What to Do If Embezzlement Occurs at Your Nonprofit

Last time, we discussed how you can protect your organization from embezzlement or other misappropriation of funds. But what if the theft has already occurred?

Gathering Evidence of Theft

If you have funds or property that can’t be accounted for, it’s time to investigate what happened. You’ll want to make sure that you know 1) you want to make sure that embezzlement actually occurred, and 2) who committed the theft. The investigation should begin as soon as possible. Delays can invite additional theft and make recovery of stolen property harder.

If you suspect a particular person, limiting his or her access to funds and other property during the investigation is probably a good idea. Another approach would be to leave the person in the position and watch for continued theft, but I don’t like that idea much. It continues to put the organization’s property at risk, and if word gets around that an investigation is underway, it’s not likely to be all that helpful. Confronting the person at this stage might be premature; I’d wait until you have pretty clear evidence that the person is actually stealing.

Punishing the Thief

Once you have clear evidence of who committed the theft, now it’s time to deal with the thief. It’s difficult for me to imagine a situation where no punishment would be appropriate; generally, I consider embezzlement to be fireable offense. Surprisingly, it doesn’t always work out that way. The Chronicle of Philanthropy reports that in one study, only 72% of organizations fired employees that stole from them, and 7% did nothing at all.

Why do so many organizations do so little? According to the Chronicle of Philanthropy, there are a few reasons:

  • Thief’s Remorse. Sometimes the thief is sorry for what they’ve done. A person that shows genuine contrition and returns the stolen property may be able to remain in the organization. Even in those cases, however, I cannot see levying no punishment at all. At a minimum, the person should not be allowed to handle organizational property again.
  • Embarrassment to the organization. Sometimes, organizations are embarrassed to admit what happened. Often, embezzlement exploits a flaw in the organization’s internal controls.
  • Loss of donors. It’s possible that donors may stop giving to an organization***It’s better, I think, to admit what happened and explain how the organization is improving its controls than to try to cover up what happened.

Additionally, you may want to consider filing a police report, particularly for large thefts. The police report is helpful in any future employment actions that might be filed by the thief and in recovering any stolen funds. Additionally, if your organization carries insurance against embezzlement, you may need to file a police report before making a claim–of course, you should check your insurance policy to make sure.

Recovering Stolen Assets

Recovering stolen assets, particularly cash, is difficult. However, that’s not to say that it isn’t worth trying. In some cases, you may be able to work out repayment with the person, and in other cases, you may need to take legal action. Just like with the investigation, it’s important not to delay the process of recovery. This is especially true if you have to file suit, because your organization will have a limited amount of time to do so.

Doing Better

Next, use this as an opportunity to improve your controls. What vulnerabilities in your system did the thief exploit? How can this sort of thing be prevented in the future? Leaving a known vulnerability in place is absolutely unacceptable–the problem must be identified and solved.

Making these needed changes doesn’t just protect your organization, but it also helps to restore the confidence of your donors, clients, volunteers, an other employees. Handling embezzlement is an enormous drain on the organization–it takes time and energy to deal with, in addition to the financial damage. Creating solid internal controls and improving them if you ever (unfortunately) need to is vital to keeping your organization focused on accomplishing its mission.

 

Preventing Embezzlement from Your Organization

To most of us, stealing money from a charity is unthinkable. Even so, embezzlement from nonprofit organizations is a serious problem. The Chronicle of Philanthropy reports that according to a 2007 study, 13% of the donations collected by nonprofits each year are lost to fraud. Further, the Washington Post reported that in 2013, more than 1,000 non-profits reported losses of $250,000 or more as the result of embezzlement, theft, misappropriation of funds, or investment fraud.

Losing that kind of money would sink–or at least seriously damage–a lot of organizations. Worse yet, the organization can be hurt even after the money is lost. Embezzlement or misappropriation can also discourage donors from supporting the organization, making it even more difficult to recover.

And worse yet, I suspect that smaller organizations are actually at greater risk than large ones. Why? Mostly, because large organizations are more likely to have controls in place. Also, I think there’s more of an expectation that a large organization will have and enforce those controls. Continue reading

The 1023-EZ User Fee Is Now $275, Down from $400

If you’re considering starting a 501(c)(3) organization, and your organization is eligible to file Form 1023-EZ, there’s good news for you. Beginning July 1, 2016, IRS has reduced the 1023-EZ user fee to $275–down from $400.

