As tax professionals, it’s critical to recognize nonprofit accounting as a prime opportunity to provide valuable advisory and tax services, yet one of the first areas you’ll focus on is setting up the organization – and that’s no easy task. While their missions are often honorable and noteworthy, nonprofits often struggle with initial setup and ongoing compliance as it pertains to taxes, accounting and reporting. In addition, the specific requirements for nonprofits vary by state. Here’s a summary of the general setup process, as well as universal compliance concerns.
Selecting the Type of Nonprofit
The first step is to determine the type of nonprofit and select the members of the governing board. According to the IRS, there are more than 29 types of nonprofit organizations, and although I won’t cover all of the various types of nonprofits in this article, I’ll mention a few for clarity’s sake.
Correctly categorizing your client’s nonprofit organization will allow for easier compliance with regulatory agencies. 501(c)(3) organizations are most common, given that they can be either private or public, and provide services that are educational, charitable or just more community-oriented. However, based on the needs of a given community, there are many other types. For example, in agricultural communities or organizations targeting this area or audience, a 501(c)(5) would be the most appropriate because it is intended for agricultural organizations. If your client wanted to open up a local social club focusing on chess or fishing, you’d likely organize as a 501(c)(7).
Selecting the Board of Directors
If you’re involved in helping or advising your clients on how to set up a governing board for their nonprofit, it may be helpful to keep a couple of things in mind.
- Ensure potential members of the governing board possess diverse abilities, skills and values that are relevant and aligned to the organization’s stated mission.
- Clearly communicate to any board candidates any and all fundraising expectations and requirements.
- Discuss legal issues in detail. For example, board members and others involved with a nonprofit can be held personally and financially responsible if they purposely injure someone, forget to file the organization’s taxes, or mix their own money with the nonprofit’s money. As long as the members involved act within the law, there should not be any legal ramifications.
Steps to Organize
The paperwork involved with starting a nonprofit is essential to the success of the organization. Because the steps vary by state, I’ll use my home state of California as an example.
Complete your forms. California nonprofits must complete the necessary forms, including Articles of Incorporation, the Secretary of State statement of information form and the bylaws. If you’re not in California, look up the requirements for nonprofits in your state.
Obtain tax exempt status. All nonprofits, except churches, need to file for tax-exempt status with the IRS for donations to be tax deductible for donors. Depending on their specific type, nonprofits apply for tax-exempt status with the federal government by filing:
- Form 1023-EZ, Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.
- Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code.
- Form 1024, Application for Recognition of Exemption Under Section 501(a).
- Form 1024-A, Application for Recognition of Exemption Under Section 501(c)(4) of the Internal Revenue Code.
Once the form has been processed and the organization has received an IRS determination letter that confirms its status, the organization will need to apply with their state to obtain state tax-exempt status. This is a step that’s often missed and can cause the organization extra work and money.
Ongoing compliance. The nonprofit must also provide the government with documents through ongoing reporting. These documents include, but are not limited to, the nonprofit’s annual federal and state tax return, statement of information filing with the Secretary of State, and other state specific filing requirements. Failure to complete and provide these documents in a timely manner may result in penalties and fees for your client, and possible revocation of their tax-exempt status.
An Emotionally Rewarding Niche
Nonprofit tax and accounting is a great opportunity; not only are nonprofits great clients that truly value the services provided to them, but we find that our team at MBS Accountancy is emotionally tied to them because they do so much good. It’s an opportunity worth looking into for any savvy tax accountant.
Editor’s note: Read a recent article from Gregg Bossen, CPA, about nonprofit tax issues with a focus on unrelated business income tax.