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THE NUTS & BOLTS OFEXEMPT ORGANIZATIONS
February 19, 2014
Brian Yacker, JD/CPA
Prepared by YH Advisors, The Exempt Org Experts 2
The Exempt Org Universe
Nonprofits
Tax-Exempt Not Exempt
Charitable Noncharitable
Private FoundationsPublic Charities
NonoperatingOperating
Other Exempts
Definitional Publicly Supported Support Org’ns
Prepared by YH Advisors, The Exempt Org Experts 3
The Exempt Org Universe (cont’d)
Charitieso §501(c)(3)
• Public charities
Definitional Churches
Schools
Hospitals
Publicly supported Donative
Program service revenue
Supporting organizations
• Private foundations
Manage investment portfolio
Make grants to other charities
Prepared by YH Advisors, The Exempt Org Experts 4
The Exempt Org Universe (cont’d)
Other Exemptso (c)(2) – title holding corporations
o (c)(4) – civic leagues, community associations, social welfare organizations• Advocacy work / Political actions / Lobbying / Community associations
• Can undertake substantial lobbying activities unlike a §501(c)(3)
o (c)(5) – labor/agricultural organizations
o (c)(6) – business leagues / chambers of commerce• Promote higher business practices / better business methods
• Promote common business interests
• Private inurement of members prohibited
o (c)(7) – social & recreation clubs• Country clubs
• Unrelated business income rules
o (c)(8) – fraternal societies
o (c)(14) – credit unions
o (c)(19) – veteran’s organizations
Prepared by YH Advisors, The Exempt Org Experts 5
Benefits of Tax Exemption
Exemption from Federal Income Taxeso Exemption from most state income taxes
• Possible exemption from state property taxes, state sales/use taxes
Generally, not exempt from sales/use taxes in California
Eligibility to Receive Tax Deductible Contributionso Generally, §501(c)(3) entities
Reduced Postal Service rates
Halo Effect
Prepared by YH Advisors, The Exempt Org Experts 6
Overview of Charities
Organizational Issueso Reg. §1.501(c)(3)-1(b)
• Organization is organized exclusively for one or more exempt purposes only if its articles of organization limit the purposes of such organization to one or more exempt purposes and do not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes
Operational Issueso Reg. §1.501(c)(3)-1(c)
• Organization will be regarded as “operated exclusively” for one or more exempt purposes onlyif it engages primarily in activities which accomplish one or more of such exempt purposesspecified in Sec. 501(c)(3)
Organization will not be so regarded if more than an insubstantial part of its activities isnot in furtherance of an exempt purpose
o No part of earnings can inure to the benefit of any insider (private inurement)• For example, unreasonable compensation / bargain sales to insiders / below market loans
• Need an insider for private inurement to exist
• No de minimis exception for private inurement
Prepared by YH Advisors, The Exempt Org Experts 7
Overview of Charities (cont’d)
Operational Issues (cont’d)o Only incidental private benefit (non-insiders derive improper benefits)
• Cannot more than incidentally benefit private (non-insider) interests
Examples in Reg. §1.501(c)(3)-1(d)(1)(iii) Organization whose purpose of which is to study history and immigration and whose educational
activities include sponsoring lectures and publishing a journal; focus of the organization’s historicalstudies is the genealogy of one family (NOT EXEMPT)
Art museum’s principal activity is exhibiting art created by a group of unknown but promising local artists, all of the art exhibited is offered for sale at prices set by the artist; when art is sold, the museum retains 10 percent of the selling price to cover the costs of operating the museum and gives the artist 90 percent (NOT EXEMPT)
Example – booster clubs If booster club confers benefit (crediting amounts raised against dues requirements) on participant
in return for their fundraising activities, the booster club is providing a private benefit
See PLR 201130012 – tax-exempt status of volunteer fundraising booster group is revoked wherethe group ran a concession stand that raised money for their children’s educational andextracurricular activity expenses
• Private benefit generally arises is contractual and joint venture settings
• Private benefit only incidental if considered incidental in both qualitative & quantitative sense
Qualitative – benefit must be a necessary circumstance of the activity that benefits thegeneral public
Quantitative – private benefit must not be substantial after considering the overall publicbenefit of the activity
Prepared by YH Advisors, The Exempt Org Experts 8
Overview of Charities (cont’d)
Operational Issues (cont’d)o No participation in political campaigns
