Lessons I Learned on the Way to Getting Nonprofit Approval from the IRS

By Ken Martin

The IRS approved tax-exempt status for the Austin Investigative Reporting Project on Sept. 21, 2009—barely six weeks after I mailed my application.

I dreaded opening the IRS envelope because I had heard so many horror stories about how long it had taken others to get through what they thought was an absolute ordeal. When I tell people I got approval this quickly, they seem amazed.

The fact that I got quick approval was exciting, for sure, but it didn’t come easy. I made lots of mistakes. I’m sharing my story in hopes you can avoid making the same mistakes and win approval for your organization to operate as a 501(c)(3) nonprofit charity.

But first let me say this: you need to ask yourself why you would want to go to the trouble and expense, and spend the time and energy, to go through the lengthy process of preparing an application to get that tax exemption.

In my case, I believed that by operating as a 501(c)(3) nonprofit public charity, I would be making the strongest possible statement that The Austin Bulldog (the name under which we do business) is dedicated to the sole purpose of serving the community by doing investigative reporting in the public interest. In return, I expect the community to support the operation with contributions. In my opinion, being able to make those contributions tax-deductible is crucial to winning financial support.

You should also ask yourself what you may be giving up by becoming a 501(c)(3) nonprofit. For one thing, you will be prohibited from supporting or opposing candidates in political campaigns and you will be prohibited from attempting to influence legislation. I don’t have a problem with that. I’m willing to give up those rights as a tradeoff for the tax-exempt status. In fact, journalists on the whole try to avoid appearing to favor or support such activities.  On the Austin Bulldog website, I put it this way:

“Instead, we will report and comment on legislation and political campaigns to provide pertinent facts that would permit members of the public to form an independent opinion or conclusion about the qualifications of the political candidates and legislation.”

If you have a good reason and strong motivation for forming your own 501(c)(3), then here are the steps—and the missteps—I made.

I chose to go ahead and apply before I started the news gathering process, as I did not want to get bogged down in seeking approval later, and disrupt our reporting.

Also note that I am not a lawyer and I am not going to provide legal advice. If you have the funds, you may decide to get an attorney to prepare your application. You may think that by getting an attorney you will be able to win your 501(c)(3) and not have to do all the work yourself. But it’s not that simple.

You, as the person forming and running your organization, will still have to come up with the information needed to fill out the application and you will have to provide the necessary supplemental information. No one who is not thoroughly familiar with your organization can do that for you.

The Steps

Misstep 1: Meet with a lawyer
My first step, which turned out to be Misstep No. 1, actually, was going to an attorney. We met for about an hour and a half. I signed an agreement to pay $200 an hour, and got an estimate that the work would take him 10 to 12 hours. Before that consultation, I had only glanced at the Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. After realizing that I was biting off a big bill for legal services, I went home and began studying the form. It didn’t take long for me to realize that: (a) this was going to cost a lot more money than I could afford, and (b) there is simply no way the attorney could fill out that application without me supplying all the information that had to go into it. I immediately cancelled the agreement and paid the attorney $260 for the consultation.

Step 2: File for a state nonprofit corporation
Every state no doubt has different forms and slightly different information that must be supplied to form a state nonprofit corporation. Filing a state nonprofit corporation is the first step toward applying for your 501(c)(3), because the state application must contain supplemental statements that the IRS will review as part of your tax-exemption application.

Step 3: Draft bylaws
Before I could open a checking account to deposit the first check from my New Voices grant, I was told by our credit union that I had to adopt bylaws. Which I promptly did in what turned out to be another misstep. I searched online for bylaws and quickly found an organization right here in Austin that published sample bylaws, Greenlights for Nonprofit Success. Eureka, I thought. I downloaded the 10-page pdf, copied the information in it, inserted enough information to label it for the Austin Investigative Reporting Project, and our three-member board adopted these bylaws. I filed a copy with the credit union to open the checking account. I would later learn that these bylaws might not be sufficient to satisfy the IRS.

Step 4: Draft IRS Form 1023 IRS application
In the following guidance I’m only going to describe the high points of what completing the Form 1023 application involves, as it’s not practical to provide guidance for every space that must be filled in.
It’s only a 12-page form. How hard could it be to fill out? That’s what I thought when I decided on a do-it-myself approach to preparing the IRS application. The good news is that the IRS has a pdf form that you can download, fill out, and save changes to as you work your way through to completion.

Completing the application requires a lot more effort than merely filling in the blanks on the Form 1023. For the Austin Investigative Reporting Project, I supplied an 18-page supplement that amplifies and clarifies the entries on the form itself.

At any rate, I started filling out the form. Right there on Page 1 of the Form 1023 is Block 4, which requires an Employee Identification Number (EIN). I Googled and quickly found an IRS page that was surprisingly easy to understand. Following the links I found the EIN Assistant, which allowed me to fill out the application online and immediately obtain my EIN. Voilà, I filled in the block.

