Steps to Start a Public Charity Under Section 501(c)(3) of the Internal Revenue Code

Steps to Start a Public Charity

 A public charity should start with plans to
benefit the public. The recognition
of exemption by the Internal Revenue Service is given for the public charity to
conduct activities benefiting the general public and does not violate the public
trust the charity operates.

 NAME  SELECTION – A  unique name should be chosen.  Go
to the website of the Secretary of State and use their name search system to see
if the proposed name is available.   The name should not be close to the name of another corporation, either
non-profit or for-profit.


BUSINESS  PLAN - The first  step is to create a business plan.   A public charity has all of the characteristics of a for- profit  business, as mission statement, a code of ethics, productive services,  management, marketing, revenue generation, expenditure  controls, financial record keeping, internal controls, employment tax
record keeping and reporting, etc.   A business plan is an assessment of the business environment. 
A business plan assists the founders in knowing where the organization is going and it helps the officers to build relationships with board of directors, clients, the public and funding sources.  The motivation for operating the charity is to be making a difference in the lives of individuals.  The dynamics and competitive edge of the organization should be emphasized in the business plan.
 
A business plan may have the following suggested structure:


A.  Mission Statement – Describe the purpose of the charity.  The mission purpose should be brief and to the point.  It should be catchy to get the reader’s attention and to encourage her/him to read the rest of the business plan.  The charity is doing more than just existing.  It is responsible for making changes in people’s lives and changing society.  This statement will the beginning block of the story of the organization and should be inspiring.  The story will involve the staff, board members, donors, participants, and stakeholders to
tell others about the charity.


B.   Code of Ethics – A public charity should have a formally adopted, written code of ethics, that the members of the board of directors, staff and volunteers are  familiar and which they see are enforced.  The values the public charity embraces should be explained.   The code should detail how the individuals who carry out their duties  related to the organization will conduct themselves.  The business plan will list and explain each value and how its meaning  applies to the charity.  Some of  the values may include integrity, honesty, accountability, confidentiality, respect of clients, staff, directors, donors, safeguarding the public trust, etc.

C.  Conflict of interest Policy – A conflict of interest policy should be adopted and be actively  involved in the decision making process of the board of directors.  A model policy is available on the Internal Revenue Service website as part of the instructions for Form 1023.  During the first meeting of the board of directors each year the members  of the board should complete a statement of their awareness of the conflict  policy and what family and business interest they have.  These statements by the board members should be reviewed by each board  member.  As transactions develop  between the family or business interest of members, the transaction should be  reviewed by the board members, with the person having the interest being  reclused from the meeting during the discussion.  Only transactions that benefit the  charity should be approved. A  conflict of interest policy reveals the board of director’s exhibition of  loyalty and full disclosure on behalf of the  organization.

 D.   Descriptions of Activities – Each activity  should be described as to the background of the need being served, who will be  the clients, who will perform the services, where will the activities take  place, what are the expected changes from the  services.

E.  Governing Body – List the names, street addresses,  board titles and business occupations of the recruited board members.  The membership of the board of  directors should include individuals of diverse backgrounds, experience,  business and organizational skills and fund raising knowledge.   They should be willing and able to operate with due diligence, due  loyalty, and confidentiality.   There should be a majority of the board members who are independent of  the founders, their family or business associates.   Explain the plans to recruit additional members, have orientation  sessions for new board members and have evaluations of performance of the board  members each year.  The number of  directors should be sufficient to properly oversee the operations of the  charity.  A small board may run the  risk of not sufficiently represent the public interest and lack the skills and  resources to effectively oversee the activities of the organization.  

F.  Governance and Management Policies –  The board of  directors should adopt policies related to (1) a whistleblower resource person and (2) procedures and record retention policies as required by Sarbanes-Oxley
law.

G.  Marketing Strategies – Describe the plans to market the programs of the organization to  the individuals and organizations needing these services and to potential donors.  Always be conscious of  opportunities to tell the story of the organization, as before civic clubs, church groups, corporations, private foundations and government agencies in requesting grants, when acknowledging charitable contributions and preparing tax  returns. 

H.   Fund Raising – Charities are encouraged to adopt and monitor charitable donation policies to ensure Federal and state law requirements are met.  Charitable solicitation activities should be registered in appropriate state agencies.   The board of directors should assure themselves the solicitation  materials are truthful, truthful and appropriate.  As part of the donation acceptance policy, if a donor offers real estate,  the organization should request the donor provide an environmental clearance  related to the property.  The  governing board may determine that the organization is adequately issuing  acknowledgement of donations, including the statement, “No goods or services were exchanged in receipt of these  donations.”

I.  Financial Planning – Anticipate the sources and amounts  of charitable contributions, membership fees, service fees and investment  income and the nature and amounts of expenditures to operate the programs of  the organization.

