An Introduction to Exempt Organizations

Brian T. Whitlock, CPA, JD, LLM

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What do we already Know about Tax Exempt Organizations?

Identify as many different types of Exempt Organizations as you can.

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Characteristics of Exempt Organizations?

Examples of Exempt Organizations?501(c)(3) Employee Benefits Other

Organized Religions and Churches

Pension /Profit Sharing Social Welfare (devoted to exclusively charitable, educational or recreational purposes)

Charitable (aid, food, clothing, disaster relief, social service)

Employee Stock Ownership Plan ESOP

Professional and Trade Associations

Scientific IRAs Social Clubs

Testing for Public Safety Roth IRAs Fraternal /Insuring Clubs

Literary Health Savings Accts Domestic Lodges

Education Educational Savings Accounts

Condominium/Homeowners Assoc.

Youth and Amateur Sports

Voluntary Employee Benefit Associations

Veterans Organizations

Prevention of CrueltyAnimals or children

Rural Utility Cooperatives

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What do we think we know about Exempts?

Are Exempt Organizations exempt from all taxes? Payroll? Earnings on Investments? Unrelated Business Income?

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What do we think we know about Exempts?

When are payments to exempt organizations tax deductible? Section 162 – Deduction for Trade or Business Expenses Section 170 – Deduction for Charitable Contributions Section 404 – Deduction for contributions to qualified plans

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What is the legal basis for granting Exempt status?

Constitution Church exemption stems from Bill of Rights State and Local Government exemption is fundamental

— If requested, the IRS will issue a letter describing the tax status of government entities. No application is required, and no fee is associated with this letter.

Federal Statute Congress exempts certain types of Organizations from regular

income Taxation under the Internal Revenue Code.— IRC Section 401, et. seq. (Subchapter D - Employee Benefit Plans)

— IRC Section 501, et. seq. (Subchapter E – Exempt Organizations)

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Why does the Congress Grant Tax Exempt to Certain Organizations?

Governments generally provide services to the Public Efficiency

— Some services such as Police and Fire are best provided in a highly regulated manner

— Government Bureaucracies are not always the most efficient method for providing social and cultural services

— Some private individuals are highly motivated to provide artistic and cultural services

Cost— The cost of providing the services can be high

— Tax incentives can induce the public to spend dollars at a cost to the Treasury equal to the marginal tax rate (Maximum of 35% currently)

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Common Section 501(c) Organizations

§ 501(c)(1) Corporations Organized Under Act of Congress Includes Nat’l Farm Loan Association and Federal Credit Unions

§ 501(c)(2) Title Holding Corporations for Exempt Orgs Holds Real Estate, collects rents, pays net to parent organization EXAMPLE: Alumni holding company for Fraternity real estate

§ 501(c)(3) Charitable Organizations Contributions deductible under Section 170 No Substantial Lobbying No Private Benefit MOST COMMON RECOGNIZED

§ 501(c)(4) Social Welfare Organizations Contributions not deductible under Section 170 Substantial Lobbying Permitted No Private Benefit EXAMPLE: League of Women Voters

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Common Section 501(c) Organizations

§ 501(c)(5) Horticultural and Agricultural Organizations Dues might be deductible as business expense (§162 or §212) No Private Benefit Lobbying Permitted but taxed EXAMPLE: American Farm Bureau

§ 501(c)(6) Professional and Trade Associations Dues might be deductible as business expense No Private Benefit Lobbying Permitted but taxed at certain levels See Political Action Committees under § 527 EXAMPLES: AICPA, ICPAS, Bar Associations and Medical Associations

NOTE: § 501(c)(3) and § 501(c)(6) are frequently used in combination . Organizations have difficulty differentiating between the activities of (c)(3) and (c)(6).

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Common Section 501(c) Organizations

§ 501(c)(7) Social Clubs Dues not deductible Group benefit but no Private Benefit No Discrimination EXAMPLES: County Clubs, Fraternities & Sororities

§ 501(c)(8) Fraternal Clubs and Insuring Groups EXAMPLE: Fraternal Order of Police

§ 501(c)(9) Voluntary Employee Benefit Associations

§ 501(c)(10) Domestic Lodges EXAMPLE: Lodges without insurance groups – Elk, Moose

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Common Section 501(c) Organizations