Some other highlights:

• Part III - Required Provisions in Your Organizing Document: As I mentioned in Step 1, above, this part requires that your “organizing document,” in my case the Form 202 for starting a Texas nonprofit corporation, have certain language in it, in effect that your organization has a charitable purpose and that in the event your organization is dissolved that your remaining assets will be used exclusively for exempt purposes.
• Part IV - Narrative Description of Your Activities: This part requires you to describe, in detail, the past, present and planned activities of your organization. In my first draft, I took a minimalist approach to writing this information. (More about that later.)
• Part V - Compensation and Other Financial Arrangements: This part takes up about 25 percent of the entire Form 1023 application, which serves to remind just how crucial it is for an organization’s financial dealings to be absolutely above board and squeaky clean. Part V requires listing the estimated total annual compensation that will be paid to anyone associated with your organization. An overriding matter of concern to the IRS is that there will be no insider dealing, no back-door compensation for the people associated with the nonprofit. The form requires explanation of relationships, whether family or business. It requires your organization to have a strong policy that prohibits conflicts of interest. The terms of any compensation must be negotiated at arm’s length and at fair market value.
• Part VIII - Your Specific Activities: Questions 1 and 2 of this section are of special interest to media organizations. You are asked if you support or oppose candidates in political campaigns and if you attempt to influence legislation. You must answer no to these questions, to attest to the fact that you understand that 501(c)(3) organizations are prohibited from participating in these activities.
• Part VIII - Fundraising: Question 4 requires answering a lot of questions about how you will go about fundraising for your organization, which is something you will need to plan for anyway.
• Part VIII - Intellectual Property Rights: Question 10 asks how your organization will handle the important matter of ownership or rights to intellectual property. For The Austin Bulldog, the information I supplied in the supplement to the application stated: “The Austin Bulldog will own the copyright to the articles, i.e., intellectual property, it publishes. The articles will be written by staff, freelance writers (work for hire), and volunteers. The Austin Bulldog will derive no revenue from these intellectual property rights. Instead, The Austin Bulldog will publish its intellectual property using a Creative Commons license (see http://creativecommons.org). The Creative Commons license will allow individuals or other media to use The Austin Bulldog’s intellectual property free of charge, provided such users give credit to The Austin Bulldog.” You may choose to try derive revenue from your organization’s content, but as this section of the “Launching a Nonprofit News Site” learning module on KCNN.org explains, there may be tax consequences.  I decided it was far more important to give legs to the investigations we publish than to try, with little probability of success in a strictly local publication, to resell our content.
• Part IX - Financial Data: This is a challenging section to complete, because it requires figuring out your revenues and expenses for a period of three years. Because I had not started operations, I had to project all these figures. I chose to be very conservative. The only revenue I counted on for sure was the money I could expect from my New Voices grant, but I added a ballpark $10,000 for contributions for the first year. Because it took longer than I initially expected to launch operations, it turned out that I overestimated my first-year revenue. Part IX also requires a balance sheet, which is simple enough for an organization like The Austin Bulldog, which had raised no other funds to supplement the New Voices grant.
• Part X - Public Charity Status: Since you want approval for your organization as a 501(c)(3) nonprofit charity, you will check no for Question 1a, which asks if you are a private foundation. You will enter a check for Question 5g, to indicate that your organization will receive a substantial part of its financial support in the form of contributions from publicly supported organizations or from the general public.

The Missteps

Having completed the Form 1023 and drafted an attachment to provide supplemental information, I was ready for some feedback. By word of mouth I found a certified public accountant who was said to be experienced in working with nonprofit organizations. I submitted my Form 1023 and supplemental information to her. I also sent a copy to our longtime business attorney. Both the CPA and attorney recommended only minor changes, and billed me for a combined $563.

So far, I had spent about $823 on professional advice and yet I did not feel entirely confident that my application would pass muster with the IRS.
One gaping hole in the original bylaws was the failure to address the crucial matter of conflicts of interest. The bylaws section of the book I recommended above,  How to Form a Nonprofit Corporation  uses more than six pages to address conflicts of interest. In retrospect, had I submitted my application using the original bylaws, I’m pretty sure the IRS would not have granted approval. (For what it’s worth, the original bylaws ran 10 pages, while the Nolo bylaws ran 23 pages.)

Another shortcoming of my original draft was that my minimalist narrative description of past, present, and planned activities was clearly inadequate, according to the Nolo book. In rewriting the narrative I went into great detail, covering more than five pages.

Lessons learned

At times it was frustrating, as I groped for answers and sought advice. In retrospect, I wasted time and money consulting with attorneys and a CPA that cost more than the IRS filing fee of $750.

Although I learned the hard way, my take on the whole process is that I gained a lot of valuable information by writing my own application. I learned not only how to prepare an application that quickly gained IRS approval, but also how to think about forming and running a nonprofit. And that’s essential to making sure that the Austin Investigative Reporting Project is properly managed and will retain its tax-exempt status.

If you want to form a 501(c)(3) nonprofit, I urge you to do your homework, and file your application with confidence that you should soon be an official tax-exempt organization.