 J.  Compensation Determination – The method the board of directors uses to determine the  reasonable compensation of chief executives should be described.   Compensation should include all expenditures that benefit the individuals, as salary, health care insurance, pension, or unaccountable  reimbursement programs as applicable.  Any payments for personal benefit in excess of the board of director  approved compensation will result in “intermediate sanctions” by the Internal  Revenue Service. Compensation  should be determined by some comparative method using compensation of similar  organizations or from a compensation consulting firm.   Compensation of similar firms should be determined by contacting the  organization directly or by reviewing the Forms 990 as secured from www.guidestar.org website.  Once the charity has used  a comparable method of determining reasonable compensation, the Internal Revenue  Service has a rebuttable presumption test whereby it has to substantiate the compensation was not computed appropriately.

 K.   Financial Record Maintenance – The organization should describe the system of protecting and
recording revenue as it is received and paying expenditures that benefit the  charitable purposes of the charity. 
Financial statements should be prepared monthly and reviewed by the  governing board. When state law
requires an audit by a Certified Public Accountant, the board of directors should have an independent audit committee to select the auditor and to receive the report of the CPA firm.  Policies and procedures should be adopted to ensure the property and financial resources are properly protected using internal control  procedures.

 L.   Transparency and Accountability – The business plan should describe how the charitable  organization will make full and accurate information about its mission, values,  activities, governance and finances available to the public.   The charity should maintain a disclosure file containing (1) Form 1023,  Application for Recognition of Exemption and all attachments and letters during the application process with the  Internal Revenue Service, (2) Form  990, Return of Organization Exempt from Taxes and Form 990-T, Exempt Organization Business Income Tax Return for the last three years.   Also, the file may contain any  news articles, brochures or other information telling the story of the organization.  This file should be  available to the public upon request.
 
ARTICLES  OF INCORPORATION

 The Internal Revenue Service analyzes the  application for exemption to determine if the organization is organized and operating in the manner required of a charitable  organization.  The initial test is  if the public charity is organized as required by the Internal Revenue  Regulations.  This test is met if  the organization’s Articles of Incorporation and bylaws conform to the  requirements of the regulations. After the business plan is prepared, the  organization should prepare an Articles of Incorporation to create the legal  entity for the charity to function.  

The Internal Revenue Service requires two clauses for limited purposes  and dissolution as follows:        
 
A.   Purpose of the  Corporation-     The  corporation is formed exclusively for charitable purposes, including the making  of distributions to organizations that qualify as exempt organizations under  section 501(c)(3) of the Internal Revenue Code of 1986 or the corresponding  provisions of any future tax code or laws.

 B.   Dissolution Clause-     Upon the  dissolution of the corporation, its assets shall be distributed for one or more exempt purposes within the meaning of section 501(c)(3) of the Internal Revenue  Code, or the corresponding section of any future Federal tax code.  Any such assets not so disposed of shall be disposed of by a court of  competent jurisdiction of the county in which the principle office of the  corporation is located, exclusively for such exempt or public purposes or to  such organization or organizations, as such court shall determine, which are organized exclusively for such purposes. 

The Articles of Incorporation should be  filed with the state’s Secretary of State.  Many state’s Secretary of State have  forms to use for the registration of the Articles of Incorporation.  Be certain the required clauses are included in the form or create a  separate attachment to the form to have adequate Articles of Incorporation.  Our firm has a model Articles of Incorporation what can be used in place of the Secretary of State’s form in some
states or as an attachment to the form in other states.       
 
The Internal Revenue Service prefers public  charities adopt a conflict of interest policy, which was discussed above, as  part of the Articles of Incorporation.   It may also be a policy adopted by the board of directors.  By having the conflict of interest as part of the Articles of  Incorporation, it is more legally binding; whereas, when it is merely a motion of the board of directors it can be changed anytime.                                                                         
 
BYLAWS -

The board of directors should adopt Bylaws  describing the formal positions (president, secretary and treasurer), election and duties of the members of the board, the meeting requirement, committees,  executive officers, means of adoption of amendments, and the indemnity of the directors.  The board of directors  should have meetings as needed to gauge the operations of the public  charity.  Committees should only be  appointed and operated for a specific need to the time the need exists.  There should not be any permanent  committees.

 APPLICATION FOR RECOGNITION OF EXEMPTION –  FORM 1023

 Form 1023, Application for Recognition of Exemption, should be prepared to file with the Internal
  Revenue Service.  The application  should include the Form 1023, a narrative describing the answers to the
questions on Form 1023, and an exhibit file containing copies of the Articles of  Incorporation, the Bylaws, a hardcopy of the organization’s website and any  paper items that tells the story, philosophy, or procedures of the public  charity, as new articles, brochures or similar documents.       

Most “yes” answers to questions of the Form  1023 should be explained in more detail as part of the narrative.  
 
