How to Start a Foundation: 8 Common Mistakes to Avoid
Starting a foundation can be a powerful way to give back and support local nonprofits, charities, and causes that matter most to you. Whether your focus is on education, health, or supporting local nonprofits, the impact of a well-run foundation can make a real difference in people’s lives. However, building a foundation from the ground up requires thoughtful planning and careful attention to detail.
Before taking the next step, you’ll need to tackle some key legal and financial tasks. From creating a clear mission statement to securing tax-exempt status, setting things up right from the start is the best way to avoid problems. Skipping these steps could lead to headaches down the line.
Starting a foundation is meaningful, but the process can be complicated. By avoiding these eight common mistakes, you can lay the groundwork for a successful, lasting organization.
Mistake #1: Failing to Define a Clear Mission and Purpose
Many people are eager to start a foundation but rush through the critical first step: defining its mission and purpose. A well-defined mission statement is more than words—it’s the foundation’s guiding principle. Without it, your organization can easily lose focus, creating confusion about your goals and making it harder to maintain legal compliance.
A vague mission can also lead to complications when adhering to IRS regulations or maintaining tax-exempt status. If your foundation’s purpose isn’t clear, it may be challenging to justify charitable grants, which could result in the loss of tax deductions or other financial benefits. Additionally, when the mission is unclear, you risk not attracting the right board members or donors who align with your fundraising goals.
To avoid these pitfalls, take the time to develop a clear and concise mission statement. Think about the specific cause or group you want your public foundation to help and how your foundation will serve them. For example, if you’re creating a family foundation to support education, your mission statement could be: “To provide educational scholarships to underserved students in rural communities.” This not only clarifies your purpose but also ensures alignment with IRS regulations.
Involving key stakeholders, such as family members or other potential board members, in this process can help shape your mission and goals. Their input can provide valuable perspectives, ensuring your foundation’s philanthropic goals and objectives are realistic and well-supported. important to ensuring compliance with all IRS regulations and avoiding delays in obtaining approval.
Mistake #2: Not Understanding IRS Classifications (Private Foundation vs. Public Charity)
One of the most common points of confusion when starting a foundation is the difference between a private foundation and a public charity. While both serve charitable purposes, the Internal Revenue Service (IRS) treats them differently. Understanding these classifications is key to ensuring your private foundation is compliant with tax-exempt status regulations.
A public charity typically receives funding from many sources, such as individual donors, government grants, and fundraising activities. They often operate programs or services directly benefiting the public. On the other hand, a private foundation is usually funded by a small group, often from one family or corporation, and focuses more on making charitable contributions or grants to support other nonprofit organizations. The rules for each organization type are different, especially regarding taxes and reporting requirements for public foundations.
Choosing the wrong classification can have serious implications. For example, private foundations are subject to stricter regulations around investment income and charitable giving, and failing to comply with these rules could jeopardize your foundation’s tax-exempt status. Public charities are less restricted in these areas than private foundations but must meet certain thresholds in terms of public support.
To avoid this mistake, carefully evaluate the charitable foundation classification that fits your mission and structure. A private foundation might be appropriate if a small group of family members primarily funds your foundation and focuses on making charitable grants to other organizations.
However, if you plan to raise funds from the general public and operate your programs, a public charity could be a better option. It’s always wise to consult with an attorney who understands nonprofit law to help you determine the correct classification for your foundation’s purpose. re your organization has the capacity to meet these requirements to avoid compliance issues.
Mistake #3: Ignoring IRS Compliance Requirements
One of the most significant errors new foundations make is neglecting IRS compliance from the very beginning. Establishing a foundation requires more than filing paperwork; it demands ongoing adherence to the IRS’s strict rules regarding tax-exempt status. From maintaining proper records to fulfilling reporting obligations, failure to comply can lead to penalties, including the loss of tax-exempt privileges.
The consequences of noncompliance are serious. Foundations that don’t meet the IRS’s requirements may be subject to financial penalties, audits, or even the revocation of their tax-exempt status. Losing this status impacts your ability to claim tax deductions on donations and jeopardizes your credibility with donors and other stakeholders.
To avoid these risks, it’s important to be diligent about IRS requirements from day one. This includes obtaining an employer identification number (EIN), filing for tax-exempt status, and complying with ongoing reporting obligations such as filing annual tax returns. Additionally, regularly review the IRS website to stay updated on any changes to regulations that might affect your foundation. For added security, working with a professional who understands nonprofit law can ensure you follow all compliance steps properly.
Mistake #4: Not Creating a Comprehensive Governing Document (Bylaws)
A well-run foundation begins with strong governance, so drafting detailed bylaws is imperative. These governing documents serve as your foundation’s operational guidebook, outlining how you make decisions, handle leadership transitions, and manage day-to-day activities. Without clear and detailed bylaws, your foundation may face leadership conflicts or operational breakdowns, leading to inefficiencies and legal issues.