§ 501(c)(11) Teachers' Retirement Fund Associations

§ 501(c)(12) Cooperatives and Homeowners Associations 85 percent or more of the organization's income consists of amounts collected

from members for the sole purpose of meeting losses and expenses) EXAMPLE: Mutual or Cooperative Telephone Companies

§ 501(c)(13) Cemetery Companies owned and operated exclusively for the benefit of their members or which are not

operated for profit

§ 501(c)(14) State Chartered Credit Unions

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Common Section 501(c) Organizations

§ 501(c)(15) Small Mutual Insurance Companies or Assoc No Life Insurance Net Premiums less than $350,000

§ 501(c)(16) Cooperative Organizations to Finance Farms

§ 501(c)(17) Supplemental Unemployment Benefits

§ 501(c)(18) Employee Funded Pensions (pre 6/25/59)

§ 501(c)(19) Veterans Organizations Organized in the US or possessions 75% US Military Veterans No Private Benefit Insurance Income is not UBIT

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Common Section 501(c) Organizations

§ 501(c)(20) Group Legal Services

§ 501(c)(21) Black Lung Benefit Trusts Financing aid to coal miners with lung disease

§ 501(c)(22) Withdrawal Liability Payment Funds

§ 501(c)(25) Title Holding Co with Multiple Parents

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Exempt Orgs for Pooling of Services

§ 501(c)(26) State-Sponsored High-Risk Health Coverage Organizations

§ 501(c)(27) State-Sponsored Worker's Compensation Reinsurance Organizations

§ 501(d) Religious and Apostolic Associations

§ 501(e) Cooperative Hospital Service Organizations

§ 501(f) Cooperative Service Organizations of Operating Educational Organizations

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Other Exempt Organizations

§ 501(k) Child Care Organizations

§ 509 Private Foundations

§ 521 Farmers' Cooperative Associations  

§ 527 Political Organizations

§ 528 Homeowners Associations

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What qualifies as a “Charitable” Organization?

A Client calls – one of his neighbor’s died leaving 4 young children and little life insurance. They are opening an account at the bank to accept donations for the benefit of the family. He wants you to get a tax id number for the account.

What kind of an account will this be? Will the receipts be taxed? Will the contributions be tax deductible? What else could you advise the client to do?

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Client decides they want their own Organization

We have three (four) choices for entities:

Corporation

LLC (or LC3)

Trust

Association

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Non-Profit vs. Tax Exempt

The term “Nonprofit Organization” is a State Law designation. It means that an organization was created under a state statute but the term does not grant exemption.

Not all Nonprofit Profit Organizations are Federally Tax Exempt. Although most exempt organizations were created as non-profit organizations, organizing as a non-profit organization at the state level does not automatically grant the organization exemption from federal income tax. 

In order to qualify as exempt from federal income taxes, an organization must meet requirements set forth in the Internal Revenue Code.

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Requirements of the “Infernal” Revenue Code

Federal Income Tax exemption is provided under Section 501(c)(3) of the Internal Revenue Code where …

“organized” and “operated” exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competitions…, or for the prevention of cruelty to children or animals…

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State Law Requirements

Charitable Solicitation Acts Many states have laws regulating the solicitation of funds for charitable

purposes. These statutes generally require organizations to register with a state agency before soliciting the state's residents for contributions, providing exemptions from registration for certain categories of organizations.

Organizations may be required to file periodic financial reports with Audited Financial Statements.

Regulation of Professional Fundraisers State laws may impose additional requirements on fundraising activity

involving paid solicitors and fundraising counsel.

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Organizational Compliance

The federal tax treatment is not uniform across all Section 501 organizations. Permitted differences exist –

Lobbying Deductibility of Contributions Private Benefit vs. Group Benefit

— Certification and Licensing

“Organizational” Structure will influence by the activities that the organization intends to “operationally” conduct.

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Permitted Activities

Activity 501(c)(3) 501(c)(6) PAC

Member Services Yes Yes N/A

Research Yes Yes N/A

Education Yes Yes N/A

Certification No Yes N/A

Advocacy – Legislative Limited Yes Limited

Advocacy - Candidate No Limited, taxed at 35%

Yes, only interest income is taxed

Advocacy – Public(not related to legislation or election of candidates)

YES YES Limited

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Many Associations operate as multiple entities

Segregate and Compartmentalize permitted activities The IRS is authorized to Grant exempt status to organizations that are

“organized” within guidelines Section 501(c)(3) of the Internal Revenue Code – Charitable activities,

