This presentation helps individuals through the process of starting a nonporofit organization.

1. Benjamin Takis
Tax-Exempt Solutions, PLLC
btakis@taxexemptsolutions.com
www.taxexemptsolutions.com
Ian Shuman
Gelman, Rosenberg & Freedman
ishuman@grfcpa.com
www.grfcpa.com
LEGAL AND ACCOUNTING
CONSIDERATIONS WHEN
STARTING A NONPROFIT
ORGANIZATION
Foundation Center
March 18, 2014

2. Today’s Agenda
• Part 1: Preliminary Stage
– Basic Concepts
– Steps to Take Before Forming an Organization
– Accounting Basics
• Part 2: Forming the Organization
– Corporate Formation
– Form 1023
– Tax and Audit Requirements

3. Professional Bio
3
Benjamin Takis, Attorney
Founding Attorney, Tax-Exempt Solutions, PLLC
•8 years of experience representing public charities, private foundations,
lobbying groups, trade associations, labor unions, retirement plans, health care
trusts, and other tax-exempt entities of all types and sizes.
•Specializes in tax, corporate governance, and employment issues for non-
profits.
•Faculty member at the Center for Nonprofit Advancement, and regular
speaker at the Foundation Center, Greater Washington Society of CPAs, and
elsewhere throughout the DC area.

4. Professional Bio
4
Ian Shuman, CPA
Partner, Gelman, Rosenberg & Freedman CPAs
•Director of Client Services
•20 years of experience in auditing, consulting and accounting
•Specializes in nonprofit outsourced accounting services
– Flexible CFO & controllership engagements, guide clients through external audit, help
with board reporting, training of client accounting personnel and set up of accounting
systems
•Nonprofit Involvement:
– Treasurer of the Bach Sinfonia, former Treasurer of Sitar Arts Center

5. Part One: Preliminary Stage
1.Basic Concepts
2.Steps to Take Before Forming an
Organization
3.Accounting Basics

6. What is a Non-Profit?
A non-profit is an entity (typically a corporation) that does
not distribute net earnings to its owners or shareholders.
Non-profit status is determined under state law.
Tax status is distinct from non-profit status: non-profit may
or may not qualify as tax-exempt under 501(c)(3) (or any
other federal code section), and it is possible to have a
taxable non-profit.

7. What is a 501(c)(3)?
501(c)(3) is one of many different tax-exemption classifications
under federal law.
Other examples:
• 501(a): qualified retirement plans
• 501(c)(4): social welfare organizations
• 501(c)(5): unions
• 501(c)(6): trade associations
States generally rely on federal 501(c)(3) status when granting
tax-exempt status under state law, but not always

8. Benefits of 501(c)(3) Status
• Earnings generally tax-exempt under federal and state
law
• Donations are tax deductible
• Eligible for grants from foundations

9. Burdens of 501(c)(3) Status
• Very complicated to administer: generally requires
articles, bylaws, board of directors, corporate
policies, plan for distribution of assets at dissolution
• Must take steps to show that any payment to yourself
is “reasonable”
• Finances open to public inspection (ex: Entire Form
990 except names and addresses of donors is public;
required to give copy if asked; many nonprofits put
audits and other documents online)

10. Burdens of 501(c)(3) Status
• Accounting is more complicated
– Tracking costs by funder/project is common
– Labor, fringe and overhead allocations are common
– Use of timesheets to track labor by projects is common
• Compliance requirements much more rigorous
– Federal audit requirements start at $500,000 for a 501(c)(3) versus
$10,000,000 under SBA 8(a) rules for government contractors
– IRS estimates for time required to complete the 990-EZ with common
schedules is 25 hours. For a Schedule C (single member LLC) its 2
hours. The 990 is full of non-financial info.

