Dos and don'ts for donations during your start-up periodNewly formed charities often encounter a chicken and egg problem. They wish to begin their operations before they receive formal approval of their tax-exempt status but they can't attract funding until they receive their federal 501(c)(3) determination.
Effective date of exemption
The exemption application can be submitted any time after the charity is formed and typically takes several months to process but can take longer. So long as the exemption application is submitted within 27 months of the charity's date of formation, the determination, once received, will be retroactive to that date. Therefore, so long as the application is successful, donors who contribute during the start-up period will be able to deduct their donations. Of course, they take a risk that the founders either don't follow through with the application or that the IRS denies tax-exempt status (which is rare but does happen, especially if the founders don't have experienced advisers).
Soliciting funds while exempt status is pending
Even though charities with pending applications can technically operate and accept donations, it is important to note that all donor solicitations must be truthful and cannot misrepresent the charity's tax status. Therefore, it is important to disclose the charity's uncertain tax status. For example, charities with pending applications can state: "XYZ Foundation is an Arizona nonprofit corporation in the process of applying for 501(c)(3) status." While casual donors may be willing to accept the risk that their donation may not be deductible, most grantmakers and major donors will not.
Charitable solicitation registration
Newly formed charities often make the mistake of soliciting prior to registering with the states where they are targeting donors. Most states require some sort of registration prior to making a first "ask" in their state. Some states apply this rule to online solicitations directed toward their residents as well. Some states will accept registrations from charities with pending applications and others require a favorable determination letter. State regulators have been stepping up enforcement of this area so newly formed charities should not take this obligation lightly.
Newly formed charities with pending applications must still follow the IRS' substantiation and acknowledgment rules for contributions they receive during the start-up period. The IRS requires charities to provide a written acknowledgment of all donations more than $250. The written acknowledgment must provide:
- The charity's name
- The amount and description of the donation
- Whether goods or services were provided in exchange for the donation
When goods or services are provided in exchange for a donation (such as in a gala dinner or similar event), the nonprofit must generally provide a written disclosure statement when the donation is in excess of $75. The disclosure statement must state that the donor's donation is only deductible to the extent that it exceeds the goods or services provided in return, and it must give an estimate of the value of the goods or services provided to the donor.
Charities that wish to engage in a major fundraising campaign or solicit grants during their start-up period will want to seek out a fiscal sponsor. A fiscal sponsor is an existing charitable organization that becomes a sponsor of your project, collecting funds on behalf of the project and making distributions to further it. Solicitations are made in the name of the fiscal sponsor and therefore permit the sponsored project to rely on the sponsor's IRS determination letter, solicitation registrations, etc.
For more from Ellis Carter, visit CharityLawyer.