Educational activities, and Scholarships— Contributions deductible as charitable contributions

Section 501(c)(6) of the Internal Revenue Code – Membership and Certification activites

— Member dues deductible as business expense

Section 527 – Political Action Committees— Contributions not deductible

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Many Associations operate as multiple entities

Each Activity Should be Organized as a Separate Legal Entity Each entity can request a Letter of Determination

501(c)(3); or 501(c)(6)

Multiple 501(c)(3) can exist within the same framework Different Missions (Continuing Professional Education vs Scholarships) Different Donor Base (CPA Endowment Fund vs CPAs for Public Interest)

PAC’s do not require formal IRS approval Should file IRS Form 8871/8872 Should register with Federal Election Commission Should compile with any State requirements

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Many Associations operate as multiple entities

Each separate entities must comply with Statute The “Association”

—Main member services organization—Organized and operated as a Section 501(c)(6)—Files IRS Form 990

The “Foundation”—Educational or Charitable arm—Organized and operated as a Section 501(c)(3)—Files IRS Form 990

The Political Action Committee (PAC)—Operated under IRC Section 527—Files IRS Form1120 POL—Files with Federal Election Commission

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Operational Compliance

The IRS measures compliance and tests whether an organization is “operating” within its exemption via:

IRS Form 990 IRS Form 990-EZ IRS Form 990-N

These are information gathering forms Not a Tax form It’s a Compliance form

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What Kind of Form Should I file?

Many Organizations do more than required

File ONLY the Form that is Appropriate Small Organizations

— Under $50,000 of Gross Receipts— E-Post Card

Form 990-EZ— Over $50,000 of Gross Receipts— Under $200,000 of Gross Receipts— Under $500,000 of Assets

Gross Receipts INCLUDE Proceeds from the sale of assets (i.e., securities) Gross Special Event Revenues (prior to deducting expenses) Gross Sales of Inventory (prior to deducting COGS)

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IRS Form 990 Senate Finance Committee Hearings on ENRON reveal

Lack of Corporate Governance Deferred Compensation Abuses Charitable Abuses

Leads to Senate Finance Committee Hearings on Charity Lack of Corporate Governance Compensation and Fringe Benefit Abuses

—Smithsonian, United Way, Goodwill

IRS lacks information to respond to Congress

Leads to Redesigned Form 990 11-page core form, completed by each 990 filer 16 supplemental schedules, completed if conducted particular

activities (70+ potential pages of form)

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IRS Form 990

Focus of New Form 990 Transparency

—Financial—Organizational

Corporate Governance – “a well-governed organization is a compliant organization”

—Emphasis on creation and monitoring of board “policies” —Emphasis on compensation and fringe benefits

Remember these forms are public documents Anyone can access easily via www.guidestar.org Most Other readers majored in Journalism not Finance

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IRS Form 990

Form Description

Form 990 Core Return of Organization Exempt from Income Tax

Schedule A Public Charity Status and Public Support

Schedule B Schedule of Contributors

Schedule C Political Campaign and Lobbying Activities

Schedule D Supplemental Financial Statements

Schedule E Schools

Schedule F Activities Outside the United States

Schedule G Gaming or Fundraising

Schedule H Medical or Hospital Care

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IRS Form 990

Form DescriptionSchedule I Grants and Assistance to Organizations,

Governments and Individuals in the U.S.Schedule J Compensation InformationSchedule K Tax Exempt BondsSchedule L Transactions with Interested PersonsSchedule M Noncash ContributionsSchedule N Liquidation, Termination, Dissolution or

Significant Disposition of AssetsSchedule O Supplemental Information to Form 990Schedule R Related Organizations and Unrelated

Partnerships

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Top Compliance Issues

Public Support Test Private Inurement

Excess Compensation Related Party transactions (Rents, Loans, etc.)