11. Before Forming an Organization
A number of steps should be taken before filing for
incorporation or applying for tax-exempt status
(1) Consider alternatives to forming a 501(c)(3)
(2) Determine whether you qualify for tax-exempt
status
(3) Recruit a Board of Directors
(4) Create a budget and business plan
(5) Find a fiscal sponsor

12. Alternatives to Forming a New 501(c)(3)
Cautionary Note: Running a successful non-profit organization requires
a compelling and viable mission, a strong network of people to help
fund and administer the organization, and a realistic stream of revenue
to fund both your activities and the hiring of professionals to assist with
the many administrative burdens.
Consider the following alternatives before forming a 501(c)(3)
• Working with an existing organization to run a pilot program based
on your idea.
• Run your project as a taxable entity (e.g. LLC) or sole
proprietorship before forming a non-profit.

13. Qualifying for Tax-Exempt Status
501(c)(3) Exempt Purposes
• Charity
• Education
• Promotion of Health
• Advancement of Religion
• Advancement of Science
• Lessening the Burdens of
Government
• Testing for Public Safety
• Promotion of Social Welfare
• Promotion of the Arts
• Literary
• Environmental Protection
• Fostering Amateur Sports
Competition
• Prevention of Cruelty to
Children or Animals

14. Qualifying for Tax-Exempt Status
The Commerciality Doctrine
• Even if you have what seems like a valid exempt purpose,
the IRS and the courts may deem your organization
unworthy of tax exemption if its activities are too similar
to a commercial business.
• The commerciality doctrine is very arbitrarily and
unevenly applied.
• The non-profit sector is becoming more and more
commercialized, and the law is not keeping up.

15. Qualifying for Tax-Exempt Status
EXAMPLE: Living Faith, Inc. v. Commissioner, 950 F.2d 365 (7th Cir. 1991)
The organization was formed to promote the tenets of the Seventh Day
Adventist Church, one of which is vegetarianism and healthy eating. The
organization’s main activity was the operation of two vegetarian
restaurants/health food stores. The stores operated on normal business hours,
except they were closed on Saturdays (in observation of the Sabbath). Prices
were the same as for-profit competitors. Adventist literature was displayed
throughout the stores, and cooking classes and bible study classes were held
after business hours. Additionally, the organization held a devotional talk and
hymn singing every morning before opening. The organization relied entirely
on income from the stores and had no plans to solicit donations.

16. Qualifying for Tax-Exempt Status
EXAMPLE: Living Faith, Inc. v. Commissioner, 950 F.2d 365 (7th Cir. 1991)
Result: The court ruled that the organization was operated substantially for a
non-exempt purpose and did not qualify for exemption. Key factors: (1) the
organization was run just like a commercial business, e.g. with regular
business hours, promotion through advertising, etc; (2) competed with similar
for-profit businesses; (3) set prices at market rates; and (4) lacked plans to
raise money from any other sources.
How would you modify the organization’s activities to
qualify for exemption?

17. Recruiting a Board of Directors
The ideal Board of Directors has people with the skills, financial
means, and connections to help fund the organization and complement
the strengths and weaknesses of the founder:
• Lawyers
• Accountants
• Entrepreneurs, Business Owners
• Nonprofit Professionals
• Well Connected Individuals (politically and financially)
Most states require a non-profit corporation to have a minimum of 3
directors.

18. Recruiting a Board of Directors
• Think about getting representation from all of the
organization's stakeholders – you want a diverse
range of backgrounds, skills and perspectives
• Consider setting term limits
• Family relationships between directors get disclosed
• Reminder: the role of the Board is to make decisions
and govern. However new organizations often have
more of a “working board”

19. Budget and Business Plan
A business plan must adequately plan for the costs of running the
organization. Some necessary expenses that are often left out of
budgets include:
• Insurance
• Accounting, tax preparation and financial audits
• Attorney fees
• Fundraising consultants
• Strategic planning consultants
• Payroll, payroll processing and related benefits
Remember that budgets should be realistic and achievable!

