Now What? Waiting for Determination Letter Can Complicate Fundraising

Our previous post discussed some basics about forming and operating a nonprofit organization, and focused in part on the application for recognition of 501(c)(3) status—the Form 1023. Completing the application itself is a time-consuming task, and it can be an unpleasant surprise for an organization then to realize that it may have to wait a while to get hear back from the IRS on its tax-exempt status.

Processing time for the Form 1023 varies depending on an organization’s structure and activities, but in general the IRS initially sorts applications to determine if the agency requires any additional information to complete its review; if so, it assigns that application to an Exempt Organizations agent who then will develop the application (and often come back to the organization with questions). Currently, the IRS is assigning applications it received in March 2012. This means that many organizations could expect to face a wait time of a year or more before their status is determined.

This delay can place organizations in a difficult position with respect to fundraising. An organization that submits its Form 1023 within 27 months of formation and ultimately is recognized as exempt by the IRS receives retroactive exempt status as of its formation date—meaning that contributions it receives during the interim are deductible. However, this lag time between submitting the application and receiving a determination letter often represents a purgatory of sorts for the organization. Many individual donors and grantmaking organizations simply will not contribute until an organization has a determination letter in hand. Others may be willing to contribute but need to be made aware of the risks. They should be clearly informed that an application is pending and that 501(c)(3) status is not certain. If they choose to donate, they may be able to take a deduction once exempt status is recognized—this could require them to amend an earlier tax return, however.

Fiscal sponsorship is another option that organizations can pursue during this pending period. A fiscal sponsorship is an arrangement in which a recognized 501(c)(3) charity approves a project in furtherance its exempt purposes, helps facilitate fundraising for the project, and accepts legal responsibility for establishing that donated funds are used for 501(c)(3) purposes. There are different ways to structure the relationship, but the cardinal rule is that the fiscal sponsor cannot merely serve as a conduit or passthrough for funds. Our next post will discuss some fundamental fiscal sponsorship concepts, options and potential missteps.

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