Nonprofits & 501(c)(3)

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Reasons to Incorporate

• There are two main reasons why people incorporate a nonprofit


1. Limited liability - protection for officers, directors and members (see below)


2. 501(c)(3) exemption from the IRS


• Donors get a tax deduction for their gifts
• The nonprofit qualifies for foundation grants
• Governments often fund only exempt entities for charitable type services

Ownership of Nonprofits

• Nonprofits have no owners
• Members (somewhat analogous to FP shareholders) are not required
• Member interest NOT TRANSFERABLE (as distinguished from FP stock)

Nonprofit Creation

• Requirements for creating- 617.0202 FS


• Articles of Incorporation - See FS 617.0202 FS


• Articles of Amendment - requirements - 617.1006 FS.  Here is the template



• Completing internal organization after incorporation - 617.0205 FS


• Consent of Incorporator - appointing directors and officers and adopting bylaws




• Clients often create the Articles of Incorporation on-line (without the IRS wording) BEFORE they come to clinic - example TEAM PETE BLUE RAYS INC.


• The on-line Sunbiz form for Articles of Incorporation DO NOT contain the IRS required provisions


• those provisions can can be manually typed into a text box but the instructions on the Sunbiz website don't tell you that)

Officers

• "Required officers - 617.0840 FS

Bylaws

• Bylaws are a corporation's rules of governance.  They are adopted by the board of directors. . They specify how directors and officers are appointed and which committees are authorized.


• The most important provisions in the bylaws are the ones identifying who has the power to appoint and removed directors.  THE TWO MOST COMMON CHOICES ARE:


• The Board of Directors Fills its Own Vacancies - This type of bylaws gives the board of directors itself the sole power to appoint or remove directors.


• Bylaws - "self perpetuating"


• Membership Organization - This type of bylaws would specify that directors are appointed or removed by the vote of a group of people who have been defined in the bylaws as the "members".  Under this kind of bylaws the only role of the members typically is to elect or remove directors and nothing else


• Bylaws - membership

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Liability of Officers & Agents

• Officers are agents, and as such, they are protected if they had authority.


• All authority must come for board of directors.

Avoiding liability to outside creditors

• Directors/shareholders/members immune unless corporation a sham or alter ego


• Actions routinely taken without formal authority from directors
• Corporate assets not segregated from the assets of directors

Honoring Corporate Formalities

• Follow the bylaws


• Have all corporate actions either authorized or ratified by a formal vote of the directors


• Maintain a credible "minute book" that contains minutes of all formal director meetings.  Try to limit minutes to a record of votes that were taken at the meeting.


• The corporation must have its own bank account and credits cards (don't pay corporate debts with an officer's personal check or credit card)


• Arms length relationship with funds

Avoiding liability to the corporation itself or members/shareholders

• Negligence - Business judgment rule


• No liability so long as the transactions are made in good faith and with reasonable skill and prudence for what they believe to be the best interests of the corporation.(essentially, for the director to be libel she must have been negligent)


• Nonprofit directors have higher protection - more than mere negligence. No liability unless breach or failure to perform amounted to one of the following:


• violation of the criminal law, or
• improper personal benefit, or
• performance of duty was done "recklessly" (i.e. with conscious disregard of a known risk) or done in "bad faith"
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• Fiduciary duties


• A duty imposed by laws when one person has placed in another person the utmost trust and confidence to manage and protect property or money. Arises only when the confidence given by one person is actually accepted by the other person.


• Duty of Loyalty
• The Duty to Act in Good Faith
• Competing With the Corporation
• Usurpation of Corporate Opportunity
• Conflict of Interest
• statutory procedure for handling conflicts

Avoiding liability to IRS

• Excess Benefit Transactions (intermediate sanctions)


• Financial sanctions can be imposed on board members, officers, and related persons for an excess benefit transaction


• Excess benefit transaction: a transaction such as payment of compensation or the transfer of property in which a disqualified person receives more than FMV from the organization or pays the organization less than FMV for property or services received.