20. Fiscal Sponsorship
Did you know …
It is currently taking about 2 years (!) for the IRS to confirm
the tax-exempt status of most new organizations.
Fiscal sponsorship enables your organization to raise money
while you are waiting to hear from the IRS.
Expedited treatment of your Form 1023 is possible, but
difficult to obtain

21. 21
Measure the activity showing how we got from
one image to another (Statement of Activities)
Snapshot
Take a photo and capture the image (Statement of Financial
Position)
Take a photo and capture the image (Statement of Financial
Position)
December 31st
January 1st
Accounting Basics

22. 22
• Assets are what you have
• Liabilities are what you owe
• Equity is the difference. It’s
also the sum result of your
whole history
• Moment in time- a different
concept than other reports
Smith Consulting
Balance Sheet
September 30, 2013
Assets
Checking account $ 1,000
Savings account 250
Total cash 1,250
Auto 7,000
Total Assets $ 8,250
Liabilities -
Car Loan 6,000
Retained Earnings 2,250
Total Liabilities and Equity $ 8,250
Balance Sheet
• Nothing here about revenue,
expenses or net income
Balance Sheet: “a moment in time”

23. 23
Smith Consulting, Inc.
Income Statement
For the Year Ended December 31, 2013
Revenue
Fees $ 10,000
Interest income 100
Total Revenue 10,100
Expenses
Salary 7,000
Travel 1,000
Supplies 300
Rent 200
Total Expenses 8,500
Net Income $ 1,600
• Who are the users of this
report?
Maybe bankers, owners,
potential owners or
management
• What do they want to know?
Profitability, ability to
repay a loan, etc.
Income Statement
• Measures activity over time
• How much cash do you have?
Income Statement: for-profit example

24. 24
Carwash for Good
Income Statement
For the Year Ended December 31, 2013
Revenue
Contributions $ 15,000
Interest income 100
Total Revenue 15,100
Expenses
Salary 7,000
Consultants 2,000
Travel 700
Program Materials 300
Rent 500
Total Expenses 10,500
Net Income $ 4,600
• For a nonprofit entity, who are the
users of the reports?
Management, potential donors,
funders, board members
• Does this format still work?
NO, it’s no longer all about net
income
• Conclusion: Nonprofits’ reports
need to address program activities
and stewardship responsibilities
Income Statement (continued)

25. 25
• The different terminology
reflects the change in
emphasis
• Biggest difference is that
expenses are grouped by
functional categories
(purpose) instead of natural
categories (how)
• What was travel expense?
Carwash for Good
Statement of Activities
For the Year Ended December 31, 2013
Total
Revenue
Contributions $ 15,000
Interest income 100
Total Revenue 15,100
Expenses
Treatment 7,450
Advocacy 2,000
Total Program Expenses 9,450
Administration 1,050
Total Expenses 10,500
Change in Net Assets $ 4,600
Statement of Activities

26. 26
• Functional -- Expenses grouped according to
the purpose for which the costs are incurred
(program, administrative, fundraising)
• Natural -- Expenses grouped according to the
kind of economic benefit received (such as
salary, printing, rent, travel, etc.)
Functional and Natural Expenses

27. 27
• Columns are used to
separate restricted and
unrestricted activity
• There’s nowhere to
show the natural
expense categories
except on a separate
page
Carwash for Good
Statement of Activities
For the Year Ended December 31, 2012
Temporarily
Unrestricted Restricted Total
Revenue
Contributions $ 4,500 $ 10,500 $ 15,000
Interest income 100 - 100
Release from restriction 9,000 (9,000) -
Total Revenue 13,600 1,500 15,100
Expenses
Treatment 7,450 - 7,450
Advocacy 2,000 - 2,000
Total Program Expenses 9,450 - 9,450
Administration 1,050 - 1,050
Total Expenses 10,500 - 10,500
Change in Net Assets $ 3,100 $ 1,500 $ 4,600
Restricted Activity

28. 28
• The limitation must come from the donor. A limitation
set by the board is called designated instead.
• Temporarily Restricted- donor specifies a limitation
based on time (when the contribution can be used) or
purpose (what the contribution can be used for).
• Restricted donations are recorded in full at the date of
pledge and are then “released” to unrestricted as the
donor’s limitations are fulfilled (if temporary). You can
think of this as temporary storage.
• Permanently Restricted- donor specifies that only the
donation’s related investment earnings can be spent.
Restricted Contributions

