Covid-19 has brought the value of estate planning to the forefront for many people. Estate planning is not just about who gets your stuff after you pass; it’s about planning for disability too. Please contact me to update or create your estate plan.
During this time, I am offering video and telephonic meetings, as well as limited in-person meetings when legally required. In-person meetings will follow the guidelines from the CDC for physical distancing.
I can be reached at anna@vanpeltlegal.com.
Being in the business of making the world a better place often requires nonprofit organizations to become politically active. The IRS rules prohibit 501(c)(3) charities from engaging in certain kinds of political activities, but there are a lot of political activities that charities can (and should) engage in to further their exempt purpose and mission.
Over the last 15 years, the IRS has made life much easier for small nonprofits. The first big change was to create a Form 990-N, which allowed nonprofit organizations with less than $50,000 in gross receipts to file the 990-N “e-postcard.” Unlike the lengthy Form 990 that requires detailed accounting information and disclosure of the highest compensated employees, the e-postcard only
Last week, I talked about welcome retreats for new board members and how critical (and easy) it is to get new members ready for their roles on the board.
This week, I’m talking about the all-board retreat. I recommend having an all-board retreat once a year, separate and subsequent to the new board retreat. The purpose of an all-board retreat is to break away from business as usual, to realign the board members with the mission of the organization, to celebrate recent successes, and to plan for future challenges.
When working with nonprofit clients (especially charities with 501(c)(3) status), I recommend having two annual board retreats: a welcome retreat or orientation for new board members only, and a strategic and team-building retreat for the entire board.
The welcome retreat is a great way to acclimate new board members to their role so they can begin meaningfully participating at their first board meeting.
I regularly get emails from friends who have recently become the treasurer of their club and are worried about the financial set-up of the club. More often than not, the club has been operating informally, which means that any funds collected from the members are being deposited in the personal account of whomever is the treasurer. And it’s right for them to be worried!
Using a personal account, rather than a business account, for club business is bad for everyone. First, it makes it really hard to figure out the accounting of the club. If you’re the treasurer, an audit could mean that everyone gets to look at your personal spending habits, and worse — it could mean that the IRS will treat the money from the club as income to you personally, and increase the amount you owe on tax day.
For most clubs, there’s a simple solution: become a 501(c)7 Social Club.
Before we dive in, a word of caution. This blog is set up to provide information about the law. It is not providing legal advice. What’s the difference? Information is an explanation of the law. Advice is applying the law to your specific situation. I don’t know the specifics of your situation (because this is a blog post and not a letter to a client), so this isn’t advice. Not sure what you should do? Ask an attorney (hint: my email is below).
First a question: what is a 501(c)7 Social Club? The IRS defines a 501(c)7 Social Club as a social or recreational club that is organized for pleasure, recreation, and other nonprofitable purposes. Members must share interests and have a common goal directed toward pleasure and recreation, and the organization must provide opportunities for personal contact among members. The organization's facilities and services must be open to its members and their guests only. The organization must be a club of individuals, and no individual may derive profit from the organization's net earnings. Examples of social clubs include chess clubs, amateur cycling clubs, book clubs, college alumni associations, country clubs, garden clubs, and so on.
The first step in this process is to find volunteers. You will need a board of directors, consisting at a minimum of a president/chair, secretary, and treasurer (and the president cannot be the treasurer). At this point, there are two paths you could choose: to incorporate (a formal existence), or to remain an unincorporated association. Either can be 501(c)(7) entities, and there are pros and cons to both.
Incorporated Clubs
If you want to incorporate, you will need to file as a nonprofit organization with the State of Washington. That costs $50 if you do it online, or $30 if you do it by mail. To fill out the form, you need to know who will be the registered agent for the organization and who the initial board members are. This person’s street address is publicly available so that he or she can receive service of process on behalf of the club, in the unlikely event that the club is sued.
There are certain clauses that you need to have in your organizing documents to ensure that you receive tax-exempt status -- a nondiscrimination clause, a clause against self-dealing and conflicts of interest, and a purpose clause that says you are formed for an exempt purpose (here, for recreation and social opportunities of the membership). After you submit your paperwork to the State of Washington, the Secretary of State will send you a certificate of incorporation, that will list your Unified Business Identification (UBI) number. You can then get an Employer Identification Number (EIN) from the federal government (even if you don't intend to hire employees). Both numbers are necessary for getting bank accounts in the name of the club as an incorporated club.
The benefit to being formal is that your existence is confirmed by the Secretary of State, there are corporate protections for your board, and your organization will exist in perpetuity. The drawback is that you will need to file an Annual Report with the Secretary of State every year (the current fee $10) and you will need someone to be the Registered Agent (or pay for a commercial service).
Unincorporated Association
To remain an unincorporated association, skip the paperwork with the Secretary of State and go to the IRS to request an Employer Identification Number (EIN). Click on the options for nonprofits or other, and be sure to select that you are an authorized officer or representative of the organization.
