Advising Clients on Starting a Charity
As 2020 ends and 2021 begins with little relief in sight from crises affecting our region, more and more attorneys, accountants, and financial advisors are fielding questions from well-intended clients who are exploring starting their own nonprofits to help people in need.
Whether a client’s passion is health care access, support for the arts, social justice, or any one of hundreds of other worthy causes, it’s critical that you provide counsel regarding the pros and cons of forming a brand new nonprofit.
Here are suggested topics to include in your client discussions:
- For profit, or nonprofit? Help your client decide whether they really, truly want to
start a charity, or whether what they are envisioning would be better structured as a for-profit business. Explain to the client that the rules and tax advantages are different, and so is the way the enterprise is funded. Most charities keep the lights on by securing donations. Businesses keep the lights on by selling goods or services. Either way, you need to hire and pay employees, and prepare and follow a budget. This seems like common sense and something that any astute client would understand, but sometimes even these basic principles are easy to overlook when enthusiasm for a cause takes over.
- The State and the Feds. Explain to the client that if they do decide to start a new charity, just like a business, it still requires setting up a legal entity. Unlike a for-profit business, though, to qualify as a tax-exempt nonprofit, the client will need to apply to the Internal Revenue Service for an exemption under Section 501(c)(3). This exemption is what allows the organization to be free from paying income tax, and it also allows people to donate to the organization and be eligible for a tax deduction on their own tax returns. Again, these rules seem like Charity 101 material, but never assume your client is in the know.
- Sell, sell, sell. Most people who start a charity are passionate about a cause and probably already have programs in place or in mind to help others. The trick, though, is to get out there and share the news about the cause to raise money. Your client needs to be aware that starting a new charity involves “sales,” just like a for-profit enterprise, except they most likely will be asking for donations to support their good work instead of selling goods or services like a for-profit business. Certainly nonprofits can generate earned income, but most organizations also should be designed to receive public support in the form of grants and contributions to avoid certain tax rules, such as those prohibiting excess “unrelated business taxable income”, or “UBTI”.
- Verify the unmet need. Finally, and perhaps most importantly, encourage your client to research whether there are any existing organizations that are already serving the mission your client intends to fulfill. Indeed, during challenging economic times such as these, best practices suggest that two or more nonprofits combining their efforts is a good way to create efficiencies and ensure more effective service delivery to people in need. Clients may consider using an established non-profit as a fiscal sponsor, if organization missions align.
- Private Foundation or Donor Advised Fund? If, after considering all the above, your client chooses to move ahead with the formation of a charitable entity, consideration should be given to the legal structure selected to carry out their charitable intent. Do they really need to set up an entity that will require daily oversight? File its own tax
return? Meet the legal requirements of a corporation in good standing? Or is the motivation simply to raise and distribute funds to a worthy mission? If the latter, a Donor
Advised Fund (DAF) is a much easier and simpler way to secure an immediate tax benefit while creating a vehicle that will serve the client’s need. And it can be named in such a way as to appear to be a Private Foundation. Donations to other 501(c)(3) charities can be made anonymously as well, another advantage of DAFs.
As you know, at the Greater Cincinnati Foundation, we encourage anyone considering making a charitable gift for tax purposes to consult their tax advisor to discuss the best approach. As clients reach out to you, we are here to assist you!