This, of course, is great for anyone planning to file the 1023-EZ. That said, I’ve argued that the 1023-EZ process would improve with a little more oversight, and a lower user fee suggests that maybe that sort of change isn’t going to happen.

So, how do you know if your organization is eligible to file Form 1023-EZ? The Instructions for Form 1023-EZ include an eligibility checklist. The financial eligibility requirements to file Form 1023-EZ are:

  • The organization does not expect annual gross receipts of more than $50,000 in any of the next 3 years;
  • The organization has not had annual gross receipts of more than $50,000 in any of the past 3 years; and
  • The organization does not have total assets exceeding $250,000.

There are 26 items total on the eligibility checklist, so you’ll want to review the whole thing. If the IRS finds that your organization is ineligible to file 1023-EZ, it will reject your application and you’ll have to file a full 1023, so make sure you’re eligible prior to submission.

A woman punching a man in the face, which is not really how conflicts of interest work, thankfully.

Why Your Organization Needs a Conflict of Interest Policy

When I meet with a new 501(c)(3) organization client, one of the things I usually ask about is whether the organization has a conflict of interest policy. Usually, one of two things happens:

  1. “Yes, we do have a policy in place.”
  2. “A conflict of interest policy? What is that? Do we need one?”

No matter which answer I get, it’s okay. Conflict of interest policies are important, but it’s not hard to get one and adopt it. Let’s answer the questions in #2 up there to explain why this is a big deal. Continue reading

What is Unrelated Business Income?

One of the big traps that can tangle up an organization is engaging in some sort of fundraising activity that generates what the government calls “unrelated business income,” which can cause an organization to have to pay taxes or, in extreme cases, even forfeit the 501(c)(3) tax exemption altogether.

Some sources of income are automatically excluded from UBI (and I’ll give you some other exceptions near the end), like dividends and interest, some types of investment income, royalties, some types of rental income, and some capital gains.

If you do have unrelated business income of $1,000 or more, you must file Form 990-T for the tax year involved. If you expect to have more than $500 in UBI during a particular year, your organization must pay estimated tax.

What is Unrelated Business Income?

Unrelated business income is money earned by an organization that meets three requirements:

  • It’s earned from activities that constitute a “trade or business.”
  • The activity is “regularly carried on.”
  • The activity does not further the organization’s exempt purpose.

For something to count as UBI, it must meet all these requirements; if one is missing, it’s not UBI. Let’s talk about each of these requirements in more detail.

What is a “trade or business?”

Here’s how I think about this requirement: is the money-making activity something that a for-profit business would engage in to make money? If you’re exchanging a good or service for money, you’re probably engaging in a trade or business. Car washes, bake sales, and selling advertising in programs, for instance, have obvious for-profit equivalents: the commercial car wash, the local bakery, and newspapers and magazines that sell ad space do the same thing. Each of those would qualify as a trade or business.

Of course, not every activity that raises funds is a trade or business. Receiving donations is not a trade or business–there’s no exchange taking place. Likewise, applying for grants from other organizations or charitable trusts isn’t a trade or business; it’s a donation.

What does it mean to be “regularly carried on?”

Generally, an activity is “regularly carried on” if it occurs roughly as often as it would for a for-profit business engaged in the activity. If a for-profit business does the activity year-round, and you’re only doing the activity every now and then, it probably won’t be considered regularly carried on.

For example, imagine that your organization operates a sandwich stand for a couple of weeks out of a year. Most for-profit sandwich sellers operate year-round, and a couple of weeks isn’t going to be frequent enough to be regularly carried on (that example is from Treasury Regulation 1.513–1(c)(2)(i), if you want to see it for yourself). On the other hand, the regulations also say that if you were to run that same sandwich stand one day each week throughout the year, that would be sufficient for the activity to be regularly carried on. Also, if a for-profit business would operate the activity on a seasonal basis, a couple of weeks of that activity within the same season might be enough.

The closer your activity is to a comparable for-profit business in terms of how frequently you’re open for business, the more likely your activity will be “regularly carried on” for UBI purposes.

What do you mean, the activity doesn’t further an exempt purpose?

