Fiscal Sponsorship, Incorporation, and Tax Exemption FAQs

No. A "nonprofit" is a type of corporation that is formed in accordance with the requirements of state law. "Nonprofit" and "not-for-profit" mean essentially the same thing. Other states use different terms, such as "nonstock".

"Tax exempt" as used in this context refers to an entity (e.g., a nonprofit corporation) that the IRS has granted exemption from federal income tax. Such an entity may also qualify for exemption from various state and local taxes.

Yes, one sign of a financially strong organization is that it makes a profit, meaning its revenues exceed its expenses. Similarly, an organization does not need to spend all of its funds in a year. It is often a good thing if there are funds to carry over to the next year’s budget or to put away as an endowment or similar reserve.

However, such profits cannot be paid out like dividends. The profits must be used by the nonprofit to further its mission. A 501(c)(3) organization may not be organized and operated primarily to make a profit – its goals must be to serve some charitable, educational, religious, or similar public good.

A "501(c)(3) organization" is an entity (often a nonprofit corporation) that (1) is "organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition …, or for the prevention of cruelty to children or animals", and (2) has been granted exemption from federal income tax under Section 501(c)(3) of the Internal Revenue Code. A 501(c)(3) organization also may be eligible for exemption from state and local taxes.

Donors to 501(c)(3) organizations may take a tax deduction for their donations, an important tool when fundraising. Donations to other types of 501(c) organizations are generally not deductible as charitable contributions.

All organizations that apply for tax exemption under Section 501(c)(3) are classified as either public charities or private foundations. A 501(c)(3) tax-exempt organization is automatically classified as a private foundation unless it falls under one of three exceptions, in which case it is classified as a public charity: (1) it is engaged in certain activities (churches, schools, hospitals, and a few others); (2) it is organized and operated exclusively for the benefit of, to perform the functions of, or to carry out the purposes of a public charity; or (3) it can show that it is "publicly supported", which generally means it receives financial support from a broad group of funding sources. The determination of whether an organization is publicly supported is based initially on the information provided by the organization on its application for tax exemption (IRS Form 1023) and then on the informational tax returns filed annually with the IRS (IRS Form 990 or 990-EZ).

Why does this classification make a difference? Determination as a public charity rather than as a private foundation is generally more desirable for most nonprofit organizations, for several reasons: private foundations are subject to a 2% tax on net investment income; private foundations are generally prohibited from engaging in a number of activities that public charities may undertake, including lobbying activities; contributions to private foundations are not deductible to the donor to the same extent as contributions to public charities; and reporting and disclosure requirements for private foundations are more onerous than for public charities.

No, a 501(c)(3) organization must have a mission that benefits the general public good in some way. Thus, a 501(c)(3) organization cannot be formed to benefit one or a handful of specially designated individuals, even if the goals are laudable, like raising funds to help a family whose child has cancer. But a 501(c)(3) organization could be formed to raise funds for families of children with cancer, with objective criteria for choosing recipients of the funds.

Religious organizations that are houses of worship and organizations whose annual gross receipts are normally not more than $5,000 are automatically tax exempt.

However, such groups often apply to the IRS in order to receive a "determination letter" from the IRS that evidences their tax-exempt status. The determination letter can be important because funders may request it, and it is sometimes required to qualify for state and local tax exemptions.

No, your organization can begin soliciting and accepting donations once your organization is incorporated as a nonprofit corporation and registered for charitable solicitation in the appropriate state(s). In fact, it is often advisable to solicit funding sources before making the decision to seek 501(c)(3) status to get a sense of whether your organization will be sustainable.

However, without 501(c)(3) status, contributions made directly to your organization are not immediately tax deductible for the donor. That said, there are ways in which donors may be able to take tax deductions for their contributions.

If your organization’s application for tax exemption is pending before the IRS, it is possible that a donor's contribution will be deemed tax deductible eventually. For an organization that files its application for tax exemption with the IRS within 27 months from the end of the month in which it was formed, tax exemption once received will be retroactive to the date of formation. If the application is filed after 27 months, tax exemption once received will be retroactive to the date that the application was filed. In other words, donors may be able to take deductions once your organization is granted 501(c)(3) status for contributions made during the interim period. Solicitations during the interim period should say that tax exemption is pending and donations may be deductible if 501(c)(3) status is granted by the IRS – solicitations must say "if" because you cannot presume or represent that tax exemption is guaranteed.

Another way in which donors may take tax deductions before your organization has obtained tax-exempt status is if your organization is fiscally sponsored by another 501(c)(3) organization such that donors make their contribution to the fiscal sponsor for the benefit of your organization.

Fiscal sponsorship is an arrangement between a 501(c)(3) public charity (the "Sponsor") and a project (which may be a nonprofit corporation or other legal entity, or an individual or group of individuals) (the "Project") in which the Sponsor receives and expends funds to advance the Project while retaining discretion and control over the funds.