• Disqualified person: any person, who at any time during 5 year period ending on the date of the transaction was in a position to exercise substantial including over the affairs of the organization, or member of their family


• Tax can also be levied on anyone that approved the excess benefit like a director, officer, or manager, tax is 10% of the excess benefit amount, max 10k per transaction

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Federal Tax Exemptions for Nonprofits

INTRODUCTION:

• All Corporations Must File a Return Unless Exempt:  Every corporation, even nonprofits, must file a corporate income tax return UNLESS it has been granted an exemption by the IRS.


• Types of Exemptions:  Section 501(c)(3) is one of many types of IRS exemptions.  A partial list of these exemptions include


• 501(c)(3) - Charitable, educational & religiousOrganizations
• 501(c)(4) - Civic Leagues and Social Welfare Organizations


• must be operated exclusively "to promote social welfare" but the IRS regulations remain murky on what that means


• 501(c)(4) corporation has much more freedom to influence legilatin that do 501(c)(3) entities


• The plaintiff in the "Citizens United" case was a 501(c)(4) organization.  Corporations are "people" and have 1st amendment free speech rights.  But, donations to a 501(c)(4) entity do not have to be disclosed (free speech with the "speakers" being anonymous


• 501(c)(5) - Labor, Agricultural and Horticultural Organizations
• 501(c)(6) - Business Leagues, etc. (includes NFL)
• 501(c)(7) - Social and Recreation Clubs
• 501(c)(8) and 501(c)(10) - Domestic Fraternal Societies
• 501(c)(4), 501(c)(9), and 501(c)(17) - Employees' Associations
• 501(c)(12) - Benevolent Life Insurance, Mutual Irrigation, Telephone Companies, etc
• 501(c)(13) - Cemetery Companies
• 501(c)(14) - Credit Unions and Other Mutual Financial Organizations
• 501(c)(19) - Veterans' Organizations
• 501(c)(20) - Group Legal Services Plan Organizations
• 501(c)(21) - Black Lung Benefit Trusts

ADVANTAGE OF 501(c)(3) EXEMPTION

• Contributions are tax deductible for the donor
  
• Only 501(c)(3) organizations qualify for foundation grants.
  

QUICK OVERVIEW OF THE QUALIFICATION PROCESS

• File "Articles of Incorporation" with the state.  This document MUST contain the IRS required language


• Apply to IRS for the exemption using either IRS Form 1023 or IRS Form 1023-EZ.

THE APPLICATION FORM (two choices)

• IRS Form 1023:  The standard application form


• filing Fee: $850
• only $400 if organization's annual gross receipts aren't expected to exceed $10,000


• IRS Form 1023-EZ - for qualified smaller organizations


• Much simpler.  Filed using an on-line form
• The filing fee is only $275
• IRS Worksheet

QUALIFICATION TO BE A 501(C)(3) ORGANIZATION

• ORGANIZATIONAL TEST: the corporation must be "organized" exclusively for an exempt purposes. To meet this test specific language must be included in the articles of incorporation.  Click Here to see the specific language that must be included.
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• OPERATIONAL TEST: An organization must "operate" "exclusively" for one of the following purposes: charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals.  Here is a summary of the main exempt purposes recognized by the IRS:


• "Charitable"
• relief of the poor and distressed or of the underprivileged
• advancement of religion
• advancement of education or science
• erection or maintenance of public buildings, monuments, or works
• lessening of the burdens of Government
• lessening neighborhood tensions
• elimination prejudice and discrimination
• defending human and civil rights secured by law
• combating community deterioration
• combating juvenile delinquency


Note that "lessening burdens of government" and "combating community deterioration" are general catch-alls which can cover many nontraditional charitable activities. Therefore, in the "narrative" section of Form 1023 there needs to be careful explaination of how the activity furthers a the "charitable purposes" (Form 1023-EZ does not require an attached narrative).


• "Educational"
• class room type programs
• educating the public about important issues.


• "Religious"
• There is no set definition but the more a proposed activity looks like something that has traditionally been considered religious the more likely it is that the IRS will grant approval


• NO EXCESSIVE PRIVATE BENEFIT.


• The organization serve a public and not a private interest.


• The organization can't be primarily for the benefit of designated individuals or "insiders" (such the founder or his family members).


• Individuals are allowed to benefit but only as part of the larger community and not as a privilege inherent in their insider status.


• If the IRS determines that the main purpose is to bring private benefit the exemption may be denied

TWO TYPES OF 501(C)(3) ORGANIZATIONS:
PUBLIC CHARITY vs PRIVATE FOUNDATION.