This criterion often surprises people. To be “substantially related to an exempt purpose,” the activity itself has to help achieve the exempt purpose. The classic example is tuition for an educational institution. Education is one of the 501(c)(3) exempt purposes, so students enrolling and taking classes directly furthers the school’s purpose.

Here’s what gets people: fundraising activities do not “further an exempt purpose” even if all the money you raise is going to an exempt purpose. Let’s go back to the car wash example. Washing cars is not an exempt purpose. So, if you have a car wash fundraiser, that doesn’t “further an exempt purpose” even if every cent you raise goes to fund your organization’s exempt purposes.

Again, don’t forget that for the organization’s income to count as unrelated business income, it must meet all 3 of these requirements. And even then, there are exceptions.

Exceptions to Unrelated Business Income

So, let’s say that your organization does engage in some sort of money-making activity that meets all three requirements for unrelated business income. We’re not done yet! There might be an exception available. There are four big exceptions:

  • Volunteer labor: Your activity is run entirely by unpaid volunteers
  • Convenience of members: Your activity is carried on primarily for your members, students, patients, or employees–(examples from the regulations: leasing dormitory apartments to students of a college, school or hospital cafeterias, or hospital parking lot all fall under this exception)
  • Selling donated merchandise: Your activity involves selling merchandise which was donated or gifted to your organization
  • Bingo: Bingo should probably get its own post, but the exception applies in bingo games where you complete a pre-selected pattern on a card (5 in a row is most common) to determine a winner, and wagers are made, winners are determined, and prizes are awarded simultaneously.

One more thing about bingo: don’t forget that bingo games may be regulated by your state or local government! You may need to apply for permits or register–or you might not be able to do it at all.

In addition to those exceptions,

Unrelated business income is an easy issue to miss–every time you consider a new fundraising activity, you should always take a moment to consider if this activity will create UBI for your organization.

Selecting Board Size: How Big Should The Board Be?

It’s one of those questions that sometimes seems to sneak up on new organizations (and sometimes troubles existing organizations too): how many people should we have on our board? Board size can affect your organization’s effectiveness, so we need to get it right.

Make Sure You Have the Minimum For Your State

Most states require 3 directors minimum, and most of the others require just 1. This number is a minimum; your organization is welcome to have more directors. In fact, it probably should have more directors; 3 people will have difficulty managing all but the smallest organizations.

There are no maximums; some boards have memberships over 20 and even into the 30s. I think that’s probably too many for most organizations.

Goldilocks and Board Size

Just like Goldilocks found the three bears’ beds were too hard, too soft, and just right (and was awfully picky, seeing as she let herself in), I think there’s too big, too small, and just right when you set up your board. Both the bare minimum size and the 20-30 member board are probably not the right choice for most organizations. Something in between those extremes, somewhere between 7 and 15, is probably best in most cases.

A board that’s too small can cause problems. The value of having numerous board members is that different board members have different perspectives. Board members with varying perspectives see problems and come up with solutions in different ways, and that’s not something you want to miss out on. Small boards make it more difficult for a quorum to be present, and can lead to more tied votes if you have an even number present.

Small boards may also have trouble staffing committees within the organization. Committees are not required, but they can help organizations address specific issues in the organization. Committees, whether permanent or temporary, often work on finances, fundraising, membership, and other issues.

Boards that are too large can quickly become unwieldy. When a proposed action comes up, board members may want to debate the matter, and if ever board member wants to speak on an issue, and you have a large board…well, your meetings could get really long, really fast. In such a large group, it’s also easier for board members to become disengaged with their duties, figuring someone else will bring up or deal with important topics.

Odds or Evens?

I usually advise organizations to have an odd number of members on the board. The obvious reason for this is to avoid ties. Of course, this is not a foolproof method of avoiding a tie; someone could abstain from a vote or not be able to attend a meeting. Still, I can’t see planning a situation to foster tied votes, like boards with even numbers of members.

What If I Have More People Interested in Serving Than I Have Board Positions?

First, be grateful to have so many people interested in leading your organization! Many organizations, especially in the startup phase, would love to have this problem.

Second, I don’t recommend expanding the board to add everyone that’s interested. People get burned out on board service, move away, have other things come up in their lives…and they may need some time away from board service. Also, your by-laws may require board members to take time off after a certain time on the board. In those cases, you could wind up with more positions than board members very quickly.

