Starting Your Own Non-Profit

© 2012 Rex Jaeschke. All rights reserved.

Once I moved to the US in the late 70's, it took a few years for me to get myself financially established there, but after that, I started thinking about what I might be able to do for some less-fortunate folks. Around that time, a major weekly newsmagazine ran an article comparing the top 50 or so well-known charities showing how much of each dollar actually went to an organization's projects. [It truly was stunning how big a percentage of total disposable assets the overhead was for some of them—to the point that their charitable projects seemed almost secondary!] One of them provided "more bang for the buck" than the others, and I started supporting that charity. 25 years later, I still am, and in a much bigger way.

I've lived 16 years in rural Australia, 10 years in suburban Australia, 32 years in suburban America, and recently I moved to rural America. Australia and America both have good standards of living although my guess is that due to its extensive social safety net Australia doesn't really have an underclass. The US certainly does!

We are all shaped by the influences of our environment, and I grew up in a small-town rural community, made up of farmers, fruit growers, a few professional people, and lots of working-class people. In general, the State and Federal Governments were expected to take care of those who needed help. That said my state has many towns with strong community organizations and branches of national and international service organizations. In my home region, the hotel (having drinks, meals, and accommodation) in each town is owned by that community and run as a non-profit venture with proceeds going back into the town's development. The projects involve town beautification, campgrounds, picnic areas, riverfront development, and the like.

From about the time I turned 16, I started playing a game, "What would I do with a spare $100?" As my own situation improved, the value of the amount went to $1,000, then $10,000, $100,000, and so on, with it now being in the millions and billions. [I've always thought it would be awfully embarrassing to win the lottery, but not have a plan for what to do with the money!]

Fast-forward to 2006. After a trans-Atlantic daytime flight to London, I lay awake jet-lagged in my hotel bed for many hours during which I had an epiphany. Instead of just dreaming and talking about all the good I might do should I ever have more than enough money, I thought, "Why not start out small, get the experience of setting up a non-profit and working with small projects, and actually do something real now instead of maybe later?" And so I did, and on a shoestring budget too. Now, nearly seven years later, my little charity is well, it has done good work, and I've learned a lot.

In this essay, I'm going to talk about my experiences in creating a non-profit organization (which I'll abbreviate as NPO), but without getting into the details of my foundation except to say that it works primarily with underprivileged kids here in the US. [As I've discovered repeatedly, unfortunately, the Third World is "right around the corner".] As I've done this in the United States, issues of a legal or tax nature will necessarily be US- and, in some cases, US state-specific.

Why Not Just Give as You Go?

For the vast majority of people, this is just fine. Perhaps you give to one or more favorite projects on a regular basis and it comes out of your pay before you get it. And maybe you have a little extra from time to time to give to various groups especially around major holidays.

For many people, they live paycheck to paycheck, so they are too busy trying to keep their own situation afloat to be thinking about helping others financially. But for those of us with some discretionary income, can we do more? As for me, not only did I want do something, I wanted to be involved in deciding where the money actually went, and in seeing that the overhead was kept as small as possible. I was certain I did not want to be an armchair philanthropist. (A lot of people feel good about writing out a check for the "needy", but they never actually met those in need. That is, except for the buzz they get by giving, they are otherwise unaffected by that need.)

But I Don't have That Kind of Money!

Mention the term Non-Profit Organization or charity, and many people think of the multinational groups like International Red Cross, Doctors without Borders, and Save the Children, or the Bill and Melinda Gates Foundation. After all, they are ones we hear about in the news. But, of course, the vast majority of NPOs are small, local-run affairs that don't have the time, budget, energy, or need to blow their own horn, so you never hear about them unless you go looking.

Don't you have to be super rich to start your own NPO? In a word, NO; I started mine with $1,600. To be sure, it has a lot bigger asset base now, but nothing too big. [I'm reminded of a lawyer in the DC area who works with people who want to start their own NPO. She said that it wasn't worth doing unless one had $10 million to start with. Once I learned of her consulting fees, I understood why her clients needed that kind of money.]

