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THE NUTS & BOLTS OFEXEMPT ORGANIZATIONS

February 19, 2014

Brian Yacker, JD/CPA

Prepared by YH Advisors, The Exempt Org Experts 2

The Exempt Org Universe

Nonprofits

Tax-Exempt Not Exempt

Charitable Noncharitable

Private FoundationsPublic Charities

NonoperatingOperating

Other Exempts

Definitional Publicly Supported Support Org’ns


The Exempt Org Universe (cont’d)

Charitieso §501(c)(3)

• Public charities

Definitional Churches

Schools

Hospitals

Publicly supported Donative

Program service revenue

Supporting organizations

• Private foundations

Manage investment portfolio

Make grants to other charities


The Exempt Org Universe (cont’d)

Other Exemptso (c)(2) – title holding corporations

o (c)(4) – civic leagues, community associations, social welfare organizations• Advocacy work / Political actions / Lobbying / Community associations

• Can undertake substantial lobbying activities unlike a §501(c)(3)

o (c)(5) – labor/agricultural organizations

o (c)(6) – business leagues / chambers of commerce• Promote higher business practices / better business methods

• Promote common business interests

• Private inurement of members prohibited

o (c)(7) – social & recreation clubs• Country clubs

• Unrelated business income rules

o (c)(8) – fraternal societies

o (c)(14) – credit unions

o (c)(19) – veteran’s organizations


Benefits of Tax Exemption

Exemption from Federal Income Taxeso Exemption from most state income taxes

• Possible exemption from state property taxes, state sales/use taxes

Generally, not exempt from sales/use taxes in California

Eligibility to Receive Tax Deductible Contributionso Generally, §501(c)(3) entities

Reduced Postal Service rates

Halo Effect


Overview of Charities

Organizational Issueso Reg. §1.501(c)(3)-1(b)

• Organization is organized exclusively for one or more exempt purposes only if its articles of organization limit the purposes of such organization to one or more exempt purposes and do not expressly empower the organization to engage, otherwise than as an insubstantial part of its activities, in activities which in themselves are not in furtherance of one or more exempt purposes

Operational Issueso Reg. §1.501(c)(3)-1(c)

• Organization will be regarded as “operated exclusively” for one or more exempt purposes onlyif it engages primarily in activities which accomplish one or more of such exempt purposesspecified in Sec. 501(c)(3)

Organization will not be so regarded if more than an insubstantial part of its activities isnot in furtherance of an exempt purpose

o No part of earnings can inure to the benefit of any insider (private inurement)• For example, unreasonable compensation / bargain sales to insiders / below market loans

• Need an insider for private inurement to exist

• No de minimis exception for private inurement


Overview of Charities (cont’d)

Operational Issues (cont’d)o Only incidental private benefit (non-insiders derive improper benefits)

• Cannot more than incidentally benefit private (non-insider) interests

Examples in Reg. §1.501(c)(3)-1(d)(1)(iii) Organization whose purpose of which is to study history and immigration and whose educational

activities include sponsoring lectures and publishing a journal; focus of the organization’s historicalstudies is the genealogy of one family (NOT EXEMPT)

Art museum’s principal activity is exhibiting art created by a group of unknown but promising local artists, all of the art exhibited is offered for sale at prices set by the artist; when art is sold, the museum retains 10 percent of the selling price to cover the costs of operating the museum and gives the artist 90 percent (NOT EXEMPT)

Example – booster clubs If booster club confers benefit (crediting amounts raised against dues requirements) on participant

in return for their fundraising activities, the booster club is providing a private benefit

See PLR 201130012 – tax-exempt status of volunteer fundraising booster group is revoked wherethe group ran a concession stand that raised money for their children’s educational andextracurricular activity expenses

• Private benefit generally arises is contractual and joint venture settings

• Private benefit only incidental if considered incidental in both qualitative & quantitative sense

Qualitative – benefit must be a necessary circumstance of the activity that benefits thegeneral public

Quantitative – private benefit must not be substantial after considering the overall publicbenefit of the activity


Overview of Charities (cont’d)

Operational Issues (cont’d)o No participation in political campaigns

• Limited lobbying activities

o No substantial conducting of unrelated business activities• No “bright line” definition of what is “substantial”

Rule of thumb stay under 30%

o Suspension of tax-exemption for organization (Tamil Foundation) designated as supporting terrorism


Exempt Purposes

Charitable / Educational / Religious / Scientific / Literary / Fostering Sportso Examples

• PLR 200736037 - IRS revoked tax-exempt status

Co-founded by father and son (only two members of the organization’s Board)

Provided frozen, donated sperm to women, however, 88% of the sperm was donated by the son (and the organization’s web site only contained a bio of the son, not any of the other donors)

Did not serve exempt purposes since its standards utilized for evaluating applicants or selecting recipients served the purposes of private interests since the son had full veto power over who received his sperm

