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Employing the disabled and other low-income individuals?
Selling gift baskets from needy third-world countries?
If this nonprofit sounds like a model of social enterprise, that's because, well, it is.
And besides exemplifying the triple bottom line, it also illustrates how the commercial character of such ventures can cause serious trouble with the IRS.
Click through the jump to read some key points from the Service's explanation for denying this nonprofit tax-exempt status under 501(c)(3). Remaking charity in the image of commercial business can yield certain benefits, but failing to respect the design logic of nonprofit form can create far more trouble than your business plan may anticipate.
One of my law class students asked me about certain popular arguments made by tax protestors. It's a subject well known to pretty much anyone who has ever clerked for a federal appeals court, because the courts get a fair number of these cases coming through every year and they always lose. Big.
The IRS explains why in its comprehensive new point-by-point refutation of the leading tax protestor arguments.
Craig Weinrich of the Nonprofit Coordinating Committee of New York left a comment below with some useful resources. So no one misses it, here it is, with links:
NPCC usually gets about a dozen calls a week on starting a nonprofit, and although we do not assist in this area, aside from the checklist, we refer people onto Community Resource Exchange (www.crenyc.org) who have a fantastic book called "From Vision to Reality" as well as workshops and consultants to help. Additionally, we refer people to both Lawyers Alliance for New York (www.lawyersalliance.org) and New York Lawyers for the Public Interest (www.nylpi.org) for legal assistance.
- Nolo's intro article covering basic elements in forming a nonprofit organization.
- The Foundation Center's instructive tutorial (with sample documents) on starting a nonprofit.
- A thorough checklist of "things ya gotta do" from the Nonprofit Coordinating Committee of New York
The issue: whether the charity had paid excessive compensation by approving a 1.265 million dollar retention bonus. The AG
ultimately was comfortable with the process because of the following factors: (i) the board was consistently involved in setting Spaulding's compensation and reviewing his performance; (ii) independent comparables were used by the compensation committee in developing Spaulding's pay package; (iii) there was no evidence that Spaulding attempted to assert undue influence; (iv) the amounts of the deferred bonus were consistently disclosed in regulatory filings; and (v) with one exception, the minutes reflected the major decisions.Re the last point, Siegel highlights a recommendation that I also make to my nonprofit law classes:
The most significant problem that Spackman [the AG] pointed to was a missing set of minutes for an important meeting (the May 3, 2001 one). Spackman made it very clear that the decision, including the reasoning behind it and the economic analysis, should be reflected in the minutes of the board and the committee. This simply reinforces our continuing belief that meeting minutes should be more detailed than many lawyers currently prefer. In our view, boards and their lawyers make a serious mistake when they claim they are avoiding potential board liability by stripping meeting minutes of any meaningful content. As we continue to observe practices, we find that more detailed minutes often would have avoided embarrassment and provided a solid defense for board decisions.
- 501(c)(4) [this is helpful too]
- 501(h) [these are also helpful]
- Political campaign activity
Here are the periodicals I mentioned in class last night:
Also, here's the Foundation Center website.
Yesterday in my law class we reviewed how good record-keeping can be key to defending a lawsuit against a nonprofit's directors and officers.
But what if you lose? Or, even if there isn't a lawsuit, how can you minimize the risk of loss for your organization's leaders?
Directors and officers insurance. More here.
We cover a lot of ground in my nonprofit law course, and at times it may seem that the penalties on groups that do wrong have little application to mainstream charities.
After all, we're all good here, aren't we?
Except good intentions can lead to any number of bad acts--and because these things are done in the name of doing good, even the most respectable group won't see anything wrong.
Here's an interesting case study from California. Although some legal details may differ from state to state--not all states would apply the language of trust law to gifts to a corporate charity, for example--the core principles and lessons remain the same. In a nutshell, a California United Way spun off a separate charity to manage charitable contributions, and then . . .
When you cut through the numbers, the problems and issues are relatively straightforward. The court concluded that PipeVine was undercapitalized when it split off from United Way, with the result that PipeVine was forced to use new contributions to meet its obligations to remit amounts attributable to older contributions. The court also concluded that Pipeline's financial statements, as a result of an adjusting entry, hid these facts by overstating PipeVine's worth.
Click the link for a full summary and essential advice.