When bylaws are vague or insufficient, problems often arise within the board of directors. A strong program officer and board of directors should have members with diverse backgrounds relevant to your foundation’s mission. The board may struggle with decision-making, accountability, or compliance without comprehensive governance policies.
To avoid governance issues, take the time to develop a robust set of bylaws that address leadership structure, decision-making processes, conflict resolution, legal protection, and board member responsibilities. Reviewing these bylaws regularly and revising them when necessary is also helpful to ensure they remain aligned with your foundation’s goals and IRS regulations.
Consider seeking professional assistance to draft bylaws that meet state and federal requirements, ensuring your foundation is built on a strong legal footing.
Mistake #5: Overlooking Financial and Reporting Requirements
Financial oversight is one of the most critical aspects of running a foundation, yet many founders overlook their obligations. Whether it’s managing the foundation’s investment assets and income, ensuring the accurate use of charitable contributions, or maintaining proper financial records, a lack of oversight can quickly lead to legal troubles.
Failing to meet financial reporting requirements can result in penalties and fines, or worse, cause your foundation to lose its tax-exempt status. Foundations that receive tax-exempt status must file annual tax returns with the IRS and, in many cases, with state authorities. Foundations that neglect these obligations may face financial penalties and will likely damage relationships with donors.
It’s important to set up proper accounting systems from the beginning to avoid financial pitfalls. Establish processes for tracking donations, grants, and expenses. Additionally, consider hiring an accountant experienced in nonprofit organizations to manage your financial reporting and ensure your foundation complies with IRS and state regulations.
Mistake #6: Mismanaging Initial Funding and Donations
Another common mistake is mishandling early donations and failing to properly manage your foundation’s initial funding. Early missteps can create compliance issues, particularly during IRS audits. Poor financial management can also undermine donor trust, making it difficult to secure future donations.
An early focus on transparency and accountability is key to maintaining good donor relations. Foundations that fail to report how funds are used or misuse donations risk damaging their reputation and ability to attract long-term donors. A lack of financial clarity can also lead to issues with the IRS, further threatening the foundation’s tax-exempt status.
To avoid these risks, ensure that all funding is managed with strict accountability. Establish processes to track how donations are allocated and spent. Develop a fundraising plan that outlines how you’ll communicate the impact of charitable contributions to donors and other stakeholders. Clear communication about how donations are used will build donor trust and help your foundation maintain its credibility.
Mistake #7: Neglecting State-Level Regulations and Filings
Many founders focus on federal compliance but overlook the importance of adhering to state law when starting a foundation. States often have their own registration and filing requirements for nonprofit organizations operating foundations, and failing to comply with these can result in fines or even prevent your foundation from legally operating.
Each state has regulations, including registering as a nonprofit corporation, obtaining specific licenses, or meeting certain reporting obligations. Ignoring these requirements can lead to operational delays or legal penalties.
To avoid these issues, research the regulations in the state where your foundation is based. File all necessary paperwork, including state-level tax exemption applications, if applicable. If you plan to operate family foundations in multiple states, meet the filing requirements for each state. Staying compliant at the federal and state levels will ensure your foundation can operate smoothly and legally.
Mistake #8: Not Seeking Legal Help
One of a founder’s most avoidable mistakes is assuming they can handle all the complexities of starting a foundation independently. There are numerous legal, financial, and operational steps involved in establishing a foundation, and overlooking any of them can have serious consequences. Whether failing to file the correct paperwork, misunderstanding IRS regulations, or ignoring state requirements, these missteps can lead to legal trouble, financial penalties, or even the loss of tax-exempt status.
Starting a foundation without legal guidance can put your long-term goals at risk. A foundation that isn’t legally compliant could face penalties or be unable to make enough money to fulfill its mission effectively.
To avoid these risks, it’s important to consult with an attorney who understands the complexities of nonprofit law. A legal professional can help you navigate the required filings, ensure compliance with all regulations, and protect your foundation’s future. At Chisholm Law, we offer comprehensive legal services to help guide founders through starting and maintaining a foundation.
Set Up a Strong Foundation with Chisholm Law
Starting a foundation is a powerful way to give back to your community or support a cause close to your heart. However, avoiding these common mistakes is a must for ensuring your foundation operates smoothly and complies with all legal requirements. Your foundation and charitable causes can thrive for years with careful planning, a legal team, transparent governance, and the right financial systems.
At Chisholm Law, we help new foundations and other nonprofits navigate the legal and regulatory landscape. Whether drafting bylaws or ensuring IRS compliance, our team is committed to guiding you through every step of starting a foundation. Contact us today to schedule a free consultation and to lay the groundwork for your foundation’s long-term success.
*Past results do not determine future outcomes