29. 29
• This report is
unique to nonprofit
organizations and
provides a detailed
breakout of the
functional totals by
natural line items
Carwash for Good
Statement of Functional Expenses
For the Year Ended December 31, 2013
Program Services
Treatment Advocacy Admin. Total
Expenses
Salary $ 5,050 $ 1,500 $ 450 $ 7,000
Consultants 1,600 300 100 2,000
Travel 500 200 - 700
Program Materials 300 - - 300
Rent - - 500 500
Total Expenses $ 7,450 $ 2,000 $ 1,050 $ 10,500
These terms are sometimes used
interchangeably: "administrative,”
“management and general,” “general
and administrative,” and "overhead"
Statement of Functional Expenses

30. Part Two: Forming the Organization
1.Corporate Formation
2.Preparing the Form 1023
3.Tax and Audit Requirements

31. Basic Steps to Forming a 501(c)(3)
After you have laid the groundwork, these are the basic
steps:
(1) File Articles of Incorporation with the state
(2) Get an Employer Identification Number
(3) Have your first Board Meeting: adopt Bylaws, Resolutions, and
Policies
(4) Open a bank account
(5) File Form 1023 and applications under state law (27-month
deadline)
(6) File Forms 990 while you wait for tax-exempt status

32. Articles of Incorporation
Elements of the Articles of Incorporation
•Corporate name
•Duration (“perpetual”)
•Statement of Purpose (required for Form 1023)
•Whether or not you have members
•Authority of the Board of Directors, and the process for appointment
•Plan for dissolution of assets (required for Form 1023)
•Names of initial Directors, Incorporators, and Registered Agent
•Authority to amend

33. Employer Identification Number
An employer identification number (“EIN”) is necessary to
apply for tax-exempt status, open a bank account, hire
employees, etc.
•Easy to obtain online from the IRS website:
https://sa.www4.irs.gov/modiein/individual/index.jsp (or google
“EIN online”)
•Can also submit Form SS-4 on paper.
Don’t make a mistake – if the IRS has more than one EIN on
record for your organization, this causes major headaches

34. First Board Meeting
Once Articles of Incorporation have been filed, the Board of Directors
should have their first meeting and take care of initial business:
• Adopt Bylaws
• Appoint Officers (Executive Director, Secretary, Treasurer)
• Adopt Policies (Conflict of Interest, Whistleblower and Document
Retention)
• Establish the authority of selected officers to open a bank account and sign
checks on behalf of the organization
• Establish the authority of selected officers to apply for tax-exempt status
and sign a power of attorney
This meeting should be documented by written resolutions and minutes

35. Inside the Form 1023
Overview of what’s needed
•IRS fee: $400 or $850
•Certified copy of Articles of Incorporation
•Bylaws
•Narrative
•Conflict of Interest Policy
•Copies of contracts and information on how compensation was
determined
•Financial data
•Answers to many, many questions

36. Form 1023: Part I
Line 10: your organization may be exempt from the requirement to file
a Form 990 or Form 990-EZ if it is (1) a church or affiliated with a
church; (2) a state or local government unit or affiliated with a state or
local government unit; or (3) an organization that normally receives
$50,000 or less in annual gross receipts.
•Note: organizations with less than $50,000 in annual gross receipts are
still required to file Form 990-N.
Line 11: date of incorporation is important because you must file within
27 months of incorporation to receive 501(c)(3) status retroactive to the
date of incorporation – may otherwise qualify as 501(c)(4)

37. Form 1023: Part II
Official governing documents are required to obtain tax-exempt status
– your organization must formally exist as (1) a corporation; (2) a
limited liability company; (3) a trust; or (4) an unincorporated
association (with Articles of Association, Constitution, etc.)
Sole proprietorships, partnerships, or loose affiliations are not eligible
for tax-exempt status.
The recommended form of entity is the non-profit corporation
•Attach Articles of Incorporation (certified by state government) and
Bylaws (showing date of adoption by Board)

