Bustos Law Firm

Why is it so hard to do good? The non-profit battlefield

In Federal Law, Legal, non-profits on March 10, 2011 at 8:53 PM

Non-profits play a critical role in our communities. They provide us educational, artistic, religious, and athletic enjoyment. The laws governing non-profit organizations are complex and interesting — to say they are a battlefield is an understatement. Particularly complex are the Internal Revenue Service (“IRS”) regulations and rules. Section 501(c)(3) of the tax code provides tax exemption for non-profit organizations that perform an exempt function. Section 501(c)(3) organizations include churches, schools, hospitals, arts and environmental groups, and other organizations that are considered charitable. To obtain exempt status under Section 501(c)(3), an organization must meet the following tests:

(1) Organized as a nonprofit corporation, or as a “community chest, fund, or foundation.”

(2) Organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, to foster national or international amateur sports competition, or to prevent cruelty to children or animals.

(3) No part of its “net earnings” may inure to the benefit of any private shareholder or individual.

(4) No “substantial part” of the organization’s activities may consist of certain lobbying activities.

(5) The organization may not participate or intervene in any political campaign on behalf of or in opposition to any candidate for public office.

 

The IRS presumes that any organization formed after October 9, 1969, is a private foundation. An organization must notify the IRS if it is not a private foundation. This “notification” process requires the completion of an intensive and complex IRS form.  Most non-profits are not private foundations. Private foundations are organizations that receive most of their income from a small group of people – usually an individual, family, or corporation. A public charity, however, receives a bulk of their money from gifts or fees. There are substantial tax consequences associated with each and any forming organization should seek legal and financial counsel before filing with the IRS.

In order to satisfy the IRS that an organization is not a private foundation, an organization must, among other things, show that it meets the requirements of Section 509(a)(1)-(4). For example, Section 509(a)(1) organizations include churches, schools, hospitals, and other organizations that receive their public support primarily from gifts, grants and contributions from a broad group of people. In addition, Section 509(a)(2) covers organizations that receive their support from a combination of gifts, grants and contributions and fees for their exempt services. Organizations that are identified or described in 509(a)(1)-(4) are considered public charities.

For the sake of example, Section 509(a)(2) organizations encompass organizations that normally receive more than 1/3 of their support from a combination of:

(1) Gifts;

(2) Grants;

(3) Contributions;

(4) Membership fees; and

(5) Gross receipts from performing exempt function activities.

In addition, a Section 509(a)(2) organization must not receive more than 1/3 of its support from investment income and/or unrelated taxable income. The major difference between this type of organization and other public charities is that a 509(a)(2) organization receives support from gross receipts from an exempt function activity – such as ticket proceeds from a museum, opera or symphony.

Non-profits really are important for our communities. The services and entertainment they provide are invaluable. People want to provide these charitable services and to also associate with them both with time and resources. But, it is a battlefield.  There are mine fields and launched grenades to watch for when filing with the IRS.  While the end result may be a very successful and beneficial non-profit, anyone contemplating forming a non-profit should be prepared for all that comes their way. 

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