Should I Start a Nonprofit? Trying (and Failing) to Take Our Own Advice

Following up on our last post, and with our firm continuing to feel frustrated about how we’re supposed to help, we started kicking around an idea.  If we think nonprofits should be open and defiant about their support of diversity, equity, and inclusion and if we think philanthropy should be putting up their resources to defend those that do, why not set up a nonprofit to gather and provide that support?   Provide our own expertise in terms of defending the exempt status of progressive organizations that are targeted, gather volunteers or use donations to hire experts to help with the things we have no business doing ourselves (immigration, civil rights litigation, criminal defense), and educate organizations in a way that pushes back on the fear campaign.

As transactional attorneys, we are not as useful as we’d sometimes like to be when it comes to times like these.  No one makes movies about tax lawyers, and they really shouldn’t.  The lawyers doing the most important work right now, and always, are the ones trying to keep people safe and out of cages.   

So, we’ll just have to settle for one of the handful of things we know how to do, which is set up a nonprofit.  And maybe we can help make it a little more meaningful by making it an educational exercise – using this blog to discuss and share documents for each step in the process in case people want to try it themselves.

Before committing to actually setting it up though, let’s ask the question that we try to get all of our prospective-charity-founder clients to ask:  is a new charity actually necessary?

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Most of the time, I’m a big advocate for the answer “No”.  There are lots of nonprofits out there doing great work, and many of them know more about the thing you want to do than you do.  It’s always an option to just give to them instead.  And if you really are an expert and want to do the work yourself, then maybe just use a fiscal sponsor to not add to the proliferation of nonprofit entities (200,000 in California and counting).

To help clients figure out that answer, there are a handful of questions we often ask, so let’s try to ask and answer them ourselves.

Do You Actually Have a Charitable Activity in Mind?   Not everything that is ‘good’ fits within 501(c)(3) (and vice versa).  Would your activity actually qualify as charitable?  If not, find a different vehicle.

Fortunately, for our idea, I think the answer is “Absolutely”.  Providing free support to charities (technically, support ‘substantially below cost’) is a charitable activity, even if the support isn’t ‘inherently’ charitable.  And here, I think it is. “Defense of human and civil rights secured by law” is right there in the IRS definition.  So is “elimination of prejudice and discrimination”.  And there will definitely be some public education.

 So this one’s easy: yes.  And yes, we are just going to blow past the fact that the current administration presumably does not agree and likes to spout nonsense phrases like “Illegal DEI”– they’re wrong and I feel good about winning a tax law argument against this guy.

But having an idea for a charitable activity, on its own, does not mean we should start a charity. 

Do You Have Time to Run a Charity?   Starting a charity takes more work and a greater commitment of time/attention than just starting an LLC.  There are four agencies that regulate California charities (IRS, Franchise Tax Board, Attorney General, Secretary of State) and they are each going to make us register/apply and submit annual filings.  We’ll have to have a Board that meets regularly to exercise their fiduciary duties and maintain separate books.  And that’s all before doing the actual work.

We are definitely not overwhelmed with free time at the moment. (On a related note, if you’re the kind of reader who could help us out there, maybe reach out.) But we are committed to this idea and confident we can make it work.

Is it Advantageous to Have a Charity Do This?  Just because something you want to do is charitable doesn’t mean you actually need to start a charity.  You could just do it in your business.  I normally say that the answer to this question is usually ‘no’ unless having a 501(c)(3) will unlock access to resources that you need, such as:

• Gifts from individuals who want a deduction (whether they can actually use it or not) or want to use their donor-advised fund to support you. 

• Grants from foundations or charities that will only give to another charity. 

• Government grants or contracts restricted to charities. 

Without one of those in the pipeline, it rarely makes sense to form a 501(c)(3) to do something a more flexible and less regulated entity could do just as well.

This is a tough one for our situation.  We already have a law firm.  We could just offer pro bono support from our firm to whoever we want to help.  We also have a 501(c)(4) nonprofit affiliate that could do the job.  Does setting up this charity actually add anything to the picture? 

I’m landing on ‘yes’.  To be clear, I don’t think anyone is clamoring to give us money.  I think our foundation clients like us fine, but I’ve never had any of them offer to pay us extra on an invoice much less make us a grant.  But people we partner with or hire are going to have great ideas of how to apply for and use grant funding to go beyond what our firm can offer in terms of our own time and knowledge.  And if we are going to get as far into the weeds as we like, some of this is going to cost money – I’m told defending against litigation from the far right and their operatives, inside or outside of the government, is expensive.  I think it’s realistic that some of the funding needed to pay those costs will be from individuals or entities that only want to fund 501(c)(3)’s, and would not want to fund our law firm or 501(c)(4).