The benefits of this process is that it’s super easy and cheap to set up. The biggest drawback is that there is less liability protection for your board members, but additionally, some banks won’t open a bank account for unincorporated associations or they may impose additional constraints, like a minimum balance or minimum/maximum transactions per month.
Setting Up Banking
To set up your business bank accounts, contact the financial institution of your choosing and set up an appointment to open an account. You may need to call around first to see if the bank will offer business checking for your type of club. At least two people must attend that meeting — typically the president at the treasurer — so both can be signatories on the account, and they will need to bring two forms of ID (usually a driver’s license or passport AND a social security card, but check with your bank first). You also need to bring your certificate of incorporation (if you have one), your EIN paperwork, your bylaws, and recent minutes showing that the two people in the meeting have been approved by the board to open the account.
Are We Tax-Exempt?
It’s possible that your club may have some or all of this already. Even if you already have articles of formation, now is the time to make sure that you have all the necessary clauses to be granted tax-exempt status. If there isn’t a clause about anti-discrimination, for example, now is the time to formally amend the articles and update them with the State of Washington — before you file for tax-exemption with the IRS.
But I’m getting ahead of myself. There are two ways to go about getting 501(c)(7) status: asking for it, and claiming. A 501(c)(7) is allowed to self-report their tax-exempt status without applying for tax-exempt status first. You do this by filling your annual Form 990 and claiming that you are a 501(c)(7). This is a valid option, especially if you are remaining as an unincorporated association.
However, if you are incorporated, I recommend applying for 501(c)(7) status. It can be really helpful to have that grant from the IRS in order to fundraise — for example, on AmazonSmile or with employer-matching. To apply, you need to fill out IRS Form 1024. It looks long, but many of the pages don't apply to c7 entities. There is a fee of $600 for the IRS for this one. You will need to describe the club’s activities, list the names of your board members and officers, list the salaries for your top five employees (if you have any), the annual budgets for the last couple years (or projected budgets, if a new entity), and disclose your assets and liabilities. It’s a long document, but the information should be relatively easy to collect.
Ongoing Reporting Requirements
Congrats! You’re a 501(c)(7)! However, you can lose this status if you fail to file your annual forms. If you are incorporated, you will need to fill out an annual report for Washington State, as mentioned above. It’s very simple and straight forward. Whether you are incorporated or not, you will need to fill out the IRS Form 990. Form 990 is free so long as your gross receipts are less than $50,000 (well, free in the sense that filing your taxes is free if you didn’t have much income that year). There is also an EZ version for clubs with gross revenue less than $200,000 annually. If you fail to submit a Form 990, it can cause you a lot of headaches. There are late fees that can apply, and if you fail to submit for 3 years, then you will automatically lose your tax-exempt status. This is one of the most important duties of the treasurer (typically), but can be assigned to any officer or you can outsource it to a CPA.
If you found this article helpful, I’d love to hear how it went with setting up your organization. Shoot me an email at anna@vanpeltlegal.com
Updated October 28, 2021
Once you have formed your organization, clarified your exempt purpose, and opened your business bank accounts, you are ready to apply for 501(c)(3) status.
Checklist:
Form 1023, all relevant parts filled out completely (the form itself is 28 pages)
Copy of the certificate of incorporation
Copy of your articles of incorporation, and any amendments in chronological order (be sure to include the conflict of interest policy, nondiscrimination clause, and dissolution clause).
Copy of your bylaws, and any amendments in chronological order
List of your founding officers and directors, and their addresses
List of your five highest compensated employees and their compensation
Budget for the current year and last three years, or, if you have a new organization, your projected budget for the current year and the following two years
A narrative description of your activities
A list of all of the organization’s assets and liabilities
Signature of a person authorized by the board of directors to submit the form, and the proper filing fee.
Simple, right? This is a big application with a lot of moving parts, many of which depend on nuance for getting approved. The IRS reports that the primary cause for delay in granting 501(c)(3) status is missing, hard to locate, or incomplete purpose and dissolution clauses. One of the best reasons to hire an attorney to help with this process is the level of detail required to submit an application that can be reviewed and granted on the first pass. My motto is: Do it once. Do it right. When we expect the process of preparing to file Form 1023 to take 6 months, we give ourselves the space to cross-check documents and ensure that what we represent to the IRS is accurate to the mission and operation of the organization.
For more information, make an appointment for a free consultation.
Wait… What did we just get ourselves into?
Most nonprofit organizations begin when someone imagines a solution to an unmet need in our community. The process for forming an nonprofit organization can be confusing, and a good attorney can help substantially. For most of my organizational clients, the process to prepare to file a request for tax-exempt status takes at least 6 months — but only if the application is correct the first time. If you want to become tax-exempt, it is important to keep that goal front and center as you take the first steps.
First Step
The first thing to do is make sure that the mission or purpose of your organization is a qualified exempt purpose. The exempt purposes set forth in section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. These categories are considered broadly; for example, most nonprofit musical groups fall under the “educational” exempt purpose, while food banks have a “charitable” purpose.
