What To Do BEFORE You Start Your Educational Foundation

By Dr. Carol Simpson, Shareholder, Eichelbaum Wardell Hansen Powell & Mehl, P.C.

So you want to start an educational foundation but you don’t know where to begin.  You know that a foundation is a tax exempt entity that can receive and disperse gifts of money or other property – a Daddy Warbucks for a school district.  High priced consultants offer to give you a “turnkey” foundation run by the superintendent.  What could be better or easier?  

Remember that old saying: If something seems too good to be true, it probably is. Establishing a foundation may be as simple as filing a short document with the Texas Secretary of State, but making that foundation a tax exempt entity is a detailed process that is not a one-size-fits-all proposition.  Some thoughtful advance planning can make your foundation a smooth-running enterprise that will serve the needs of your school district for many years to come.  

The Big Picture

Here is a short timeline of the steps in the process and their approximate time frames for the various offices to process the applications:

  1. Incorporating the foundation in Texas through the Texas Secretary of State (2 weeks)
  2. Applying for and receiving 501(c)(3) status from the IRS (4 months);
  3. Applying for and receiving tax exempt status from the Texas Comptroller (2 weeks).

The times indicated are following receipt at the respective offices. They do not include the time necessary to draft the respective applications, which can be time-intensive.  This article will outline the various steps the foundation must take to get from square one to complete tax exempt status.

Forming the Foundation

The new foundation will need a name.  The new foundation will also need three founding directors.  The founding directors can be school trustees/employees, but that usually changes when the final board is chosen.  

Organizational Meeting

The most important part of the organizational meeting will take place before—maybe weeks before—the meeting starts: setting the purpose for the foundation.  The wording of the purpose statement is critical to receiving tax-exempt status.  The purpose statement also limits what the foundation can do in the future, so significant thought and input should go into its construction. Make sure to have an attorney review the statement.

The first official action of the founding directors is to hold an organizational meeting.  At the meeting the founding directors will select a registered agent (to receive official correspondence and service of process).  The agent could be a local businessperson who could use a business address if the foundation will not have its own office and an executive director.  The founding directors will authorize one of the directors to file the formation documents with the Secretary of State.

You will mail the following to the Texas Secretary of State, to P.O. Box 13697, Austin, Texas, 78711-3697:

Incorporation through the Texas Secretary of State generally takes about two weeks or less.  Six months from the date of incorporation, the foundation will have a state tax return due.  The tax return can be filed online, and there should be no state taxes due.  The process of review through the IRS for 501(c)(3) exempt status takes approximately four months, and the foundation sends the IRS designation to the Texas Comptroller to achieve Texas tax-exempt status. Preparing the IRS application requires detailed plans regarding how the foundation will acquire and disperse money.  General statements are not accepted. So the directors should have clearly outlined plans regarding income and expenditures before the IRS application is ready to file.  That means being almost finished with all that before you file with the Secy of State to incorporate.

Hold First Meeting of Board of Directors

Once incorporated, the Founding Directors should meet and adopt bylaws, elect officers, and elect a full Board of Directors.  The foundation will also need a conflict of interest policy and a procurement policy.  It is helpful to know who will be appointed to the Board, and have them present at the first meeting so they can start work immediately. Directors from the school district should not make up the majority of the final board, because the IRS views that as simply an extension of the District and may not grant 501(c)(3) status if there is not an “arm’s length” between the two entities. Good directors for a Board are those who either have money to donate to the foundation or who know those who do.

Apply for EIN

As soon as you receive the Certificate of Formation from the Secretary of State, apply online for an Employer Identification Number.  You will need that number to apply for 501(c)(3) status.

Agree on a Memorandum of Understanding

Part of the application for 501(c)(3) status requires that if the foundation plans to raise money to benefit another organization (i.e., the school district), the foundation must have a memorandum of understanding with that organization.  Negotiate the Memorandum before the process starts so it is ready to sign as soon as the Board of Directors is in place.

Application for 501(c)(3) Status

The next step in the process is to file IRS form 1023.  The 1023 form submission must include a copy of the approved certificate of formation from the Secretary of state, the foundation’s bylaws, a conflict of interest policy for board members (adopted at the first meeting of the Board), a procurement policy (adopted at the first meeting of the Board), and minutes of all board meetings.  In addition, the 1023 submission will require the following:[1]

The IRS estimates that Form 1023 will take about 125 HOURS to complete the form and its schedules. Do not underestimate the amount of time involved.  Because this will take so much time and effort, it is generally a good idea to have this information almost complete before submitting the first application to the Texas Secretary of State.

An application fee must accompany the application. The amount of the application fee will depend on how much income the foundation projects to earn across the next four years.  If the foundation anticipates earning $10,000 or more per year over the next four years, the application fee is $850.  If the foundation anticipates earning less than $10,000 per year over the next four years, the application fee is $400. 

Application for Texas Tax Exempt Status

Once the foundation receive notification from the IRS that it has been identified as a 501(c)(3) organization (which makes it exempt from federal income taxes), the foundation immediately applies for tax-exempt status with the Comptroller’s office. The state tax exempt status exempts the foundation from paying both franchise and sales taxes. 

Once the Comptroller provides notice of tax exempt status, the process ends as far as applications.  The foundation will need to file yearly franchise tax reports with the Secretary of State, and yearly “tax returns” (actually Form 990) with the IRS.  If the foundation’s tax year ends before it receives 501(c)(3) status, it will have to file a normal corporation tax return.  If it forgets to file, that omission can jeopardize getting tax exempt status.

Your school attorney can guide you through the process, provide model documents for you to modify, and assist with any questions from the reviewing agencies. Once the foundation is on its own, it will need its own attorney to handle any legal issues that may arise, as well as an accountant to file tax returns.  A foundation is just like any other corporation, and should expect to transact business in a similar manner.

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[1] This is just a sampling of the documentation that must accompany the 1023 application.  Please consult your school attorney for advice on what information to include.