38. Form 1023: Part III
Required Provisions in organizational documents:
•Statement of purpose: the Articles of Incorporation must state that the
organization is operated for a purpose consistent with section 501(c)(3),
and may not engage in activities that are prohibited for a 501(c)(3)
organization.
•Dissolution: if the organization dissolves, its assets must continue to
be used for 501(c)(3) purposes rather than returned to the founders.
Easiest way to satisfy this requirement is to require that assets be
contributed to another 501(c)(3) organization.
– It is not recommended that you rely on state law for your
dissolution provision

39. Form 1023: Part IV
The Narrative
•Describe your major activities, and give some concrete examples
(3-5 paragraphs is usually enough)
•The Form 1023 narrative is not a grant proposal and shouldn’t
look like one.
•You should know all the IRS hot-button issues associated with
organizations likes yours, and avoid triggering IRS concerns
•Note: if you later engage in activities that are not described in
the narrative or elsewhere in the Form 1023, the validity of your
tax-exemption letter may be called into question.

40. Form 1023: Part V
Compensation of Officers, Directors, Employees and
Independent Contractors
Background Law:
•Private Inurement: organization “insiders” may not be paid more than
“reasonable” compensation
•Intermediate Sanctions: penalty excise taxes imposed on “excess
benefit transactions” with “disqualified persons”
•Private Benefit: a 501(c)(3) organization may not use its assets to the
benefit of a private party, except to the extent that such benefit is
incidental to the organization’s tax-exempt purpose

41. Form 1023: Part V
Line 2: describe family and business relationships among your officers,
directors, highest compensated employees or independent contractors.
• Business relationships include common ownership of a business (i.e.
related parties together hold more than 35% ownership), as well as
employment and contractual relationships.
• The IRS is looking for conflicts of interest that may compromise the
independence of the organization and lead to private inurement and
private benefit violations.
• EXAMPLE: one organization board member is also on the board of
a for-profit business that is a client of a law firm of which another
board member is a partner.

42. Form 1023: Part V
Line 3: list name, qualifications, average hours worked and duties of
each officer, director, highest compensated employee, and highest
compensated independent contractor
•The IRS is looking to ensure that the people running the organization
have actual qualifications and duties, and not just handpicked by the
founder to act as “rubber stamp”

43. Form 1023: Part V
Line 4: you should answer “yes” to all these questions if you want your
Form 1023 approved without complications
•Follow Conflict of Interest Policy (see IRS sample)
•Approve compensation in advance
•Document compensation arrangements in writing
•Record board decision (i.e. minutes of board meeting)
•Obtain comparability data from at least 3 similarly situated
organizations
•Document the data and its source in the meeting minutes

44. Form 1023: Part V
Line 5: Conflict of Interest Policy (see IRS sample) is optional but
highly recommended
Line 6: non-fixed payments such as discretionary bonuses and revenue-
based payments are inherently suspect and should be avoided, if
possible
Lines 7, 8, 9: transactions should be negotiated at arm’s length (i.e.
decided by an independent board) and at fair market value (based on
comparable data).
•Good board procedures are of the utmost importance

45. Form 1023: Part VI
Provision of goods, services, or funds to individuals and
organizations
Again, the IRS is concerned about possible private inurement and
private benefit violations. Any disbursements must directly further the
organization’s exempt purpose, and not unduly benefit insiders.

46. Form 1023: Part VII
History of any predecessor organizations:
•Line 1: If your organization has taken over the activities or assets of
another organization, the IRS will take a closer look to ensure that your
organization is truly independent and worthy of its own 501(c)(3) – See
Schedule G.
•To maintain independence from a related organization, be sure to
negotiate all dealings at arm’s length, and have either: (1) a majority of
different, independent board members, or (2) a different executive
director and staff running the day-to-day details of the organization
•Line 2: 27-month rule for retroactive 501(c)(3) status

47. Form 1023: Part VIII
Line 1: must check “no” – 501(c)(3) organizations are prohibited from
opposing or supporting political candidates
Line 2: 501(c)(3) organizations are allowed to influence legislation (i.e.
direct lobbying and grassroots lobbying), so long as these activities are
not “substantial”
•If your organization engages in direct or grassroots lobbying at all, it is
generally recommended to file Form 5768 (the “501(h) election”)
Line 6: you must be able to show that any economic development
activities are charitable and do not just benefit private businesses