Form 1023 must be filed within 27 months of  the date of the registration of the Articles of Incorporation for the effective  date of the recognition of exemption in the Internal Revenue Service’s  determination letter.  

The Internal Revenue Service prefers the  application for recognition of exemption be for organizations that are
operating, rather than proposed organizations, which will begin operating when  the determination letter is approved by the Internal Revenue Service.  Once a public charity has registered  their Articles of Incorporation, it is entitled to operate in every way,  including accepting charitable donations.   The determination letter can be given to the donors  later.

Part  IV – Narrative Description of Your Activities –  Each activity of the organization should be explained as to the reason it was  started, who will be the clients, what need will you be serving, how will the  need be met, who will conduct the activity, where will the activity be  conducted, what will be the results of the activity, how is the activity  funded, and what is the percentage of this activity’s time to the organization’s total time will be dedicated to this activity.


Part  VIII – Your Specific Activities – Question 4 Fund Raising  – The methods of raising funds (donations, membership fees, program service charges, investment income) should be explained.  Any agreement with professional fund raisers should be explained and the contract with them should be included as an exhibit.

Part  IX Financial Data – The application should contain a financial statement with the sources of  revenue detailed and the nature of expenses listed. The descriptions shown on the lines of page 9 do not meet the
  requirements of generally accepted accounting principles.  Prepare a financial statement based on generally accepted accounting principle showing the line items with the breakdowns that make up the line items. An illustration of this  principle is line 1 is as follows:

Line 1 – Gifts, grants, and  contributions:   Public  contributions   100,000                                                                  
Government levees  50,000                                                                          
Government Grants   27,000                  
Total Line 1     177,000    
Enter the amount of the total for the year involved on page 9 on  line 1.

 Enter the financial statement as the sheet behind page 9 and note  on page 9 a “Schedule of the financial information is included as the next  page.”

Primarily, many of the expenses will be included in line 23 –  “any expenses not otherwise classified.”                                                 

Part  X – Public Charity Status  - Every organization that recognized as  tax-exempt under Section 501(c)(3) of 
the IRC is a private foundation unless it qualifies as under one of the  exception of organization as described under some part of Section 509(a) and  170(b)(1)(A)(i) through 170(b)(1)(A)(iii) of IRC.   Organizations, that are statutorily classified as public charities under  Section 509)(a) of the IRS, are (1) churches, (2) schools, (3) hospitals, (4)  organizations which receive a substantial part of their support from general  public donations, government grants, and organizations and (5) organizations  that normally receive more than one-third of their support from contributions,  membership fees, and gross receipts from activities related to their exempt  function. 

If the organization requests public charity  classification, because it is receiving support from the public, it must
continue to seek significant and diversified public support in future  years.  All fund raising efforts  must be aimed at bringing funds from a significant number of individuals, private foundations, corporations or government sources.   This test for public support is measured using Form 990 Schedule A as the  tax returns are filed.

Part IX  Financial Date Section B Balance Sheet-  Include the amounts of the balance sheet of the organizations for the end of the last month a statement may have been prepared.  Many charities may only have a bank
account and should enter the reconciled balance of the last date the bank  statement was issued on lines 1, 11, 17 and 18. If there isn’t a bank account, enter a statement on lines 1 and 2, “No bank account is opened.”

 Part X – Public Charity Status – Questions 6 – All of the section for question 6 is not applicable any longer. 
Form 1023 has not been revised to remove this section.

 Part XI  –User Fee Information -  The user fee for organizations  with annual gross receipts of $10,000 or more, during the three period is $850,  while the user fee for organizations with gross receipts less than $10,000 is
  $400.  Check irs.gov/charities for changes to the fees.

 Pages 27 and 28 – Checklist – Use these  pages to assemble the application for recognition of exemption before it goes to  the IRS.


Annual  Filing Requirements

Annual  Report with Secretary of State -   Each year the organization should file and annual report with their  Secretary of State.  Be sure to go  the website of your Secretary of State and determine this  requirement.

 Form  990 with Internal Revenue Service –  Each organization recognized as exempt from Federal income taxes, except  churches and integrated auxiliaries of churches, are required to file one of the  Forms 990.  If the gross receipts  is $200,000 or more or the net assets or $500,000 or more, the organization is
required to file Form 990 and its schedules.  If the gross receipts of the  organization is $50,000 or more or the net assets of $250,000 or more, the  organization is required to file Form 990-EZ.  It the gross receipts is less than  $50,000 the organization must file a Form 990-N on the computer.  

If the organization does not file a Form  990 for three (3) years, the Internal Revenue Service will revoke the
recognition of exemption of the organization.  The organization will have to file  another Form 1023 and request reinstatement of their recognition of exemption as  a Section 501(c)(3) public charity and pay the user fee again. 
From the date of the revocation of exemption to the date of  reinstatement, the donations the organization receives cannot be claimed as  charitable contributions on individual or corporate tax  returns.