Accountability works only so long as we know how to read the numbers. Case in point: this Harvard Crimson op-ed condemning gross fiscal irresponsibility by some of the nation's leading charities:
For all their publicity stunts and feel-good lines, many of today’s powerhouse nonprofits are extremely inefficient. They commit the majority of their resources to pulling in potential donors through razzle-dazzle, so that there is little left in the way of resources for their actual causes. Inevitably, every organization has overhead costs, but a staggering number of charities today are falling out of control in this respect.
Sounds bad, doesn't it . . . until you read the corrections:
The May 15, 2006 op-ed, “Corrupt Charities,” incorrectly stated the percentage of donations to several charities that goes towards the people and programs that the charities exist to serve. According to Charity Navigator, a non-profit organization that reviews charitable groups, the Susan G. Komen Breast Cancer Foundation spends 76.2 percent of money on its causes, not 13 percent. The Greenpeace Fund spends 78.8 percent on its causes, not 18 percent. The March of Dimes Birth Defects Foundation spends 75.1 percent, not 18 percent. Charity Navigator does, however, rate the efficiency of Greenpeace and March of Dimes as deserving only two stars, which signifies that it “needs improvement.” The Komen Foundation received a three-star “good” rating.
These significant mistakes occurred because the writer did not correctly read the information on the organizations listed on Charity Navigator’s website. Though Crimson policy is that all pieces must be fact-checked by an editor, the editor of this piece also misread the numbers.
The Crimson will investigate how the writer, the editor of the piece, and two proofers missed the factual inaccuracies, and will move to ensure that existing fact-checking policies are strictly followed so that similar errors will not happen in the future.
Quel scandal!
Continuing the list with explanatory links:
Supporting organization (and types)
One of the most important yet least understood aspects of running a nonprofit is managing its intellectual property. This podcast interview with Professor Susan Scafidi covers the basics.
All the questions in the interview were drawn from actual questions I've received from students, nonprofits or other social enterprises. And here are a couple follow-ups:
Q: Can a nonprofit get a trademark, since it's not a business?
A: Yes. A trademark is a symbol used to identify the source of goods or services in the marketplace. Even if a nonprofit does not perceive itself as a business, it may actually enter the marketplace in any number of ways, not least of all by fundraising. For more on nonprofits and trademark, check out the article linked here.
Q: When I start my nonprofit, do I have to register its name as a trademark?
If you are going to use the name on goods or services, then it's a good idea to protect yourself by registering the name as a federal trademark rather than simply relying on common law trademark protection. On the other hand, the name of a nonprofit (or for-profit) organization cannot be registered as a trademark unless it is also applied to goods or services.
Q: Can a church get a trademark?
A: Yes. Here's an example of how the Presbyterian Church (USA) uses trademark law to avoid confusion with other churches and to prevent unauthorized use of its name. Similarly, here's the trademark policy of the Seventh Day Adventists. Religious groups may generally be full of peace and light, but mess with their trademarks and they can get pretty badass.
And finally, here are the web sites noted in the podcast, plus one extra:
This question flows from one of the tax code's more insidious and retrograde provisions with regard to tax exemption.
First, some background.
In a nutshell, the Internal Revenue Code divides 501(c)(3) organizations into two major categories: public charities and private foundations. Both are 501(c)(3)s, but private foundations are subject to a few more restrictions. (Folks who want a short-and-sweet summary should really click that last link. Really.) In order to avoid these restrictions most 501(c)(3)s prefer to be treated as public charities.
But how do you get recognized as a public charity? The right side of the chart below sums it up: you want to meet the standards set out in one of the sections in Code Section 509(a). For most organizations the path lies in sections 509(a)(1)-(3), although 509(a)(4) also provides a way out for organizations testing for public safety.
The groups listed above "Section 509(a)(1)" take us to our main question. Publicly supported public charities have to meet complicated mathematical tests, as do 509(a)(2) public charities. 509(a)(3)s have to meet complex tests relating to organizational structure, and they're also subject to some additional rules. However, churches, schools and hospitals have it easier--if they fit the relevant definition, they don't have to bother with the mathematical or structural tests.
What are the relevant definitions? They can be a bit hard to remember, but fortunately the main details are spelled out for you in the application for recognition as a 501(c)(3) organization, IRS Form 1023--and I've clipped the pertinent parts here.
