Five things to consider before starting a nonprofit in Alabama
New nonprofit organizations are launched every day. If you are considering beginning your own, here are a few big issues that you should consider.
1. Will my organization’s purpose qualify as a public charity?
When most people hear the term “nonprofit,” they are generally thinking of a charitable corporation that has obtained tax exempt status under section 501(c)(3) of the Internal Revenue Code. Many people also assume that if their organization’s purpose sounds charitable, then obtaining tax-exempt status is just a formality. However, obtaining that exemption may not be quite so straightforward, and not all nonprofits are created equally.
The 501(c)(3) designation carries great benefits, but also great responsibilities. The exemption is reserved for organizations that meet specific requirements under the Internal Revenue Code. Namely, the entity must be organized and operated exclusively for one or more of the exempt purposes set forth in section 501(c)(3). Those purposes include charitable, religious, educational, scientific, literary, testing for public safety, fostering certain types of sporting competition, and preventing cruelty to children or animals. “Charitable” includes relief of the poor, distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.
While the scope of the purposes found in 501(c)(3) is broad, it is not limitless. Therefore, it is crucial that an organization’s stated purpose fall within the required scope to be approved for (and to maintain) tax-exempt status as a charitable organization. Also, your organization’s activities and mission should align with its exempt purpose. Engaging in activities outside the bounds of your organization’s exempt purposes can result not only in mission drift—but the loss of its exemption.
Keep in mind that other types of tax-exemptions are available for entities that do not satisfy the requirements of section 501(c)(3), such as advocacy groups, homeowners associations, and social clubs. Therefore, if your organization does not qualify as a public charity under section 501(c)(3), it may still qualify for one of the other exemptions in sections 501(c)(1)-(7).
Determining whether your organization will meet the requirements to be approved for a 501(c)(3) exemption is a crucial first step before forming a nonprofit, and may require more thought and analysis than first expected. Additionally, ensuring that your charitable organization maintains its (c)(3) designation is an ongoing process that will mandate constant awareness and sound legal advice.
2. Will your organization exist exclusively to benefit charitable causes?
When deciding whether to start a charitable organization, one should be familiar with the doctrine of “private inurement”—the fundamental principle that distinguishes nonprofit organizations from for-profit organizations. The gist of this rule is that, unlike the income of a for-profit organization, no part of the income or assets of a charitable organization may unduly benefit (directly or indirectly) a person who has a close relationship with the organization, when that person is able to exercise a significant degree of control over the organization. In other words, the rule exists to prevent individuals from exploiting tax-exempt organizations to benefit themselves, family members, friends, etc., rather than charitable purposes. As one would imagine, the concept can prove difficult to apply at times, but it exists for good reason.
The IRS has stated that private inurement is “likely to arise where the financial benefit represents a transfer of the organization’s financial resources to an individual solely by virtue of the individual’s relationship with the organization, and without regard to accomplishing exempt purposes.” Similarly, it has stated that the “inurement prohibition serves to prevent anyone in a position to do so from siphoning off any of a charity’s income or assets for personal use.”
The concept of private inurement can arise in many scenarios, but one of the easiest (and most common) examples is excessive compensation. A nonprofit’s compensation of its board members, executives, employees, or vendors should be reasonable in light of the facts and circumstances surrounding such compensation. However, determining what is “reasonable” can prove difficult, particularly for large nonprofits, and may require legal advice—particularly given that private inurement and excess benefit transactions can lead to sanctions, excise taxes, and other penalties.
Other forms of private inurement can arise within the context of self-dealing, such as the sale or exchange of property, loans, furnishing of goods and services, and gifts between a tax-exempt organization and one of its insiders. The U.S. Tax Court and IRS are in clear agreement that any element of private inurement can cause an organization to lose (or fail to obtain) its tax exemption.
For these reasons, it is advisable to understand the doctrine of private inurement when deciding whether your organization will truly function as a charitable organization. Further, existing charitable organizations should have safeguards in place (such as robust conflict of interest policies) to avoid private inurement, and board members should seek experienced legal counsel when considering compensation or other transactions that could risk causing the organization to run afoul of the doctrine.
3. Does it make better sense to join up with a pre-existing nonprofit?
Every good organization knows, communicates, and executes its purpose and mission. This is especially true for nonprofits, whose tax exemption depends on that purpose. However, if you are considering forming a new nonprofit in Alabama, considering its purpose is important for an additional reason. Our state has thousands of wonderfully effective charitable organizations, including one or more that may already be working in the area in which you desire your organization to serve. If you have not done so, it may be worth spending a bit of time researching and learning about what other organizations are doing in our state before launching out on your own. You may find that someone is already hard at work in the exact area in which you are seeking to contribute, and joining forces may be a strategic means of accomplishing your mission.
4. Do I have a strong team of initial directors?
Every healthy nonprofit has a healthy board of directors. Running a nonprofit is hard work, and requires a wide range of strengths and abilities. Most of all, your organization needs board members who have strong character, passion for the organization’s cause, strong work ethic, good communication skills, and a sense of loyalty that keeps them committed and prepared. A strong board of directors is so crucial that it is worth delaying the formation of the organization until the right candidates have been assembled.
In Alabama, your nonprofit is required to have at least three directors. They are chiefly responsible for ensuring that the nonprofit fulfills its mission as stated in the nonprofit’s articles of formation and bylaws. The board of directors acts as trustee of the nonprofit’s assets and ensures that the organization is managed appropriately. Directors owe the organization fiduciary duties of loyalty and care, which include, among other things, making decisions in the best interests of the organization, faithfully attending and participating in board meetings, and disclosing and avoiding any conflicts of interest. Directors also need to be deeply invested in the nonprofit’s mission and, if possible, trained to serve in that capacity.
5. Have my team and I developed a strong business or ministry plan?
One of the most often over-looked steps before forming a nonprofit is developing a business plan (or ministry plan in the case of a religious nonprofit) describing how the charitable organization will implement its mission and achieve its goals. For example, you and your team should develop and draft your organization’s mission statement; an outline of concrete objectives and goals; an inventory of the organization’s assets and resources; a fundraising plan; and practical thoughts regarding how to leverage the organization’s resources, networking, and other strengths to function effectively. During this process, you will experience the benefits of having assembled a strong team of individuals with varied strengths and abilities.
Whether you are considering starting a nonprofit corporation in Alabama, or are already running a well-established nonprofit with years of experience, our attorneys are here to assist you. Contact us today with your nonprofit needs at 205-874-0339.