Don't you have to have a big ego to start your own NPO? I can't attest to the size of the ego one might need, but the question suggests that having a largish ego is a bad thing. In fact, show me a repeatedly successful person and I'll show you someone with a sizeable ego.

To be sure, starting an NPO takes some serious thought, effort, and commitment. After all, it's a business! Once you have it going, you have to keep it going; otherwise, you defeat your original purpose. For that reason, most people would shy away from going that route. If they fall on lean times, they can simply reduce their contributions or simply not give to their usual charities. But even if you have your own NPO, you don't have to donate to it on a regular basis. Rather, you give when you can and have most of the assets invested for later disbursement (see later below).

If you start something, you are much more likely to keep it going. And once the vehicle exists, it's much easier to "get in the philanthropic mood". Until you do that, the dream of starting something is exactly that, an untested dream. (See my essay "Talk is Cheap. Write it Down" from February 2011.)

One of the reasons to start something formal is to involve the whole family, thereby training the next generation in basic business practices as well as philanthropy. And consider having them inherit responsibility instead of (or as well as) monetary assets.

Public vs. Private Charity

One basic question is whether your NPO will be funded just by you/your family, or whether it will raise money from the public at large. The US taxman sees the former as a private charity and the latter as a public charity. That said there is nothing stopping a private charity from accepting donations from outside the founding group. In either case, the founders can control the board of directors and run operations as they wish. Of course, if they stray from their stated aims, they risk their donor base drying up.

From a personal tax point of view, an individual can claim up to 30% of her adjusted gross income (AGI) a year as donations to a private charity, whereas the limit is 50% for a public charity. If one gives more than those limits, the excess is rolled over to future tax years until it is used up, which means that the donor actually pays tax on all that excess in the year she donates it, and then gets the deductions in subsequent years.

[An interesting thing here is that you cannot escape the taxman. Say you win a million dollars in the lottery and you give it all to some public charity. As you can only claim half of that in the first year, you still have to pay taxes on the other $500,000, and you probably don't have that kind of money lying around. Then you get deductions over future years at 50% of your then AGI, which means you might never get the full benefit of the claim especially as the deduction is lost after some years. That is, "Use it or lose it!" Frankly, if you want to give the potentially large winnings of a lottery to a charity, buy the ticket in the charity's name instead.]

Operating vs. Non-Operating

The next basic question involves the level of control you want over the way in which your disbursements are spent. An operating NPO runs its own projects while a non-operating NPO partners with one or more other groups that do operate their own projects. Clearly running projects takes administration and bodies, and this is not for most family foundations including mine. That said there's nothing to stop a non-operating NPO from being involved in the projects it sponsors.

Going the 501(c)(3) Route

The US tax code has a subsection whose number really is 501(c)(3)! (There are other related sections worth knowing about, but for most NPOs this is the one to understand.) Most local NPOs do not have 501(c)(3) certification, which means that donations one gives to them—even by the founders of a private NPO— are not tax deductible.

Having this certification takes extra work (such as filing state and federal tax returns), but clearly it has benefits.

Making Disbursements

I mentioned earlier about the concern you might have with an uneven income. If I start an NPO, what if I can't donate the same amount of money every year or any at all? It's very important to understand the (very big) difference between the two main kinds of charitable fund raising:

• Each year, giving away everything you raise in that year
• Each year, giving away at least the legal minimum and investing the rest

Most community NPOs (think Parent-Teacher-Associations and local chapters of veterans and service organizations, such as Rotary and Lions) are in the first category. Perhaps they save some money for long-term/large projects, but for the most part, they disburse what they raise. That is, the amount they raise and give away is directly proportional to the skills of their fundraisers in that year.

According to US federal law, a 501(c)(3)-certified NPO is required to give away at least slightly less than 5% of its assets each year. The big win here is that an NPO can invest its income and disburse its assets over many years. Have a $100,000 windfall in appreciation of real estate or stocks? You can claim the tax deduction when you donate it, but the NPO can give away $5,000/year for at least the next 20 years (and more assuming the money is invested at a profit).