• PUBLIC CHARITY (technically: "Publicly Supported Organization") is a 501(c)(3) organization that meets the 1/3 public support test, that is, it receives at least one third of its support from "public" sources such as small contributions, government grants, or from other public charities AND it does not receive too much income from investments.
  
  
  • ADVANTAGES OF BEING A "PUBLIC CHARITY":
  
  
  • Private foundations have more restrictions on their activities
  
  
  • The rules governing the deductibility of contributions are more favorable.
  
  
  • For public charities there is no tax on its investment income [if it has any], while a private foundation must pay a 2% tax
  
  
  • The IRS considers certain organizations to be public charities simply by the nature of their activities (schools, hospitals, religious organizations, etc.) or because the organization is affiliated with or controlled by another public charity.
  
  
  • For most 501(c)(3) organizations, however, the IRS presumes that it will be a private foundation UNLESS that organization can overcome the presumption by demonstrating that a sufficient amount of its financial support comes from "public sources" [small contributions from the general public, grants from governmental agencies, and grants from other public charities].
  
  
• PRIVATE FOUNDATION STATUS: A "private foundation" is any 501(c)(3) organization that has failed to demonstrate that it is a "publicly charity".


• Disadvantages


• can only give money to a public charity
• excise tax on investment income not given away as grants in a timely manner''
• generally, gifts to a private foundation are not tax deductible
• a private foundation cannot receive grants from another private foundation.


• PRIVATE OPERATING FOUNDATION - Less rigorously regulated than other types of private foundations and, like public charities, they can offer their donors the possibility of getting a tax deduction for donations and they can qualify for certain types of foundationgrants. To qualify they must devote most of their resources to the active conduct of its exempt activities

RESTRICTIONS ON 501(C)(3) ORGANIZATIONS:

• NO UNDUE PRIVATE BENEFIT: The IRS will take away your tax exempt status if feels that the primary purpose is to benefit insiders or an overly small group of people rather that the exclusive furtherance of charitable purposes.


• LOBBYING: the basic rule is that a 501(c)(3) organization cannot attempt to influence legislation either by directly contacting decision makers or indirectly by urging others to do so. This includes local legislation pending before a city or county commission.


• "Insubstantial" or incidental amount of lobbying is permitted


• There is a "safe harbor".  A public charity can make an election to with the IRS to allow lobbying up to a certain specified level of expenditure


• Educating the Public may not be lobbying Educating the public about an important issue is not lobbying so long as you don't directly urge people to contact their legislators. It is permissible to do "educational" activities such as nonpartisan research, policy papers, websites, newsletters, trainings, conferences, etc.


• NO ENDORSING POLITICAL CANDIDATES: Section 501(c)(3) organizations cannot support or oppose political candidates. Section 501(c)(3) groups can distribute nonpartisan "voter education" information.  Also, Section 501(c)(3) organizations are not permitted to allow groups or individuals to use their facilities and equipment to campaign for candidates.

GROUP EXEMPTIONS:

• The IRS sometimes recognizes a group of organizations as tax-exempt if they are affiliated with a central organization. This avoids the need for each of the organizations to apply for exemption individually. A group exemption letter has the same effect as an individual exemption letter except that it applies to more than one organization.

Common Mistakes Made by Nonprofits

• Not Having a Qualified Leader.
  A leader of a nonprofit needs the following traits: A head for business, Desire to do good, Sincerity, Confidence, Goal Setting, Organization Skills


• No Website Or Poorly Designed Website.
  Make a user-friendly website, avoid bulky language, make sure the contact information is accessible & accurate. Have strong compelling content. A rule of thumb is make sure nothing is further than "two clicks deep". Display your mission in a clear area. Have a clear button to donate on every page.


• Poor Planning and Record Keeping
  No plan of action. A nonprofit is much like a business. There has to be a clear plan to get funding to stay afloat.


• Poor Accounting and Money Management
  Building a solid capital structure is a key, Keep Strict Money Records, File all Documents & Forms Correctly and on time, Set Aside Seed Money, Spend wisely Evaluate Wants Versus Needs


• Marketing Only to Large Donors and Not Thinking Smaller Donors are Just As Important
  Small donors are just as important as large donors. Don't expect donors to maintain or increase the size of their contribution each time they give. Thank every donor in every circumstance they donate no matter how much they give


• Nonprofit Doesn't Mean Tax Exempt.
  Know your tax laws and file your taxes.