• PLR 200914064 - IRS denied exempt status to an organization which raises money to pay for equipment and activities for children attending a private school

IRS concluded that the activities and earnings benefit the school and the parents of the children rather than serving exempt purposes

• PLR 201002041 - IRS denies tax-exempt status to organization that provides spiritual counseling to individuals and receives most of its funding from sale of books written by founder and from the founder’s speaking engagements

IRS believes organization is operated primarily for the founder’s benefit

• PLR 201050033 - IRS denied tax-exempt status for organization formed to train gymnasts

Not provide free gymnastics instructions to the community

Not offer financial assistance to the less advantaged


Exempt Purposes (cont’d)

Charitable / Educational / Religious / Scientific / Literary / Fostering Sports (cont’d)o Examples (cont’d)

• PLR 201115026 - IRS denies tax-exemption to organization formed to provide low-cost heating and cooling service and repair to low-income individuals

Key determinative here is that the founders of the exempt organization owned a taxable heating and cooling business which would undertake transactions with the exempt organization

• PLR 201105048 - IRS denied tax-exempt status to an organization that sought exemption as a business league because they concluded that the organization’s activities and purposes were primarily directed at the improvement of its members’ businesses

• PLR 201150034 - IRS denied tax-exempt status under §501(c)(3) to an organization that runs a coffeehouse because operation of a coffeehouse is consistent with running a trade or business and the organization failed to establish that its activities further a tax-exempt purpose

Exemption denied notwithstanding the fact that the coffeehouse would have donated resources to local charities and exempt organizations

Operations competed directly with taxable enterprises through product pricing, compensated staff, commercial advertising

• PLR 201205011 - organization which was formed to provide aid to three special needs children from the same family was denied tax-exemption by the Internal Revenue Service

Probably would have been different result if had been organized to support special needs children from the broader community

• PLR 201215019 - IRS denied exempt status under §501(c)(4) to an organization formed to provide fertility medication to individuals because the organization’s activities were the same as the activities of a commercial pharmacy


Formation

Start-Up Procedureso Draft and file Articles of Incorporation

• Expressly limit purposes of the tax-exempt organization to §501(c)(3) purposes

• Permanently dedicate assets to charity upon dissolution

o File Form SS-4 to obtain Employer Identification Number• Obtain electronically

Takes about 10-15 minutes

o Open bank account

o Draft Bylaws• Purposes and mission of the organization

• How Directors elected and selected

• How Board may take action and quorum rules

• How Board meetings to be conducted

• Duties and responsibilities of Officers

• Authorization of Board committees

• Reports due to Directors

• Managing of conflicts of interest


Formation (cont’d)

Start-Up Procedures (cont’d)o Prepare and file Tax Exemption Application

• Must prepare and file to be recognized as tax-exempt entity

• Religious entities do not need to file

• Presumption that entity is a private foundation

• Timeline

IRS receives about 100,000 Tax Exemption Applications each year

Retroactivity filing deadline 15 months from the end of the month in which the organization is formed (Reg. §1.508-1(a)(2))

Automatic 12-month extension under Reg. §301.9100-2(a)(2)(iv)

Thus, essentially have 27 months to file the Tax Exemption Application

Good cause exception if miss deadline Filed Form 1023 with the Internal Revenue Service before they discovered failure to file

Failed to file within 27 months because of intervening events beyond control

Exercised due diligence but were not aware of the filing requirements

Reasonably relied upon written advice from the IRS

Reasonably relied upon the advice of a qualified tax professional



Start-Up Procedures (cont’d)o Prepare and file Tax Exemption Application (cont’d)

• IRS review time

Average wait time is approximately 4-6 months

Red / Yellow / Green piles Additional questions

o Receive IRS Determination Letter

o Obtain state tax exemption

o Register with state Attorney General

Other Options than Creating Exempt Organizationo Creation of a donor advised fund

o Contribution to community foundation

o Partnering with existing exempt organization

o Fiscal sponsorship

o Starting a chapter of an established national exempt organization



Organizational Legal Checklisto Ensure that have most updated copies of following documents

• Articles of Incorporation

• By-Laws

• Determination Letter (federal and state)

• Tax Exemption Application (federal and state)

• Form 990 for past 3 years (Form 990-T if applicable)

o Ensure that filing required Statement of Information reports with the Secretary of State

o Check IRS Master File to ensure correctly reporting information on Form 990

o Ensure that contemporaneously documenting all Board and Board Committee meetings

o Current listing of all insiders of the organization for past 5 years• Board members / Officers / Key employees

o Whether retaining necessary financial records for at least 7 years

o Whether preparing charitable contribution acknowledgements when necessary

o Whether registering to solicit in other states other than home state

o Whether implemented conflict of interest policy

o Whether prepared reasonable compensation binder


Public Disclosure

Public Documentso Articles of Incorporation

o Bylaws

o Tax Exemption Application

o Determination Letter

o Form 990 for the past three years• Automatically posted on GuideStar (www.guidestar.org)

o Form 990-T for the past three years (if applicable)• Not yet posted on GuideStar (www.guidestar.org)


