Legal Center for Nonprofits, Inc.

© Legal Center for Nonprofits, Inc. Information provided herein is not legal advice and is intended for informational purposes only. Consult an attorney before acting on the information contained herein. Attendance at this program does not result in an attorney-client relationship.

Presented by Linnea R. Michel, Esq.

At the conclusion of this program, you will:

Understand basic requirements to maintain

501(c)(3) tax-exempt status; and

Understand the causes and consequences of

automatic revocation of tax-exempt status.

Generally, we will be discussing tax-exempt charities

(that is, 501(c)(3) organizations).

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Maintaining Tax-exempt Status

1. Private Inurement/Benefit

2. “Operate exclusively for exempt purposes”

3. Political activity prohibition

4. Lobbying/legislative prohibition

5. Annual filing requirement

6. Record-keeping

7. Governance practices

Repairing Tax-exempt Status

1. Automatic revocation – what it is, why it happens

2. Recovering from automatic revocation

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Prohibition against Private Inurement

Fundamental doctrine underlying tax-exempt

status, states:

No part of an organization’s net

earnings may inure to the benefit of

any private shareholder or individual.

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Charities serve a

public interest

not a private interest.

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Flashpoints where private inurement may be implicated:

When insiders benefit from organization’s activity; ◦ Board member transactions with organization

Compensation ◦ Executive Director

◦ Board Members

Percentage-based compensation ◦ E.g., fundraisers, development staff

Rental arrangements

Loans

Sales of assets

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A finding of private inurement may be fatal to

tax exempt status.

However:

Other penalties have been devised to avoid

harsh result of revocation:

◦ “Intermediate sanctions” tax imposed on

persons who improperly benefit from transaction

with org and on managers who allowed it.

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Private Benefit doctrine is similar but different:

Occurs when a private person (individual or

entity) one who is not an insider

benefits from the activities of the charity.

Not fatal to tax-exempt status if incidental.

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Private Inurement

occurs when

“Insiders” – those with

Control or Influence –

receive benefits.

May arise

in compensation situations

(e.g., “excess benefit

transactions”)

Private Benefit

occurs when

“Outsiders” benefit

more than incidentally.

Can arise in vendor,

contractor

arrangements

Jeopardy to

tax-exempt status

No Private

Inurement/Benefit

Incidental

Benefit

Insiders

Outsiders

Charities are organized and operated exclusively for

exempt purposes.

Most of an organization’s activities must be for

exempt purposes.

“Exclusively” not defined; courts suggest 90% of

activities must be related to exempt purpose.

Activities that do not directly “further” or support

exempt purposes are called “unrelated”.

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What is an exempt purpose?

Purposes deemed worthy of tax-exemption & recognized in statute, by IRS, or by court:

Statute: Section 501(c)(3): Corporations, and any community chest, fund, or

foundation, organized and operated exclusively for

◦ Religious

◦ Charitable

◦ Scientific

◦ testing for public safety

◦ Literary

◦ Educational purposes, or to

◦ Foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or

◦ For the prevention of cruelty to children or animals…”

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IRS and the courts have recognized many other

exempt purposes, such as:

◦ Child care organizations

◦ Farmers’ cooperatives

◦ Medical research organizations

◦ Veterans’ organizations

At least 74 categories, as of now…

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Organizations with more than “insubstantial” unrelated activities are at risk for: Unrelated Business Income Tax (“UBIT”);

Loss or denial of tax-exempt status.

An activity that may provide funds in support of exempt purposes is still unrelated; for example:

Raffles;

Activities engaged in for profit ( e.g., merchandise sales).

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For most tax-exempt organizations, unrelated

business income is income from a trade or

business, regularly carried on, that is not

substantially related to its exempt purpose.

An exempt organization that has $1,000 or more of

gross income from an unrelated business must file

Form 990-T and may be liable for tax.

Exceptions abound!