Read the standards carefully and you'll get a sense as to why this subset of 509(a)(1) organizations is sometimes referred to "traditional public charities." The standard explanation for the grouping is that churches, schools and hospitals have traditionally been associated with serving the interests of the general public, but the definitions follow tradition in deeper sense:
To qualify as a church, school or hospital, your organization has to look like something out of 1954.
A church has such things as a hierarchy, a place of worship, a code of doctrine and Sunday school.
A school has a faculty, curriculum, buildings (or other physical "facilities") and enrolled students.
A hospital is, well, a hospital, a real-world facility providing discrete medical services to patients.
And that's the real story. These organizations were not given privileged treatment because they are most responsive to the public--if they were, the standards would be written so as to allow the categories to adapt as society itself evolves. Rather, this is yet another example--all too common in law--of the wealthiest, most powerful organizations using their influence to get out of burdensome rules that apply to less well connected groups.
An established "church" doesn't have to meet either the mathematical or supporting organization tests; an upstart "religious organization" does, in part precisely because its approach to worship is non-traditional. No accident, this--at the time the rules were written, mainstream Christian churches were a central component of America's civic identity. Similarly, private schools and hospitals were seen as an extension of the governmental system of education and medical care, with entrenched bureaucracies, a fixed infrastructure and centralized control.
In sum, the grouping of these three institutions is designed to keep privileged social status as the status quo, all in the guise of protecting the organizations most responsive to ordinary people.
Bah.
Another excellent question I've received: If a person donates property to a charity, how much can they deduct? The scenario that sparked the ask: an artist donating her art to a church for it to sell. She can deduct the price the art sells for, right?
Wrong!
Artists can only deduct the cost of the items used to create art of their own that they've donated--and if they deducted those items as a business expense, they can't deduct 'em again as a charitable deduction! The same thing goes for donations of personal papers. You also can't deduct the value of your time--for example, I could not deduct the value of free legal consultation to a charity, nor could a carpenter deduct the value of time spent helping to build a house with Habitat for Humanity.
But what about gifts of property more generally? Let's say the church member donated someone else's painting or some jewelry or stock?
Charitable business has been in the news quite a bit, and once again the fact that charities don't pay taxes on much of that business is attracting a fair bit of negative attention, especially from commercial competitors. We can expect the complaints to grow louder as the economy gets worse.
I've been asked to provide a brief overview of UBIT. Since it was just my dumb luck to get sick I've decided to set aside the podcast format for a day or two and set the answer out in writing.
Click below for more:
Class meetings today, so no podcast. Tomorrow's will cover the topic in the title of this post. Until then, by special request, here are the core documents.
IRS on the 2006 tax law changes (general & donations)
Form 8282: Donee information return
A few years ago the Smithsonian honored Martha Stewart in an exhibit.
Here's more about the history of the Smithsonian's business ventures, including its controversial deal with Showtime.
(My opinion about the Showtime-Smithsonian venture? I'd be all for it if it meant that Dexter could travel through time!)
The Wall Street Journal today has an op-ed criticizing Nancy Pelosi's attempt to spike a proposal to make employers immune from federal civil-rights lawsuits for requiring workers to speak English.
What prompted this proposed amendment?
The EEOC's lawsuit against the Salvation Army, which fired two clothes-sorters for failing to adhere its English-only policy.
Now some of you might wonder, aren't charities already supposed to be free from lawsuits under the doctrine of charitable immunity?
Short answer: Not this kind of lawsuit, and more generally, not as much as you think.
Charitable immunity is a state-law doctrine--it has no bearing on an organization's liability under federal law, including federal anti-discrimination law.
Beyond that, charitable liability is not an absolute absolution from all liability. Generally, charities in states that recognize charitable immunity protect charities from liability due to the negligence of their employees. (The level of protection does vary; some states grant total immunity; others merely limit it.)
Note that I said "charities in states that recognize charitable immunity." Not all states do, and last I knew, New York was one of the exceptions.
Sorry, kids.
Why would a state not choose to recognize charitable immunity? Historically, attempts to limit or eliminate the doctrine have followed some egregious incident of perceived wrongdoing, such as medical malpractice or, more recently, the sex scandal in the Catholic Church.