• Limited lobbying activities
o No substantial conducting of unrelated business activities• No “bright line” definition of what is “substantial”
Rule of thumb stay under 30%
o Suspension of tax-exemption for organization (Tamil Foundation) designated as supporting terrorism
Prepared by YH Advisors, The Exempt Org Experts 9
Exempt Purposes
Charitable / Educational / Religious / Scientific / Literary / Fostering Sportso Examples
• PLR 200736037 - IRS revoked tax-exempt status
Co-founded by father and son (only two members of the organization’s Board)
Provided frozen, donated sperm to women, however, 88% of the sperm was donated by the son (and the organization’s web site only contained a bio of the son, not any of the other donors)
Did not serve exempt purposes since its standards utilized for evaluating applicants or selecting recipients served the purposes of private interests since the son had full veto power over who received his sperm
• PLR 200914064 - IRS denied exempt status to an organization which raises money to pay for equipment and activities for children attending a private school
IRS concluded that the activities and earnings benefit the school and the parents of the children rather than serving exempt purposes
• PLR 201002041 - IRS denies tax-exempt status to organization that provides spiritual counseling to individuals and receives most of its funding from sale of books written by founder and from the founder’s speaking engagements
IRS believes organization is operated primarily for the founder’s benefit
• PLR 201050033 - IRS denied tax-exempt status for organization formed to train gymnasts
Not provide free gymnastics instructions to the community
Not offer financial assistance to the less advantaged
Prepared by YH Advisors, The Exempt Org Experts 10
Exempt Purposes (cont’d)
Charitable / Educational / Religious / Scientific / Literary / Fostering Sports (cont’d)o Examples (cont’d)
• PLR 201115026 - IRS denies tax-exemption to organization formed to provide low-cost heating and cooling service and repair to low-income individuals
Key determinative here is that the founders of the exempt organization owned a taxable heating and cooling business which would undertake transactions with the exempt organization
• PLR 201105048 - IRS denied tax-exempt status to an organization that sought exemption as a business league because they concluded that the organization’s activities and purposes were primarily directed at the improvement of its members’ businesses
• PLR 201150034 - IRS denied tax-exempt status under §501(c)(3) to an organization that runs a coffeehouse because operation of a coffeehouse is consistent with running a trade or business and the organization failed to establish that its activities further a tax-exempt purpose
Exemption denied notwithstanding the fact that the coffeehouse would have donated resources to local charities and exempt organizations
Operations competed directly with taxable enterprises through product pricing, compensated staff, commercial advertising
• PLR 201205011 - organization which was formed to provide aid to three special needs children from the same family was denied tax-exemption by the Internal Revenue Service
Probably would have been different result if had been organized to support special needs children from the broader community
• PLR 201215019 - IRS denied exempt status under §501(c)(4) to an organization formed to provide fertility medication to individuals because the organization’s activities were the same as the activities of a commercial pharmacy
Prepared by YH Advisors, The Exempt Org Experts 11
Formation
Start-Up Procedureso Draft and file Articles of Incorporation
• Expressly limit purposes of the tax-exempt organization to §501(c)(3) purposes
• Permanently dedicate assets to charity upon dissolution
o File Form SS-4 to obtain Employer Identification Number• Obtain electronically
Takes about 10-15 minutes
o Open bank account
o Draft Bylaws• Purposes and mission of the organization
• How Directors elected and selected
• How Board may take action and quorum rules
• How Board meetings to be conducted
• Duties and responsibilities of Officers
• Authorization of Board committees
• Reports due to Directors
• Managing of conflicts of interest
Prepared by YH Advisors, The Exempt Org Experts 12
Formation (cont’d)
Start-Up Procedures (cont’d)o Prepare and file Tax Exemption Application
• Must prepare and file to be recognized as tax-exempt entity
• Religious entities do not need to file
• Presumption that entity is a private foundation
• Timeline
IRS receives about 100,000 Tax Exemption Applications each year
Retroactivity filing deadline 15 months from the end of the month in which the organization is formed (Reg. §1.508-1(a)(2))