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Activities that may be subject to UBIT:

Parking lot rented to general public

Advertising revenue

Sale of membership lists to for-profit entity

Typically excluded from UBIT:

Real property rentals

Income from research activities

Member convenience activities

Dividends, interest, annuities, royalties

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Charities may attempt to influence legislation to an insubstantial degree, but political activity is prohibited. Political activity includes: Directly or indirectly participating in, or intervening in,

any political campaign on behalf of (or in opposition to) any candidate for elective public office; and

Contributions to political campaign funds or public statements of position (verbal or written) made on behalf of the organization in favor of or in opposition to any candidate for public office.

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What can 501(c)(3) organizations do in the

political arena? Voter education activities (including presenting

public forums and publishing voter education

guides) conducted in a non-partisan manner;

Activities intended to encourage people to

participate in the electoral process, such as voter

registration and get-out-the-vote drives, if

conducted in a non-partisan manner.

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Charities may engage in some

(“insubstantial”) lobbying, but too much

lobbying activity risks loss of tax-exempt

status.

Other tax-exempts may lobby without limits;

e.g., 501(c)(4) social welfare organizations,

501(c)(6) industry groups.

Since “insubstantiality” has never been quantified, a

test was devised that would provide an ascertainable

measurement, called the Expenditures Test.

Organizations that do not affirmatively choose to be

measured under the Expenditures Test fall into the

original Substantial Parts Test.

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Expenditure Test is “elected” at time of filing Form 1023, any filing of Form 990, or by filing IRS Form 5768, Election/Revocation of Election.

Choosing the Expenditure Test submits the charity to a 20% limit on expenditures for lobbying and influencing legislation.

Organizations that expect to lobby should choose the Expenditure Test unless their budgets are very large and they plan to do grassroots lobbying (which is limited under the Expenditure Test).

Record-keeping requirements are significant under Expenditure Test and organizations should factor that into their consideration of whether to choose the Expenditure Test.

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Tax-exempt organizations must file annual

information returns with the IRS.

Failure to do so for 3 consecutive years results

in automatic revocation of tax-exempt status.

Revocation is automatic “by operation of law”

after 3 consecutive years of failing to file,

effective as of the due date of the filing of the

3rd year.

More on this to come…

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Only certain specified organizations are exempt

from the filing requirements:

◦ Churches

◦ Certain schools

◦ State & governmental institutions

◦ Political organizations

For the full list, visit http://www.irs.gov/Charities-

&-Non-Profits/Annual-Exempt-Organization-

Return:--Who-Must-File

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Information Return (990, 990-EZ, or 990-N) must be

filed by 15th day of the 5th month after the close of

the fiscal year.

For example, organizations with a calendar (i.e.,

January to December) fiscal year, must file by May

15. The return for 2013 is due on May 15, 2014.

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2010 Tax Year and later

(Filed in 2011 and later)

Form to File

Gross receipts normally less than or equal to $50,000 Note: Organizations eligible to file the e-Postcard may

choose to file a full return

990-N

(aka “e-postcard”)

Gross receipts less than $200,000, and

Total assets less than $500,000

990-EZ

or 990

Gross receipts greater than or equal to $200,000, or

total assets greater than or equal to $500,000 990

Private foundation

990-PF

Retention of Records Some records should be kept permanently:

◦ e.g., Form 1023 Application for recognition of exemption (1023 & attachments), determination letter, formation documents, and Board records such as minutes of meetings.

Employment tax, hiring and personnel records should be kept for at least four years after the date the tax becomes due or is paid, whichever is later.

Generally, records should be kept until they are no longer needed for non-tax purposes; other agencies and entities may have differing retention requirements.

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Gift Substantiation Requirements Donors cannot claim a tax-deduction for any single contribution of

$250 or more unless the donor obtains a contemporaneous written acknowledgement of the contribution from the recipient charity.

Contributions are deductible only to the extent that they are gifts and nothing of value is received by the donor in return.

Donors may only take a charitable deduction to the extent that the contribution exceeds the fair market value of the item received in exchange. (This is the so-called “quid pro quo”.)

For example, a gala ticket priced at $100 where the dinner’s fair market value is $25--only $75 is a deductible charitable gift.