Instead, I suggest having those interested people serve in other capacities–committees, volunteers, that sort of thing. You want to keep them engaged in the organization. As you need new board members, you can start with these folks.

Board size is one of the first big decisions a new organization makes, and for most organizations, using Goldilocks as our guide–not too big, not too small, but just right–is what we want to strive for when it comes to board size.

10 Tips For Writing an Effective Form 1023

For folks that are starting a 501(c)(3) organization, preparing Form 1023 is usually a pretty daunting task. I’ve prepared a few of these, and it can take significant time and work to really prepare the form properly. Ideally, you want to get the application through on the first try, and limit the amount of follow-up and supplemental information you have to provide. There’s no guarantee or magic formula for getting your 1023 approved (and approved quickly), but there are things you can do to improve your chances:

#1: Write a complete, detailed response to Part IV, Narrative Description of Your Activities.

Here’s the most important question on the application:

Part IV

You’ll want this description to be as complete as possible; the way I like to think about it is that you want to give the IRS reasons to approve your application. Here’s what you need to work through:

  • What does your organization do–past, present, and future? If you’re a really new organization, and you haven’t done much, that’s okay, you’re just going to have an answer that is more forward-looking.
  • Use the 4 Ws & 1 H: Who performs your activities? What are the activities? When do you perform the activities? Where do you perform the activities? How do you perform the activities. The IRS suggests this approach, and I think it makes a lot of sense.
  • Align your activities with your charitable purposes. Remember, 501(c)(3) organizations have to be organized for one (or more) specific purposes: charity, education, literary, religion, science, testing for public safety, fostering national/international athletic competition, and preventing cruelty to children/animals. Your activities should be fulfilling those purposes.
  • Take the opportunity to brag about what you do. This is a great chance to tell people what you do–if you’re approved, this is public record. I don’t know that many people will look at your completed Form 1023 after approval, but to the extent people do look at it, it gives you a chance to tell the public what you do.

#2: Make sure you attach answers whenever necessary.

Most of us are used to filling out IRS forms–fill in the blanks, check the boxes, and you’re done…Form 1023 isn’t like that. Often, the form will ask you to attach answers that explain in greater detail. Here’s an example:

Attach stuff

When the form tells you to “explain” or “describe,” you’ll need to attach an answer to your application.

Extra tip: When I prepare a 1023, I answer the questions on the form, and as I answer the questions, I make a list of every additional response I have to attach. When I finish preparing the form, I use the list to make sure I didn’t miss any needed responses. This has been effective for me, and it might help you not miss anything as well.

#3: Provide supporting documentation.

If you’ve produced documents to accomplish any of your exempt purposes, include that material. Provide an annual report to your donors? Have an application for your scholarship program? The IRS often looks for these sorts of documents, and if you’ve got them, it’s helpful to include them.

That said, don’t provide anything you wouldn’t release to the public.

#4: Look up terms that the IRS defines for you.

If you look through Form 1023, you’ll notice there a lot of bolded terms. Any time you see a term in bold, that means that the IRS has a definition for that term in the Instructions for Form 1023. The instructions are a separate document from the form itself. Here’s an example:

Compensation Question

Notice that the word “compensation” is in bold. If you went into the instructions, you could find a definition for compensation. Lo and behold, here it is:

Compensation Definition

Notice that “compensation,” for our purposes here, goes way beyond salary or wages, and includes some items you might not have otherwise thought of. This is why I suggest that even if you think you know what a word means, if you’re doing your first 1023, you should look up just about every bold term, so that you understand the question you’re answering.

#5: Read the first few pages for changes or adjustments to the form.

Updating any document, I suspect, is kind of a pain for the IRS. So, instead of releasing a new form each time they make a change, they sometimes put changes to the form at the beginning of the form. Unfortunately, most people skip right over that stuff and get to the first page of the form. Don’t do that! You’re only going to guarantee yourself follow-up questions from the IRS (or other problems).

For instance, as I look at the form today, here are the changes mentioned in the first couple of pages before the form itself actually starts:

  • There’s a new mailing address to send the application to; the one listed on page 28 is not the correct address (that seems important);
  • Advance rulings are no longer available, even though the form says they are;
  • The amount of financial data you must provide has changed;
  • You should skip certain lines in Part X about public charity status; and
  • The user fees have increased.