Although charitable immunity is not a federal law, Congress has extended limited protection to volunteers under the Volunteer Protection Act of 1997. Click here for a brief overview of its main provisions.
IRS model articles of incorporation
Delaware Certificate of Incorporation: A Non-Stock Corporation
New York model not-for-profit certificate of incorporation
Forming a Not-for-Profit Corporation in New York State
This week in my nonprofit law class: a look at the not-so-wonderful world of UBIT, the unrelated business income tax.
And just in time for it: a nifty New Yorker survey of the contents of NYC museum gift shops. The article: "Art and Commerce," by Patricia Marx. It's not online yet & it has, well, pretty much nothing in the way of legal analysis, but once you grasp the basics of UBIT the stuff in the article makes a lot more sense.
Are all charitable organizations considered NGO's by definition?
That's an excellent question, not least of all because of its final two words. Precise definition is one of the keys to law--when Bill Clinton said "it depends what the meaning of 'is' is" he may have seemed too clever by half, but he was talking like the lawyer he is.
Whatever that may mean.
Anyway, back to the question. The answer depends on how we define our terms.
In this instance, all charities are NGOS, since 501(c)(3) does not encompass the federal government, states or their political subdivisions. Why doesn't 501(c)(3) apply to governments? In a nutshell, commentators point to three reasons:
- Our constitutional structure does not allow states to be taxed.
- The tax code does not define the scope of taxable entities to include sovereign political entities.
- A government's power to tax, power of eminent domain and police power go beyond the purposes specified in 501(c)(3).
That may seem to be a clear enough answer, but the devil's in the details. Although 501(c)(3) does not encompass governmental units, there are nonetheless a bunch of separately organized governmental organizations that can qualify as tax-exempt under 501(c)(3). A few common examples (assuming they're organized the right way) include public libraries, public hospitals and state universities.
In fact, one of the country's largest charities--the American Red Cross--is chartered by an Act of Congress and also recognized as exempt under 501(c)(3). It is what some would call a GONGO, or government organized nongovernmental organization.
Which leads to another answer to our main question. There are a number of folks who see governmental involvement to be inherently contradictory to being an authentic nongovernmental organization. From their perspective, an organization created by or working for the government is not an NGO, at least not in the sense of being a voluntary organization formed outside the sovereign political structure. That means a charity could be exempt under 501(c)(3)--or, more globally, be a nonprofit serving a public purpose--and yet not fit their definition of what constitutes an NGO.
What's the right answer?
I don't think there is one. Terms such as nonprofit, charity and NGO are inherently contingent--their particular meaning depends on their immediate context.
Case in point: the very fact that American corporate law tends to use the term "nonprofit" or "not-for-profit" while NGO prevails in the context of international associations and public interest work is itself a historical accident. "Nonprofit" form reflects its origins in a reaction against industrial-age commerce and the accumulation of capital, while the term "NGO" reflects a twentieth-century reaction against provincial nationalism and authoritarian political sovereignty.
So here's your takeaway:
Is every charity by definition an NGO?
It depends what the meaning of "is" is!
BONUS RESOURCE: For more information on this topic, hearty souls may want to consider the helpful summary provided by Jody Blazek and David Nelson in the September 2006 Exempt Organization Tax Review: "When Can a Governmental Organization Qualify as a 501(c)(3) Organization and What is the Tax Reporting Consequence?"
Whenever I tell folks in the social enterprise that I think the time may be turning against their hybrid model of charity, the reaction is typically disbelief.
This year, for instance, the U.S. Treasury will be receiving about $40 billion less than it would if the tax code didn't allow for charitable deductions. (That's about the same amount the government now spends on Temporary Assistance for Needy Families, which is what remains of welfare.) Like all tax deductions, this gap has to be filled by other tax revenues or by spending cuts, or else it just adds to the deficit.
I see why a contribution to, say, the Salvation Army should be eligible for a charitable deduction. It helps the poor. But why, exactly, should a contribution to the already extraordinarily wealthy Guggenheim Museum or to Harvard University (which already has an endowment of more than $30 billion)?
(from Is Theater Really a Charity? by Robert Reich)
Worth noting: Reich's emphasis on wealth and quid-pro-quo exchange versus the traditional understanding of charity as poor relief. Reich's op-ed points to where public policy is likely to shift, particularly if there's a recession.