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Certain documents must be kept available for public inspection: ◦ Form 1023 or 1024; ◦ Annual Information Returns (Forms 990, 990-EZ;

990-Ns appear on automatically on IRS website and www.Guidestar.org).

◦ Form 990-T (unrelated business income) report form.

Organizations need not comply with individual requests for copies if it makes the documents widely available, such as on a website.

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IRS generally cannot require specific governance practices, but does make recommendations about what it deems “best practices” and inquires about these in the full Form 990; for example:

Policies & procedures to establish executive compensation Conflicts of interest policy Policies for Investments, fundraising policy, document

retention, and whistleblowers Documentation of board decisions (minutes)

Board members’ review of financial statements and information returns.

Make-up of governing board; board should NOT be dominated by the charity’s employees, or those with family or business relationships.

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Over 400,000 organizations

have experienced revocation,

over 200 in greater New Bedford alone.

Automatic Revocation of Tax-exempt Status

Occurs upon failure to file information returns

(Form 990, 990-EZ or 990-N) for 3 consecutive

years, effective upon the due date of the 3rd year’s

filing.

Revocation is automatic, by operation of law.

Organizations may also experience revocation for

reasons we’ve discussed, usually as a result of audit

findings or other investigation.

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Organizations with annual gross receipts less than

$5,000 have never been required to apply for tax-

exempt status (i.e., submit 1023 or 1024) and prior

to 2006, had no requirement to file information

returns (990, 990-EZ or 990-N).

Now very small organizations must file information

returns, usually the 990-N. (However, they are still

not required to submit 1023s or 1024s—unless they

have been automatically revoked).

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Organizations may apply for reinstated tax-exempt

status.

Tax-exempt status will be reinstated effective either:

Retroactively to the date it was revoked (“retroactive

reinstatement”); or

Effective as of the date the application for

reinstatement was mailed and postmarked

(“postmark reinstatement”).

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Retroactive Reinstatement

Within 15 months of revocation, “Streamlined”

◦ For orgs eligible to file either 990-N or 990-EZ.

More than 15 months after revocation; or

“Postmark” Reinstatement

15 months is counted from either the date of the

IRS Revocation letter, or the date on which the

revocation was posted—whichever is later.

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http://apps.irs.gov/app/eos/

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Streamlined Retroactive Reinstatement

1. Submit properly completed IRS Form 1023 or 1024

and attachments within 15 months of revocation,

noting on top, “Revenue Procedure 2014-11,

Retroactive Reinstatement”.

2. Include User Fee (either $400 or $850).

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Streamlined (continued)

Reinstatement will be effective as of the date of

revocation.

If organization was eligible to file 990-N, no penalties

will be assessed.

If 990-EZ filer, no penalties will be assessed if owed

990-EZs are filed.

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If organization has been required to file the full Form 990, it may not be reinstated under the streamlined process. Instead, it must:

1. Submit properly completed IRS Form 1023 or 1024 and attachments within 15 months of revocation, noting on top, “Revenue Procedure 2014-11”.

2. Include User Fee (either $400 or $850); AND,

3. Include Reasonable Cause Statement for at least 1 of 3 years; AND,

4. File properly completed 990s for the 3 years owed.

If all steps properly completed, reinstatement will be made retroactively as of the revocation date.

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Application for reinstatement outside 15 month period:

Same procedure as full 990-filers, except slightly

different Reasonable Cause Statement.

◦ Statement needed for all 3 years.

Postmark Date Reinstatement

File the application and user fee as under

streamlined; however, it appears these organizations

may be liable for penalties ($20/day on both

organization & responsible managers).

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The clock begins to toll with incorporation! Or for established organizations, with the most recent 990 filing. Annual reports become due to IRS –whether applying for tax-

exempt status or not– beginning with incorporation—5 ½ months after close of fiscal year.

If organization does not file annual reports (990 or 990-EZ) within 3 years of incorporation date, it will be at risk for revocation, and revocation will be automatically effective on the due date of the third year’s filing.

Having submitted a 1023 or 1024 is no protection; waiting to file until exemption is recognized is not an option.

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Whether organization’s name appears on the

IRS’s website revocation list is not relevant;

revocation occurs automatically on the date the

return was due.

