Nonprofit Law Jargon Busters

Nonprofit v. Tax-Exempt: Associations can be organized and operated as both nonprofit and tax-exempt entities. Nonprofit status refers to incorporation status under state law; tax-exempt status refers to federal income tax exemption under the IRS code.

Private Foundation v. Public Charity: Generally, ever since 1968, Section 501(c)(3) organizations have been divided into two categories for tax purposes, public charities and private foundations.

Public Support Test: Private foundations are subject to more restrictions than public charities and have to pay a tax on investment income so qualifying as a “public” charity is usually considered a pretty darn good thing.

The Commerciality Doctrine: The Commerciality Doctrine has evolved in the courts and is applied to determine whether an organization complies with Section 501(c)(3)’s requirement to operate exclusively for exempt purposes.

Private Inurement v. Private Benefit: The private inurement rule and private benefit rules exist to ensure that charitable assets are preserved for the benefit of the public and not diverted to private use. This is a fundamental concept that distinguishes tax-exempt organizations from for-profits.

Tax-exempt Purpose: There are 28 different exemptions under Code Section 501, the most popular of which is Section 501(c)(3).  If the corporation plans to qualify for tax-exemption under Section 501(c)(3), the articles must limit the corporation’s activities to permissible tax-exempt purposes.

Ultra Vires Acts: A Latin term that essentially means that acts outside the permissible scope of authority set forth in the governing documents is unauthorized activity that cannot be ratified by the board.

Commensurate Test: Essentially, the “commensurate test” requires 501(c)(3) organizations to conduct charitable activities commensurate in scope with their resources. The idea is that donors fund charities to do charitable works, not to amass a fortune with no clear plan of how the funds will be spent.

Ex Officio Director: There is widespread misunderstanding regarding the meaning of the term. Ex officio members of a board are serving on the board “by reason of their office,” rather than by being elected or appointed to the position.

Social Welfare Organizations: A social welfare organization is an nonprofit organization exempt under Code Section 501(c)(4). It is similar to a 501(c)(3) organization in that its income is generally exempt from tax and is subject to the same limits on private inurement and excessive payments to insiders.

Proxy Voting: Proxy voting is legal mechanism for a member of a voting body to delegate his or her voting right to another member of the voting body. Some nonprofit corporations rely on proxy voting to ensure a quorum at meetings where all the directors cannot attend because it allows directors or members who have confidence in the judgment of other directors or members to vote on their behalf.

Voting Members vs. Self-perpetuating Boards: When forming a nonprofit corporation, it is important to decide whether the corporation will be board driven or member driven. If the corporation is board driven, there are typically no members or the members have very limited rights. If the organization is member driven, the members are typically voting members who have the power to elect and remove members of the board of directors.

Voting by Unanimous Written Consent: Occasionally, urgent board action is required yet it is not possible or practical to have the board meet in person or even over the telephone. In these cases, most states permit the board members to conduct official business by signing a unanimous written consent.