Those changes are significant; missing something like that could cause some problems and delays for your application.

#6: Make the best financial projections you can in Part IX.

For a new organization, completing Part IX (the financial data section) can be very difficult. New organizations don’t have a lot of data, but the IRS requires them to make projections. Your projections don’t have to be perfect, but they do need to be made in good faith.

But how can you make good faith projections? First, do some research–are there similar organizations to you that might be willing to help you make projections? Second, consult with professionals that have experience with nonprofit budgeting–an accountant who works with nonprofit organizations might be particularly helpful here. Additionally, if you or others in the organization have experience with budgeting, that should help as well.

Also, doing these financial projections is a useful exercise, and you should treat it that way. You should do some financial planning as part of the startup process, and you should know how much money you need to raise to fund your work.

#7: Include your organizing documents.

There are a few different types of organizations that can apply, most commonly nonprofit corporations and trusts. For a corporation, there are two important documents to submit: your articles of incorporation (or something similar–the exact terms might vary from state to state) and your by-laws. You’ll also need to include any amendments made to these documents.

The IRS uses these documents to determine if your organization is set up in compliance with the requirements of 501(c)(3) organizations. In particular, they’ll be looking for language that limits your organization’s activity to the 501(c)(3) exempt purposes we discussed earlier and that requires the organization’s assets be given to another 501(c)(3) organization when your organization dissolves.

#8: Don’t forget the schedules.

Form 1023 contains eight different schedules that might apply to your organization. Here are the schedules:

  • Schedule A: Churches
  • Schedule B: Schools, Colleges, and Universities
  • Schedule C: Hospitals and Medical Research Organizations
  • Schedule D: Section 509(a)(3) Supporting Organizations
  • Schedule E: Organizations that Have Not Filed Form 1023 Within 27 months of Formation
  • Schedule F: Homes for the Elderly or Handicapped and Low-Income Housing
  • Schedule G: Successors to Other Organizations
  • Schedule H: Organizations Providing Scholarships, Fellowships, Educational Loans, or Other Educational Grants to Individuals and Private Foundations Requesting Advance Approval of Individual Grant Procedures

Of course, not all of these schedules will apply to your organization, and it’s entirely possible that none of these schedules will apply, but if one (or more) of these applies, make sure to complete each schedule that does.

#9: Don’t release any social security numbers in the application.

I have no idea why this is a problem–the form never asks you for a tax ID other than the nonprofit organization’s–but the IRS reports that SSNs show up fairly regularly in applications. SSNs from directors, officers, volunteers, staff, and donors have shown up in applications. They should not be in there, and they certainly shouldn’t be released publicly, so do not include them. Simple as that.

#10: Use the checklist to make sure you’ve got everything.

At the end of the application, there is a checklist reviewing everything that you need to submit. It’s there to help you–take advantage of it! You’re much better off finding anything you missed before submitting rather than having the IRS request it later.

Photo credit, Kaitlin Gentry, via Unsplash.com, licensed under CC-0

Tea Party Class Action Wins in Federal Appellate Court

Last week, the U.S. Court of Appeals, Sixth Circuit (which covers Michigan, Ohio, Kentucky, and Tennessee) ordered the IRS to produce discovery (the pre-trial exchange of information between the parties in a lawsuit) required by the trial court in an ongoing legal battle with a class of conservative and “Tea Party”-related organizations.

If you’re new to this story–or if you’ve forgotten about it, because it’s been off the radar for a while–Forbes contributor Kelly Phillips Erb (or “taxgirl,” as she’s often known) has a pretty good timeline here. The short version is that after the Citizens United decision, there was a dramatic increase in applications for tax-exemption under Section 501(c)(4) of the Internal Revenue Code. That’s because Citizens United held that the government cannot prevent a nonprofit corporation, for-profit corporation, or a labor union from making “independent political expenditures,” which are expenditures on statements supporting or opposing a political candidate but is made independently of any candidate’s control or cooperation. (Note: That’s not the same as requiring the government to subsidize that speech with a tax exemption, though, which is why 501(c)(3) organizations can lose their tax-exempt status for political speech. Even with 501(c)(4) organizations, political activities must be an insignificant part of their activities.)

