While in many ways similar to for-profit corporations, nonprofit organizations are bound by legal, tax, and accounting laws that are unique to them and them alone. As they navigate through their business lifecycles they will face many different challenges, of which the startup phase is an especially crucial time. It is riddled with obstacles that, if not overcome, could stall a nonprofit’s progress or perhaps halt it all together. Fortunately, leaders who plan well for their startup’s launch will be better prepared for whatever comes their direction. To help clients, prospects, and others identify the key issues in the startup phase, Selden Fox has compiled a list of key legal, accounting, and tax considerations below.
Before nonprofit startups commence business, they must first ensure that all their legal ducks are in a row. This begins with entity selection.
Contrary to popular belief, 501(c) is not a legal designation; it is a federal tax designation. For ventures to be treated as nonprofit organizations for legal purposes, they need to organize themselves as “nonprofit corporations” with their states. The benefits of having a state-recognized nonprofit designation varies by jurisdiction. Most states will provide nonprofit organizations with income tax exceptions. However, some states will also provide certain nonprofits with relief from property and sales taxes. A nonprofit’s tax-saving potential will depend heavily on where they choose to set up shop. Nonprofit leaders should have a good-quality attorney and CPA in their corner to help them figure out their best move.
Nonprofit leaders should ensure that their business plans are fully formed before they officially open for business. To receive nonprofit tax treatment by the IRS, nonprofit organizations need to prove that they have a strong mission, a well-defined consumer population, and reliable funding. A well-developed business plan will also help ensure a nonprofit organization can sustain operations and will be able to weather the ups and downs of running a business.
Legal and tax concerns often go together, so the nonprofit organization should assemble a team that will address their legal and tax concerns holistically.
To receive tax-exempt status at the federal level, nonprofits can elect to be treated as 501(c) organizations by filing Form 1023 (Charitable Organizations) or Form 1024 (Other Tax-Exempt Organizations). Each year thereafter, the organization must file annual informational tax returns – Form 990 – and follow certain guidelines required by the IRS, which generally include:
- Limiting political and other lobbying activities.
- Keeping all related activity at arm’s length so that leaders and employees are not given special treatment; and,
- Restricting their non-exempt activities.
Nonprofit organizations who generate more than $1,000 from non-exempt activities detached from their organization’s exempt purpose, are subject to income taxes on that non-exempt revenue, which must be reported on Form 990-T. If this return is not filed, the organization will incur fines and penalties, and the IRS could potentially even revoke their tax-exempt status.
While certain nonprofits may receive an exemption from paying sales taxes when they make purchases on behalf of their organization, oftentimes they will not be exempt from collecting and remitting sales taxes. When nonprofit organizations sell taxable goods and services to the public, they must charge sales tax just like any other business, and unfortunately, sales tax compliance can be both costly and time consuming.
Similar to other entities, nonprofit organizations must withhold Medicare, social security, and federal and state withholdings employees’ paychecks each pay period. Nonprofit organizations are also required to follow all employment laws, including those for unemployment insurance and disability benefits.
Nonprofit organizations share many of the same accounting considerations than other entities do, but they are also subject to their own rules and regulations.
While nonprofit organizations are governed by the same oversight board as for-profit entities (the Financial Accounting Standards Board – FASB), they must comply with different standards. The FASB regularly releases standards that are specific to nonprofit organizations, for instance there is a specific standard on how nonprofit organizations should present their financial statements (ASC 2016-14). They must also comply with their states’ laws and the laws of the states in which they do business. For example, each state grants nonprofit charitable organizations the privilege to solicit for donations in their state, so nonprofits hoping to ask for donations even temporarily from other states’ residents need to apply for the appropriate licenses.
Financial Statement Audit
The IRS does not require nonprofit organizations to obtain independent financial statement audits, but many state and local governments do. These requirements typically kick in once the entity reaches a certain size. Many banks, contributors, and granting agencies may require a nonprofit to have a financial statement audit as well. Such audits should be performed by a reputable CPA firm with experience in the nonprofit sector. In addition to reporting on their financial statements, CPA firms will oftentimes identify areas where a nonprofit organization can improve its business practices. Even if an audit is optional, it can provide nonprofit leaders with the peace of mind that they are doing things as they should.
If you are considering starting a nonprofit organization and would like additional information, please contact us. We help nonprofits navigate all parts of their growth cycle and understand just how exciting it can be to see a dream come to fruition!