Substantiation of Charitable Contributions Lobbying Unrelated Business Income Tax (UBIT)

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The Public Support Test

This Test is used to determine whether a charitable organization under Section 501(c)(3) is taxed as a

public charity or a private foundation

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Public Support Test

In order to be a Public Charity and not a Private Foundation an organization must prove they are publicly support under one of the following tests:

The One-Third Public Support Test

The Ten Percent Facts and Circumstances Test

The combined test of support, investment, and unrelated income

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Section 170 Deduction Limit for Public Charity

Type of Property Contributed

Amount Deductible

Percentage of AGI Limitation

Cash Cost 50%

Ordinary Income Property Cost 50%

STCG Property Cost 50%

LTCG Property Fair Market Value 30%

LTCG Property, with election to use cost

Cost 50%

Tangible Property, unrelated use Cost 50%

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Section 170 Deduction Limit for Private Foundation

Type of Property Contributed

Amount Deductible

Percentage of AGI Limitation

Cash Cost 30%

Ordinary Income Property Cost 30%

STCG Property Cost 30%

LTCG Property Cost 20%

LTCG Property (qualified appreciated stock – i.e., marketable securities)

Fair Market Value 20%

Tangible Property, unrelated use Cost 20%

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Private Inurement

If private inurement exists an organization will be subject to Intermediate Sanctions

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Private Inurement or Private Benefit

No part of the net earnings of an organization may inure to the benefit of any private shareholder or individual. A private shareholder or individual is a person having a personal and private interest in the activities of the organization.

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Intermediate Sanctions

Excess Benefit Transactions IRC Section 4958 imposes an excise tax on excess benefit transactions between

a disqualified person and an applicable tax-exempt organization.

The excise tax can be assessed against multiple parties: The disqualified person who benefits from the transaction. An organization manager who allowed it to occur.

A person may be liable for both excise taxes in appropriate circumstances.

These taxes are reported on Form 4720, Return of Certain Excise Taxes on Charities and Other Persons Under Chapters 41 and 42 of the Internal Revenue C

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Substantiation of Charitable Contributions

Both Donors and Donees need to consistently report contributions

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Substantiation of Charitable Contributions

Contributions to eligible organizations are deductible under Section 170 as Charitable Contributions.

A donor claiming a deduction of $250 or more is also required to obtain and keep a contemporaneous written acknowledgment for a charitable contribution

An organization must provide a written disclosure statement to donors of a quid pro quo contribution.

A quid pro quo contribution is any payment over $75 that is partly a contribution and partly for goods or services provided to the donor by the charity.

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Substantiation of Charitable Contributions

Where personal property is donated for a related use, the donor may deduct the fair market value of the item.

Household items and clothing contributed to charity after August 17, 2006 must be in at least good used condition to be deductible. 

Automobiles, jewelry, and boats have been particularly troublesome because the cost of the item regularly exceeds its market value at the time of gift.

— New limitation in 2007 for automobiles - $500 or the sales proceeds, if more

Contributions over $5,000 require a qualified appraiser. If the contribution of tangible personal property and it is sold by the organization

within 3 years of receipt. The organization must report the sales proceeds to the IRS and the donor.

Where personal property is donated for an unrelated use (i.e., auction), the donor's charitable deduction is limited to the donor's tax basis in the contributed property and does not permit the donor to claim a fair market value charitable deduction for the contribution. 

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Lobbying Activities

Depending on the type of organization lobbying activities may be engaged in, subject to tax

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Lobbying and Political Activities

Commonly referred to as lobbying, however each is different and subject to two different sets of rules. The rules depend on several issues:

The type of tax-exempt organization The type of activity (political or lobbying) at issue The scope or amount of the activity conducted, and The consequences of exceeding the given set of limitations

 

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Section 501(c)(3) - Strictly Prohibited Activities

Section 501(c)(3) organizations are absolutely prohibited from directly or indirectly participating in, or intervening in, any political campaign on behalf of (or in opposition to) any candidate for elective public office.

Contributions to political campaign funds or public statements of position (verbal or written) made on behalf of the organization in favor of or in opposition to any candidate for public office clearly violate the prohibition against political campaign activity. 

Violating this prohibition may result in denial or revocation of tax-exempt status and the imposition of certain excise taxes. 

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Section 501(c)(3) - Permitted Activities

Grass Roots Activities

Activities intended to encourage people to participate in the electoral process, such as voter registration and get-out-the-vote drives, would not be prohibited political campaign activity if conducted in a non-partisan manner.

However activities with evidence of bias are prohibited: (a) would favor one candidate over another; (b) oppose a candidate in some manner; or (c) have the effect of favoring a candidate or group of candidates, will

constitute prohibited participation or intervention.

 

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Non-Section 501(c)(3) Organizations and Politics

Section 501(c)(5)&(6) organizations are permitted to engage in lobbying activities.

Limitations are imposed on Section 501(c)(5)&(6) organizations because their members are allowed deduct their membership dues under IRC Section 162.

