You love dogs. Or maybe it’s art. Or you want to help pay the medical bills of indigent individuals. Or you want to start a shelter for the unhoused (cats, dogs, humans or some combination).
Your heart is in the right place, but you need donations. And naturally, you think starting a nonprofit is the way to go. You’re a good person.
You might also be nuts.
Forming a nonprofit in California
Okay, you might not be nuts, but you might be taking on a lot more than you think.
There are different types of nonprofits, not all of which are tax-exempt. This article discusses nonprofit, public benefit charitable organizations. For simplicity, I’ll use the term “charity.”
The process of forming a charity can be a lengthy one. But let’s count the number of government agency interactions involved in these steps:
—Determine a name for your charity and check its availability with the Secretary of State (government interaction #1)
—Create and file Articles of Incorporation with the California Secretary of State (government interaction #2)
—Appoint a board of directors (more on that in a bit)
—Draft and adopt bylaws and a conflicts of interest policy
—Obtain a tax identification number from the IRS (interaction #3)
—Apply for federal tax -exemption with the IRS (that’s 4); and completing this form alone is very time consuming
—Apply for California tax-exemption with the Franchise Tax Board (interaction #5)
—File the initial registration form (CT-1) with the California Attorney General’s Registry of Charities and Fundraisers (interaction #6 and the 4th governmental agency)
—File the Statement of Information (Form SI-100) with the California Secretary of State (#7)
While some of these interactions might be quick and painless, other steps, such as 6 and 7, can require substantial work and time. Currently, the IRS is processing tax exemption applications that were filed in November 2024, and their website unapologetically tells you that when they begin processing an application, action is usually taken within 191 days.
Running a nonprofit
Congratulations, you’ve made it through all the logistics of forming a charitable organization, or at least reading about it.
But now you’ve got to run the thing.
Will it surprise you to know there’s a lot of government oversight there, too? I wish I could tell you it’s all good deeds and making the world a better place from here on out, but unfortunately, bad actors have made things difficult for the well-intentioned.
Both the IRS and California have strict rules for running a tax-exempt entity to ensure funds are being used for public, charitable purposes.
For example, Section 5227 of the California Corporations Code limits the number of “interested directors” on a charity’s board to less than 49%. An “interested director” is generally defined as someone who has received compensation from the corporation within the last 12 months or is a family member of such a person.
If you were planning on taking a salary from or leasing property (e.g., office space) to your newly formed charity, you’ll need to have at least two other unrelated board members who have no financial transactions with the charity.
California also has rules regarding “self-dealing” by directors, when a director has a material financial interest in a transaction with the charity. These transactions are permissible if they are in the organization’s best interest, fair and reasonable at the time of the transaction, and properly disclosed and approved. There is a procedure to follow, which takes time and knowledge.
The IRS similarly has rules about private inurement (benefits to individuals associated with the charity) and “excess benefit transactions” (paying excessive compensation or other benefits to individuals in positions of influence, including board members, substantial donors, employees and family members of those persons). A breach of these rules can result in a loss of tax-exempt status for the organization, and personal liability for the directors and other individuals involved.
In addition to these types of laws, there are annual filings and an annual tax return that must be filed, no matter how big or small your nonprofit is.
Alternatives to a nonprofit
My point here is not that forming a new charity is bad. Not at all. But forming and running a charitable organization is a lot of time and effort (that’s why they need your support!) and generally requires professional advice. If you’re not up for that, there are some other options for improving your community.
First, consider becoming involved in an existing organization — volunteer, serve on the board of directors or partner with that organization to start new programs.
Another option is to consider a donor advised fund (known as a DAF). You can set up a DAF with your local community foundations, enter into an agreement for the types of charities or programs you want to support, and contribute annually, or as often as you’d like.
The community foundation manages the funds, assists you in locating existing charities already doing the work you’d like to support, advises on where the need is, and then, with your advice, distributes the funds each year. Financial advisors can also set up DAFs’ through their custodian.
Charities exist for the public benefit, and thus the government has an interest in making sure that tax-exempt entities are, in fact, benefiting the public and not just certain individuals.
Nonprofits receive tax exemption because they are doing work that might otherwise fall to the government, thus saving the government money. The donations made to these charities are public money. Hence, the extensive oversight. If you’re up for that, and you truly want to make your community a better place, please do.
But you might save yourself some heartache by supporting existing organizations or creating a donor advised fund.
Teresa J. Rhyne is an attorney practicing estate planning and trust administration in Riverside and Paso Robles, CA. She is also the #1 New York Times bestselling author of “The Dog Lived (and So Will I).” You can reach her at Teresa@trlawgroup.net