richardfseymour

It’s Way Too Easy to Start a Nonprofit Organization that will Fail

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“There are too many nonprofits out there.”

Statements like this should give people who want to start a nonprofit organization some pause. Indeed, the National Center for Charitable Statistics estimates there are 1.5 million of them in the United States, and here in my home state of Oregon there are over 18,000. That does seem like a lot — maybe too many — but taking this approach glosses over a key point. 1.5 million well-functioning organizations would be a wonderful thing. The problem is that so many of these nonprofits are unsustainable or poorly functioning.

How did we get here? There are many answers to this question, and there are several root causes. Perhaps one important factor is to consider that all-important bureaucratic entity new nonprofit organizations face when they start up, the Internal Revenue Service.

In the mid 2010s the IRS was facing a massive backlog of applications for tax-exempt status. It could take months to get a letter of recognition, and the waiting list was getting longer. The reason was that when the IRS receives the 30-page application its staff gets busy reviewing the collected information to determine if the organization is truly worthy of tax-exemption. This process takes time. The form requires a lot of supplementary documentation, and IRS agents rigorously pour over this information to ensure that all tax-exempt statuses are properly awarded. The amount of time required for this, multiplied by the sheer number of applications they were receiving, produced the long waiting time for new organizations.

So in 2014 they introduced a slimmed down version of their application aimed at smaller organizations, and this form required much less documentation. The new IRS form (called a 1023-EZ) made it easier than ever to legally start a small nonprofit. The price of filing this form was set at $400, less than half of the $850 required for the longer form (called a form 1023), and the price was later dropped to $275. The waiting time for confirmation is now measured in weeks for this simpler form, rather than the months nonprofit founders had been experiencing. The floodgates were opened.

It’s easier than ever to haphazardly establish a fundamentally flawed nonprofit. Click To Tweet

Many articles have pointed out how this cheaper and simpler process can lead to an abuse of the system, how a large number of tax dodgers can take advantage of the lowered amount of scrutiny and establish a fake nonprofit. That is a problem, but I’d like to focus on something else, because in my experience most people are actually trying to do some good in the world, and this new system tempts them to take some unwise shortcuts.

If your ambitions are modest (under $50,000/year), it’s easier than ever to haphazardly establish a fundamentally flawed nonprofit organization. All those hoops the IRS made you jump through on the long form, it seems, had a purpose.

First, the IRS wants to ensure that money and other resources contributed to your organization will stay in the nonprofit realm no matter what. That means you must have certain legal language included in your articles of incorporation and bylaws. The longer form 1023 requires you to submit these documents, and an IRS agent reviews them to be sure you got the language right. The simpler form 1023-EZ just asks you to check a box saying the proper language is there and it’s up to snuff. It’s easy to check that box even if you didn’t get the language right, and this can put your organization in danger.

More fundamentally, the longer form requires a number of narrative explanations of your purpose, how you do business, a solid budget, and detailed descriptions of your intended activities. In brief, you need to be detailed and coherent about some important things:

  • Your purpose (or mission statement) explains why your organization exists and how it will benefit society.
  • This gives rise to your program activities that deliver that benefit. These need to be spelled out in terms of who you serve, how that service is delivered and by whom.
  • Looking at all that, you also discover your supporting activities — what else you need to do (like fundraising) in order to make this organization viable.
  • This big picture implies costs which you need to understand, both in terms of what they are and how the revenue will be raised, in short a realistic budget.

The longer form 1023 requires you work through all these important factors early on, because you can’t move forward without spelling all that out. The shorter 1023-EZ simply asks you on good faith to state if you’ve done that legwork. It’s almost an invitation to gloss over these aspects and just check the boxes you think they want you to check.

But you know you need to figure out all that stuff up front anyway, right? It can’t afford to be glossed over. Even if there were no IRS requirements for nonprofits, these basic pieces are essential for your organization’s sustainability.

Failing to solidly think through this stuff will scatter several potential landmines along your path. So, if you’re starting a small nonprofit organization, take the time to read through and complete the full form 1023 even if it’s just an exercise and you have no intent to actually file that form. That is, do the hard work up front even if you want to take the shortcut to save the money and simplify the process.

NOTE: It has come to my attention recently that many people filing the full 1023 (long form) are no longer experiencing the long waits for approval that were once par for the course. One firm I spoke with estimated that approval could come in a matter of a few weeks. So I made a minor change to this post on September 30, 2017 in order to remove any confusion about that.

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