Public Disclosure (cont’d)

Other Public Disclosure Considerationso Penalties

• $20 per day / $10,000 maximum

• Individual can be penalized up to $5,000

• File Form 13909 with IRS to lodge complaint

o Form 4506-A• File to request copy of public documents

Form 990

Form 990-T

Form 1023

Determination Letter

• IRS usually responds within 60 days

• Anyone can file the Form 4506-A with the Internal Revenue Service

Generally, free, as long as not utilizing for commercial purposes


Annual Reporting

Form 990o Purposes of Form 990

• Provide transparency into the operations of the exempt organization

• Primary source of information for “users” of Form 990

Members of general public

Internal Revenue Service / State authorities (e.g. Attorney General)

Potential donors

Researchers

Newspapers and other media

Competitors

Those not agree with your exempt purpose activities

Charity rating organizations / GuideStar

Anyone else

• Ensure adequate collection of information for the various types and sizes of exempt organizations

Facilitate comparisons between similar types of exempt organizations

• Primary compliance tool for tax-exempt organizations

Key transparency document


Annual Reporting (cont’d)

Form 990 (cont’d)o Guiding principles of the Form 990

• Enhancing transparency

Many members of the general public rely upon the Form 990 as their primary or sole source ofinformation regarding a tax-exempt organization How the public perceives a tax-exempt organization could be largely controlled by the information

presented on the Form 990

• Promote compliance

Very detailed reporting requirements

Elimination of unstructured attachments

Allow IRS to efficiently assess risks of noncompliance

• Minimize filing burdens for exempt organizations and reduce recordkeeping

Asking Form 990 questions in manner that makes it relatively easy to complete the form Not impose unwarranted additional recordkeeping or information gathering burdens

IRS woefully failed here



Form 990 (cont’d)o General overview

• History

First Form 990 was applicable for the 1941 tax year

Generally the same Form 990 from 1979 through 2007 Massive redesign of the Form 990 first effective for the 2008 tax year

o No requirement to file Form 990• Annual gross receipts normally less than $50,000

• Particular types of organizations

Foreign charities

Churches Including integrated auxiliaries and church-affiliated organizations

Governmental entities (Sec. 115 of the Internal Revenue Code) For example, public universities

o Time preparation considerations• Not an ordinary tax return

Significant and complex because is information return subject to public disclosure

Form creates much “new” law and tries to motivate certain behaviors

• IRS perspective

Over 158 hours just for core form



Form 990 (cont’d)o Filing deadlines

• Initially due the 15th day of the 5th month after the close of the organization’s tax year

Extensions First – automatic 3 months

Second – additional 3 months with reasonable cause

o Failure to file penalties• $20 per day (small exempt organizations)

Maximum of lesser of $10,000 or 5% of the gross receipts of the exempt organization

• $100 per day (gross receipts exceed $1 million)

Maximum of $50,000

• IRS currently investigating increasing these penalty amounts

• Organization’s manager could also be liable for penalties

o Filing incomplete return is deemed to be as if never filed• Rev. Rul. 77-162 – organization which omits material information from its Form 990 and does not

establish reasonable cause for the omission has failed to file a return

Statute of limitations does not start in such a situation

Reasonable cause = reliance upon a knowledgeable professional if organization furnishesprofessional with all the necessary information



Form 990 (cont’d)o “Helpful” hints from the Internal Revenue Service

• IRS Checklist (IRS Publication 4740)

Review the Form 990 and Instructions before preparing

Identify the Schedules that need to be completed

Discuss with key internal stakeholders, including finance, program leaders, fundraisers, public/government relations, and human resources

Involve the board and management team, and make them aware of the new reporting rules

Discuss with key external stakeholders, including grant makers or fundraisers, accountants, and lawyers

Assign an internal leader to coordinate Form 990 preparation

Identify related organizations and those persons required to be listed in the compensation tables

Be prepared to answer precise questions about governance and compliance with federal tax rules

Determine overseas and joint venture activities

Establish or modify internal systems, if necessary, to prepare for filing season



Form 990-No General

• Small tax-exempt organizations must file electronically on an annual basis

Technically, no extension permitted

No paper filing permitted

o Required information• Employer Identification Number

• Tax year

• Legal name / Mailing address

• Any other names the organization utilizes

• Name and address of a Principal Officer

• Web site address if the organization has one

• Confirmation that the organizations gross receipts normally less than $50,000

• If applicable, statement that the organization has terminated or is terminating

o Failure to file• Automatically have tax-exemption revoked if not file Form 990-N with the Internal Revenue