Fiscal Sponsorship is no protection; organization

must file information returns if any funds are held

in its own name (e.g., checking account). Fiscal

Sponsor only reports on funds it holds.

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If your organization’s tax-exempt status has been revoked, or if

your organization is in the process of applying for original

recognition of tax-exempt status, file annual reports (990 or

990-EZ) in hard copy by their due date. Mail to:

Department of the Treasury

Internal Revenue Service Center

Ogden, UT 84201-0027

It appears 990-Ns (electronic postcard) are not available for

these filers, regardless of size, because the organization is no

longer/not in the IRS system.

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To be compliant and maintain tax-exempt status, a 501(c)(3) organization: Must absolutely refrain from participating in the political

campaigns of candidates for local, state, or federal office.

Must restrict its lobbying activities to an insubstantial part of its total activities.

Must ensure that its earnings do not inure to the benefit of any private shareholder or individual.

Must not operate for the benefit of private interests such as those of its founder, the founder's family, its shareholders or persons controlled by such interests.

Must not operate for the primary purpose of conducting a trade or business that is not related to its exempt purpose, such as a school's operation of a factory (such activities will be taxed, i.e., UBI; or tax-exempt status revoked).

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May not provide commercial-type insurance as a substantial

part of its activities.

May not have purposes or activities that are illegal or violate

fundamental public policy.

Must satisfy annual filing requirements – failure to file for 3

consecutive years results in automatic revocation of tax-

exempt status.

Must apply for reinstatement of tax-exempt status if tax-

exempt status has been revoked, even if the organization

never applied for tax-exempt status originally, due to very

small size or membership in a group exemption program.

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IRS Notice 2011-44 - Application for Reinstatement and

Retroactive Reinstatement for Reasonable Cause Under

Internal Revenue Code § 6033(j) available at:

http://www.irs.gov/irb/2011-25_IRB/ar10.html#d0e479

IRS Life Cycle of a Charity -- http://www.irs.gov/Charities-

&-Non-Profits/Charitable-Organizations/Life-Cycle-of-a-

Public-Charity-Private-Foundation.

IRS website (generally) -- http://www.irs.gov/Charities-&-

Non-Profits/Charitable-Organizations

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IRS Compliance Guides –

◦ Publ. #4221-PC Compliance Guide For 501(c)(3) Public Charities

◦ Publ. #4221-NC Compliance Guide for Tax Exempt Organizations (other than 501(c)(3) Public Charities and Private Foundations)

◦ Publ. #4221-PF Compliance Guide for 501(c)(3) Private Foundations

Massachusetts Society of Certified Public Accountants, Inc., The Records Retention Guide, available at http://www.cpa.net/resources/retengde.pdf

Sandy Deja, Prepare Your Own 501(c)(3) Application, 2012 ebook, available by emailing c3book@aol.com or postal mail to P.O. Box 10525, Fairbanks AK 99710. Contains section on applying for reinstatement of tax-exempt status.

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Upcoming Programs Nonprofit Start-Up Series Session 2, March 11 — Incorporation & Bylaws

Pros & cons of incorporation; steps to incorporate, creating bylaws, corporate reporting. 6:00 pm, $5/pp

Nonprofit Start-up Group, March 19.

Networking and info-sharing. Meets monthly, 3rd Wednesday at 6:00 pm. Free!

Nonprofit Start-Up Series Session 3, March 25 — Is It a Charity?

Charity registration, in Massachusetts, and beyond. 6:00 pm, $5/pp

Nonprofit Annual Filings: What to File & When; Thursday, April 17, 8:30-10:00 am

Nonprofit organizations—from smallest to largest—must file annually with state and federal agencies or risk serious consequences. Do you know what your nonprofit’s filing obligations are? Lisa Aldrich CPA will join us for this important topic.

Legal Center for Nonprofits, Inc. 412 County Street

New Bedford, MA 02741

Linnea@LegalCenterforNonprofits.org

www.LegalCenterforNonprofits.org

Connect on Twitter: @LglCtrNP

(508) 264-5996

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