Originally published on June 7, 2013.

By Taylor Griffith

In July 2009, James O’Shea and several other Chicago journalists joined together to create a nonprofit digital news organization for the city. The Chicago News Cooperative began publishing content by November of that year, a swift start to what many thought would be a major success in providing investigative journalism for Chicago at a time when traditional news outlets were cutting back.

In early 2010, the organization applied for tax-exempt status through Section 501(c)(3) of the Internal Revenue Code, a key factor in the survival of nonprofits. But two years later, the organization was still waiting for a ruling from the IRS. On February 27, 2012, the CNC shut down.

“It was supposed to take six months,” O’Shea says. “But by 2012, which was two years later, we still hadn’t been approved, and we couldn’t see when [the IRS was] going to approve it. So we just stopped everything.”

The long waits and long lists of rejected 501(c)(3) applications have caught the attention of leading media organizations and others who care about the survival of quality journalism. As legacy news organizations have retreated, nonprofits are an increasingly important part of the journalism landscape.

In 2011, the Federal Communications Commission issued a report stating the existing IRS policies were deterring nonprofit news startups from being successful. In the wake of the FCC report, the Council on Foundations used a grant from the John S. and James L. Knight Foundation to create the Nonprofit Media Working Group. The group, comprised of a dozen leaders in the media and nonprofit worlds, met for a year to study IRS policies regarding nonprofit media. The culmination of their work, “The IRS and Nonprofit Media: Toward Creating a More Informed Public,” was published in March and featured specific recommendations for changes to the Internal Revenue Code.

“The issue regarding the IRS, as the report states, has a lot to do with the fact that the IRS is working with rules and regulations are now 30 years old in many cases. Many of [them] predate cable television, let alone the internet,” says Kevin Davis, a member of the Nonprofit Media Working Group and CEO of the Investigative News Network, a consortium of more than 60 nonprofit news outlets.

“In the report, we went into great detail to make recommendations on what needs to be changed and why. The net effect is that because of, frankly, budget issues and because of the vertical nature of Congress, as much as the IRS wants to help–and really I do think there is some genuine good will on their part, they want to get this right, we’re not seeing any agenda–this is not about the IRS being against journalism as much as it is working through these guidelines that are kind of difficult to do.”

The IRS did not respond to requests for comment.

Among its recommendations, the Nonprofit Media Working Group suggested the IRS refocus its criteria for tax-exemption on the business organization applying for nonprofit status, rather than concentrating on the operational similarities they may have to for-profit newsrooms.

The study and its recommendations have garnered a wide array of support, including an almost immediate endorsement from the Carnegie-Knight Initiative on the Future of Journalism Education. The Initiative–whose 12 members are deans at prestigious journalism schools–drafted a statement of support for the Council on Foundations study, saying “accountability journalism, a vital public good, cannot thrive without a measure of explicit support.”

For Lucy Dalglish, dean of the Philip Merrill College of Journalism at the University of Maryland and a member of the Carnegie-Knight Initiative, the prospects for accountability journalism are “dim” if the IRS does not change its policies.

“As major news organizations downsize, they have been scaling back their investigative reporting efforts to save money,” she says. “Some very experienced investigative reporters have taken buyouts from their former employers. Many of them love being investigative reporters and are looking for ways to continue their work, which makes valuable contributions to society. I view [supporting nonprofit media companies] not as growing accountability reporting; I believe it’s essential for the survival of accountability reporting by trained professionals.”

According to both Davis and O’Shea, the most common path to becoming a 501(c)(3) tax-exempt organization is through fiscal sponsorship. Applying organizations, such as the Chicago News Cooperative, often partner with an existing 501(c)(3) organization – called a fiscal sponsor – that will accept tax-free donations on their behalf; for O’Shea and the CNC, the local public broadcasting station, WTTW, acted as the fiscal sponsor. During this time, sponsors charge the startup a percentage of money raised to cover the costs of administration and financial oversight. According to Davis, most sponsors charge 10 to 12 percent.

In the end, the fiscal sponsors, the donors and the startups get something out of the deal: sponsors get an extra source of revenue from the startups in exchange for helping them manage their finances; donors get a deduction from their taxes after making a gift to a nonprofit organization; and the startup uses the sponsor’s 501(c)(3) status to get tax-free gifts from donors while they’re awaiting their own tax-exemption.

Dalglish explains: “Newly formed nonprofit investigative reporting groups are largely dependent on philanthropy. Individual donors are much more likely to donate to tax-exempt nonprofits because they may then take a charitable deduction on their income tax for making the contribution. In addition, the only way a nonprofit foundation may legally contribute to a nonprofit investigative reporting organization is if it has 501(c)(3) tax-exempt status under the IRS code. So, unless you have 501(c)(3) exempt tax status from the IRS, you cannot raise money. Simple.”

While having the support of a fiscal sponsor is fine at the outset, says Davis, it’s not a long-term solution. If a startup does not gain independence from the sponsor, it will not appear in searchable databases of nonprofit organizations, which is a major avenue foundations use to donate. In addition, it’s against the policy of some foundations to donate to fiscally sponsored projects. “Ultimately independence, including have a board [of directors], is essential to the long-term viability of a nonprofit.”

Because of the IRS logjam, he adds, “What’s happening is there are a lot of organizations and people who want to start nonprofits..that have sort of been sitting on the fence because it’s hard enough to be a nonprofit newsroom right now, it’s hard enough to get funding, but the speed of the IRS and the need to use fiscal sponsorship as a means of getting around it is having a chilling effect and has had a chilling effect on several organizations.”

Though he doesn’t blame IRS policies for causing the CNC to fail, O’Shea says the slow response to his tax-exempt application was a major factor.

“I don’t think getting 501(c)(3) status would have meant we were going to necessarily survive long term,” he says. “The key to our success was going to be if we could raise enough money to build a journalistic infrastructure to cover the city the way we felt it should be covered. And the answer was the foundations weren’t going to do that. We were going to have to learn how to create revenue to support that.”

But, as O’Shea learned from experience, without early philanthropic support buying it time, an organization doesn’t have the means to create revenue streams. According to Davis, if the IRS policies don’t change, the number of surviving nonprofit newsrooms will be limited to communities where financial support and a well-established base of investigative journalism already exists, which will perpetuate the deficit of investigative reporting in areas where it’s needed most. While it’s possible in some cities to solicit support from the affluent population, “news deserts”–areas where there is a distinct lack of news coverage – don’t stand a chance.

“If you’re in a community that is below the poverty line–so we’re talking about people of color, we’re talking about immigrants–it’s much, much harder to serve them with the nonprofit model. As a result, we are sort of propagating this coverage of areas that already have coverage. So the best way for nonprofit newsrooms to be able to fill those news deserts is not only..get the IRS to get out of the way, but also to actually find a way to make it easier for people to serve their community with good journalism, with information.”

Both the Carnegie-Knight Initiative statement and the Council on Foundations study support the idea that nonprofit status will drastically affect the future of nonprofit news. But for O’Shea, solving the nonprofit news conundrum is not that simple.

“I think it’s very good,” O’Shea says of the working group’s report . “I just don’t think that the statements they made in several instances–that these kind of organizations are going to take up the slack that’s being created by the troubles of the newspaper–I just don’t think they’re going to do that. I think the main problem is, ‘How can you generate the kind of revenue you need?’ That’s the main question right now, and not too many people are really addressing it.”

Taylor Griffith is a student at the Philip Merrill College of Journalism at the University of Maryland.