Service for three consecutive years

Must reapply for tax-exemption with the Internal Revenue Service if have exemptionautomatically revoked

• Auto-Revocation List


Important EO Concepts

Governanceo Board of Directors

• Majority independent Board of Directors

• Contemporaneous documentation of all Board meetings

Including Board Committee meetings

o Policies• Conflict of interest policy

• Whistleblower policy

• Document retention and destruction policy

• Gift acceptance policy

o Procedures• Form 990

Board review of the Form 990 before filing Board Committee review permissible

Forwarding of “final” copy of Form 990 to all Board of Directors members before filing

• Reasonable compensation documentation

• Make required documents available for public disclosure


Important EO Concepts (cont’d)

Transactions with Insiderso Definition of insiders

• Voting Board members

• Top management official / Top financial official

• Key employees

• Anyone related to an insider

• Former insiders of the organization

o Recommendations• Implement conflict of interest policy

Annually monitor compliance with conflict of interest policy

• Contemporaneously document why transacting with the insider

Special skills

Discounted cost

Familiarity with the organization

• Review and approval of all insider transactions by disinterested Board members



Reasonable Compensationo Must reasonably compensate insiders of the exempt organization

o How best ensure payment of reasonable compensation• Board approval of the insider compensation arrangement

• Board reliance upon salary surveys and comparability analysis when determining whether to approveinsider compensation arrangement or not

• Contemporaneous documentation of the entire process

o Penalties for unreasonably compensating an insider• Insider penalized

• Board members who approved the unreasonable compensation penalized

• Organization could lose its tax-exemption

o Recommendations• Conduct Reasonable Compensation Study

• Implement expense reimbursement policies



Unrelated Business Incomeo Definition

• Trade or business

• Regularly carried on

• Not substantially related to the furthering of the exempt purposes of the entity

o Taxation• Organization pays tax at the normal corporate rates if generating unrelated business income

o Substantiality• Organization could lose its tax-exemption if its unrelated business activities are too “substantial”

Conducting of Special Eventso Calculating the charitable portion of special events revenue

• Complexity of accounting for auctions

o Ensuring that legally permitted to conduct gaming events in particular state where operating

o State charitable solicitation registrations



Political Activities o Limited amount of lobbying permitted for charitable entities

o No political activities permitted for charitable entities• Other exempts may be permitted to conduct political activities

For example, §501(c)(5) labor unions



State Charitable Solicitation Registrationo Charities must generally register in states where they are soliciting contributions

• Most states have very broad definitions of “solicitation”

o Initial registration• Certain types of entities exempt from registration

• Must provide significant amount of information for initial registration

Articles of Incorporation

Bylaws

Determination Letter

Most recent Form 990

Audited financial statements

o Annual renewals• Some states have significant fees for renewal registrations


Resources

Federal Resourceso IRS web site

• Charities link

Life Cycle of a Public Charity

EO Select Check

EO Newsletter

• www.stayexempt.irs.gov

New modules (e.g. political)

Online case studies

o IRS training materials• Governance

o IRS Publications• 526 – charitable contributions

• 557 – tax-exempt status

• 598 – unrelated business income

• 1771 – substantiation of charitable contributions

• 1828 – church tax guide

• 3079 – gaming

• 4221 – compliance guide

• 4779 – terminations / mergers of tax-exempt organizations


For More Information…

Please contact:

YH Advisors, Inc.One Pacific Plaza

7755 Center Avenue, #1225Huntington Beach, CA 92647

Brian Yacker, Partner Lauren Haverlock, Partner310-982-2803 (direct) 310-982-2804 (direct)310-266-7196 (cell) 949-636-4418 (cell)

[email protected] [email protected]

Stacey Bergman, Principal310-982-2805 (direct)562-965-2554 (cell)

[email protected]

We Opened a 501c3

Louis Peltier Volunteer, Mercy Hospitals of Bakersfield Bakersfield, California

ATTORNEY

(Get to know his executive assistant)

ARTICLES OF INCORPORATION

MIRROR

BY LAWS

Name of organization in bylaws same as

Corporation name

MERCY AUXILIARY By-Laws

MERCY AUXILIARY INC. Articles of Incorporation

• Single purpose organization to serve the hospital.

• Members pay dues or not.

• Officers elected by members or by previous board.

• Set your fiscal or calendar year.

• Dissolution section.

• Get permission from your executive board to use their personal information.

• Determine what address to use for your corporation.

OTHER DOCUMENTS

YOU WILL NEED • Fictitious name statement

(for checking account) • Business license • Resale license

(sales tax)

POLICIES YOU MIGHT WANT TO CONSIDER

• Memorandum of Understanding • Conflict of Interest • Liability Insurance for board members • Rent hospital space ($1 year lease) • Set a policy for obtaining Auditor/Tax

Preparer