Tuesday, February 24, 2015

Understanding the language of nonprofits

With all the press about how bad things are, it's comforting to know that we still have a human need to help, to make things better.

A lot of awfully nice people out there want to do really nice things for people. If there is a perceived need, there is almost always someone who wants to fill it, and most of them feel that starting a nonprofit is the way to do that.

Doing those nice things effectively is not so clearly defined.
One of the first obstacles that greets many people is understanding what it takes to legally become a tax-advantaged nonprofit.
One of the core principles is that any non-profit must operate for the "public" good. The problem is that the term "public" doesn't just mean "for someone's benefit other than the founder(s)."

Benefitting just one person or a few families isn't what the term implies. When used in the strictest legal sense, it means to benefit a class of beneficiaries.  For instance, the class could be low-income children or victims of domestic violence.  The class can be geographically localized, such as low-income children in a specific city, but the mission has to be inclusive enough to have a wide-ranging impact within that geographic border.

Case in point.  One person sees a young person who needs assistance in paying for college, and wants to start a charity to benefit that one person.  That's not "public". It's targeted to that one specific beneficiary. Although the mission is purely philanthropic, it would not qualify to receive tax-exempt status.

Another person sees that low-income children in general have a hard time finding money for college.  The proposed charity is meant to acquire funds to help children in that area immediately, and any subsequent qualifying children going forward in time. Although these children may live within a specific area, such as a city, town or county, the mission is aimed at all of them. The potential area of impact might be a population of several thousand.

The latter is defined as operating in and for the public (general) good.

Another example of a non-qualifying charity would be one that exists to  benefit the founders in some way. One of the most common requests I get is for people who want to generate personal income by starting a charity.

It doesn't work that way. Once you start a charity, any funds collected belong to the public.

For instance, a person owns some undeveloped property and needs to derive income from it.

The person decides to start a charity and rent the land to urban farmers. Although on the face of it  the charity could claim that it was promoting healthy nutrition, the underlying principle is to generate income for the founder. If the rental income is principally used to pay a salary to the property owner, it is not being operated "for the public good"  in the sense that the law intends.

One of the thinnest lines any charity has to walk is the one involving use of funds. Funds have to be used primarily to advance the purpose for which they were collected. An awful lot of the legislation generated around charitable giving is to assure that the "public" derives the maximum benefit from the collected funds. Some states have even proposed legislation requiring charities to spend at least 60-80% of the funds for direct program costs, not administrative funding.

While that doesn't preclude a founder taking a salary from the charity, the salary has to be for the advancement of the mission, not to provide a job for the charity's key personnel.

You can't "sell" a charity or its assets in the way you do personal or traditional business property, i.e. for personal profit. All proceeds have to be used for the "public" good, such as by donating the assets or the proceeds of any sale of them to another charity.

These are just a few of the things that potential nonprofit founders have asked me when contemplating starting a charity of their own.

If you need more information or would like to contact me about your nonprofit plans, drop me a line at rightwords@ida.net.

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