Tag Archives: 501(c)(3)

A woman punching a man in the face, which is not really how conflicts of interest work, thankfully.

Why Your Organization Needs a Conflict of Interest Policy

When I meet with a new 501(c)(3) organization client, one of the things I usually ask about is whether the organization has a conflict of interest policy. Usually, one of two things happens:

  1. “Yes, we do have a policy in place.”
  2. “A conflict of interest policy? What is that? Do we need one?”

No matter which answer I get, it’s okay. Conflict of interest policies are important, but it’s not hard to get one and adopt it. Let’s answer the questions in #2 up there to explain why this is a big deal. Continue reading

What is Unrelated Business Income?

One of the big traps that can tangle up an organization is engaging in some sort of fundraising activity that generates what the government calls “unrelated business income,” which can cause an organization to have to pay taxes or, in extreme cases, even forfeit the 501(c)(3) tax exemption altogether.

Some sources of income are automatically excluded from UBI (and I’ll give you some other exceptions near the end), like dividends and interest, some types of investment income, royalties, some types of rental income, and some capital gains.

If you do have unrelated business income of $1,000 or more, you must file Form 990-T for the tax year involved. If you expect to have more than $500 in UBI during a particular year, your organization must pay estimated tax.

What is Unrelated Business Income?

Unrelated business income is money earned by an organization that meets three requirements:

  • It’s earned from activities that constitute a “trade or business.”
  • The activity is “regularly carried on.”
  • The activity does not further the organization’s exempt purpose.

For something to count as UBI, it must meet all these requirements; if one is missing, it’s not UBI. Let’s talk about each of these requirements in more detail.

What is a “trade or business?”

Here’s how I think about this requirement: is the money-making activity something that a for-profit business would engage in to make money? If you’re exchanging a good or service for money, you’re probably engaging in a trade or business. Car washes, bake sales, and selling advertising in programs, for instance, have obvious for-profit equivalents: the commercial car wash, the local bakery, and newspapers and magazines that sell ad space do the same thing. Each of those would qualify as a trade or business.

Of course, not every activity that raises funds is a trade or business. Receiving donations is not a trade or business–there’s no exchange taking place. Likewise, applying for grants from other organizations or charitable trusts isn’t a trade or business; it’s a donation.

What does it mean to be “regularly carried on?”

Generally, an activity is “regularly carried on” if it occurs roughly as often as it would for a for-profit business engaged in the activity. If a for-profit business does the activity year-round, and you’re only doing the activity every now and then, it probably won’t be considered regularly carried on.

For example, imagine that your organization operates a sandwich stand for a couple of weeks out of a year. Most for-profit sandwich sellers operate year-round, and a couple of weeks isn’t going to be frequent enough to be regularly carried on (that example is from Treasury Regulation 1.513–1(c)(2)(i), if you want to see it for yourself). On the other hand, the regulations also say that if you were to run that same sandwich stand one day each week throughout the year, that would be sufficient for the activity to be regularly carried on. Also, if a for-profit business would operate the activity on a seasonal basis, a couple of weeks of that activity within the same season might be enough.

The closer your activity is to a comparable for-profit business in terms of how frequently you’re open for business, the more likely your activity will be “regularly carried on” for UBI purposes.

What do you mean, the activity doesn’t further an exempt purpose?

This criterion often surprises people. To be “substantially related to an exempt purpose,” the activity itself has to help achieve the exempt purpose. The classic example is tuition for an educational institution. Education is one of the 501(c)(3) exempt purposes, so students enrolling and taking classes directly furthers the school’s purpose.

Here’s what gets people: fundraising activities do not “further an exempt purpose” even if all the money you raise is going to an exempt purpose. Let’s go back to the car wash example. Washing cars is not an exempt purpose. So, if you have a car wash fundraiser, that doesn’t “further an exempt purpose” even if every cent you raise goes to fund your organization’s exempt purposes.

Again, don’t forget that for the organization’s income to count as unrelated business income, it must meet all 3 of these requirements. And even then, there are exceptions.

Exceptions to Unrelated Business Income

So, let’s say that your organization does engage in some sort of money-making activity that meets all three requirements for unrelated business income. We’re not done yet! There might be an exception available. There are four big exceptions:

  • Volunteer labor: Your activity is run entirely by unpaid volunteers
  • Convenience of members: Your activity is carried on primarily for your members, students, patients, or employees–(examples from the regulations: leasing dormitory apartments to students of a college, school or hospital cafeterias, or hospital parking lot all fall under this exception)
  • Selling donated merchandise: Your activity involves selling merchandise which was donated or gifted to your organization
  • Bingo: Bingo should probably get its own post, but the exception applies in bingo games where you complete a pre-selected pattern on a card (5 in a row is most common) to determine a winner, and wagers are made, winners are determined, and prizes are awarded simultaneously.

