intervention activity as long as it isn’t their primary activity. Groups that lobby must inform their members what percentage of dues they use for lobbying activities, and they can’t work toward a candidate’s election.

Charitable organizations, or nonprofits that the IRS considers public charities under section 501(c)(3): These nonprofits may participate in some legislative lobbying if it isn’t a “substantial” part of their activities. The IRS doesn’t define the term substantial, so it determines this question on a case-by-case basis. These nonprofits can generally spend a higher portion of their budgets on lobbying activities if the organization chooses to elect the 501(h) designation (IRS Form 5768). The IRS allows more expenditures for direct lobbying (when members of the nonprofit talk with a legislator about an issue at hand) than for grassroots lobbying (encouraging members of the general public to contact legislators to promote an opinion about a piece of legislation).

Private foundations: Although they, too, are recognized under section 501(c)(3), these organizations may not participate in any legislative lobbying. The only exception to this rule is when pending legislation may have an impact on the foundation’s existence, tax-exempt status, powers, or duties, or on the deductibility of its contributions.

Penalties for engaging in too much political activity can include loss of your organization’s tax exemption. However, going deeper into the details of these laws and reporting requirements is beyond the scope of this book. So if you’re contemplating involving your nonprofit in serious legislative activity, consult an attorney or a tax specialist for advice. One place to find more information is the National Council of Nonprofits. ( www.councilofnonprofits.org ).

Churches are in a category all by themselves. The IRS doesn’t require them to file for a tax exemption, nor does it require them to file annual reports. Some churches, however, do apply for an exemption because their social-service outreach programs often include anything from preschools to soup kitchens to affordable housing. These programs seek 501(c)(3) status so that they can more easily apply for foundation funding and government grants or contracts to help pay the costs of providing the services.

Churches that haven’t been officially recognized as being tax-exempt are highly unlikely to receive foundation grants or government contracts.

Nonprofit organizations may be subject to unrelated business income tax, also known as UBIT. When a nonprofit makes $1,000 a year or more in gross income from a trade or business that’s regularly carried on and that’s unrelated to its exempt purpose, this income is taxable even if the proceeds support the organization. In addition, some corporate sponsorship funds may be subject to UBIT if they’re perceived by the IRS as advertising dollars. IRS Publication 598 tells you all you need to know about this subject; visit www.irs.gov to take a look at this publication.

Some states exempt some nonprofits from paying state sales and use taxes. Check the laws in your state to see whether your organization is exempt from paying these taxes. The same is true of property taxes — it depends on your local jurisdiction. Your nearest tax assessor can tell you whether you have to pay property taxes.

Nonprofit employees must, of course, pay income tax on their salaries and other taxable compensation.

Nonprofits can own for-profit businesses. We don’t recommend it, because you’ll have enough on your plate, especially when you’re starting out, but it is possible. The business is subject to all regular taxes, just like all other for-profit businesses. Profits from the business may be distributed to the nonprofit, and the nonprofit must use them to further its goals and programs.

If your nonprofit has less than $5,000 in annual revenues, it doesn’t need to apply for a tax exemption. You can even go a bit over $5,000 in a year if your average annual income over a 3-year period is less than $5,000. When your income averages more than that amount, however, you have 90 days following the close of your most recent tax year to file for a tax exemption.

Even if your organization has revenues under $5,000, you may still need to file the IRS 990-N form. This form can only be filed online. Check the IRS website at www.irs.gov for the latest information about this requirement.

Nonprofit organizations have one common feature, regardless of their type: No board member, staff member, or other interested party can benefit from the earnings of a nonprofit. Instead, assets are forever dedicated to the purpose of the organization. If the organization dissolves, the nonprofit must transfer the assets to another organization that performs a similar function. Keep in mind that board members cannot be compensated by the nonprofit they govern. This would be considered a conflict of interest and could result in the nonprofit losing its tax-exempt status.

Just because assets are dedicated to fulfilling an organizational mission doesn’t mean that staff are required to work for nonprofit organizations for free. Nonprofits can and should pay reasonable salaries to their staff members, if they have any. But keep in mind the difference between paying a salary and splitting the profits at the end of the year.

Believing that nonprofit organizations have special advantages isn’t uncommon. And to some extent, it’s true. How many for-profit businesses, for example, get help from volunteers and generous donors? On the other hand, the advantages to owning your business exist, too. In this section, we discuss the similarities and differences between nonprofits and for-profits to help you decide which direction you should go.