An important potential benefit of a fiscal sponsorship arrangement is that donors may make tax-deductible contributions to the Sponsor for the benefit of the Project. The Sponsor may not, however, simply act as a pass-through.

The mission of the Project must fit within and further the Sponsor’s mission, but need not be identical. For example, a mentoring program for at-risk kids could be sponsored by a social services agency that runs many programs for the same or similar population.

Sponsors often provide assistance to the Project, such as general administration, accounting, management, human resources, or fundraising. Sponsors sometimes request a fee for their services, which may be a percentage of funds raised. All of this and other things that the parties agree upon should be set out in a written agreement.

It depends.

It may make sense to incorporate because there are significant benefits. The primary benefit of incorporating is limited personal liability for the individuals involved. Also, it is often easier for corporate entities to open bank accounts and purchase insurance.

However, in some cases the individuals involved in the organization would rather not devote the time to the administration and incur the expense of incorporating and maintaining a corporation. Also, it can be a long process to dissolve a corporation.

Fiscal sponsorship is often a great idea for a short-term project because you don’t need to devote time and expense to incorporating and applying for tax exemption, complying with state and federal filing requirements, or dissolving a corporation when the project has ended.

It depends.

The process of incorporating varies depending on factors such as how long it takes the organization to draft the certificate of incorporation (called "articles of incorporation" in some states) and bylaws, the requirements and processing time in the state, whether expedited processing is requested, whether the state authority has follow-up questions after reviewing the certificate of incorporation, and whether any consents of other state agencies are required prior to the certificate of incorporation being filed. It generally ranges from days to weeks.

The time it takes to receive tax exemption varies depending on such things as how long it takes the organization to prepare the application (IRS Form 1023), how big of a backlog the IRS has, whether the IRS examiner has follow-up questions (which varies depending on the subject matter and complexity of the organization’s programs and the clarity with which the application is prepared), and whether expedited processing is requested and granted. It generally ranges from weeks to months.

The advance ruling period existed under prior IRS regulations. After an organization filed for tax-exempt status, it was subject to a probationary five-year period during which it was obligated to prove that it was a publicly supported charity (meaning that it was receiving financial support from a broad group of funding sources). If the organization operated as a public charity during those five years, it would receive a final determination letter of its exempt status at the end of the advance ruling period. The advance ruling period was eliminated in 2008 and no longer has application.

The IRS now considers an advance ruling letter with an expiration date on or after June 9, 2008 to be an organization’s final determination letter. However, if an organization has an advance ruling letter with an expiration date on or after June 9, 2008, it may wish to request an affirmation letter from the IRS. This letter will provide unambiguous evidence of the organization’s public charity status to potential donors who are unaware of the changes in the law. See Question 31 for more information on obtaining an affirmation letter.

Alternatively, a nonprofit may refer donors to IRS Publication 78, which provides a partial list of the organizations recognized by the IRS as eligible to receive tax-deductible donations. Donors can also contact IRS Customer Account Services at (877) 829-5500 to verify the organization’s status.

A 501(c)(3) organization is not automatically exempt from state and local taxes. After receiving federal tax exemption, it generally must apply for such exemptions with the appropriate taxing authority at the state or local level.

Note that state tax exemption in one state is not transferable to another state. So, for example, a charity must apply for a sales tax exemption specific to any state in which it purchases taxable items.

Generally, an organization must register as soon as it begins fundraising activities in a state, and/or, in some states, doing business or having some kind of presence there (e.g., being incorporated in the state).

Some states have a minimum annual dollar threshold that must be crossed before registration is required. For example, in New Jersey, registration is not required if a charity does not receive gross contributions in excess of $10,000 and does not use a paid professional fundraiser.

Some states, including Connecticut and New York, provide for exemptions from the full filing if an organization is below a certain size. In Connecticut, an exemption applies if an organization normally receives less than $50,000 per year in contributions and does not compensate any person primarily to conduct solicitations. The exemption must be claimed by making a short form filing. Exemption need be claimed only once and does not have to be renewed. However, if the circumstances of the organization change so that the exemption no longer applies, the organization is required to register at that time.

In New York, an exemption applies if the organization has less than $25,000 in annual gross receipts and does not use a professional fundraiser. The organization may make a short-form filing to claim the exemption, but is not required to do so. If the circumstances of the organization change so that the exemption no longer applies, the organization is required to register at that time.

Many states, including Connecticut, New Jersey, and New York have annual filing requirements for organizations registered to solicit charitable funds.

The requirements vary by state, so it is important to check the rules in any state where your organization plans to fundraise or otherwise be present. To see which states have charitable registration laws, go to www.multistatefiling.org.

For more information, please see the Partnership’s materials on fundraising.