One more thing about bingo: don’t forget that bingo games may be regulated by your state or local government! You may need to apply for permits or register–or you might not be able to do it at all.

In addition to those exceptions,

Unrelated business income is an easy issue to miss–every time you consider a new fundraising activity, you should always take a moment to consider if this activity will create UBI for your organization.

10 Tips For Writing an Effective Form 1023

For folks that are starting a 501(c)(3) organization, preparing Form 1023 is usually a pretty daunting task. I’ve prepared a few of these, and it can take significant time and work to really prepare the form properly. Ideally, you want to get the application through on the first try, and limit the amount of follow-up and supplemental information you have to provide. There’s no guarantee or magic formula for getting your 1023 approved (and approved quickly), but there are things you can do to improve your chances:

#1: Write a complete, detailed response to Part IV, Narrative Description of Your Activities.

Here’s the most important question on the application:

Part IV

You’ll want this description to be as complete as possible; the way I like to think about it is that you want to give the IRS reasons to approve your application. Here’s what you need to work through:

  • What does your organization do–past, present, and future? If you’re a really new organization, and you haven’t done much, that’s okay, you’re just going to have an answer that is more forward-looking.
  • Use the 4 Ws & 1 H: Who performs your activities? What are the activities? When do you perform the activities? Where do you perform the activities? How do you perform the activities. The IRS suggests this approach, and I think it makes a lot of sense.
  • Align your activities with your charitable purposes. Remember, 501(c)(3) organizations have to be organized for one (or more) specific purposes: charity, education, literary, religion, science, testing for public safety, fostering national/international athletic competition, and preventing cruelty to children/animals. Your activities should be fulfilling those purposes.
  • Take the opportunity to brag about what you do. This is a great chance to tell people what you do–if you’re approved, this is public record. I don’t know that many people will look at your completed Form 1023 after approval, but to the extent people do look at it, it gives you a chance to tell the public what you do.

#2: Make sure you attach answers whenever necessary.

Most of us are used to filling out IRS forms–fill in the blanks, check the boxes, and you’re done…Form 1023 isn’t like that. Often, the form will ask you to attach answers that explain in greater detail. Here’s an example:

Attach stuff

When the form tells you to “explain” or “describe,” you’ll need to attach an answer to your application.

Extra tip: When I prepare a 1023, I answer the questions on the form, and as I answer the questions, I make a list of every additional response I have to attach. When I finish preparing the form, I use the list to make sure I didn’t miss any needed responses. This has been effective for me, and it might help you not miss anything as well.

#3: Provide supporting documentation.

If you’ve produced documents to accomplish any of your exempt purposes, include that material. Provide an annual report to your donors? Have an application for your scholarship program? The IRS often looks for these sorts of documents, and if you’ve got them, it’s helpful to include them.

That said, don’t provide anything you wouldn’t release to the public.

#4: Look up terms that the IRS defines for you.

If you look through Form 1023, you’ll notice there a lot of bolded terms. Any time you see a term in bold, that means that the IRS has a definition for that term in the Instructions for Form 1023. The instructions are a separate document from the form itself. Here’s an example:

Compensation Question

Notice that the word “compensation” is in bold. If you went into the instructions, you could find a definition for compensation. Lo and behold, here it is:

Compensation Definition

Notice that “compensation,” for our purposes here, goes way beyond salary or wages, and includes some items you might not have otherwise thought of. This is why I suggest that even if you think you know what a word means, if you’re doing your first 1023, you should look up just about every bold term, so that you understand the question you’re answering.

#5: Read the first few pages for changes or adjustments to the form.

Updating any document, I suspect, is kind of a pain for the IRS. So, instead of releasing a new form each time they make a change, they sometimes put changes to the form at the beginning of the form. Unfortunately, most people skip right over that stuff and get to the first page of the form. Don’t do that! You’re only going to guarantee yourself follow-up questions from the IRS (or other problems).

For instance, as I look at the form today, here are the changes mentioned in the first couple of pages before the form itself actually starts:

  • There’s a new mailing address to send the application to; the one listed on page 28 is not the correct address (that seems important);
  • Advance rulings are no longer available, even though the form says they are;
  • The amount of financial data you must provide has changed;
  • You should skip certain lines in Part X about public charity status; and
  • The user fees have increased.

