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Section 4. Understanding Nonprofit Status and Tax Exemption

Example 1: Filing for 501(c)(3) status by the Lawrence (KS) Partnership for Children and Youth

Sydney Karr is the executive director of Lawrence Partnership for Children and Youth in Lawrence, Kansas. Her group, a non-profit corporation, applied for charitable exemption from federal taxes. "The 501(c)(3) status does a couple of things for you ," Sydney said. "The first thing is that it saves you money because you don't have to pay state income tax or federal income tax. The second thing is that it allows you to solicit more donations (because donors don't have to pay taxes for charitable contributions). To many donors that makes a big difference." Sydney also points out that a 501(c)(3) status can be beneficial in terms of purchasing insurance for the corporation, and in terms of state and their unemployment compensation. "Legally, you are a different kind of entity," she said. And that difference can bring benefits to your organization.

Sydney started her application using an example of another organization who had applied, so that her organization would have a sample of the way they should answer questions. "My accountant has alerted me that when you send this paperwork in," Sydney said, "the federal government will send back questions. It could be a series of questions, and quite often they send you a second series of questions and then you answer those . About the third time you send them something, they send you a letter saying you got it." That is standard practice, according to Sydney's accountant. No matter how thoroughly you fill out the paperwork, or how well you think you've done it, they will always have questions for you. And it's not a matter that they're not going to grant you the status, it's just that they always have questions, Sydney said.

So is it necessary to have both an accountant and a lawyer working on your application? Not necessarily, but in Sydney's experience, she got some legal advice from her lawyer, and then worked closely with her accountant. Her attorney, who works for free, said that if he just sent an example from his files from another organization to Sydney, she probably wouldn't have to come back to him for other questions. "It really is my intention to go ahead and do all of the paperwork myself," Sydney said . "But in the meantime, I was talking with our accountant, because he's the person who really knows both the federal and the state regulations, and he has really kind of pointed out to me the need for the 501(c)(3) status."

Getting 501(c)(3) status can help your organizations in more ways then one. Sydney offers an example about when her organization was trying to get directors and officers liability insurance. That's a way to insure the members of the board of directors against personal liability for the decisions that they make on behalf of the corporation , referring to director's and officer's liability in medical or treatment settings. "For instance, if a client or a patient says that he was harmed as a result of what this not-for-profit corporation did, then he could sue the corporation and each individual member of the board of directors," Sydney said. "The board of directors could actually have their own money at stake. I was trying to check into what the cost would be and get some quotes on the insurance. And one of the insurance companies that I was trying to get the quote from would not even give it to us until we had proof of our 501(c)(3) status. That was kind of an interesting kind of sideline that came up."

And that was not the only one. Sydney remembers when her organization was dealing with the state of Kansas on unemployment compensation insurance. Even though Sydney's corporation is a very small one with only three employees, the board decided that they would like to insure any members of the staff against being unemployed, having that state benefit available to them. "In trying to buy into that, and pay into the unemployment compensation fund, I just learned that we have to have 501(c)(3) papers pending at the very least," Sydney said. She ended up not needing the directors and officers liability, because they are not seeing patients.

"One of the things that is very confusing to people," Sydney remarked, "is the fact that when you say you're tax exempt, many vendors believe that means that you don't pay sales tax. I believe there are a few states where this is not the case, but in Kansas and in many states, just because you are tax exempt from income taxes and have that 501(c)(3) status, it does not exempt you from sales taxes." This can be tricky, because some business may set your business up as sales tax exempt, and then they will come back and ask you for your proof of sales tax exemption, when you might hot even had known they had you down as such. That's happened to Sydney. "I just discovered that a bill [that] was $50 and the amount owing was $50." And I said "that's not right, there's no taxes there." And they said "well, you're a non-profit." We know we are, but we pay sales taxes."

Sydney has experienced some hassles in filing her organization forms. She said that, when dealing with a lengthy federal form like the 501(c)(3) application, you may not know what it is they're asking for in each blank, and it might be helpful to look at an example of someone else and the way they've filled it out. Some of the regulations are very specific, and learning exactly what they are asking for before you submit the application can save an organization many headaches.

Example 2: Creating Affirm Youth, a nonprofit organization serving gay youth in Greenville, South Carolina

Recounted by Paul Evensen

I didn't have "start a nonprofit organization" on my list of things to do in life, and I don't think that is why any of us tackle something so overwhelming and challenging . What happens is that you become either very angry or very sad about what is going on in your community. Then, you get excited about what you could do to change things, and you end up half way into it before you know it.

I was compelled by the stories of several young people in my community who had been thrown out of their homes as teenagers because their parents discovered they were gay. The driving question became, "How can we keep families together and gay teens connected to school, churches and their community?" Part of the answer was to start a non-profit organization dedicated to crisis intervention, advocacy, and support.

I spoke with at least a hundred people including pastors, teachers, counselors, leaders in the gay community, parents, and representatives from the whole spectrum of social service agencies. I shared my ideas and solutions and asked for their feedback and suggestions for next steps and who else I should talk to. Most importantly, I asked for their personal commitment.

Through this process I found a fellow "preacher" who could see my vision and was willing to take a primary role in helping bring it about. It turns out he was a preacher in real life and he eventually became the full-time director of the agency . I also found those willing to shoulder key leadership roles on the board. We held a public meeting and announced the new organization, the name, logo, mission, the newly formed board, and the director to a very surprised community.

From there, it was a team effort to put a fund-raising plan together, to further develop the board, to create appropriate services, and to begin outreach.

I would offer several lessons to anyone trying to create a nonprofit:

  • Get legal help early. Preferably, find a volunteer with experience in both nonprofit administration and the subject area your group deals with.
  • Network quickly and nationally. Go to a national meeting of similar agencies and ask, ask, ask and ask again for what you need. This is where I found free legal help, as well as mentors from neighboring states and cities who could offer invaluable advice.
  • It is not about you. It is about the issues and needs that draw us to common action. Many will want to make it about people, personalities, and politics. To counter this always focus on ideas and vision, and surround yourself with key people who do the same.
  • Involve new young leaders. The work is very often not about the needs your organization is going to meet. Rather it is about giving the community a chance to learn and act. This includes new opportunities for young leaders to gain skills and experience. Give them a chance and pair them up with a mentor. They'll be running your organization after you're long gone.

Extending yourself to others is the heart of service. Seeing families changed because of work you've done will give your soul immeasurable rewards and an amazing energy to do more.

Example 3: A Sample Letter of Determination from the IRS

What follows is the text of an actual letter of determination. Special thanks to the United Way of Douglas County, Kansas, for furnishing and allowing the printing of this letter.

Internal Revenue Service
Department of the Treasury

1100 Commerce St.
Dallas, TX 75242

Person to contact: First read Tax Examiner
Telephone Number: (214) 767-1870
Refer Reply to: EP/EO:SBP:495ODAL

Date: May 07, 1986

United Way of Douglas County, Inc.
PO Box 116
Lawrence, KS 66044


Our records show that UNITED WAY OF DOUGLAS COUNTY, INC is exempt from Federal Income Tax under section 501(c)(3) of the Internal Revenue Code. This exemption was granted AUGUST 1973 and remains in full force and effect. Contributions to your organization are deductible in the manner and to the extent provided by section 170 of the Code.

We have classified your organization as one that is not a private foundation within the meaning of section 509(a) of the Internal Revenue Code because you are an organization described in section 170(b)(1)(A)(vi).

If we may be of further assistance, please contact the person whose name and telephone number are shown above.

Sincerely yours,

Theresa Nelms