Pitfalls for Not for Profit Organizations

George W. Mead

"No good deed ever goes unpunished"
Attributed to Clare Booth Luce

In 2005, the IRS marked a significant milestone, which like most things the Service does was understated and passed without fanfare. As of 2005 more than one million Charitable organizations filed under section three of IRS code 501 (c) were in existence. Even as far back as 2005, industry publications quoted the rate of new not for profits coming into existence at the rate of 40,000 per year. [1]

The rapid increase in the number of organizations, coupled with shrinkage in available dollars, has given rise to what one commentator called "non- profit Darwinism"[2] with organizations seemingly united in addressing a particular social issue, vying for the same group of dollars. "Not for Profit Darwinism" , as the name implies, means survival of the fittest organization. Where good will and energy used to account for ninety percent of the success of a charitable mission, the new state of affair requires careful planning and organization, and even business acumen. In addition to raising the level of competition among charities, the increase in organizations and concomitant decrease in funds, has also raised the eyebrows and alertness levels with those monitoring the industry. Probably the biggest concern to those at the IRS , a well as those serving the Not For Profit sector is "best practices.".

As counsel to not for profits we have come to recognize several common issues which can confront a new NPO, or plague an existing ones. Failure to address these issues can have serious consequences for the organization as well as its board members.

1. Observe the Corporate Formalities

Corporations , including not for profit organizations are given certain privileges under law. Not for profit organizations provide an excellent vehicle for members to accomplish hundreds of philanthropic activities, while providing tax incentives to donors for supporting a charitable activity. These privileges are conditioned on the organization being in good corporate standing, and timely and completely submitting financial information. Keeping resolutions of board activities and detailed minutes are an important part of the company function. To those involved in the heat of charitable work, these requirements can seem onerous and time consuming. However, failing to observe such formalities as financial reports, and meeting minutes can have serious consequences, and may ultimately, affect the corporate standing of the organization.

2. Keep Charitable Purpose and Personal Interests Separate

Individuals frequently start charitable organizations because an issue has a place in their personal experience, which makes it of special interest. It is not uncommon for individuals with family members affected with disabilities, to rally and start an organization devoted to better care or services. For musical or educational groups, it is frequently a member of the founding group who will be selected as artistic director and executive director . Significantly , members of a Not for Profit will often either be receiving services similar to the ones being offered by the organization, or be in need of funding for those services. State and Federal law prohibit board members from personally benefitting from charitable donations, and special care should be taken to ensure board members maintain a clear line for those services.

3. Carefully Draft Job Description and Organizational Charts

Not for Profit organizations often involve a mixture of volunteers and paid personnel. In the case of paid personnel it is critical to keep careful payroll and wage records. Being a not for profit is no defense to a wage claim, or wrongful termination. It is important to have an employment contract which spells out the terms of employment, goals and expectations. While less critical, having job descriptions for key volunteer personnel is also a good idea, as it defines their role in the organization, and will prevent bruised feelings, and turf battles.

4. Put Principles Before Personalities

Not for profits are often created by one or two people with a vision and an enormous amount of energy, devoted to an ideal. Over time, the organization can devolve into a cult of personality, with the result the founder "can do no wrong". With this dynamic, embers feel stifled and the organization becomes mired in the cult of personality. For a successful not for profit, candid and direct communication is essential to healthy maintenance of the vision. Board retreats are a healthy and productive way to air ideas and resolve stress points, keeping the organization fresh.

5. Obtain Qualified Professional Assistance As Soon as Possible

The life blood of a 501(c)(3) is grants and donations. It is critical the legal, accounting, and bookkeeping be done with absolute accuracy and transparency. Frequently charitable organizations starting out on a shoe string are reluctant to get professional help from accountants and attorneys, fearing the cost. The reality is the cost associated with establishing appropriate structure and financial bookkeeping is minimal compared to the liability of improperly run charitable organizations, and the cost of cleaning up a 501 (c)(3) which has been running improperly. Expending the funds makes sense for another reason: If you are looking for grants and donation , any potential serious donor will want to see the books and see the organization has been carefully run, prior to making a contribution.


[1] Each 501(3)(3) Is Now ; Cohen, T. Non Profit Times, May 2005

[2] Id.