"I am forming a nonprofit organization with two other investors who want to effect social change in our community.

"Because it will take quite a while to launch our fund-raising activities, get money from private donors, and file applications for government grants, the three of us have decided to put up some money to get this organization off the ground.

"Some of this money we intend as a donation, but because it's such a large amount (over $250,000), we want to be able to get some of this back from the organization once it's financially solvent and able to stand on its own.

"Is this legal? If so, how can we do this without getting the IRS upset? Our attorney is in the process of filing an application for 501(c)(3) tax-exempt status and we don't want to do anything that would put that in jeopardy."

The short answer to this question is yes, it's legal. But you have to be careful how you go about doing it.

First of all, you want to be sure the IRS doesn't classify you as a private foundation for tax purposes. A private foundation is an exempt organization that is financed primarily by one or more private sources, such as a corporation or an extremely wealthy family (like the General Electric Foundation or the Bill & Melinda Gates Foundation). When you file your application for 501(c)(3) exempt status on Form 1023, you are automatically classified as a private foundation unless you demonstrate to the IRS that you are not. For a nice summary of the IRS rules, visit www.irs.gov/charities-non-profits/charitable-organizations/private-foundations.

The concept of a capital contribution, or paid-in capital, doesn't exist for nonprofit organizations the way it does for business corporations and limited liability companies, or LLCs. Basically, when you put your own funds into a nonprofit organization, it is either considered a donation or a loan (or some combination of the two, which you obviously have in mind here).

Form 1023, the IRS form for tax-exempt status, requires you to project your income and expenses for the current year and the next two fiscal years. You will have to disclose your donation-plus-loan arrangement as part of the income statement required by Part IX of the form.

If you are putting all your money in at once and you intend your initial contribution as a tax-deductible donation, you should put the total amount down in line 3 for the current year and leave the boxes for subsequent years blank. If you are spreading the donation out over several years, you should put in the box for each year the total amount you plan to donate each year. Keep in mind you will not be able to take a tax deduction on any part of your donation until you actually get IRS approval for tax-exempt status. This can take anywhere from six to nine months based on the IRS' current workload.

If you intend your contribution as part donation, part loan, you would handle the donation part as I've indicated above, but the loan part is a bit trickier. You will have to indicate the total donation and loan amounts you will pay each year in line 3, but then, you will also have to fill in line 16 (payment of compensation or other amounts to the nonprofit directors and officers each year) showing the amount the nonprofit is expected to repay on the loan each year.

Your attorney will need to create a schedule to Part IX explaining exactly what you are doing and why, so the IRS doesn't get confused and think you are paying yourselves upfront for your services to the nonprofit (that's always a red flag when filing for tax-exempt status).

Here's how I handle this for my clients: Each of you would sign a grid (a simple spreadsheet) promissory note offering to lend up to X dollars each year to the nonprofit, up to a maximum of Y dollars. The loans would not bear interest and would have a maturity date of 10 years (no principal would be legally due until that time), but the nonprofit can pay it back sooner whenever it can, and any principal remaining unpaid at the end of 10 years would be treated as a donation to the nonprofit. Your promissory notes would be attached as an exhibit to Form 1023.

Each time you loan money to the nonprofit, you would record the loan on the grid attached to the note, along with the date the loan was made. As the nonprofit pays back the loan principal, that payment would also be recorded on the grid.

The IRS should not raise its eyebrows at this arrangement. The arrangement may also be attractive to potential donors — they will like that you have skin in the game, as would be the case with any other start-up venture.

Cliff Ennico ([email protected]) is a syndicated columnist, author and former host of the PBS television series "Money Hunt." This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our webpage at www.creators.com.