Even the basics can get tricky, according to our specialist in arts and tax law

Creative fundraising strategies are all to the good, but keep a watchful eye: Nonprofit  organizations are subject to the laws and regulations of the state in which they operate (and possibly other states as well, which we’ll get to in a minute). Tax-exempt entities—also known as 501(c)(3) organizations—also are governed by federal law. Don’t know the difference between a nonprofit organization and a 501(c)(3)? [See What’s the difference between a nonprofit and a 501(c)(3)?]

The agencies that regulate nonprofits vary from state to state. For example, in New York, it’s the New York Attorney General’s office; in New Jersey, it’s the New Jersey Division of Consumer Affairs. Always check the official list posted by the National Association of State Charity Officials to be sure where to register. Meanwhile, here are a few common mistakes to watch out for.

Soliciting donations in a state without registering there:
Almost every state requires an organization to register before it can solicit donations. The definition of “solicit” is pretty broad, and includes any type of fundraising directed at state residents. This includes not only actual fundraising events but also written or verbal solicitation communications including advertising and publicity.

Here’s an example: a small nonprofit theater produces several shows a year in New York City. It solicits donations in Manhattan and Westchester, which is okay because it has registered with the New York Attorney General’s office. After several seasons, the company has a hit, and begins to attract patrons from New Jersey and Connecticut. But if it plans to solicit donations in those states, it must first register to do so, in both.

Hiring a fundraiser who gets a “cut” of the funds raised:
While this type of arrangement is not illegal in itself, it does create a number of potential legal pitfalls. Because charitable donations cannot be used for “private inurement” (legal jargon meaning the money is going into someone’s pocket instead of toward the nonprofit’s charitable mission), certain limitations must be in place beforehand to keep the arrangement legal. First, the commission or percentage received by the fundraiser must be “reasonable,” as must the fundraiser’s compensation. (“Reasonable” here means that the fundraiser provides services, and that the total compensation is commensurate with the time spent rendering services.)

Example: an orchestra hires a professional fundraiser to solicit donations. The fundraiser agrees to spend 10 hours doing so, and as compensation he will take a 20% commission. Miraculously, he raises five million dollars! A million dollar compensation is hardly reasonable for 10 hours of work. On the other hand, if the agreement stipulates that the fundraiser will spend a specific number of hours on specific fundraising tasks, AND there is a cap on what he can earn, AND that cap is not unreasonable for services rendered, then the arrangement would be acceptable. The bottom line is, the total compensation to the fundraiser must be reasonable in relation to the amount of time spent soliciting.

One last note: Many states regulate “professional fundraisers” and “fundraising counsel.” Be sure to check out the guidelines in your state—and any one in which you’ll be soliciting.

Improper documentation of charitable contributions:
The Internal Revenue Service and many states require that most charitable contributions be documented. A 501(c)(3) organization must adhere to the following:

1. All monetary gifts (cash, checks, etc.) of $250 or more must be acknowledged in writing and “contemporaneously.” This does not mean that you must send out an acknowledgement minutes after you receive a contribution. “Contemporaneously” means only that a donor must receive written acknowledgement no later than the timely date he files his or her tax return for the year the contribution was made. Example: Joe Smith gives the ABC Dance Company, a 501(c)(3) organization, a $500 donation on June 1, 2013. ABC’s acknowledgment to Mr. Smith must be sent to him before he files his 2013 tax, or April 15, 2014, whichever is earlier.

2. All in-kind contributions (i.e., non-monetary) valued at $250 must also be acknowledged in writing and contemporaneously, with an accurate description of the item(s) being donated. The acknowledgement also must state either that no goods or services were provided by the organization, or describe the goods and/or services that were provided and give a good faith estimate of their value. (See IRS Publication 561)

3. These written acknowledgments need not be lengthy or involved! Here are two acceptable examples:

• “Thank you for your cash contribution of $300 that (organization’s name) received on December 12, 2012. No goods or services were provided in exchange for your contribution.”
• “Thank you for your cash contribution of $350 that (organization’s name) received on March 6, 2013. In exchange for your contribution, we gave you a cookbook with an estimated fair market value of $60.”

4. All donations of property valued in excess of $5,000 requirethe receiving the donor to complete Form 8283. Before the donor submits the form to the IRS, the receiving organization must complete Part IV, which acknowledges receipt of the donated property.

Additional IRS Resources and Forms 
Publication 1771: Charitable Contributions—Substantiation and Disclosure Requirements

Robyn Guilliams is a partner in the law firm of Goldstein & Guilliams PLC (GG Arts Law) and a contributor to the Law and DisOrder blog on MusicalAmerica.com. She is a frequent speaker at national arts conferences, and is a co-author of the web site Artists from Abroad.