In this poor economic climate, the problem with investing an NPO's assets is the tradeoff between safety and return on investment. In my case, I worked hard for the money I donated, so I'm darn sure I do not want my NPO to risk it in some speculative way. As such, the assets go in Federal Government-secured instruments. However, the problem with that is they don't pay anywhere near 5% interest, which is what is needed to keep the NPO going "in perpetuity" without new funding. A second consideration is that the highest rates require locking in the investment for longer periods, perhaps up to five years. How then does the NPO pay for its 5%-minimum disbursements each year? The simplest formula is for the NPO to raise 5% in new donations each year, to cover those disbursements, but that can be problematic for a small, private NPO. That is, it requires an on-going donation stream. Of course, by staggering the maturity dates of investments, so funds become available for disbursement, this can be avoided.

By the way, here's an annoying thing I learned about US bank Certificates of Deposit (CDs). When you buy one, say $5,000 for five years, the bank never asks you how often you want interest paid. And in many cases, it seems that the buyer has no control. My NPO has had CDs that received interest every 1, 3, 6, 10, 11, or 12 months. The problem here is that a 501(c)(3) has to maintain a record of the average-monthly balance of its assets, and that is complicated if you have to find out the interest in a series of investments every month, and update your records. Having to do so once each year is best, but that might result in a slightly lower effective interest rate.

The Organizational Requirements

In my case, here are things I needed to do/create:

• Articles of Incorporation: An NPO is a legal entity that is a non-profit corporation in the state in which it will be based. To create a company, one needs these articles, which take only a page of text to describe. The articles contain things like a simple statement of the NPO's purpose, the initial corporate officers, the name and address of the corporation's registered agent, and what will happen to the assets of the corporation if it is disbanded. This gets your NPO a state corporate ID number, which you use to open bank accounts and such.
• A Charter: This has as much as you like to define the mission of the NPO. It can be a challenge to write, and it's most important if you are to convince others to donate to your cause. It's for the NPO's own use and is not a legal requirement.
• Bylaws: These detail the rules by which the NPO will operate. Who can be members of the corporation? What are the officer positions and how long can they serve? Can the board of directors charter a private jet to meet at a resort in the Caribbean? How are decisions made? It's for the NPO's own use and is not a legal requirement.
• Corporate Officers: You need at least a President and a Treasurer, who are different people.
• Board Members: You'll want a chair and at least one other director. [Board members can also be corporate officers.]
• 501(c)(3) Certification: This is optional.

It turns out that each of these things is not difficult or complicated even for small NPOs. But again, you are creating a business.

The startup costs involve less than a few hundred dollars, mostly in registration fees. Most importantly, you do not need to hire a lawyer or accountant to do the work.

Expenses and Tax Considerations

Regarding expenses, my NPO pays a state company registration fee and a tax preparation fee. [Eventually, I plan to prepare the 13-page tax return myself.] The few other costs (such as postage, computers, internet usage, and phone) are very small and are covered by me personally or via my consulting business.

While federal tax is payable on all income, donations are not considered income. As such, the only income my NPO has is interest on its investments, and the tax rate on that is quite low. No state income tax is payable in my state, Virginia. The county in which my NPO resides requires a business license whose fee is based on income. But as it also excludes interest income from that, the income is zero and so the tax is zero. The county also levies a personal property tax on furniture, equipment, and automobiles owned or leased by businesses, but as my NPO has no such property, it pays no such tax.

In my location, if an NPO invests some of its asset base in a business (such as real estate, a farm or ranch, or some other profit-generating scheme) rather than so-called cash investments, it would pay tax on the profits from those just like an ordinary company.

One of the rules imposed on a 501(c)(3) is that it must make available on demand by any member of the public a copy of its federal tax return for each of its last few years. That said, the names of donors need not be included in that copy.

On-Going Administration

In my NPO, we perform the following tasks:

1. Operate a checking account into which donations and interest are deposited and from which disbursements are made. However, on average, I keep no more than $500 there, as it is a non-interest-bearing account. (Yes, I could have an interest-bearing account, but that would require a much higher balance and all kinds of other rules and restrictions.)
2. Maintain in Quicken that checking account and various investment accounts.
3. Maintain a spreadsheet that tracks the average monthly asset balance (checking, savings, and investments).
4. Maintain a project activity log in a spreadsheet. This tracks all activities and events in chorological order and gives each a category from 5–6 options.
5. Produce board meeting minutes.