48. Form 1023: Part VIII
Line 8: “joint ventures” with non-501(c)(3) organizations are inherently
suspect and should be handled with caution
•There are specific cases and IRS rulings that should be closely
followed – in general, the 501(c)(3) must retain voting control over the
project to ensure that the joint venture furthers charitable purposes
Line 14: contributions made to your organization that are used for the
benefit of a foreign organization will qualify for the charitable
deduction only if specific rules are followed:
•Your organization must retain discretion over the funds (i.e. no
earmarks), and adequate control over the projects abroad

49. Form 1023: Part VIII
Line 15: you have a “close connection” with another organization if:
•You control the organization or it controls you through common officers,
directors, or trustees, or through authority to approve budgets or expenditures.
•You and the organization were created at approximately the same time and by
the same persons.
•You and the organization operate in a coordinated manner with respect to
facilities, programs, employees or other activities.
•Persons who exercise substantial influence over you also exercise substantial
influence over the other organization, and you either (1) conduct activities in
common, or (2) have a financial relationship.
Must take steps to maintain the separateness of the organizations

50. Form 1023: Part IX
Financial Data – Statement of Revenue and Expenses
•If the organization has existed for 4 years or more: provide actual data
for the most recent completed year and the three prior years (4 years
total)
•If the organization has existed for more than 1 year but less than 4
years: provide actual data for all completed years, and projected data as
needed to get to a total of 3 years of financial data
•If the organization has existed for less than 1 year: provide projected
data for the current year and the following 2 years (3 years total)
•Generally speaking, this is the only page that your CPA can do

51. Form 1023: Part X
Public Charity Status- general rules
•A 501(c)(3) nonprofit can be either a public charity (ex: Red Cross) or
a private foundation (ex: Gates Fdn).
•Private Foundations file a different tax return (990-PF), pay tax on
investments, are subject to very strict conflict of interest rules, and have
to distribute a portion of their assets every year. Most importantly:
private foundations are very unlikely to give money to other private
foundations.
•To be a public charity you have to pass the public support test: done
every year on Schedule A of the Form 990. Schools, hospitals, churches
and government entities are exempt from this test.

52. Form 1023: Part X (continued)
Public Charity Status- general rules (cont.)
•The test calculates what portion of revenue over a five-year
cumulative period was “public support.”
•You become a private foundation if you fail two years in a row
but you get a pass in your first five years.
•Use this first five years to develop a broad base of support and
remember that any inactive time after formation counts.

53. Form 1023: Part X (cont.)
Public Charity Status: general rules
•Form 1023 provides 8 possible versions of this test. Most organizations
will choose between option (g) “509(a)(1) and 170(b)(1)(A)(vi)” and
option (h) “509(a)(2).”
•Option (g) generally seeks to ensure that 1/3 of total support is from
contributions and grants, with most sources subject to a 2% limit (support
from government and other public charities is not subject to the 2% limit).
It’s possible to pass with 10% public support under “facts and
circumstances” test.
•Option (h) also generally seeks to ensure that 1/3 of total support comes
from the public, except “exempt function revenue” is counted.

54. Tax Filing Requirements
• Filing thresholds:
– 990: Gross receipts over $200,000 OR totals assets over
$500,000
– 990-EZ: Gross receipts from $50,000 to $200,000 AND
totals assets under $500,000
– 990-N (“postcard”): gross receipts normally under $50,000
• The 990-N is an online-only version that is mostly just name
and address information.
• Exempt status is automatically revoked if an organization fails
to file for three consecutive years.

55. Audit Requirements
A requirement to have an organization audited can come
from any of several sources:
• State charitable registration requirements often set thresholds
for requiring an audit, review or compilation based on total
contributions reported on the 990.
• A single audit under A-133 is required if an organization
spends $500,000 of federal funding in one fiscal year.
• Donors may require an audit (but may also accept a review or
compilation).
• Bylaws, banks or best practices