These organizations allege that the IRS treated applications from conservative groups unfairly. The IRS specifically looked for applications with terms such as “Tea Party,” “9/12,” and “Patriots,” as well as those advocating positions on taxes and government spending. Those applications were either delayed or subject to pretty heavy requests for information from the IRS. Indeed, the Treasury Inspector General for Tax Administration found that the criteria used were inappropriate. As the Sixth Circuit points out, charges that the government has targeted its own citizens for mistreatment based upon those citizens’ political viewpoints are a serious matter.

As part of the discovery process, the plaintiffs (the organizations alleging mistreatment) wanted to find out what organizations were screened out by the IRS’s “Be On The Lookout” lists, which the IRS has, up to this point, resisted turning over. The Sixth Circuit rejected the IRS’s request to avoid turning over this information in clear terms:

“The lawyers in the Department of Justice have a long and storied tradition of defending the nation’s interests and enforcing its laws—all of them, not just selective ones—in a manner worthy of the Department’s name. The conduct of the IRS’s attorneys in the district court falls outside that tradition. We expect that the IRS will do better going forward. And we order that the IRS comply with the district court’s discovery orders of April 1 and June 16, 2015—without redactions, and without further delay.”

As Nonprofit Quarterly explains, this most likely opens the door for depositions of IRS officials involved in this matter, and depending on the facts that come out of those depositions, this controversy may find its way back into the limelight.

Photo credit, Siyan Ren, via Unsplash.com, licensed under CC-0

Is Starting a Nonprofit for You?

“This dream of theirs is just that. Most of them don’t even have anything written down that they can present to me. They don’t have even a starting point yet. But they have the passion. They have the dream.”

Jim Maltry, SCORE Cincinnati

And many times the people who have the dream do not wind up creating a nonprofit. I agree with the article–that’s not necessarily a bad thing–but it’s important to understand why that is and how you can go from dream to functional organization.

Is the nonprofit itself a good idea?

Starting and running a nonprofit organization is a lot of work, and I think it makes sense at the beginning to decide whether or not what you want to do will work. If you’re thinking about it, I recommend asking yourself these questions:

1. Do you do something unique compared to the other organizations around you?

Often, people think of non-profits as somehow separate from the world of business. I don’t see it that way. Nonprofits have to deal with many of the same issues for-profits do, and one of those issues is competition. If you duplicate something that an already-established organization does, you might be better off working with them instead. Duplicate organizations compete with each other for donors and grant dollars, and that may lead to each organization being less effective than it could be without its competitors.

2. Is this organization aimed at a recent disaster or tragedy?

Sometimes a tragic event can cause an outpouring of support and assistance. There are others who disagree with me on this, but I’m generally not a fan of creating an organization in response to a specific event. Here’s why:

  • Other relief organizations already have assets in place to assist; if the disaster spurred you to create an organization, odds are you probably don’t.
  • Putting together an organization takes time. Governance structures, legal entity creation, and tax-exemption application are all important steps, and it really can’t (and even if it can, it shouldn’t) be done overnight.
  • Organizations that appear in response to a disaster are more likely to be scammers. Obviously, not everyone falls into that category, but that perception can hinder your efforts.

Short version: when a disaster or tragedy occurs, help through reputable, established organizations.

 

3. Do you have a plan?

I think that business plans can be helpful for a new (or established) business. It’s not so much that I think you need to have this pretty report with cool charts and graphs, but rather that putting together the business plan is serious work. It forces you to think about your business, and seriously answer questions like:

  • What is my business going to do?
  • Who will my business help?
  • Who is going to buy my product?
  • How will my customers know I exist?
  • How much money does the business need to keep running?
  • Who is going to run the business?
  • What competition does my business face?

Those questions, with minor modifications, can be asked of non-profits quite easily:

  • What is my organization’s mission?
  • Who will my organization help?
  • Who will donate to support my organization’s mission?
  • How will my organization’s potential donors and potential clients know I exist?
  • How much money does the organization need to accomplish its mission?
  • Who will be responsible for leading the organization?
  • What other organizations are doing the same thing my organization is doing?

I think that even if you don’t put together a pretty report with cool charts and graphs, I recommend writing your answers out. Putting the answers in writing focuses and clarifies your answers.