I mentioned earlier the possible need to get investment interest information on a regular basis. Another twist is that in the US, a company can declare its tax year to be any 12-month period that starts on the first day of some month. In my NPO's case, its business year does not match the calendar year. But all of the institutions in which the asset base is invested appear to be incapable of issuing annual statements for other than a calendar year! So when they send their statements to the taxman, of course they report a different amount of interest income than my NPO does on its tax return. C'est la vie!

Choosing Projects

It is all well and good to want to help some less fortunate person or group, but what is your process for deciding on who the recipients will be? If a friend/neighbor's house burns down, can/should your family-run NPO give him $X,000 to cover immediate basic costs? Maybe. But what if another friend/neighbor has an emergency and they hear about your previous donation? Are you obliged to help them as well?

Be careful to write a clear statement in advance as to the kinds of events and activities you will consider for disbursement and the criteria you will use if you have more applicants than you can service. For example, if you give away scholarships or support for overseas travel, it will look suspicious if only your children or grandchildren are eligible. For competitive awards, it is better to have an independent group of experts select the winners from among the applicants.

My NPO requires that for the most part, each director have a hands-on involvement in their projects. We also require status reports from recipient groups, so we can monitor things.

In the first few years, I had trouble giving away time and money. Most groups I contacted had no way to deal with someone phoning them offering resources. Either they were disorganized or the front line of contact was so remote from the founders' vision they simply were lost in the bureaucracy! It was quite sad. Eventually, I found a couple of projects that were not only worthy, but the people with whom I spoke were welcoming and came up with lists of ways in which to help in advance of our first face-to-face meeting.

I've rejected far more projects than I've accepted, and I'm a great believer in "tough love". In general, we're in the business of giving hand-ups, not hand-outs!

Here's an excerpt from my NPO's charter:

The Foundation is a private, family-directed, non-profit organization that provides funding to deserving individuals, organizations, and programs, while allowing recipients to maintain their dignity. Areas in which The Foundation may be involved include, but are not limited to, the following:

• <list deliberately removed>

Support for the following cannot or will not be considered:

• Any individual religion or religious organization's non-secular activities. [This is prohibited by the Articles of Incorporation.]
• Any political party, politician, or political candidate, holding or running for any local, state, or national elected office. [This is prohibited by the IRS and is explicitly stated in the Articles of Incorporation.]
• Any organization or individual that receives non-trivial funding from organized casino-style gambling games (such as slot machines, roulette wheels, and games involving cards or dice), that are run directly by, or directly for, that organization or individual. [However, organizations or individuals receiving trivial funding from small-scale social gaming such as Bingo, raffles, and the like, are not excluded by the above clause.]

Lessening the Administrative Burden

A lot of local NPOs simply spend what they raise each year, and they don't have board members with the interest and/or expertise in managing a business. They are also not 501(c)(3)-certified. It so happens, that a niche-market has grown up in the US that involves 501(c)(3)-certified NPOs that exist solely to provide a business umbrella for those local NPOs. For example, an NPO raises money and sends that along to its umbrella parent, which invests it. Usually the NPOs disburse all their money at the end of their business year, so the parent has to write out checks only once each year. Depending on the amount of money involved, the only fee the parent charges might be the interest on the money raised. And the parent may take care of most, if not all, of the federal, state, and local government paperwork. There are also entities called Donor-Advised Funds (DAFs).

Conclusion

If by the end of reading this essay, you are convinced that starting an NPO is not for you that's just fine with me. But at least I hope it has given you something to think about and some ideas on focusing your efforts. In particular, hopefully you can see that organized philanthropy is not just for the very rich. Whichever way you want to get involved in helping others, just do it, and thank you. Oh, and remember that you have to take good and long-lasting care of yourself before you can effectively take good and long-lasting care of others!