Reasons Why Nonprofits Fail

• No Compelling Reason to Exist.  Ultimately, the real reason so many nonprofits fail is because they shouldn't have existed in the first place


• Empty Optimism - or pie in the sky dreams


• Values Vacuum - or Poor Organizational Development


• Competitive Blinders - or 'we're unique, there's no one like us in the market'


• Iced Innovation - or 'our website is good enough for now' - failure to embrace technology


• Mission Creep or 'yeah, we should do that too!'


• Misplaced Priorities - chasing money becomes more important than mission

Checklist of Legal Issues for Non-Profits

1.   Payroll Taxes:   If you have employees, is the financial officer making timely deposits of all appropriate federal payroll taxes? Are there any unpaid fines owed to the IRS due to late filings?

2.   Personnel Policies:   If you have employees, has the board adopted adequate written personnel policies (CLICK HERE to download a sample policy document)?

• If so, are they periodically reviewed to insure that they are being adhered to?
• Are they sufficiently comprehensive so as to give management authority to deal with most routine personnel matters without having to seek additional board authority?
• Are there any "hoops" that must be jumped through before an employee can be fired (such as formal notice, hearings, etc.)? Non compliance can give fired employees grounds for legal action.

3.    Adequate Anti Discrimination Policies:   Has the board adopted sexual harassment and discrimination policies that could help protect the corporation from potential claims being filed by disgruntled former employees? CLICK HERE to download a sample sexual harassment policy.

4.   Overtime Pay Compliance:   Do you have policies governing non-management staff that occasionally work more than 40 hours per week?

• If so, do such policies require employees to sign weekly time sheets and require them to first obtain written permission before working overtime? Do you require that such policies be strictly adhered to?
• Such policies could help protect the corporation from claims filed by disgruntled former employees with the US Department of Labor (pursuant to the federal "wage and hour" law)

5.   Independent Contractors vs Employees:   Do you have workers that are paid as independent contractors yet are supervised and work roughly in the same manner as regular employees? If so, you might be at risk if you are audited by the IRS (the IRS might reclassify them as "employees" and charge the corporation with years worth of unpaid FICA tax and penalties). CLICK HERE for more information.

6.   Property and Sales Tax Exemptions:   If you are classified as exempt under Sec 501(c)(3), are you taking full advantage of your exemption from state sales and property tax?

7.   The Handling of Potential Conflicts of Interest:   Are there any agreements, leases, or loans between the corporation and its directors or officers or with companies controlled by a directors or officer? If so,

• were such agreements authorized by the board of directors
• If so, can you locate the minutes of the relevant meetings.
• If so, was it clear in the minutes that the potential participation of the director or officer was disclosed and that the director in question did not vote on the matter?
• Was the transaction objectively fair and reasonable and in the best interest of the corporation at the time it was authorized? If so, is that fact documented in the minutes where the vote was taken?
• Has your board adopted a written conflict of interest policy?  (CLICK HERE to download a sample)

8.   Insurance Policies:   From time to time there should be a review all insurance policies (e.g. general liability, casualty, officers and director's liability, errors and omissions, etc.) in order to determine whether the organization's activities are adequately covered.

9.   Contract Compliance:   Does the corporation maintain a separate file folder for each contract that it has entered into (with its employees, consultants, landlords, vendors, funding sources, lenders, tenants, homebuyers, suppliers, etc)?

• are these records kept in a central location so that they are easy to find?
• for each particular contract, are all relevant documents kept together or are the scattered in various locations?
• have these contracts recently been reviewed? Are you familiar with the termination provisions, penalty clauses, payment deadlines, notice requirements, etc?
• Do any of these contracts obligate the nonprofit to perform any act that might jeopardize its tax-exempt status?

10.   Check Signing Authority:   Have you revoked the check-signing authority of former staff and board members? If so, has the bank been informed?

