Nonprofit Law YOU Want to Know

We regularly feature answers to questions from readers in our “To the Point” column. The full list can be viewed here. Here are some of the questions recently received from readers.

Insurance for nonprofits
I have been told that a 501(c)(3) corporation needs to have insurance. What kind of insurance does a nonprofit need?

Every organization, whether or not a 501(c)(3) charity, that is serious about conducting activities and wants to protect its corporate capacity and its volunteers and managers needs insurance. You probably start with required coverages such as workers’ comp, and add general liability and directors and officers insurance. But check with a broker who understands nonprofits and your type of business for a careful review of your risks and needs. (See articles in our Risk and Reward Archive, and Ready Reference Page: “Directors Often Fear Risks of Personal Liability.”)

Can marketing organization be exempt?
If a nonprofit organization markets certain handcrafted items for the sole purpose of raising charitable funds, where all proceeds after expenses are directly deposited towards the charitable purpose, and none of the profit is payable to any member or beneficiary other than the charity itself, will the organization be eligible for a 501(c)(3) tax exemption?

If a purchaser/contributor claims a charitable contribution deduction, will he/she deduct the entire amount paid or be limited to the proceeds that will directly go to the charity after payment of operating expenses?

If the sale of handcrafted items is not substantially related (other than by raising funds) to the charitable purpose for which the organization is exempt, you will be generating unrelated business taxable income. (See Ready Reference Page: “Nonprofits Often Worry About UBIT.”) Congress long ago outlawed charitable exemption for “feeder” organizations, those that conduct non-charitable activities solely for the purpose of raising funds for charities.

If this unrelated business activity is the sole activity of the organization, it will not qualify for exemption. If it is not a substantial activity and the organization otherwise carries on an active charitable program, it may be permissible, although subject to tax.

It sounds as though the purchaser/donors will not be entitled to claim a charitable contribution deduction. No deduction is available if the payment is essentially the market value of the item. Where donors make payments to charities and receive goods or services in return, they are usually able to deduct the difference between the payment and the fair market value of the items received. That calculation, except in the case of low cost souvenir-type items, is not based on cost of the items, but on the value. (See Ready Reference Page: “Charities Must Set Value on 'Quid Pro Quo' Gifts.”) If the seller is not a charity, of course, there is no deduction even if they pay far more than the fair market value.

Where do we live?
We are a 501(c)(3) nonprofit organization incorporated in one state, although originally our offices were located in another state. We subsequently moved to a third state and still do not have a permanent location. What are the reasons that we would have to become certified in a given state?

I am not sure what you mean by “certified.” Your (c)(3) status is federal and is not affected by your state or states of operation. Your incorporation and your corporate existence will be recognized in any state. It may be appropriate to register to do business in any state in which you are conducting activities other than your state of incorporation. Although technically required, in many cases there is no penalty for failing to do so except an inability to sue in the state, and even that disability can be cured by later registration. Without regard to where you principally conduct your business, if you are soliciting charitable contributions in any state, you need to check the charitable solicitation registration statute of the state to see if you need to register. If you want charitable tax exemption for real estate or other state or local taxes where you are operating, you will probably have to apply for that status.

What happens to inactive charity?
I formed a 501(c)(3) organization in 1988. We operated and had a checking account at a local bank. From 1992 until 2006, however, we had no activities. The checking account still exists with under $100 in it. Is our IRS charitable organization ruling still good? Is there a statute of limitations or is the ruling good until the organization goes out of business?

Although the Senate Finance Committee proposed that charities should be recertified every few years (See Ready Reference Page: “Senate Committee’s White Paper Proposes Vast Expansion of Federal Power Over Charities.”), Congress did not adopt the proposal. The New Pension Protection Act, however, will require an annual report of continued activity from all exempt organizations, even if they do not receive more than $25,000 in annual income, and will terminate the exemption of any organization that fails to file for three years. (See Ready Reference Page: “Congress Passes Charitable Reforms.”)

The IRS can revoke the exemption of an organization that does not carry out a charitable purpose, but normally does not follow-up on the status of an organization unless it gets a complaint. You may still have a difficult situation, however, if the charity has lost its public support status and become a private foundation because it did not have sufficient public support to qualify. (See Ready Reference Page: “Calculating Public Support Percentage.”) You may owe some foundation taxes. If you want to reactivate the entity and have become a private foundation, you may need to request an advance ruling to reestablish your public charity status and not be treated as a private foundation.

Does the IRS dictate an annual meeting?
Does the IRS have any regulations on when our nonprofit organization can hold its annual meeting? Is it entirely up to the organization’s Board?

The IRS does not control the internal governance issues of nonprofits. This is a matter of state nonprofit corporation law. If the corporation has voting members, they can normally call an annual or special meeting if the Directors fail to do so. If there are no voting members, it will probably be entirely up to the Board.

Changing the form of an organization
Can an exempt organization change its form of organization while keeping its exemption? I'm on the board of one organized as a trust, which really should be a corporation.

If you change organizational form from trust to corporation you will have to file for a new recognition of exemption from the IRS. It should not be difficult to obtain if you are conducting a charitable program, but it will be required. You may also have to file with the state or local authorities as a new entity.

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