Those changes are significant; missing something like that could cause some problems and delays for your application.

#6: Make the best financial projections you can in Part IX.

For a new organization, completing Part IX (the financial data section) can be very difficult. New organizations don’t have a lot of data, but the IRS requires them to make projections. Your projections don’t have to be perfect, but they do need to be made in good faith.

But how can you make good faith projections? First, do some research–are there similar organizations to you that might be willing to help you make projections? Second, consult with professionals that have experience with nonprofit budgeting–an accountant who works with nonprofit organizations might be particularly helpful here. Additionally, if you or others in the organization have experience with budgeting, that should help as well.

Also, doing these financial projections is a useful exercise, and you should treat it that way. You should do some financial planning as part of the startup process, and you should know how much money you need to raise to fund your work.

#7: Include your organizing documents.

There are a few different types of organizations that can apply, most commonly nonprofit corporations and trusts. For a corporation, there are two important documents to submit: your articles of incorporation (or something similar–the exact terms might vary from state to state) and your by-laws. You’ll also need to include any amendments made to these documents.

The IRS uses these documents to determine if your organization is set up in compliance with the requirements of 501(c)(3) organizations. In particular, they’ll be looking for language that limits your organization’s activity to the 501(c)(3) exempt purposes we discussed earlier and that requires the organization’s assets be given to another 501(c)(3) organization when your organization dissolves.

#8: Don’t forget the schedules.

Form 1023 contains eight different schedules that might apply to your organization. Here are the schedules:

  • Schedule A: Churches
  • Schedule B: Schools, Colleges, and Universities
  • Schedule C: Hospitals and Medical Research Organizations
  • Schedule D: Section 509(a)(3) Supporting Organizations
  • Schedule E: Organizations that Have Not Filed Form 1023 Within 27 months of Formation
  • Schedule F: Homes for the Elderly or Handicapped and Low-Income Housing
  • Schedule G: Successors to Other Organizations
  • Schedule H: Organizations Providing Scholarships, Fellowships, Educational Loans, or Other Educational Grants to Individuals and Private Foundations Requesting Advance Approval of Individual Grant Procedures

Of course, not all of these schedules will apply to your organization, and it’s entirely possible that none of these schedules will apply, but if one (or more) of these applies, make sure to complete each schedule that does.

#9: Don’t release any social security numbers in the application.

I have no idea why this is a problem–the form never asks you for a tax ID other than the nonprofit organization’s–but the IRS reports that SSNs show up fairly regularly in applications. SSNs from directors, officers, volunteers, staff, and donors have shown up in applications. They should not be in there, and they certainly shouldn’t be released publicly, so do not include them. Simple as that.

#10: Use the checklist to make sure you’ve got everything.

At the end of the application, there is a checklist reviewing everything that you need to submit. It’s there to help you–take advantage of it! You’re much better off finding anything you missed before submitting rather than having the IRS request it later.

Photo credit, Kaitlin Gentry, via Unsplash.com, licensed under CC-0

Tea Party Class Action Wins in Federal Appellate Court

Last week, the U.S. Court of Appeals, Sixth Circuit (which covers Michigan, Ohio, Kentucky, and Tennessee) ordered the IRS to produce discovery (the pre-trial exchange of information between the parties in a lawsuit) required by the trial court in an ongoing legal battle with a class of conservative and “Tea Party”-related organizations.

If you’re new to this story–or if you’ve forgotten about it, because it’s been off the radar for a while–Forbes contributor Kelly Phillips Erb (or “taxgirl,” as she’s often known) has a pretty good timeline here. The short version is that after the Citizens United decision, there was a dramatic increase in applications for tax-exemption under Section 501(c)(4) of the Internal Revenue Code. That’s because Citizens United held that the government cannot prevent a nonprofit corporation, for-profit corporation, or a labor union from making “independent political expenditures,” which are expenditures on statements supporting or opposing a political candidate but is made independently of any candidate’s control or cooperation. (Note: That’s not the same as requiring the government to subsidize that speech with a tax exemption, though, which is why 501(c)(3) organizations can lose their tax-exempt status for political speech. Even with 501(c)(4) organizations, political activities must be an insignificant part of their activities.)