In order to avoid problems the organization can either: Pay an excise tax on the Lobbying expenditures over a certain level; Report they can report to their members the amount of the dues that went towards

lobbying activities (so that the members do not deduct). NOTE: Some organization avoid the reporting by establishing a separate Political

Action Committee (PAC). 

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Understanding the Unrelated Business Income Tax

How an organization describes itself publically will generally determine what is “Related” v. “Unrelated”

Form 990 Mission Statement Website

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The Unrelated Business Income Tax (UBIT)

Exempt Organizations are subject to tax if they engage in activities outside of the exempt purpose

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Substantially Related

Providing Exempt Function Goods and Services Sale of Research materials, guides

Advocacy

Continuing education (including Travel)

Member Services not Otherwise Available

Lack of Profit Motive – Member Service

Trade Show – Exhibitors fees and Sponsors

Motive - Cash to Support other activities - insufficient

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Substantially Related

THE TEST FOR SUBSTANTIALLY RELATED: Whether the business contributes importantly to accomplishing the purpose for which tax exemption was granted to the organization.

[Treas. Reg. Sec. 1.513‑1(d)(1) and 1.513‑1(d)(2)].

Is part related to performance of exempt function

Are the activities larger in scale than reasonable necessary to perform the function

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Who is Subject to UBIT?

All Exempt Organizations and Exempt Plans (EO/EP) are potentially subject to the tax

Section 501(a) organizations State and municipal Colleges and Universities Section 401(a) plans (i.e., pension, profit-sharing, 401(k) Plans,

ESOPS, etc.) Sections 408 and 408A (i.e., IRAs and ROTH IRAs) Sections 529 and 530 college savings plans Section 220(d) Medical Savings Accounts

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When is Income Subject to Tax?

The TEST for Unrelated Trade or Business Income:

Activity is a “Trade or Business” The Trade or Business is not be “Substantially Related” to

the organization’s exempt purpose The Trade or Business is “Carried on Regularly” The Income is not specifically “excluded” from tax or under

Section 512, 513 or 514 (See Exclusion Codes IRS Form 990)

NOTE: The Test looks at the “Source” of the Gross Income not the “destination” of the Net income.

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Statutory Exceptions Modifications and Exclusions

General Exceptions

(1)Activity is “Not Regularly Carried On” (e.g., annual dinner dance)

(2)85% Volunteer Labor (e.g., Hospital Flower/Gift Shop)

(3)Activity is for the Convenience of the organizations members, students, patients, visitors, officers, or employees (e.g., Parking, food service)

(5) 85% Donated Merchandise (e.g., Thrift Shop)

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Statutory Exceptions Modifications and Exclusions

Specific Exceptions

(6) Trade Show

(9) Bingo• Must not violate state law

• Exception not available for Homeowners Association or Employee Benefits Associations

(12) Low Cost Articles• Return address labels

• Coffee cups

(13) Rental of Membership and Donor Lists – Only available for rentals between (c)(3) Organizations of

Veterans Organizations

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Statutory Exceptions Modifications and Exclusions

Modifications and Exclusions

(14) Dividends, Interest or income from ordinary and routine investments

(15) Royalty Income• Payments for Trademarks, Copyrights or Logos

• Affinity relationships

Bureau can not provide services (e.g., stuffing mailers, follow-up calls)

(16) Real Property Rental Income

(18) Proceeds from the Sale of Investments

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Exclusion for Debt Financed Property

(30) If at least 85% of the use of the property is for the organization’s exempt purposes, then the income generated on the remaining 15% non-exempt use is excluded from UBIT.

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Trade or Business Exclusions

(41) If a “Trade or Business” was consistently losing money, the losses might not be available to offset actual UBIT income.• Profit Motive Test• Similar to Hobby Loss Rules

(42) Qualified Sponsorship Payments• Allowed

• Sponsor may display Corporate Name, Logo, or product lines without qualitative endorsement

• Disallowed• No qualitative endorsement or comparative description• No arrangement or expectation that Sponsor will receive a

substantial return benefit• Benefits will be disregarded if value is 2% or less than the

amount of payment

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Questions and Comments

Brian T. Whitlock JD, CPA, LLMBlackman Kallick, LLP

10 S. Riverside Plaza, Chicago, IL 60606

Direct Phone: (312) 980-2941

Website: www.blackmankallick.com

Email: bwhitlock@blackmankallick.com

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