Contracts and Grants, LLC

5 Reasons the US Government Comes After Nonprofits

9 May 2018 11:18 AM | Linda Chatmon (Administrator)

It’s the unfortunate truth: Many of the people who say they want to start a nonprofit, or who do start a nonprofit and serve as Executive Director, have no idea how to actually run one. And that can lead to legal and financial trouble for both the ED and the nonprofit.

Over the years, I have found there is no shortage of people who start nonprofits with the wrong motives. They start the organization with a mission, but not for the mission. Meaning, their proposed cause is legitimate, but they have ulterior motives for investing the time and resources into building the nonprofit.

As a result, they don’t learn how to properly structure the organization. They don’t understand the laws governing nonprofits. They don’t know the difference between being a nonprofit and being tax-exempt.

Unfortunately, this mindset often leads one of three places: Either the organization will survive, but pay tens of thousands of dollars in donated money trying to course-correct later down the line, the organization will go out of business, or the government will get involved. And that’s where things can get sticky.

The Slippery Slope That Is Self-Dealing

One of the trickiest spots for newly-crowned Executive Directors to navigate is managing their existing relationship and building new relationships, both personal and professional. One such relationship is the one you (and the nonprofit) have with your other personal and professional activities.

If any part of your nonprofit’s actions is tied to another one of your businesses, it’s self-dealing. You, your friends, or family members cannot privately benefit from your mission-driven nonprofit.

Let me give you an example from my book, Grant-Worthy.

A client came to me for help starting a nonprofit that transitions renters into first-time homebuyers. It was a fantastic mission: Creating a path for working-class Americans to buy affordable homes in areas hit the hardest by the Great Recession.

She wanted me to help her find government and community grants that would allow her organization to refurbish blighted properties and get these homes back on the tax rolls and back in the market. Had it worked, that nonprofit would have helped rebuild hundreds of neighborhoods, and started many young families on the road to homeownership.

There was just one problem.

The woman who had this great idea was a real estate agent. She planned to use her ongoing real estate business as a way to direct qualified homebuyers into the nonprofit program.

The real estate broker for whom she worked would facilitate the deals and pay her a commission on each house she sold. On the nonprofit end, she would eventually earn a salary as a managing member of the nonprofit once the organization could afford it.

In this instance, the nonprofit business depended on the managing director’s for-profit business to survive. The for-profit business would have been directly impacted by the success of the nonprofit business. This method of running a nonprofit is both unethical and illegal.

Here is another example of self-dealing that's not so blatant.

If you are a pastor of a church and your wife owns a floral shop, the church cannot buy its weekly floral arrangements from your wife’s shop. This violates private inurement laws that prohibit you or your immediate family members from benefitting privately from the nonprofit organization.

The Stiff Penalty for Self-Dealing

Nolo defines private inurement as a 501(c)(3) using a nonprofit’s money for private uses instead of the charitable cause for which it was intended. Board members as well as an organization’s managing members can find themselves in trouble for self-dealing or embezzlement even if they weren’t directly involved in the act. Being found complicit can be as simple as not being as thorough with the accounting as a prosecutor or government agent thinks you should have been.

I’ve heard it said that embezzlement happens; it’s how your organization deals with the embezzlement that matters. At the end of the day, once the mis- dealings are discovered – and they usually are – the least you stand to lose is a little face by having to pay penalties. Next, your nonprofit can lose its tax-exempt status, which will absolutely level the organization. But the greatest loss will be your reputation. That is something from which you and your organization may never recover.

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