Should a New Nonprofit Start Fundraising Before 501c3 Status?

Caution May Be Your Best Bet

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Startup nonprofits often wonder if they can raise funds before they receive their tax-exempt status. For instance, one reader asked:

"I want to start a nonprofit for single parents with a employment staffing component to it, along with a liberal housing and education arm. Is there a way to fundraise in an effort to obtain the startup funding without having forwarded the IRS forms for nonprofit status approval? The operational funds are what our agency would need."

I invited Emily Chan, a San Francisco-based attorney who specializes in nonprofit, to explain. Here is her answer:

"Organizations can fundraise before receiving 501(c)(3) tax-exempt status. However, those contributions are not tax-deductible.
If the organization is subsequently granted exemption and the date of exemption precedes the date of the contribution, the donor may then be eligible to take a tax-deduction for that contribution which may require an amendment to that donor's personal tax return.
Exemption is generally retroactive to the date of incorporation if the application is filed within 27 months of incorporation.
Otherwise, exemption is recognized as of the date the application is filed.
Organizations should not give tax advice to donors but should inform donors they are not recognized as tax-exempt and the application is pending (if applicable). They should not say that they are certain to receive 501(c)(3) status.
Additionally, organizations should make sure that their state incorporation is in order.  If they fundraise outside their home state, they need to inquire about solicitation filing requirements in the states where they plan to fundraise."

Although, as Chan says, it is possible to fundraise before receiving tax-exempt status, it might be wise to wait until you are incorporated as a nonprofit in your state and have your letter of nonprofit status as a 501(c)(3) from the IRS.

Also, check into whether you need to register with your state's attorney general's office before you start asking for donations. Otherwise, you might find yourself facing fines eventually.

Incorporation will protect your personal assets in case you are later sued. Also, before incorporation, you are personally responsible for how you handle donated money. Therefore, donations could be considered personal income and be subject to taxes. 

If you do fundraise before receiving your tax-exempt status, you should inform donors that you are waiting for approval. And that if approved, donations will be tax-deductible retroactively to the date of your organization's founding.

However, if your application is not approved, any donations received would not be tax deductible. That may or may not be relevant to a donor, especially under the new tax rules that make charitable deductions harder to get. The point is to be transparent about your status.

If you need to start raising funds before you are incorporated and officially designated a nonprofit by the IRS, you might want to consider a fiscal sponsor that can receive contributions for you. A fiscal sponsor is merely another nonprofit that is willing to handle your donations for you.

Other ways to get the funds to start your nonprofit include these suggestions from GrantSpace:

  • Turn to family, friends, businesses and other potential donors who are invested in your success. They might arrange funding until you can launch more formal fundraising campaigns. 
  • Investigate bank loans and other traditional financing methods.
  • Look for possible non-cash contributions, such as free services (pro bono legal or accounting services for instance), office space, computers, and other office equipment.

The bottom line is you must be careful about fundraising before you are officially tax-exempt. It can be done, but only if you abide by all of the legal requirements. It might be time to review all the steps of incorporating and then applying for 501(c)(3) status.

It is tough to wait when you are anxious to get started on your nonprofit mission, but, in this case, going slowly and making sure to check every box of legal requirements for setting up and fundraising just might save you from many headaches later on.

This article is just for informational purposes. It is not intended to be legal advice. Check other sources, such as the IRS, and consult with legal counsel or an accountant.