About to fill the paperwork to create an organization: should it be a business or a non-profit?

Question

I'm building a product that you would think is perfect for the typical "startup" scenario.

However, I hate everything that usually involves startups: I don't want to raise money (I want this product to be bootstrapped), I don't want to have equity, I don't want to have investors, I don't want to have shares, etc.

I simply want my product to bring enough revenue to cover some salaries (and if it keeps growing, just hire more people and increase the salaries).

So then I have two questions:

• Would then this count as a 501(c)(3) non-profit (or any other non-profit type)?
• I've read about how normally some non-profit organizations (such as Foundations) work, but I'm not interested in those legalities either (e.g. having a foundation board whose members are not employed by the foundation and don't receive a salary from it, etc). Is there any non-profit org model that is simpler and has a simple hierarchical structure?

Answer 1

If you hate paperwork then a 501(c)(3) is not for you. Because there are no free lunches, in return for giving you a tax exemption, the IRS imposes a bunch of requirements to prevent tax fraud. These requirements cover everything from your board (yes, you need one) to where you get your money, and how you spend it.

To understand what a 501(c)(3) requires, and why, it might help to call them "private foundations" instead of "501(c)(3)s." For example, when you say "foundation" you think, "oh, a charity," not "oh, an ordinary business." Foundations are charities because they provide a service to the public at reduced cost, not because they don't make a profit.

Because the goal of a charity is to provide a benefit to the public, to run a foundation you have to specify that benefit, and have plans to provide it. If the IRS decides your plan is genuine, then they give you a pass on paying taxes.

To make sure you are carrying out your charitable plan, the IRS requires you to spend a certain percentage of your money each year on charitable work. (This is called the "distribution requirement .") Documenting how you are spending money means more paperwork.

Most 501(c)(3)s meet this requirement by giving grants to others, who then use the money to do charitable work. Since you are not going to be giving grants, you have to do what the IRS calls "direct charitable activities.” These are, as the name suggests, charitable activities that the foundation does itself, rather than paying someone else to do. The money used to pay for “direct charitable activities” does count against the distribution requirement.

You might also be eligible to organize as a "private operating foundation." But again, organizing this way brings its own requirements.

Answer 2

If you just want to avoid a hassle, you can just start the business under your name, and it is a sole-proprietorship. Only you will have to pay full tax and be subject to the laws of the US. Corporations are setup to reduce taxes and shield people from the law in certain circumstances. Also financial institutions, and others, may require that structure for a variety of reasons, including disclosure requirements.

If you want to setup a 501(c)(3), you can submit a Form 1023-EZ. It should be fine if you have a clear charitable purpose. It still requires you to provide details about what you are planning on doing. Then income tax doesn't have to be paid for salaries, and donors can tax-deduct donations. And, like a corporation, you get some legal shielding.

I would personally just keep it as a sole-proprietorship, though, if it's a matter of not wanting to be hassled. If things are successful, you might want the option of making money from it. On the other hand, if your purpose is really charitable, you can avoid taxes and maybe have an easier time getting people to work for lower wages if it's a charity.