11.   Important Documents: Do you have a current and legible copy of your

• Articles of Incorporation
• Bylaws
• Federal tax exempt recognition letter
• Federal tax exemption application (IRS Form 1023)
• Copies of IRS Form 990 for the past 3 years
• Sales tax exemption form

12.     Filling Board Vacancies Properly:   Do your bylaws accurately describe procedures that you actually following in appointing or electing new persons to serve on the board of directors? Is there documentation in the minute book to show that the requirements of the bylaws are being complied with?

13.   Registered Agent:   Is the address of your registered agent still the same as the address filed with the Secretary of State?  Is your registered agent normally physically present at that address during daytime business hours?  Can you rely on your registered agent to give you mail that comes to the corporation?

14.   Annual Reports to the State:    Are you filing the required annual reports with the Florida Secretary of State? If not, have you checked to see if your corporation been "administratively dissolved" by Florida Secretary of State for failure to file the annual report?

15.   Original Activities vs Current Activities:   Have your structure, purposes or activities changed significantly since you received your letter of recognition of tax-exempt status from the IRS?  If so, have you notified the IRS?

16.   Form 990:   Are you filing Form 990 with the IRS each year as required by law?  Did you make paper copies of all such filings for the current and prior years (and can you actually find those copies if you had to)?

17.   Documents Available for Public Inspection:   Are your Form 1023 and Form 990 (for the past three years) available for public inspection at your principal place of business as required by law?

18.   Corporate Records: Are the corporation's permanent records (minutes,financial records and membership list) available to your directors for inspection?

19.   Adequate Minute Book:   Do you keep as permanent records minutes of all meetings of the board, your members, and committees, including resolutions and other formal actions? 

• If so, is there a formal looking "Minute Book" containing the minutes of every official directors meeting (in chronological order) or are minutes of meetings kept in assorted folders, boxes, files, etc?
• If you have a Minute Book is it cluttered with items that are not actually "minutes" (such as miscellaneous documents that might have been handed out at a meeting)?

20.   Validity of Officers:   Is there documentation in the minutes showing the date and manner of the appointment of each of the Corporation's current directors? Are resignations similarly documented?

21.   Director Terms:   Do your bylaws provide that each director shall have a specified "term"?  If so, are these terms being kept track of and are the bylaws being followed when replacing or reappointing a director?  Does your minute book provide accurate documentation showing that all bylaw mandated terms are being consistently honored?

22.   Delegation of Board Authority to an Executive Committee

• Has an executive committee been given authority to act on behalf of the corporation?
• If so, where was that authority granted? (in the bylaws? by board Resolution?)
• If it was by board resolution can you to locate the minutes of the meeting where that authority was granted?

23.   Members:   Do the bylaws require that directors be elected by "members"?

• If so, is there a current list with the names and addresses of each member?
• If so, do your bylaws clearly describe the procedure for conducting elections? (CLICK HERE to download sample "membership" type bylaws)
• If so, does the minute book provide accurate and complete documentation showing that all bylaw mandated elections were properly held?
  

24.   Annual Financial Statements:   Do you prepare an annual financial statement or audit?

• Do you provide a copy of your annual audit or financial statement to members or directors upon request?
  
• If the annual financial statement is not prepared by a public accountant, does the person who prepares it state whether the statements are prepared on the basis of generally accepted accounting principles and if not, the basis on which they were prepared?

25.   Record Retention:    Are you saving financial records for at least seven years? If so, do you actually know where they are stored?  Has your board adopted a written policy regarding record retention that complies with the requirements of the federal Sabans Oxley law (CLICK HERE to download a sample of such a written policy)?

26.   Acknowledgment of Gifts:   Do you acknowledge in writing gifts over $250?

27.   Charitable Registration:   Are you registered with the state of Florida for Charitable Solicitations?

28.   Real Estate Records:    If the corporation owns real estate, is a separate file folder kept for each parcel - if so, are all relevant documents kept there (tax bills, "Notices to Owner" sent by subcontractors, mortgages, leases, code violation notices, surveys, deeds, etc)?

28.   Property Tax Exemptions:   Have property tax exemptions been obtained for all real estate?

29.   Volunteer and Participant Waivers. Depending upon the nature of the organization's activities, the organization should have waivers and participation agreements whereby volunteers and participants accept any risks and release the organization from liability.  The review should consider whether appropriate releases and waivers exist, whether they are adequate, and whether procedures have been implemented to ensure they are consistently used.