In my practice representing nonprofit and tax-exempt organizations, there are often themes that emerge. Over the last few weeks I have had a spate of calls from would be nonprofits that paid either a nonprofit start-up “consultant” or a document preparation company to form their nonprofit and handle their IRS filings. In each case, the work product that made it to my office required substantially more work to fix than it would have taken to do properly the first time around. You get what you pay for, and sometimes, you pay dearly for what you get. Before hiring someone to help you with the legal and tax aspects of starting a nonprofit, make sure they are licensed to provide the type of assistance they are offering, have specific experience representing nonprofits, and are in fact representing you rather than helping you to commit malpractice on yourself.
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.
The rules originate in the language of Code Section 501(c)(3). Code Section 501(c)(3) contains the specific requirement that:
[N]o part of the net earnings of [the exempt organization] inures to the benefit of any private shareholder or individual . . . .
In addition, under the regulations, an organization is not treated as organized and operated for exclusively exempt purposes “unless it serves a public rather than a private interest,” Based on this provision, tax exempt status is not available to any organization if its net earnings inure to the benefit of private individuals “in whole or in part.”
In practice, the law distinguishes between different degrees of inurement depending upon who is being benefitted. The two types of inurement are referred to as “private inurement” and “public benefit.”
Forty-one U.S. states as well as the District of Columbia and many local jurisdictions require some type of registration for charities trying to solicit funds. These laws create a patchwork of largely inconsistent laws that nonprofits must contend with. To add to the confusion, the jurisdictions that require registration have different definitions and standards regarding who must register, which documents are required, whether nonprofits must renew their registrations, and which government agencies process the registrations.
Sometimes no good deed goes unpunished. In this case, the board and staff of both nonprofits did a great job of putting their mission and beneficiaries first, only to be ambushed by their lack of stakeholder communication and buy-in.
Often, in an effort to save money, clients come to their attorneys with a plan and simply ask them to “draft X.” Frequently, X isn’t the most appropriate solution. This case was one of those. The deal started out as an acquisition with the lawyer (me!) being kept at arm’s length when in fact more involvment early on would have quickly identified that this program was not a candidate for an acquisition, but rather a simple management arrangement.
Sometimes collaborations do not go smoothly. This post summarizes some of the pitfalls and lessons learned when a nonprofit tried to acquire a struggling nonprofit for all the right reasons, but the effort ended up being more trouble than it was worth.
Case study of successes, disappointments and lessons learned from a successful merger of two human service organizations.
The well-meaning have been advising exempt organizations to “operate like a business” for years. If the organization is a Section 501(c)(3) organization, operating too much like a business can cost it its tax-exempt status due to the “Commerciality Doctrine.” Practically, the issue of commerciality usually arises when a tax-exempt organization engages in any endeavor for which a clear for-profit counterpart exists in the marketplace. Typical examples include publishing, consulting and sales of arts and crafts. Today, the Commerciality Doctrine is a threat to the increasingly popular movement toward social enterprises. Those that choose to organize as Section 501(c)(3) organizations should only do so after a thorough review of the Commerciality Doctrine.
Here’s a tip for nonprofits planning to apply for tax exempt status: submit the application for exemption in 2009, before […]
In Ripples from Zambezi, the author, Ernesto Sirolli, turns the top down model of grand economic development on its head. Instead, his focus is on nurturing the passion and creativity of individuals.
The title comes from Sirolli’s early experiments in economic development in rural Africa, where he worked as a foreign aid worker for the Italian government. The beginning of the book details his experiences in Africa and the ideas that those failed experiments planted in his mind.
From that experience, he learned firsthand the damage traditional top down development models could do and made it his life’s work to find a better way to build local economies. He later discovered that the ideas that germinated in Africa applied to Western economies, too.
Sirolli’s approach builds on the theories of E.F. Schumacher, A.H. Maslow, Carl Rogers and others. The fundamental concepts underpinning Sirolli’s work include:
– A belief in the intrinsic goodness of human nature.
– If people don’t ask for help, leave them alone.
– There is no good or bad technology to carry out a task – only an appropriate or inappropriate one. Something big, modern, and expensive is not necessarily best; it all depends on the circumstances.
First, the Bad News Recent reductions in the Arizona Corporation Commission’s budget are impacting nonprofit corporations doing business in Arizona […]
As discussed in last week’s Nonprofit Law Jargon Buster, there are some organizations that are, by their very nature, considered “public.” These include churches, schools, and hospitals. Other types of charitable organizations must pass one of two mathematical tests calculated on a four year rolling average to qualify is public.
Asks Forgiveness, Not Permission. I receive calls from nonprofit CEOs who are struggling with their boards. I am also asked by boards to intervene when there is a an issue with the CEO. What I have learned is that great CEOs do not overly confer with the Board. Instead, great CEOs understand that it is their job to implement the Board’s strategy within the scope of the strategy, policies, and budget the Board has set. Too much “checking-in” can have the unintended consequence of inviting the board to micro-manage. Conversely, scribbling too far outside the lines of the board approved strategy, policies, and budget can get a CEO fired.
Private foundations are subject to a more strict regulatory regime than public charities. There are penalties for “self-dealing” transactions, failure to distribute sufficient income for charitable purposes, holding concentrated interests in business enterprises, making risky investments, and for making certain types of expenditures.
A plain language explanation of the difference between a nonprofit organization and one that is tax-exempt.
As the recession deepens, we get more and more creative ideas from people wanting to conduct complex raffles. In Arizona, the most popular questions this year involve raffles of real estate. While raffles can be great revenue generators for charitable organizations, many charities do not realize that in most states, including Arizona, raffles are illegal gambling. Cautionary tales abound. Most states have specific exceptions for charitable raffles but require the charity and the raffle to meet specific criteria to qualify.
Boards are entitled to delegate tasks to committees, officers, staff, or in certain cases, professionals, but only if they perform sufficient oversight. Oversight is commonly exercised through policies and procedures so long as the board ensures that the policies and procedures are actually followed. Common oversight mechanisms include review of financial statements and the annual Form 990 as well as the implementation of various governance policies.
Forming a nonprofit corporation is not the same as being tax-exempt. To obtain 501(c)(3) status, newly formed entities must apply to the IRS for a formal determination of exemption. Entities seeking 501(c)(3) status apply by filing Form 1023. (Entities seeking exemption under other sections of 501(c) file Form 1024.)
Newly formed organizations applying for exemption face a chicken and egg dilemma. Form 1023 requests considerable detail regarding the charity’s planned programs and activities. The attitude of the IRS is that requiring applicants to articulate detailed plans is a small price to pay for the significant tax benefits associated with 501(c)(3) status.
Once a non-profit founder has surveyed the non-profit landscape and found a legitimate need, recruited an initial board, created business and fundraising plans, and scraped together some start-up funding, he or she is ready to proceed. In Arizona, it usually makes the most sense to form the entity as an Arizona non-profit corporation. The steps required to form a nonprofit in Arizona are covered.
I receive several calls a week from people who want to start a new non-profit. Looking back on my legal career, I realize that many of the tax-exempt organizations I helped to create early on never got off the ground. Today, I consider it part of my responsibility to the potential new client and to the sector to educate would be founders on the realities of the marketplace. What follows is a walk through the typical discussion that I have with potential founders.