Yes. All 501(c)(3) organizations must file a Form 990 informational tax return annually, but it may be possible to file a short form depending on the organization’s annual gross receipts and total assets.

Form 990-EZ is a shorter version of the Form 990, and Form 990-N (or "e-Postcard") is an electronic notice that asks for very basic information and is filed online.

Following are the thresholds for 2010 tax year and later (different thresholds apply for earlier years):

It depends on the state. For example, Connecticut requires a filing with the Secretary of State and New Jersey requires a filing with the Department of the Treasury, Division of Revenue, but other states, such as New York, do not have such a requirement.

Any such report is in addition to an annual report that may need to be filed with a state charities bureau.

Bylaws are an internal operating manual for the board (and members, if any). They guide the board of directors in governing effectively, and generally contain provisions on topics such as the roles of members (if any), directors, and officers; elections; meetings; committees; conflicts of interest; basic financial matters (e.g., check writing authority); and the authority to hire an executive director and other staff members. When an organization has a choice between putting a provision in the bylaws or in the certificate of incorporation, it is often advisable to put it in the bylaws because they are easier to amend.

Bylaws should be simple and flexible so that they are easy to follow and a helpful governance tool. It is a good idea to review them regularly to ensure that they reflect current practices and conform with the organization’s certificate of incorporation.

Bylaws are filed with the application to the IRS for tax exemption (Form 1023), and sometimes are required to be filed with state charities bureau registrations. Otherwise, they generally are not required to be filed with government authorities. Significant changes to the bylaws may need to be reported on annual government filings (e.g., IRS Form 990 informational tax return). With respect to reporting changes in the bylaws and/or the certificate of incorporation to the IRS, see IRS Publication 4221-PC, Compliance Guide for 501(c)(3) Public Charities, available at www.irs.gov.

Generally speaking, nonprofits are organized as either membership or non-membership organizations. Membership organizations have members who are entitled to vote on certain organizational issues. In some ways, members are analogous to shareholders of a for-profit corporation in that they play a role in governance (e.g., they elect directors). But unlike shareholders, members do not have a pecuniary interest in a nonprofit corporation.

Non-membership organizations have self-perpetuating boards of directors, meaning that the directors nominate and elect people to serve on the board. Many non-membership organizations have people they call "members" but they are not members in the legal sense because they do not have voting rights.

Your organization’s certificate of incorporation and/or bylaws should state whether it is a membership or non-membership organization. If it is a membership organization, the bylaws should set forth the requirements of membership, including the definition of a voting member, quorum and meeting requirements, notice requirements, and the specific voting rights of members.

Requirements about having members vary by state. New York organizations should note that under the New York Not-for-Profit Corporation Law, certain nonprofit organizations are required to have voting members; check with the Pro Bono Partnership or your organization's legal counsel for more information. For organizations with a choice, having members may make sense. But many organizations decide not to have members, primarily for ease of administration.

State law generally requires a minimum number of board members (also referred to as "directors" in Connecticut and New York and "trustees" in New Jersey). Connecticut, New Jersey, and New York require at least three (3) board members, all of whom must be at least 18 years old.

The organization’s corporate documents (generally the bylaws) should specify the number, which is often greater than the minimum required and is sometimes a range (e.g., at least 5 and no more than 11).

Board members have significant fiduciary duties and are ultimately responsible for the organization. It is critical that board members understand their responsibilities to lead the organization, and recognize that they can be held personally liable in certain limited circumstances.

Board members may delegate responsibility for day-to-day management of the organization to an executive director, but the board must exercise oversight as appropriate and continues to bear ultimate responsibility for the organization.

Board members must exercise due care in the performance of their duties, which includes overseeing the nonprofit, approving its financial and accounting practices, and ensuring compliance with all applicable laws. However, board members generally will not be liable for failure to exercise due care if they have relied, in good faith, on advice provided by competent professional advisors, such as lawyers and independent/certified public accountants. Boards can therefore protect themselves by hiring reliable professionals, asking pertinent questions, and familiarizing themselves with their nonprofits’ finances, legal responsibilities, and internal controls.

Yes, an executive director may serve on the board, as long as it is not prohibited by the organization’s corporate documents (i.e., certificate of incorporation and/or bylaws).

It is strongly recommended that the organization have a conflict of interest policy to ensure that no director (including an executive director serving on the board) participates in any votes on issues where the director, his/her relatives, or his/her related entities stand to benefit. For example, the executive director should recuse him/herself when the board discusses his/her salary.

Some organizations avoid these types of conflicts by adopting a policy whereby the executive director attends board meetings to keep the board apprised of programmatic developments but is not a board member.

It is not recommended for anyone to have the right to be on the board forever, even the founder. And, as explained in our Corporate Governance FAQs, Connecticut, New Jersey, and New York require that all members of the board be elected periodically. Thus, in these three states, unless the certificate of incorporation and/or bylaws provides for term limits, it is possible for a founder to serve the organization for many years, but this way there is a periodic check on performance.