These organizations allege that the IRS treated applications from conservative groups unfairly. The IRS specifically looked for applications with terms such as “Tea Party,” “9/12,” and “Patriots,” as well as those advocating positions on taxes and government spending. Those applications were either delayed or subject to pretty heavy requests for information from the IRS. Indeed, the Treasury Inspector General for Tax Administration found that the criteria used were inappropriate. As the Sixth Circuit points out, charges that the government has targeted its own citizens for mistreatment based upon those citizens’ political viewpoints are a serious matter.

As part of the discovery process, the plaintiffs (the organizations alleging mistreatment) wanted to find out what organizations were screened out by the IRS’s “Be On The Lookout” lists, which the IRS has, up to this point, resisted turning over. The Sixth Circuit rejected the IRS’s request to avoid turning over this information in clear terms:

“The lawyers in the Department of Justice have a long and storied tradition of defending the nation’s interests and enforcing its laws—all of them, not just selective ones—in a manner worthy of the Department’s name. The conduct of the IRS’s attorneys in the district court falls outside that tradition. We expect that the IRS will do better going forward. And we order that the IRS comply with the district court’s discovery orders of April 1 and June 16, 2015—without redactions, and without further delay.”

As Nonprofit Quarterly explains, this most likely opens the door for depositions of IRS officials involved in this matter, and depending on the facts that come out of those depositions, this controversy may find its way back into the limelight.

Photo credit, Siyan Ren, via Unsplash.com, licensed under CC-0

Form 990 Deadline Looms for Calendar-Year Organizations

For organizations that use the calendar year as its fiscal year, the deadline for filing your annual information return (on Form 990, or some variant of it) is fast approaching: May 16, 2016. Let’s look at some of the basics of annual information return reporting for 501(c)(3) organizations:

 Which version of Form 990 do I file?

There are three main variants for Form 990:

  • Form 990, for most organizations with gross receipts of $200,000 or more OR total assets of $500,000 or more;
  • Form 990-EZ, for most organizations with gross receipts of less than $200,000 AND total assets of less than $500,000;
  • Form 990-N (e-Postcard), for most organizations with gross receipts under $50,000.

Private foundations have their own 990, the 990-PF, and black lung trusts also have their own variant, the 990-BL.

Don’t forget that your filing may be more than just the form itself–you may have additional schedules to fill out as well. If you’re working on these forms, be careful; make sure you get all the schedules you need as well–and you may want to have a professional work on it anyway.

If you qualify for 990-N (e-Postcard) filing, there is no paper form; the form is submitted electronically through the IRS website. If you’ve filed a 990-N before, that’s a new thing–the IRS had accepted them through the Urban Institute, but that changed at the end of February 2016.

There are still some organizations that are exempt from filing Form 990, and the IRS has a list of those exceptions. If your organization is of a type on that list, make sure you review the list closely to ensure that you don’t have to file something else instead. For instance, the list includes stock bonus, pension, or profit-sharing trusts that qualify under section 401 of the Internal Revenue Code. However, that entry also indicates that those trusts should file Form 5500, so be careful to make sure you don’t have some other reporting requirement.

When do I have to file?

Form 990 is due by the 15th day of the 5th month following the close of your fiscal year. If your organization’s fiscal year is the calendar year, that usually means May 15 of the following year. This year, May 15, 2016 happens to fall on a Sunday, so the deadline falls on the following Monday, May 16. If you have a different fiscal year, you’ll need to calculate it from the end of your fiscal year.

What if I miss required filings?

If you don’t file for 3 consecutive years, the IRS will automatically revoke your organization’s tax-exempt status. If that happens, the organization will no longer be tax-exempt starting from the due date of the third missed return. If the organization was a 501(c)(3) organization prior to revocation, any contributions you receive after revocation will no longer be tax-deductible for your donors, which can be a very big mess.

If your organization is automatically revoked, it is significant work to have the tax-exempt status reinstated. If this happens, you have to file an application to have your organization’s tax-exempt status reinstated. Depending on the circumstances, this can be a lot of work–in one case, I had an organization that had to file a new 1023, 990-EZs for each of the missing years, and a statement explaining why the failures occurred and how the failures would be prevented in the future. Short version: make sure the return gets filed each year!

If your organization needs an extension, it can apply for one using Form 8868.

Remember, Form 990 is a public document, and it tells the public a lot about your finances. It should be completed carefully and accurately. However, it also gives you some opportunity to brag about the projects you’ve completed, so you really can use it as an opportunity to show off your organization’s work.

Note: a version of this post originally appeared on my firm’s website, attorneykevinkelly.com, and has been updated for publication here.

Photo credit: Mari Helin-Tuominen, via unsplash.com, licensed under CC0