501(c)3: Different Mission but Business as Usual

In my last column on DBA's & Sole Proprietors I mentioned having a background of 20 years in small business development. What I failed to mention was that 13 of those years were in a non-profit environment; 4 years in small business development centers, 5 years in a community college economic development center, 1 year in a research project and 3 years as co-founder of a small business incubator. So it is safe to assume I qualify to comment on the types of non-profit corporations that exist (especially the 501(c)3), the advantages of non-profit corporate status, the application process and some of the issues their officers and staff must address in starting and keeping the doors open.

There are 30 different categories of non-profit corporations of which 20 are listed under Section 501(a) of the Internal Revenue Code. For the benefit of this column, we will describe what many consider the most coveted of them all – 501(c)3. Why? The most obvious advantage is that donations to 501(c)3's are tax deductible, whereas other forms of non-profits either cannot afford that tax status to their contributors, or there are restrictions on what can be defined as tax deductible. Other advantages of 501(c)3 include:

All but unrelated business income is exempt from federal income tax.

They are eligible for low-cost, non-profit, bulk mailing permits.

Many major donors in the private sector will not make donations to any other than 501(c)3.

Virtually every level of government agency in the United States requires this status to qualify for most forms of public grants.

Due to the level of accountability required of the IRS, this status lends itself to credibility for the organization to the public and private sectors.
Every lawyer with whom I have conversed about this subject has also indicated 501(c)3 is the most rigorous application approval process receiving scrutiny from the IRS, again, for the tax-exempt contribution status.

So what are the requirements for 501(c)3 status? Including the application process, they include:

All corporate assets must be devoted exclusively to charitable activities.

No political activity is allowed.

Organizing documents to include articles of incorporation and the certificate.

Historic financial statements, or two years of proposed budgets and a current statement of assets and liabilities.

The mission and related activities are limited to charitable, religious, educational, scientific or literary purposes.

Just as with the for-profit sector, there must be an employer identification number and payroll deductions for FICA and FUTA, with some exceptions, are treated the same as a for-profit organization.

The board of directors, though receiving no compensation, is responsible for ensuring adherence to all laws governing the non-profit status.
Obviously, there are no shareholders in this form of corporation, and net profit of any form for the benefit of income distribution does not exist. Employees are limited to compensation and benefits only. As you can imagine, being an IRS designation, there are many details to consider, and I suggest you view IRS Publication 557 and Form 1023 for more details.

According to recent research, it is safe to say the non-profit sector is a significant part of the economic fabric in this country. Estimates suggest:

They employ 16.6 million, or approximately 7% of the U.S. workforce,

Health (43%), education (22%) and social services (18%) are the most dominant sectors, and

Approximately 670,000 501(c)3's were registered with the IRS as of 1998.
Over the years, I have witnessed the formation of many non-profits rising out of local initiatives of community leaders. With many there seems to be a social theme related to training and upward socio-economic mobility. Health-oriented initiatives seem to be spearheaded with the technical support and expertise of individuals from major institutions, while the others have to "learn the ropes" and grasp the unapparent realities of successfully starting and operating these institutions. The pitfalls to overcome include:

Realizing 501(c)3 status is necessary to secure support from foundations and government institutions.

Adopting a business management style geared toward self-sufficiency; in other words, have a for-profit approach to self-sufficiency.

Realize you are competing with many other 501(c)3's for foundation and government support.

Accept the reality, in most cases, that you will have to charge some minimal fee for the services you provide your targeted, "underprivileged" clients.

Learn the politics of networking with the decision-makers in government and foundations. Face-to-face interaction is so important. You want them relating, in a positive way, to people and faces when evaluating the grant application.

Learn the "agendas" of the institutions from which you seek funding. Your goals and objectives must address those priorities.
There is so much more to learn. Honestly, it is sometimes more important, than all else, to know the decision-makers. Being able to deliver what the foundation or government agency wants only makes it easier to get their attention.

If you are considering the formation of a non-profit, especially a 501(c)3, review the definition, FAQ and Advantages & Disadvantages sections at MyCorporation.com. And don't forget the matters of a Board of Directors, Tax ID and Articles of Incorporation. If you have more questions go to the live help page to arrange for MyCorporation.com to give you a phone call and address your questions and concerns.

Source for statistics noted above: http://www.community-wealth.org/_pdfs/articles-publications/social/book-salamon-intro.pdf