When small mission-oriented organizations are just getting up and running, there can be a lot of confusion around becoming a “nonprofit.” In those first months and years of operation, many organizations with charitable intentions find themselves stuck in an identity purgatory, pursuing a mission without a clear organizational structure. Here are your three primary options in those founding months (or years):
1. Just Keep Doing Your Thing: You don’t have to become a nonprofit to act charitably or serve your community. Many organizations prefer not to become a formally incorporated nonprofit (per the IRS) because – quite frankly – it’s easier, it’s a lot less paperwork, and you can retain a certain level of flexibility.
The big downside of choosing this path is that it will dramatically limit your growth opportunities (if you care about that). Without formal tax-exempt status, people can still give money to support your mission, but they won’t be able to claim those donations on their tax returns, which means they may have less incentive to give. There’s also no formal accountability built into this structure and people may be wary of your intentions. This is the path of what we might call the “personal project” (no judgment!) and not the path of organizational sustainability or growth.
2. Apply to the IRS to Become A Nonprofit Organization: While there are many types of tax-exempt organizations, the most commonly recognized charitable nonprofit is the 501(c)(3) organization. To become a 501(c)(3) organization, you must apply directly to the IRS by filing Form 1023 (or you may qualify for the more streamlined Form 1023-EZ). Before applying to the IRS, you must incorporate your organization at the state-level and meet some basic requirements (such as building a Board of Directors and creating Corporate Bylaws). There are many excellent, free online resources to help guide you through this process, and check your state for free legal resources for nonprofits (shout out to our partners at Lawyers Clearinghouse here in MA!)
The good news? The IRS approves most applicants (about 90%), so if you do your due diligence, you will likely be approved. Once approved, people and institutions can make donations to your organization and receive a tax-deduction for their good deed. Woohoo! Remember that once you become a nonprofit, you must provide some form of written acknowledgement to your donors that their gift is tax-exempt, among other requirements.
The bad news? Well, you are dealing with the IRS and completing the paperwork can honestly be a bear. After you do all the work to submit your forms, application wait times average 3-6 months (much less on the Form 1023 E-Z) but can be delayed up to a year or more in some instances.
3. Get Yourself a Fiscal Sponsor: This is like having a nonprofit sugar mama (terrible analogy, but we’re keeping it!). A fiscal sponsor is a well-established 501(c)(3) organization willing to accept – and pass through – donations for your organization. The big plus here is that you can operate as a small organization without being formally incorporated and people or institutions can still make tax-deductible gifts to support your work. It’s the ultimate workaround.
Many small organizations will opt to go this route while waiting for the IRS to approve their tax-exempt status, or if they want to test out their mission and programs further before applying to the IRS. This is a great “in-between” option but it does take some work (and a lot of trust): it is on you, after all, to seek out and identify a fiscal sponsor. Any 501(c)(3) organization can act as a fiscal sponsor if it has been in operation for at least five years and is up to date on all required federal and state filings.
This is all still well and good, but there’s a major word of warning to be made: to benefit from a fiscal sponsor relationship, you will need to create a formal written agreement outlining the terms of sponsorship. Some organizations that as fiscal sponsors will – as a requirement of the agreement – take a small percentage of any donations made to your organization before passing it through to you. Be sure you have a complete understanding of all aspects of the relationship – and again, take advantage of any free legal resources in your state and get an extra set of eyes on your draft agreement.
What route is best for you depends entirely on your organization’s goals. Be honest with yourself as to whether or not you are willing to put in the elbow grease to find and confirm a fiscal sponsor, to move through with your IRS Form 1023, or if you’d just rather leave that all for another day. There is no correct answer, but if your ultimate goal is to grow your mission and serve your community in a long-term, sustainable way, you will want that 501(c)(3) status. How you get there is up to you!