Automatic 12-month extension under Reg. §301.9100-2(a)(2)(iv)
Thus, essentially have 27 months to file the Tax Exemption Application
Good cause exception if miss deadline Filed Form 1023 with the Internal Revenue Service before they discovered failure to file
Failed to file within 27 months because of intervening events beyond control
Exercised due diligence but were not aware of the filing requirements
Reasonably relied upon written advice from the IRS
Reasonably relied upon the advice of a qualified tax professional
Prepared by YH Advisors, The Exempt Org Experts 13
Formation (cont’d)
Start-Up Procedures (cont’d)o Prepare and file Tax Exemption Application (cont’d)
• IRS review time
Average wait time is approximately 4-6 months
Red / Yellow / Green piles Additional questions
o Receive IRS Determination Letter
o Obtain state tax exemption
o Register with state Attorney General
Other Options than Creating Exempt Organizationo Creation of a donor advised fund
o Contribution to community foundation
o Partnering with existing exempt organization
o Fiscal sponsorship
o Starting a chapter of an established national exempt organization
Prepared by YH Advisors, The Exempt Org Experts 14
Formation (cont’d)
Organizational Legal Checklisto Ensure that have most updated copies of following documents
• Articles of Incorporation
• By-Laws
• Determination Letter (federal and state)
• Tax Exemption Application (federal and state)
• Form 990 for past 3 years (Form 990-T if applicable)
o Ensure that filing required Statement of Information reports with the Secretary of State
o Check IRS Master File to ensure correctly reporting information on Form 990
o Ensure that contemporaneously documenting all Board and Board Committee meetings
o Current listing of all insiders of the organization for past 5 years• Board members / Officers / Key employees
o Whether retaining necessary financial records for at least 7 years
o Whether preparing charitable contribution acknowledgements when necessary
o Whether registering to solicit in other states other than home state
o Whether implemented conflict of interest policy
o Whether prepared reasonable compensation binder
Prepared by YH Advisors, The Exempt Org Experts 15
Public Disclosure
Public Documentso Articles of Incorporation
o Bylaws
o Tax Exemption Application
o Determination Letter
o Form 990 for the past three years• Automatically posted on GuideStar (www.guidestar.org)
o Form 990-T for the past three years (if applicable)• Not yet posted on GuideStar (www.guidestar.org)
Prepared by YH Advisors, The Exempt Org Experts 16
Public Disclosure (cont’d)
Other Public Disclosure Considerationso Penalties
• $20 per day / $10,000 maximum
• Individual can be penalized up to $5,000
• File Form 13909 with IRS to lodge complaint
o Form 4506-A• File to request copy of public documents
Form 990
Form 990-T
Form 1023
Determination Letter
• IRS usually responds within 60 days
• Anyone can file the Form 4506-A with the Internal Revenue Service
Generally, free, as long as not utilizing for commercial purposes
Prepared by YH Advisors, The Exempt Org Experts 17
Annual Reporting
Form 990o Purposes of Form 990
• Provide transparency into the operations of the exempt organization
• Primary source of information for “users” of Form 990
Members of general public
Internal Revenue Service / State authorities (e.g. Attorney General)
Potential donors
Researchers
Newspapers and other media
Competitors
Those not agree with your exempt purpose activities
Charity rating organizations / GuideStar
Anyone else
• Ensure adequate collection of information for the various types and sizes of exempt organizations
Facilitate comparisons between similar types of exempt organizations
• Primary compliance tool for tax-exempt organizations
Key transparency document
Prepared by YH Advisors, The Exempt Org Experts 18
Annual Reporting (cont’d)
Form 990 (cont’d)o Guiding principles of the Form 990
• Enhancing transparency
Many members of the general public rely upon the Form 990 as their primary or sole source ofinformation regarding a tax-exempt organization How the public perceives a tax-exempt organization could be largely controlled by the information
presented on the Form 990
• Promote compliance
Very detailed reporting requirements
Elimination of unstructured attachments
Allow IRS to efficiently assess risks of noncompliance
• Minimize filing burdens for exempt organizations and reduce recordkeeping
Asking Form 990 questions in manner that makes it relatively easy to complete the form Not impose unwarranted additional recordkeeping or information gathering burdens
IRS woefully failed here
