Q&A #41 – How should new nonprofits acknowledge donations received prior to approval of 501(c)(3) status?

Question: I recently formed a new nonprofit and submitted a Form 1023 application for 501(c)(3) status. I have already received contributions from some friends and family members to help cover start-up expenses. I understand that I must send acknowledgment letters documenting these donations to these early donors. How do I handle this when the organization has not yet received 501(c)(3) status?

Answer: This question is one that is shared by virtually all new nonprofits that are seeking 501(c)(3) status. You are correct that an acknowledgment letter will be required in order for your donors to use the charitable deduction for their donations (assuming the donations exceed $250). And yes, donations made prior to the organization receiving 501(c)(3) status should retroactively qualify for the charitable deduction if and when 501(c)(3) status is approved (assuming the Form 1023 was correctly prepared and timely submitted). Your main question regarding how to handle the donation acknowledgment letter requires a bit more explanation.

Per Internal Revenue Service (“IRS”) rules summarized in Publication 1771, one of the requirements of an acknowledgment letter is that it must be “contemporaneous.” This means that the organization should not wait until 501(c)(3) status has been approved to send the acknowledgment letters. Most 501(c)(3) organizations send acknowledgment letters no later than January 31 of the year following the year of the donation (and many send acknowledgment letters promptly after receiving each donation in alignment with donor management best practices). In all cases, acknowledgment letters must be sent no later than the date the donor files his or her federal income tax return (or, if earlier, the due date of the return, including extensions).

This leads to the tricky part. A nonprofit must not misrepresent its tax status while is awaiting approval of its Form 1023 application (in an acknowledgement letter or otherwise). Thus, acknowledgement letters for donations received prior to approval of 501(c)(3) status will look a bit different.

Go ahead and include the date and amount of the contribution, and (if true) a statement that no goods or services were provided in exchange for the contribution (refer to Pub. 1771 for situations where donors do receive goods or services). But instead of stating that the organization is a 501(c)(3) public charity, note that the organization has recently submitted an application for 501(c)(3) public charity status (retroactive to its date of formation) and that its 501(c)(3) status is currently “pending” and awaiting approval from the IRS.

I also recommend noting in the initial acknowledgment letter that the organization will follow up to inform the donor whether or not 501(c)(3) public charity status has been approved.

Planning Tip – For initial contributions aimed at helping with the organization’s start-up expenses, encourage founders, new Board members, and other early donors to write checks directly to the new nonprofit organization instead of personally paying for start-up expenses in the beginning. Open the new organization’s bank account as soon as possible with these early contributions and pay the organization’s start-up expenses directly from the new bank account. This will simplify the tax compliance and recordkeeping requirements for both the new organization and the early donors.

If and when the organization does receive approval from the IRS, provide a second updated gift acknowledgement letter that notes the initial letter that was sent and includes all the information that would normally be included in an acknowledgment letter along with other updated good news of how the new organization is doing. Any opportunity to communicate positive news to donors is a good opportunity.

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