Is starting a nonprofit a good idea for you?

Also, starting a nonprofit organization isn’t for everyone. If you’re going to lead the organization, here’s what you should be asking yourself:

1. What skills do you and the other people involved bring to the organization?

In the early days of an organization, the people running the organization are usually the people that are working directly on doing the work. Later on, you might have people that manage the organization, staff, and volunteers, but in my experience, it usually doesn’t start that way. However, the startup phase is where a lot of the groundwork is laid–so the skills of you and your team are very important.

What kind of skills should you be looking for?

  • Management: At the board level, you want to have someone who can make high-level management decisions. In the beginning, those same people might also need to be able to lead others, both staff and volunteers.
  • Fundraising: Almost every mission requires some money to be accomplished. Without money, an organization is bound to fail. People with connections throughout the community and the ability to raise funds are vital to almost every organization’s success.
  • Finance: That money you need to bring in needs to be tracked. Even if you need help creating financial reports, it’s important to have people that can understand them on board.
  • Legal: Organizations can run into a variety of legal issues. It’s great to have your very own expert on board, or at least someone who may be able to recommend outside lawyers.

2. Have you (or at least someone involved in your organization) done work in the area you want to serve already?

If your organization wants to complete a certain mission, it’s reasonable to expect someone in the organization to have some experience executing the mission. This will help you understand what resources you need, the logistical issues you face, and the challenges of completing that mission. If the answer to this question is “no,” maybe now isn’t the time. If you don’t have this, you might be better off volunteering for a similar organization to learn about how to better fulfill your mission.

3. How will you support yourself during the start-up phase?

When you start a for-profit business, money doesn’t just appear out of nowhere; you need customers who want to trade money for whatever you sell. It’s a similar idea for a non-profit; money won’t just appear. You’ll have to get people to donate, and to do that, they have to believe that you will handle their donation wisely. That requires trust, and that doesn’t appear overnight either. I’d suggest to you that’s even harder than starting a business, because when you accept a donation, you have nothing to give in return. Money may be hard to come by early on in the organization’s life, and if you plan to work full-time for the organization and be paid, you may find life very difficult in the early stages.

Starting a nonprofit organization is not impossible, but it does require an honest assessment of your chances of creating something successful. If you’re gone through this assessment and you are confident in your project, then you likely have a good foundation for success. If not, you may need to make some adjustments before going forward.

Note: An earlier version of this post originally appeared on my firm’s website, attorneykevinkelly.com. I have updated the post for posting here. Enjoy!

Photo credit, Tim Gouw, via Unsplash.com, licensed under CC-0

Documentation Requirements for Donors Making Donations of $250 or More

Note: An earlier version of this post originally appeared on my firm’s website, attorneykevinkelly.com. You can read the the post about $250 contributions here, and the post about $75 contributions here. I have updated and revised both posts for posting here. Enjoy!

If you run a 501(c)(3) organization, one of the important benefits your donors enjoy is the ability to deduct their contributions on their taxes. In certain cases, the IRS requires the organization receiving the donation to provide donors with written acknowledgements of the contribution. It’s not difficult, but it is critically important for your donors.

There are two situations that require written acknowledgement from charities:

  • Any contribution of $250 or more, and
  • A contribution of $75 or more when the donor receives goods or services in exchange.

Contributions of $250 or More

If a donor makes a single donation of at least $250 to your organization, the donor needs a contemporaneous written acknowledgement of the contribution. The acknowledgement must contain:

  • The name of your organization;
  • If any money was contributed, the amount of money donated;
  • If there was a non-cash contribution, a description of the contribution (but you need not provide the value);
  • If no goods or services were received by the donor, a statement saying that;
  • If goods or services were received by the donor (more on that in a moment), a description and a good faith estimate of the value of the goods or services; and
  • If only intangible religious benefits were received by the donor, a statement saying that.

What is “contemporaneous?” You don’t actually have to provide the acknowledgement immediately–it’s “contemporaneous” as long the donor receives it before the donor files his or her tax return or the due date (plus extensions) for filing the tax return. Because taxpayers may still be getting W-2s through the end of January, January 31 of the year following the year of the contribution is about as late as I’d want to wait.