Prepared by YH Advisors, The Exempt Org Experts 19
Annual Reporting (cont’d)
Form 990 (cont’d)o General overview
• History
First Form 990 was applicable for the 1941 tax year
Generally the same Form 990 from 1979 through 2007 Massive redesign of the Form 990 first effective for the 2008 tax year
o No requirement to file Form 990• Annual gross receipts normally less than $50,000
• Particular types of organizations
Foreign charities
Churches Including integrated auxiliaries and church-affiliated organizations
Governmental entities (Sec. 115 of the Internal Revenue Code) For example, public universities
o Time preparation considerations• Not an ordinary tax return
Significant and complex because is information return subject to public disclosure
Form creates much “new” law and tries to motivate certain behaviors
• IRS perspective
Over 158 hours just for core form
Prepared by YH Advisors, The Exempt Org Experts 20
Annual Reporting (cont’d)
Form 990 (cont’d)o Filing deadlines
• Initially due the 15th day of the 5th month after the close of the organization’s tax year
Extensions First – automatic 3 months
Second – additional 3 months with reasonable cause
o Failure to file penalties• $20 per day (small exempt organizations)
Maximum of lesser of $10,000 or 5% of the gross receipts of the exempt organization
• $100 per day (gross receipts exceed $1 million)
Maximum of $50,000
• IRS currently investigating increasing these penalty amounts
• Organization’s manager could also be liable for penalties
o Filing incomplete return is deemed to be as if never filed• Rev. Rul. 77-162 – organization which omits material information from its Form 990 and does not
establish reasonable cause for the omission has failed to file a return
Statute of limitations does not start in such a situation
Reasonable cause = reliance upon a knowledgeable professional if organization furnishesprofessional with all the necessary information
Prepared by YH Advisors, The Exempt Org Experts 21
Annual Reporting (cont’d)
Form 990 (cont’d)o “Helpful” hints from the Internal Revenue Service
• IRS Checklist (IRS Publication 4740)
Review the Form 990 and Instructions before preparing
Identify the Schedules that need to be completed
Discuss with key internal stakeholders, including finance, program leaders, fundraisers, public/government relations, and human resources
Involve the board and management team, and make them aware of the new reporting rules
Discuss with key external stakeholders, including grant makers or fundraisers, accountants, and lawyers
Assign an internal leader to coordinate Form 990 preparation
Identify related organizations and those persons required to be listed in the compensation tables
Be prepared to answer precise questions about governance and compliance with federal tax rules
Determine overseas and joint venture activities
Establish or modify internal systems, if necessary, to prepare for filing season
Prepared by YH Advisors, The Exempt Org Experts 22
Annual Reporting (cont’d)
Form 990-No General
• Small tax-exempt organizations must file electronically on an annual basis
Technically, no extension permitted
No paper filing permitted
o Required information• Employer Identification Number
• Tax year
• Legal name / Mailing address
• Any other names the organization utilizes
• Name and address of a Principal Officer
• Web site address if the organization has one
• Confirmation that the organizations gross receipts normally less than $50,000
• If applicable, statement that the organization has terminated or is terminating
o Failure to file• Automatically have tax-exemption revoked if not file Form 990-N with the Internal Revenue
Service for three consecutive years
Must reapply for tax-exemption with the Internal Revenue Service if have exemptionautomatically revoked
• Auto-Revocation List
Prepared by YH Advisors, The Exempt Org Experts 23
Important EO Concepts
Governanceo Board of Directors
• Majority independent Board of Directors
• Contemporaneous documentation of all Board meetings
Including Board Committee meetings
o Policies• Conflict of interest policy
• Whistleblower policy
• Document retention and destruction policy
• Gift acceptance policy
o Procedures• Form 990
Board review of the Form 990 before filing Board Committee review permissible
Forwarding of “final” copy of Form 990 to all Board of Directors members before filing
• Reasonable compensation documentation
• Make required documents available for public disclosure
Prepared by YH Advisors, The Exempt Org Experts 24
Important EO Concepts (cont’d)
Transactions with Insiderso Definition of insiders
• Voting Board members
• Top management official / Top financial official
• Key employees
• Anyone related to an insider
