Starting a Social Club (aka a 501(c)7)

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

Filing Form 1023

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:

1. Form 1023, all relevant parts filled out completely (the form itself is 28 pages)

2. Copy of the certificate of incorporation

3. 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).

4. Copy of your bylaws, and any amendments in chronological order

5. List of your founding officers and directors, and their addresses

6. List of your five highest compensated employees and their compensation

7. 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

8. A narrative description of your activities

9. A list of all of the organization’s assets and liabilities

10. 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.

How to become a 501(c)(3) nonprofit organization

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.

The Do's and Do Not's of Fundraising

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.

Board of Directors

Congratulations! You’ve been recruited and elected to serve on a board of directors for your favorite nonprofit organization!

Now what?

Being a board member is an important and enjoyable way to give back to a community or organization that matters to you. The board of directors is tasked with ensuring that the organization carries out its exempt purpose. But what does that mean exactly?

You have three primary legal and fiduciary duties:

1. The duty of care means that you must take care of the assets of the organization, whether monetary, staffing, volunteers, facility, or goodwill. Be a good steward of the organization’s funds.

2. The duty of loyalty requires you to put the organization and its mission first. This includes recognizing and disclosing conflicts of interest, and making decisions that are in the best interest of the organization and not in the best interest of an individual board member or for-profit entity. It’s your job to make sure that the organization is working to fulfill its stated mission.

3. The duty of obedience covers your role in making sure that the organization follows all applicable laws and regulations, and its own bylaws.

What does this look like in practice?

As a board member, you are responsible for advancing the mission of the organization. I recommend reviewing your mission statement regularly, such as at every board meeting, so as to keep that mission at the forefront of your discussions. It is also important to track what other similar organizations are doing, whether in your area or across the country. If your organization is membership-based, it is helpful to keep communication open with your members. In a membership organization, you also “represent” the members.

If your organization has an executive director, the board of directors is responsible for hiring, setting compensation, and supervising this person. This is a key relationship, as the executive director typically manages the other staff and volunteers (directly or indirectly), fund raises with donors, and is often the “face” of the organization.

The board of directors is responsible for setting the budget for the year and overseeing that income and expenses stay on track. It is helpful to learn how to read and interpret financial statements, including profit/loss statements and balance sheets. Similarly, you are responsible to make sure the minutes and agendas are accurate, as this is the best legal protection should a potential issue arise. This is also a great time to brush up on Robert’s Rules of Order.

You are a walking advertisement for your organization. Spreading the word about your organization helps it grow, and part of the duty of care is to make sure your organization is growing. For most board members, this means sharing the mission with people you meet. For some, in can include public relations and talking with the media.

Board members should be involved in the work of the mission. This could be working on a committee, taking a lead role in a fundraising activity, or volunteering in another capacity. It’s hard to know if the organization is advancing its mission by reading a report. The more you are able to be a part of the work, the better you will be able to make decisions in the best interest of the organization.

Board members are fundraisers. This means both that you are contributing financially to the organization, and that you are helping to solicit donations too — whether by helping to put together a fundraising event or by asking the people in your network to contribute.

Lastly, board members are always recruiting new board members. It may seem odd to think about finding your own replacement as soon as you are elected, but many board members find that their time goes fast. Continual recruitment allows for greater continuity.

If you are welcoming new members to your board, I strongly recommend having an orientation to review their legal and fiduciary duties, your organization’s mission and bylaws, and their particular role and responsibilities. This should be an annual event, as you welcome new members every year, and separate from any all-board retreats that focus on long-term planning and mission.

If you are interested in setting up a new-members orientation and would like more information, please let me know.

Nonprofit Organizations

When most people think of a nonprofit organization, they think of a 501(c)(3) nonprofit corporation. But did you know that there 28 different kinds of nonprofit entities and many of them are easier to form and operate than a 501(c)(3)? When I first meet with a client who is interested in applying for tax-exempt status, I ask whether their goals might be better served by a different form of nonprofit.