Organizations and those serving on the board evolve over time, and it is not a good idea to be stuck without the ability to make leadership changes. Oversight of the organization ultimately is the responsibility of the board (and voting members, if any), and it should have the ability to remove anyone, including the founder.

If someone wants certainty that he/she will be part of an organization forever, forming a nonprofit may not be the right route.

Yes, an organization can have an advisory board (or any other group of constituents), but everyone involved should recognize that such a group does not have the legal rights and responsibilities that the board of directors has, and cannot bind the organization. It may be a good idea to have a charter for the advisory board that clearly defines its role and limits.

Yes, board members may provide services to the organization, as long as the transaction is on fair terms (or terms beneficial to the organization) and proper conflict of interest procedures are followed.

If such procedures are not followed and a board member improperly benefits from the transaction, he/she could be subject to fines or other consequences. The board members who approved the transaction with full knowledge of the facts may also be subject to fines or other consequences.

For more information on conflicts of interest, please see the Partnership’s materials on corporate governance.

Yes, a 501(c)(3) public charity can lobby (defined simply as taking a position on a bill or attempting to influence legislation), but the amount of lobbying is subject to a limit. The limit can be measured qualitatively (whether lobbying is a "substantial part" of the organization’s activities) or quantitatively (based on what the organization spends on lobbying).

Your organization may elect how it would like its lobbying measured; often it is advisable to elect the quantitative measure (referred to as the "Section 501(h) election") because the limit is clearer.

Lobbying is subject to complex rules and, in some cases, state and federal registration and reporting requirements.

No, a 501(c)(3) organization may not participate in political campaigns (defined simply as supporting or opposing a candidate for public office). However, a 501(c)(3) public charity is permitted to engage in non-partisan political activities, such as get-out-the-vote drives or educating the public on various issues. There are specific rules on this topic that your organization should understand, particularly around election time.

Board and staff members of an organization may participate in political campaigns in their individual capacity on their own time and without use of the nonprofit’s resources.

A politician may serve on the board of a 501(c)(3) organization or participate in an organization’s event so long as the politician is clear that he or she is doing so in his/her individual capacity. If it is too challenging to make such a distinction, the organization may decide not to have the politician be involved.

If a politician running for office is invited to speak at an organization’s event, the organization may wish to consider also inviting that person’s opponents so as not to appear to be endorsing a candidate.

No, a 501(c)(3) organization must not pay excessive compensation to its staff (or officers and directors). Compensation must be "reasonable" in light of the services provided by the employee, which is often determined by the board looking at what people in similar positions at similar organizations earn. Failure to do so can result in personal liability for the person who received the excess compensation and the board members who knowingly approved the compensation.

It depends on your organization’s activities (and, of course, its budget). Your organization should consult an insurance professional – if possible, one who is familiar with the needs of nonprofit organizations. It is important to understand the potential losses your organization could suffer and what your insurance policies will and will not cover.

There are many types of insurance. General liability insurance covers claims by other people for bodily injury and property damage arising from accidents. Property insurance covers property that your organization owns or leases. Your organization may be able to purchase a Business Owner’s Policy ("BOP"), a package of insurance policies that cover bodily injury, property damage, crime, and employee benefits errors and omissions. If your organization owns or leases an automobile, you also will need to purchase auto insurance.

Directors and officers ("D&O") insurance covers claims arising from the activities and decisions made by board members and officers in those capacities. Some people will require that an organization have D&O insurance before agreeing to serve on an organization’s board.

If your organization has employees, make sure that your D&O policy includes employment practices liability coverage. Organizations with employees also need to purchase workers’ compensation insurance.

Other activities such as child care, professional services, or food service may require additional or specialized coverage. It may also be appropriate for an organization to get "special events" insurance in connection with a particular event, trip, or fundraiser.

To obtain a copy of an organization’s tax-exempt status determination letter, fax your request to the IRS at (513) 263-4330. An updated version of the letter is called an "affirmation letter" and will reflect any change(s) in your organization’s name and address previously provided to the IRS. Include the following information in your request: the name, title, and daytime phone number of the officer making the request; the name of the organization (and all former names if the name has changed); the organization's address (and the original address if the organization has moved); and the organization's EIN number. If you know the year the organization was incorporated, provide that information as well. The IRS will normally mail an affirmation letter within two weeks of a request.

If your organization (1) filed its application for tax-exempt status before July 15, 1987 and had in its possession on July 15, 1987 a copy of its application or (2) filed its application for tax-exempt status on or after July 15, 1987, then your organization is required to have the application on file to comply with mandatory public disclosure requirements. If you no longer have a copy of the application, you can request a copy from the IRS, using IRS Form 4506-A.  The request normally takes 60 days to process but may take longer during tax season.