• Former insiders of the organization
o Recommendations• Implement conflict of interest policy
Annually monitor compliance with conflict of interest policy
• Contemporaneously document why transacting with the insider
Special skills
Discounted cost
Familiarity with the organization
• Review and approval of all insider transactions by disinterested Board members
Prepared by YH Advisors, The Exempt Org Experts 25
Important EO Concepts (cont’d)
Reasonable Compensationo Must reasonably compensate insiders of the exempt organization
o How best ensure payment of reasonable compensation• Board approval of the insider compensation arrangement
• Board reliance upon salary surveys and comparability analysis when determining whether to approveinsider compensation arrangement or not
• Contemporaneous documentation of the entire process
o Penalties for unreasonably compensating an insider• Insider penalized
• Board members who approved the unreasonable compensation penalized
• Organization could lose its tax-exemption
o Recommendations• Conduct Reasonable Compensation Study
• Implement expense reimbursement policies
Prepared by YH Advisors, The Exempt Org Experts 26
Important EO Concepts (cont’d)
Unrelated Business Incomeo Definition
• Trade or business
• Regularly carried on
• Not substantially related to the furthering of the exempt purposes of the entity
o Taxation• Organization pays tax at the normal corporate rates if generating unrelated business income
o Substantiality• Organization could lose its tax-exemption if its unrelated business activities are too “substantial”
Conducting of Special Eventso Calculating the charitable portion of special events revenue
• Complexity of accounting for auctions
o Ensuring that legally permitted to conduct gaming events in particular state where operating
o State charitable solicitation registrations
Prepared by YH Advisors, The Exempt Org Experts 27
Important EO Concepts (cont’d)
Political Activities o Limited amount of lobbying permitted for charitable entities
o No political activities permitted for charitable entities• Other exempts may be permitted to conduct political activities
For example, §501(c)(5) labor unions
Prepared by YH Advisors, The Exempt Org Experts 28
Important EO Concepts (cont’d)
State Charitable Solicitation Registrationo Charities must generally register in states where they are soliciting contributions
• Most states have very broad definitions of “solicitation”
o Initial registration• Certain types of entities exempt from registration
• Must provide significant amount of information for initial registration
Articles of Incorporation
Bylaws
Determination Letter
Most recent Form 990
Audited financial statements
o Annual renewals• Some states have significant fees for renewal registrations
Prepared by YH Advisors, The Exempt Org Experts 29
Resources
Federal Resourceso IRS web site
• Charities link
Life Cycle of a Public Charity
EO Select Check
EO Newsletter
• www.stayexempt.irs.gov
New modules (e.g. political)
Online case studies
o IRS training materials• Governance
o IRS Publications• 526 – charitable contributions
• 557 – tax-exempt status
• 598 – unrelated business income
• 1771 – substantiation of charitable contributions
• 1828 – church tax guide
• 3079 – gaming
• 4221 – compliance guide
• 4779 – terminations / mergers of tax-exempt organizations
Prepared by YH Advisors, The Exempt Org Experts 30
For More Information…
Please contact:
YH Advisors, Inc.One Pacific Plaza
7755 Center Avenue, #1225Huntington Beach, CA 92647
Brian Yacker, Partner Lauren Haverlock, Partner310-982-2803 (direct) 310-982-2804 (direct)310-266-7196 (cell) 949-636-4418 (cell)
[email protected] [email protected]
Stacey Bergman, Principal310-982-2805 (direct)562-965-2554 (cell)
We Opened a 501c3
Louis Peltier Volunteer, Mercy Hospitals of Bakersfield Bakersfield, California
ATTORNEY
(Get to know his executive assistant)
ARTICLES OF INCORPORATION
MIRROR
BY LAWS
Name of organization in bylaws same as
Corporation name
MERCY AUXILIARY By-Laws
MERCY AUXILIARY INC. Articles of Incorporation
• Single purpose organization to serve the hospital.
• Members pay dues or not.
• Officers elected by members or by previous board.
• Set your fiscal or calendar year.
• Dissolution section.
• Get permission from your executive board to use their personal information.
• Determine what address to use for your corporation.
OTHER DOCUMENTS
YOU WILL NEED • Fictitious name statement
(for checking account) • Business license • Resale license
(sales tax)
POLICIES YOU MIGHT WANT TO CONSIDER
• Memorandum of Understanding • Conflict of Interest • Liability Insurance for board members • Rent hospital space ($1 year lease) • Set a policy for obtaining Auditor/Tax
Preparer