You can start a nonprofit to aid a specific group or class of individuals — everyone suffering from diabetes, for example, or chronically homeless individuals — but you can’t create a nonprofit for individual benefit or gain.
Being accountable and transparent
Although nonprofit organizations aren’t public entities like government agencies and departments, their tax-exempt status — and the fact that contributions are tax-deductible — require them to be more accountable and transparent to the public than a privately owned business is.
It takes only a few media reports about excessive salaries or concerns about how a nonprofit has spent donated funds to prompt donors, legislators, or the general public to begin asking questions regarding the nonprofit’s finances and management. An IRS tax-exempt, 501(c)(3) nonprofit organization is required to be transparent and open in all of its operations and transactions.
A few nonprofit organizations have taken on the task of collecting information about other nonprofits and sometimes rating them in various categories so that prospective donors can use this information to help them choose which organizations to support. Charity Navigator (www.charitynavigator.org), CharityWatch (www.charitywatch.org), GuideStar by Candid (www.guidestar.org), and the Better Business Bureau Wise Giving Alliance (www.give.org) are four prominent organizations providing information about domestic (US-based) nonprofit organizations. If you’re just starting out and your nonprofit is small, your organization us unlikely to be evaluated by one of these organizations; however, a new nonprofit should definitely create a profile on GuideStar by Candid. For small, early-on funding requests, foundation and corporate grant makers will look for your profile on this website. Be sure to update it annually.
We discuss nonprofit disclosure requirements in more detail in Chapter 6, but at minimum, federal law requires that nonprofits file a report (Form 990, 990-N, or 990-EZ) every year with the IRS. The amount of detail required in the report depends on the size of the nonprofit organization. States have their own reporting requirements, so contact your appropriate state office to learn what’s required.
A WORD ABOUT EXCESSIVE COMPENSATION
Although nonprofit employees have no dollar limit on the amount of compensation they can earn, the IRS does have the authority to penalize individuals (and organizations) who receive (or pay) excessive compensation. Whether the IRS considers benefits excessive depends on the situation. For instance, a staff member earning $100,000 annually from an organization with a budget of $125,000 may need to worry, but someone earning $100,000 from a nonprofit with a $5 million budget probably doesn’t.
An employee who’s found to be receiving excessive compensation may be required to return a portion of his compensation and to pay an excise tax, and, in dire cases, the nonprofit organization may lose its tax-exempt status. Chapter 6 offers more information on excessive compensation.
So, when setting your nonprofit’s executive director’s salary (or your own), make sure the amount of compensation is justified by salary surveys of similar organizations. Also factor in the local cost of living, the size of the nonprofit’s budget, and the type of services being provided. Community foundations and nonprofit consulting firms can offer salary guidelines to aid in the compensation decision. Also, many states have a statewide nonprofit organization that collects information about, and provides information to, other nonprofits.
Federal law also requires nonprofits to make their three most recent 990 reports, as well as their application for tax exemption and supporting documents, available for public inspection. State and local laws in your area may require additional disclosures. Posting your 990 reports and other required documents on the web is an acceptable way to meet disclosure requirements.
www.irs.gov. You also can view completed 990 forms from other nonprofit organizations at GuideStar by Candid (www.guidestar.org).
Looking at the Many Varieties of Nonprofits
The words nonprofit and charity go together in most people’s minds, but remember that not all nonprofits are charitable organizations. The most common examples are business and trade associations, social welfare organizations, labor organizations, political advocacy groups, fraternal societies, and social clubs. Although these nonprofits enjoy exemption from corporate income taxes, people who donate to them can’t claim a tax deduction for their contributions.
Most nonprofits, charitable or not, are incorporated organizations that are formed under the laws of the state in which they’re created. Some nonprofits have other legal structures, such as associations or trusts, but these are in the minority. The IRS grants tax-exempt status to a nonprofit after reviewing its stated purpose. (See Chapter 5 for information about incorporating and applying for a tax exemption.) Nonprofit types are identified by the section of the IRS Code under which they qualify for tax-exempt status.
In this section, we provide an overview of the types of nonprofit organizations and some of the rules and regulations that you’ll be subject to if you decide to incorporate and seek tax-exempt status from the IRS. You may discover, for example, that your idea will have a better chance for success if you create a social welfare organization — a 501(c)(4) — or a for-profit business.
Identifying nonprofits by their numbers
Nonprofit organizations can be formed under
