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Do I Need 501(c)(3)
I go through the same set of questions with every client who wants to set up a 501(c)(3) charitable organization, so I thought it would be helpful to others who might be interested in starting a charity in the near future.
Does your company need to be nonprofit?
If you don't have an income at the end of the fiscal year, you might not need to be a nonprofit. The primary benefits of a nonprofit are the lack of taxation at the end of the fiscal year, and the ability to become a charity. If your company shows $0 in earnings at the end of the year, you will report $0 on your business tax form and then pay a certain percent of $0, the result being that you pay no tax. However, if you pay any amount as payments for equity or ownership, such as dividends, those payments will not be deducted from your taxable income and you will be taxed on that portion. That's fair, however, because nonprofits are forbidden from making payments such as dividends to owners or equity holders. Loan payments, employee wages and ordinary expenses are all still allowed as long as they are reasonable and not set up to be a fraudulent way to take money from the company.
Does your company have a charitable purpose?
There are a finite number of general purposes allowable under 501(c)(3). If your company does not fit into one of these, then it will not qualify as a 501(c)(3), so there will be no point in pursuing the application. Furthermore, your company must be restricted to performing only these charitable purposes, so if your company has a dual purpose, you might want to consider two companies instead. Some of these purposes are: religious, educational, charitable, scientific and literary. These are fairly ambiguous terms, but they're defined in greater detail in regulations and through the Internal Revenue Code itself.
Does your company rely on donations?
The real reason people choose to become 501(c)(3) charitable organizations is that it allows the donors to deduct their donations from their federal taxes. If your company doesn't rely on donations, it may not add any value to apply for 501(c)(3) status.
Is it worth it to apply for 501(c)(3)?
It costs $300 for companies with average revenues less than $5,000 and $750 for companies with greater than $5,000 annual revenue just to file for recognition with the IRS. That means, by having this 501(c)(3) status, you will need to bring in $300 or $750 more in donations to make up for the filing. Sure, having 501(c)(3) status gives some branding and some legitimacy to a nonprofit, but financially speaking, it might not be worth it. Furthermore, unless you do it yourself or find someone who can do it for you for free, the application process is a long and expensive one. I'm not saying I condone the practice, but some attorneys charge more than $10,000 to fill out and file the application for you.
Will your 501(c)(3) last?
It takes about 9 months from start to finish to start a charity, mostly because the application process with the IRS takes a very long time. If your cause is short lived, or you don't have the financials in place to make it 3 years, you may want to re-look at your finances to see if 501(c)(3) is right for your company. It's not surprising that most nonprofits fail since most businesses in general fail. Would you rather dedicate the capital to keeping your company alive, or to making it a charity?
Would your cause be better as a for profit?
I know, charity makes everyone feel so much better about themselves; however, many things are done better as a for-profit entity. This may stir some political debate as to what operates better as a for-profit, but there are industries and business models for which this is true. One of the key points of interest is whether you want to seek out investors or donors. For example: Amazon.com could just as easily been nonprofit by giving profits to charity instead of owners and investors, but they chose to be for-profit. Another site, thehungersite.com is a nonprofit with lots of goods you can purchase, but they're significantly less successful. If you were Amazon.com today, you could support your cause far more successfully than thehungersite.com can, but that's a decision point you'll have to play with because there are also areas of business that work very poorly as for-profit entities. For example, churches are pretty awful for-profit entities. I'm sure there are some though.
I hope these questions help you in deciding whether or not to file for 501(c)(3) recognition through the IRS.