Next, file to incorporate with the Secretary of State. To do this, you will need articles of incorporation (that specifically state your exempt purpose), by-laws, and founding board members. If you later change your purpose, you will need to amend your articles with the Secretary of State — which is why it’s so important to keep your exempt purpose in front of you while you go through this process.
Three other required clauses for your articles of incorporation are:
What happens to your assets should the nonprofit be dissolved (hint: they go to other nonprofit organizations);
Nondiscrimination clause: the organization does not discriminate on the basis of race, national origin, sex, gender, ethnicity, or any other protected class status; and
Conflict of interest: that no director or officer should privately benefit from the business of the nonprofit organization.
The Secretary of State will mail you a certificate of formation, along with a letter that includes your Uniform Business Identification (UBI) number. With your UBI, you can request an Employer Identification Number (EIN) from the IRS. These two numbers can be used to open business bank accounts, which is very important. You never want to mingle your monies with the monies of your organization (the IRS might decide all of the donations are your personal income — eek!). You can also use these numbers to hire employees, but you should have an EIN even if you do not intend to hire anyone in the foreseeable future. You cannot apply for 501(c)(3) status without an EIN.
You are now ready to submit Form 1023 to request tax-exempt status. In the next post, I’ll discuss the items you need line by line.
Fundraising is an important activity of most charities. Without fundraising, many charities would not be able to carry out their exempt purpose. How an organization raises funds, however, is regulated by the IRS, and there are important tax implications that organizations need to consider before beginning a new fundraising campaign.
Types of fund-raisers
While there are always new ways to fund raise, they generally fall into one of four buckets: direct solicitation, grants, in-kind, and events or sales.
Direct solicitation is familiar. If you have ever received a phone call or letter from your alma matter requesting a donation, then you have been directly solicited. Direct solicitation can happen in person, over the phone, by mail or email, or by any other means of direct communication. It is a “straight up ask” — no need to attend an event or buy a product.
Grants are another common method for raising funds. Grants can be given from the government (think scientific research) or from nonprofit foundations. In either case, the applications are often lengthy, and require oversight. Different foundations or government branches will target their grant-making toward different problems or causes. Additionally, nearly all domestic grant-makers require that the grant recipient have 501(c)(3) status, which makes it nearly impossible for smaller clubs and organizations to rely on grant monies.
In-kind donations are another common fundraising strategy. Instead of paying for a service (for example, website design or manual labor to clear a park), individuals (or businesses) will donate their time and expertise for free. This is usually a net gain for everyone, as the individuals or businesses can write-off the donation on their taxes, while the nonprofit receives the benefit of the donation without having to pay for it.
Lastly, events and sales are common ways for organizations to fund raise. Events include things like auctions or carnivals, and sales include everything from candy bars and bake-sales to t-shirts and hats with the organization’s logo or motto.
Pitfalls
The first pitfall that organizations should watch out for is Unrelated Business Income. Unrelated Business Income (abbreviated UBI) is a complicated topic, but basically it includes any income that comes from activities not related to the exempt purpose of the organization. And it’s taxable.
There’s a three-part test for determining whether income is UBI:
1. Is the income from a trade or business? If someone could do the same thing without being part of the nonprofit (for example, for-profit businesses also sell t-shirts), then it is income from a trade or business.
2. Is it regularly carried on? To use the t-shirt example again, if your nonprofit sells shirts once a year, then it is NOT regularly carried on. But if the t-shirts are always available for purchase, year-round, then it IS regularly carried on.
3. Is the activity substantially related to the exempt purpose of the organization? Or, if it isn’t, is the activity taking up more time and effort than the exempt purpose of the organization? For most nonprofits, selling t-shirts is not substantially related to their exempt purpose. However, one example of an organization where selling t-shirts is substantially related to their exempt purpose is Goodwill. Their purpose is to provide employment placement services and job training, and specifically retail sales training, to individuals with barriers to employment. In this specific case, they cannot provide retail sales training without selling a t-shirt. Their purpose isn’t to sell t-shirts, but they cannot do their purpose without selling t-shirts either.
Tax law also has some specific exemptions for UBI. First, activities conducted by volunteers, like an all-volunteer bake sale, will probably be exempted.
Second, businesses that are carried on for the primary benefit of the organization’s members are exempted. A typical example is a school cafeteria.
Third, any trade or business selling merchandise, substantially all of which is donated to the organization, is not taxed. Many thrift shop operations of exempt organizations would meet this exception.
Also, just because an activity creates UBI and may result in a tax liability does not mean that the organization has to discontinue the activity. It's only when unrelated activities are substantial compared to all of the organization's exempt activities, that those activities could jeopardize an organization's tax-exempt status.
UBI is a complicated topic, but I hope this has provided a framework to begin thinking about how your organization solicits donations. For more details and the reporting requirements, go to IRS.gov and download or order Publication 598, Tax on Unrelated Business Income of Exempt Organizations.
