Moving to a 501(c)(3) structure--some warnings

Moving to a 501(c)(3) structure–some warnings

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I’m amazed. Both of the contacts to whom I wrote yesterday afternoon have already replied. And their replies to my question about moving toward 501(c)(3) status were not encouraging.

My first contact responded yesterday evening:

You may want to seriously consider connecting with the people at [____ company]. I have a couple of friends there.

As far as I know, they switched from for-profit to 501(c)(3) at the same time they moved from _____ to _____.

And as I recall, the switch was HUGELY painful.

And my second contact responded late last night:

Becoming a nonprofit corporation is a state affair, not Federal. Becoming tax exempt, in addition, is a Federal affair. Both non-profits and commercial entities have to make money. The supposed difference is that beyond stated salaries for services rendered, a nonprofit cannot pay or allow any “inurement” on anyone’s part. You cannot use money for anything but that which comes under your corporate tax exempt purpose.

In our history on two occasions our board almost slipped out of our purpose. Finally we discovered that more than half of all corporations have internal boards and we have had nothing but peace since 1988, Many mission agencies have internal boards and are 501(c)(3) tax exempt. We are, in addition classified as a religious order by the IRS and thus don’t even have to submit a financial report to the IRS any more than does a church.

You can incorporate in two hours, from scratch, and $200. But getting tax exempt status can take a long time. I found out talking to a Washington, D.C. IRS official that they prefer you don’t use an attorney in this. They can’t tell you not to. They just say that 75% of those gaining tax exemption just walk into a local office and do what they tell you. That is much quicker, because they are the source of your guidance. A lawyer-prepared application is almost always thrown out the first few times. When the Evangelical Missiological Society was incorporated I gave them this same advice. They ignored it, went to a law office, and 7 years and $44,000 later they got tax exempt.

I will add a guess. I know Scripture Press was non profit and thought they gained tax exemption but after a few years was deemed a moneymaking (not needing donations to operate) operation and had to pay $800,000 back taxes.

Basically, any enterprise that does not need donations to operate (and thus give tax-deductible receipts) is considered able to pay taxes and thus denied tax exemption. Meanwhile a commercial operation cannot render tax deductible receipts.

Let me say that I discount several comments by this second contact.

You can incorporate in two hours, from scratch, and $200. [And you can gain] tax exemption [on your own:] just walk into a local office and do what they tell you.
I have no doubts one can do both things. But when it comes to certain tasks, I always outsource. And when it comes to incorporating, acquiring copyrights and trademarks, etc., I have always hired competent attorneys. Even for tasks that seem simple. I have discovered that attorneys who specialize in these things can–they won’t always, but they can–actually save you a lot of trouble and time in the long run. They will ask you questions or word things in a way that will gain you more than you would have thought to push for on your own.

But in our case, where we would be attempting to switch from an S-corp to 501(c)(3), we would be looking at something that is far from simple or straightforward! I want competent counsel.
They . . . say that 75% of those gaining tax exemption just walk into a local office and do what they tell you.
Again, I have few doubts that something like this is true. Maybe the number is only 50% or even 25% (and many others could–and probably would–do this “if only they knew”).

HOWEVER, just because one can do something doesn’t make it a good idea. And, again, in our case, I am convinced it wouldn’t be a good idea at all.
[Working on your own with the help of the IRS] is much quicker, because they are the source of your guidance. A lawyer-prepared application is almost always thrown out the first few times.
I’d say “maybe” to both allegations. However, with respect to the idea that lawyer-prepared applications create more problems: I seriously doubt it. Especially do I doubt the idea that the applications are thrown out because they are prepared by attorneys or (possibly implied by what my contact said) because the attorneys who prepare them are somehow incompetent.

If it is true that the attorney-prepared applications are thrown out more frequently than applications prepared by the applicants themselves, then I would venture to guess it is because lawyer-completed applications are for non-profit concepts that, on average, are more complex–kind of like the difference between tax returns whose Form 1040EZs are filed by individuals as compared to Form 1040s, such as ours, that are accompanied by 15 schedules and are the result not only of W-2 wages and bank interest, plus standard deductions for things like mortgage interest payments, but also include impacts from an S-corporation, several foundations, and more.

Well.

We’ll have to see how this shakes out!

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Technorati Tags: 501(c)(3), governing board, inurement, tax-exempt organizations, using an attorney

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This entry was posted on Wednesday, April 9th, 2008 at 8:02 am and is filed under corporate forms, structures. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.