It’s fairly common for a nonprofit organization to want to seek funding prior to applying for tax exemption. After all, the most logical order of operations would seem to be making sure the organization can manage some early success before bothering with administrative taxes. Yet there is a catch: nonprofits have a hard time attracting that funding before they are granted their 501(c)(3) status.
The fact is, nonprofits gain a great deal of their funding from donors—and many donors are only willing to donate money if they can be granted tax deductions for doing so. That only happens if the nonprofit succeeds in becoming tax exempt. Many—perhaps even most—donors won’t be willing to take the risk of tax-exempt status being denied, no matter how unlikely that may be.
Because the IRS tends to take at least three months to process an exemption application, this creates a conundrum. It is possible to solicit funds during this pending period—and since 2013 Arizona does not even require the organization to register with the Secretary of State prior to doing so—but the nonprofit will need to be careful how it goes about it. For one thing, the status of the organization must not be misrepresented—claiming the organization is tax exempt prior to receiving a determination to serve as proof-positive is a no-go. Therefore any solicitations for funding must contain clear language indicating that the organization’s tax-exempt status is in process of application.
Once a determination of exemption is received by the nonprofit, the exemption is considered retroactive to the date of the nonprofit’s formation (provided the application has been sent in before 27 months have passed since formation). Thus, donations accepted during this time can be deducted by the donors. This also makes it possible for an organization to utilize something known as “fiscal sponsorship” for the gap period. This is where a fiscal sponsor organization, which is an already-existing nonprofit organization, solicits and accepts donations in its own name but on behalf of the nonprofit in question using its own tax-exempt status determination.
When a nonprofit organization in Arizona needs legal aid or advice about securing tax-exempt status and/or financing, Provident Law’s nonprofit attorneys are here to help. We recognize how essential these organizations are to society, and we provide broad transactional and general counsel services—including the drafting of such policies—to keep them running smoothly. Contact us to learn more.