So what is a 501(c)(3)?

The most common type of nonprofit is the “charitable organization.” It qualifies for tax exemption under the IRS tax code, section 501 (c) (3). To qualify, organizations must be operated to fulfill one of these purposes: religion, education, science, literature, public safety testing, amateur sports, and the prevention of cruelty to children or animals This is the category that includes museums, churches, libraries, low-income housing, colleges, food banks, hospitals, and symphonies. While the income received by the organization related to its purpose is tax-exempt, these organizations are also limited (but not totally prohibited) in how and whether they can engage in lobbying activities.

And what is a 501(c)(4)?

This section of the code regulates social welfare organizations, civic leagues, and local employee associations. These tax-exempt organizations are NOT limited from lobbying activities. If you donate money to an exempt organization that engages in lobbying activities, there’s a good chance you are actually donating to two sister organizations — a 501(c)(3) that carries out the mission and a 501(c)(4) that lobbies for the best laws to support that mission.

Both 501(c)(3) and 501(c)(4) organizations are vetted through an lengthy application process, that can take months to complete. In addition, to continue to qualify as tax-exempt, these organizations must submit detailed annual reports of their activities, income and expenses, and publicly identify their key staff and board members.

That still sounds like a lot of work. Are there any easy nonprofit organizations?

There are many nonprofit organizations that are easy to form and maintain, but my favorite is the social club. I have worked with several recreational and hobby clubs who did not need 501(c)(3) status to carry out their charitable purposes. For example, I worked with a model airplane and drone club who was interested in a more formal business structure. They collected membership dues, which helped to pay for a small field that the club owned and maintained. Members were entitled to use the space whenever they liked to fly their airplanes, and the club used the space to host races and '“fly-ins." Another organization that I represented was a recreational bicycle racing team. They collected dues from team members and used that money to enter races and go out after races to celebrate. Both organizations qualified for tax-exemption under 501(c)(7) — Recreational or Social Clubs. While they still need to file annual tax returns for the organization, they are not required to apply for tax-exempt status and do not need to disclose their activities or leadership. Moreover, their annual return is a simple postcard, since neither organization received more than $50,000 in income in a year.

Among the other 25 types of nonprofit organizations are trade or professional associations (like the Chamber of Commerce), fraternal societies (anything that follows the “lodge” model of governance), veterans organizations, and state chartered credit unions.

But our club when through the hassle of getting 501(c)(3) status. Are you saying we didn’t need to do that?

Not necessarily. There are certain benefits to having 501(c)(3) status. First, if you intend to apply for grant money from foundations, it is helpful to have 501(c)(3) status. Many (if not all) foundations require it, as it helps them to guarantee that their funds are being used for exempt purposes. While the IRS doesn’t require foundations to give their money to 501(c)(3) charities, it does require that they only distribute funds to tax-exempt organizations, and the easiest way for a foundation to know that your organization qualifies is for you to have 501(c)(3) status.

Similarly, other businesses may not recognize discounts or other benefits for your organization without 501(c)(3) status. A few years ago, the IRS issued a warning that churches should not allow bands or other musical groups to play in their churches, whether for set ticket prices or for a “free-will donation” to the band. This was because a church, as an exempt organization, may not allow its property to be benefit private individuals or entities, and when the local garage band plays and takes home money from that concert, it isn’t furthering the exempt purpose of the church. However, it is permissible for the church to lease its sanctuary to an organized musical group, like the NW Girlchoir, to perform (even though that concert will have set ticket prices and the choir will earn money from it) because the NW Girlchoir is an exempt organization. The church’s property can be used for the exempt purpose of another exempt organization. So for many music organizations, applying for and receiving tax-exempt status is helpful for booking venues.

If you are interested in possibly starting a nonprofit organization, or if you have questions about an existing nonprofit, let me know. I love working with all kinds of exempt organizations, and would be happy to help you.