As a practical matter, though, why wait that long? I think it’s probably best to issue written acknowledgements shortly after receiving the donation so you don’t forget later. If you do wait, you may wind up having a bunch to issue at once (that doesn’t sound fun) or you might miss the deadline, which will disqualify those donations from deduction (which makes for angry donors, which also doesn’t sound fun).

Above, I mentioned that if there were goods or services received by the donor, a description and good faith estimate of the value of those goods or services is required. There are a couple exceptions to that rule:

  • Low-value items. I like to think of this as the “tote bag” or “coffee mug” exception. An item qualifies for this if:
    • The fair market value of the benefit received no greater than 2% of the donation or $106 (the $106 part is adjusted each year for inflation–that’s the 2016 value), or
    • These three things are true:
      • The donation is at least $53 (again, that’s inflation-adjusted, and $53 is the value for 2016),
      • The only items provided bear the organization’s name or logo, and
      • The cost of the items is within the limit for “low-cost articles,” which is $10.60 for 2016 (and is also inflation-adjusted)
  • Membership benefits. If members get some sort of benefit for an annual payment of $75 or less, it doesn’t count as substantial. For instance, free/discounted admissions, parking, or gift shop discounts for members would qualify under this exception.

One of the great things the IRS does in Publication 1771 is to give you clear examples of acknowledgements that follow the rules:

Cash contribution, nothing in return:

“Thank you for your cash contribution of $300 that (organization’s name) received on December 12, 2015. No goods or services were provided in exchange for your contribution.”

Cash contribution, something substantial in return:

“Thank you for your cash contribution of $350 that (organization’s name) received on May 6, 2015. In exchange for your contribution, we gave you a cookbook with an estimated fair market value of $60.”

Non-cash contribution:

“Thank you for your contribution of a used oak baby crib and matching dresser that (organization’s name) received on March 15, 2015. No goods or services were provided in exchange for your contribution.”

 

Contributions of $75 or more where the donor receives goods or services in return

From the point of view of a charitable organization, this documentation requirement is different than the “$250 disclosure” in a very important way: failure to provide written documentation when a donor contributes more than $75 and receives something in return results in a penalty to the charitable organization. The penalty is $10 per undocumented contribution with a cap of $5,000 per fundraising event or mailing.

The reason the IRS is so interested in whether or not a donor receives goods or services in return for a contribution because that affects how much of the contribution is deductible. If a donor receives something in return, the value of whatever he or she received is not deductible. For example, if a donor donates $200 to a charitable organization, and gets an item in return that is valued at $50, only $150 of that contribution is deductible.

The written statement has to have two additional key pieces of information:

  • A statement informing the donor that, in the words of 26 U.S.C. 6115(a)(1), “the amount of the contribution that is deductible for Federal income tax purposes is limited to the excess of the amount of any money and the value of any property other than money contributed by the donor over the value of the goods or services provided by the organization,” and
  • A good faith estimate of the goods and/or services received.

A “good faith estimate” is exactly what it sounds like: a fair estimate of what the goods or services provided were worth.

The disclosure must be made either during the solicitation or once the contribution is received, and the disclosure has to be made in writing that would be sufficient to get the donor’s attention.

There are also a couple of exceptions to this rule. A written disclosure is not required when:

  • The “low-value item” (or as the IRS calls it, the “token” exception) or “membership benefits” exceptions that we discussed earlier apply,
  • The only benefit consists of intangible religious benefits, or
  • There’s no real donative intent involved–the classic example is a sale of an item at a gift shop, it’s not really a donation, it’s more like a retail sale.

Beyond the legal stuff: donor communication

These acknowledgments don’t have to be bland, “let’s meet those legal requirements” boring stuff. Donation acknowledgements are a great way to deepen your relationship with your donors and help them feel like they’re supporting a great cause–because they are, right?

I’m a blood donor (I know, I talk about this a lot, but stick with me here). Every time that I do a donation, the blood center sends me an e-mail, thanking me for my donation and telling me that my donation helped save lives, and they usually provide an example patient–usually a cute, smiling kid that needed blood. It’s not a legal requirement, but they want me to feel good about my donation and encourage me to keep coming back in the future. You have to communicate with the donor anyway, why not use it to meet the legal requirements and deepen your relationship with the donor?

Photo credit: Volkan Olmez, via unsplash.com, licensed under CC-0