Close call, but I’m satisfied – 501(c)(3) it is.

Even if That’s True, Why Not Just Use a Fiscal Sponsor?  Fiscal sponsorship is great. While we know how to set up a nonprofit legally, that’s different from running one – fiscal sponsors run nonprofit operations as their core mission.  Very often, especially with new projects of uncertain scale, fiscal sponsorship is the perfect way to test out whether the idea will work and whether people will fund it, without having to spend time on the less interesting stuff.  And even if it proves out, and the project turns into a mature operation, remaining fiscally sponsored can be a great alternative to setting up your new organization.  Focus on the stuff you’re good at and let the people who are good at the back-end stuff do that.

In a vacuum, I’d say we should absolutely partner with a fiscal sponsor or make a custom arrangement with an existing nonprofit that provides free legal support and similar services. That would make much more sense for getting something started right away, and it would spare us the process of forming and securing an exemption for a new entity, not to mention keeping it going. 

But I think the goals of this project present a few unique reasons as to why we should do a new nonprofit anyway (why yes, that is what they all say…)

• The goal of this nonprofit is to swallow up some of the risk, both actual and perceived, with supporting this work and put it on people best equipped to handle it – lawyers who professionally advise on maintaining charities’ exemptions.   Using a fiscal sponsor would put that risk, whatever it is, on another nonprofit.  They have their own risk calculus to do it, and we don’t need to add to someone else’s problem.

• I think the tax-exemption application here is part of the point.  Like I’ve argued before, we should not be wordsmithing our mission statements; instead, we should be taking the fight to them and making clear to the IRS that the law, the regulations, the case law, and the IRS’s own guidance collectively makes it very clear that providing free support to charities and their work around immigration, DEI, trans rights and many other types of progressive activity expected to be targeted is an exempt activity, as is advancing diversity, equity, and inclusion itself.  

o   If they approve the application, as they should, we have the leg up on any argument in the future. 

o   If they want to object to that, let’s have them go on record about it and explain their absurd legal position.  I guess if that happens, Paul Weiss will probably be their pro bono counsel, but that’s fine – they are wrong and we are right.

• I genuinely do believe this could be a useful educational exercise for other people.  We are going to have a lot of interesting discussions internally about how to do this and how to structure it – and a lot of that is work we can share freely to support others going through a similar process.  And an opportunity to hear from others about what they think we’re doing wrong or what we could do better. 

So, I think we’re doing this. 

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More to come soon, my expectation is that future blog posts in this series will cover*:

• Dealing With an Affiliate Structure:  How does our law firm or our 501(c)(4) (MLC Collective) fit into this?  How do we come up with a compliant 501(c)(3) affiliated in some way with our existing for-profit and 501(c)(4)? 

• Articles of Incorporation:  What state do we form it in? What form do we use?  What do we name this thing?  How should we draft the purposes and why do they matter?

• Bylaws and Other Corporate Documents:  What needs to be in there to implement the structure we choose?  What do we need to make sure we have approved and signed before we start operating?

• Conflict of Interest Policy:  How do we make this align with corporate and tax law applicable to insider transactions?  And how do we apply it to some of the transactions that might come up?

• Tax-Exemption Application:  This might take a few posts, but we want to both (A) go high-level on how to make the most of an exemption application – I wrote this blog post back at my prior firm and stand by it, and (B) go through the application itself piece-by-piece and think about specific questions that often puzzle people. 

• Initial Registrations:   Where do we need to register once we form?   How do I fill out these forms and what am I going to have to calendar for in the future?

• Corporate Governance:  How do we set up good practices and make sure the directors exercise their fiduciary duties? 

• Whatever Other Stuff Comes Up Along the Way:   Ideally, the formation and exemption application process brings up a lot of questions that are hard to predict.   I hope that is true here too.

* DISCLAIMER:  I suspect, as we do this, that we’ll end up making public some documents that people might want to use as samples.  And I think that’s mostly a good thing – at the end of the day if our business was just peddling forms, it wouldn’t be much of a business.  And they could be useful to people as a reference point.

But let me just disclaim now (and I will disclaim repeatedly) – none of this is legal advice – just general education and a transparent example of what we are doing with this specific organization.  It really is true that every situation is different, and that you can’t just assume that someone else’s document will work for you without reviewing it closely and getting legal counsel to advise you.  You will not believe some of the things people have signed and adopted because they found it as a sample on the internet, even though it makes no sense at all for them, and it can have real, unfortunate consequences.