Nonprofit Myth Busters III: Nonprofits and the IRS
Are you dreaming about starting a nonprofit? That's great! Maybe you aren't sure whether a nonprofit is the right vehicle for your big idea. That's okay, too. I spend a lot of time helping people figure out what exactly they should be doing when starting a charity. Breaking down the false ideas and myths about the nonprofit sector ends up being a big part of my work with founders.
In the last two episodes of this series we talked about nonprofit money myths (here) and setting up the board problems (here). This time I want to talk with you about the limiting beliefs around the IRS and nonprofits.
1. I can file IRS forms myself OR for cheap with an online document filer.
Are you a tax accountant? If yes, are you a tax accountant who specializes in nonprofit accounting? Yes? Okay, get down with your bad self, and then please email me so we can meet for coffee because I love nonprofit-focused CPAs and we need to be friends.
If that's not you, then you should not be filling out IRS forms. They are written in a secret language that only lawyers and special accountants can understand. Okay, that's a lie. LOL.
But honestly, the forms are terrible, confusing and extremely hard to decipher. If you’re doing it on your own, it's basically impossible to know if you're answering the question the right way because half the time the question itself is unintelligible!
And I will tell you a dirty little secret: When you pay hundreds of dollars to the online document filer companies (like Legal Zoom and others), usually, they are just giving you the IRS form through a fancier user interface. And they are not allowed to answer your questions. So, all you're doing is paying to have the IRS's drivel regurgitated to you in a different format. In the end, you pay a premium to hang yourself with the same rope.
2. Since we'll be tax exempt, the financials don't matter. AKA: I can figure out a budget later after we have some money to work with
Admit it, you love budgeting and you are just hoping to start a nonprofit because you'd like to bone up on your accounting skills…………………………………………said nobody EVER.
It's ok. I know. For like 98% of the population we are not excited about building a budget or setting up a chart of accounts or bank reconciliations or any of that. But when you start a nonprofit that is all part of the deal.
A sole proprietor or a single member LLC can get away with doing the bare minimum because – hey – it's just you. But nonprofits have more in common with a big corporation than a lemonade stand. If you are wishing you could just run a lemonade stand then starting a nonprofit might not be the right fit.
Oh, but we don't have to do bank recs and journal entries from day one, do we, Jess? Well, ok not on DAY ONE. You know what I mean.
On day one you do need to have a plan for what you're going to do and what it's going to cost – not just because it's the best practice or because I said so but because the IRS application will require you to have one! And then, yes, as soon as you get the first $1.00 donated you are going to need to account for it. As in “accounting” accounting.
And since you probably don't know what that is and how to do all the accounting you're going to need to hire good help. You'll need a CPA that specializes in nonprofit accounting to file your IRS forms at the end of the year, and ideally somebody to help set up the bean-counting system with you (my friend Megan at the Mobius Group does this if you're looking).
You may think that since nonprofits don't pay income tax, that the IRS doesn't care or need to know. But the IRS definitely still cares about what you're doing with donated money. And if you're supposed to pay some tax – they want it.
3. Nonprofits pay NO tax ever. I don't need to worry about the IRS or government.
*Buzzer sound* Wrong answer! Nonprofits pay tax! They have to pay taxes like sales tax on those mugs and t-shirts with your logo (and that's to the state government). And you might have to pay federal income tax too.
“Wait, wait,” you're thinking, “but what about tax exemption?” Yes, some nonprofits – the ones that qualify for income tax exemption (ie: 501(c)(3) tax-exempt organizations) don't pay income tax on revenue that is substantially related to their mission. Other nonprofits pay income tax no matter what.
But even income tax-exempt nonprofits may have to pay income tax on activities that are “unrelated” to their mission. That can get complicated. I mean that sentence is complicated by itself, and trust me, I have had to prop my eyes open with toothpicks just to try and follow all the rules around Unrelated Business Income Tax for nonprofits at the continuing education seminars I go to, so if you really need to know about UBIT please, call me.
The important thing is to get it out of your head that nonprofits are tax free. This usually gets paired with a belief that it's cheap to run a nonprofit and or that money falls from the sky once you get your c3 status, so be sure to check out my first article if that sounds like you.
So, now what?
Are you willing to take on the responsibility of reporting to the IRS? Are you ready to admit you need help figure out how the application forms work? Are you prepared to sit down and do the hard work of figuring out how much the programs you want to start are going to cost and figuring out a budget and fundraising goals? Or are you trying to get around all that? You can't get tax exemption and limited liability of a nonprofit corporation without the hard work and due diligence – and compliance.
Lemonade stands are great. You can do good deeds out of your garage and just help people out of the goodness of your heart all day long. Sometimes I help people decide it's not worth it to go through the agony and work involved with a nonprofit (if you need help deciding and want to talk here's where you can do that). Sometimes the lemonade stand is just better. Lemonade stands make people very happy.
There are a lot of things to think about when starting a business or starting a nonprofit. You don't know what you don't know. That's ok! That's why we educate ourselves. If you want to learn even more about the most common mistakes I see founders making, get a copy of my free e-bookStarting a Nonprofit: Five Things Every Founder Must Know and let me know what your founding questions are, I'd love to hear from you.