Legal column: Tax-exempt, not law-exempt
By Teresa J. Rhyne
– Are you considering joining the board of directors of a charitable organization? Maybe you’re considering forming one?
I have served on the board of directors for several charities. I have also done pro-bono work for some and been asked to do pro-bono work for other charities. I’ve helped form several tax-exempt entities, and I’ve talked with well-meaning people who wanted to form a tax-exempt charity, but ultimately chose not to.
I am always struck by how many laws and government entities control non-profits, and how often people misunderstand “tax-exempt” as “law-exempt.” To the contrary, because charitable organizations are stewards of public money (that is, money donated by the public to support certain activities) charitable organizations are subject to more regulations and reporting requirements than the average business.
Tax-exempt charities, also knowns as 501(c)(3)s after the Internal Revenue Code that defines them, are regulated by several state agencies and the IRS.
Forming a charity
A charitable organization can be an unincorporated association or even a trust, but most commonly charities in California are formed as non-profit public benefit corporations. To be a public benefit corporation the organization must be formed for public or charitable purposes and may not be organized for the private gain of any person. (Note the term “non-profit” means the organization’s purpose is not to make a profit for individuals, it does not mean the organization loses money every year!)
A Public Benefit Corporation is formed by filing articles of incorporation with the California Secretary of State. The person signing the Articles of Incorporation, and therefore creating the entity, is the “Incorporator.” Once the articles have been filed, the Incorporator elects a board of directors and officers, and adopts bylaws. Bylaws are the “operating manual” for the corporation.
Other state filings
Forming the corporation is only part of the work to be done. The corporation must also file a Statement of Information (Form S1-100) with the Secretary of State reporting the names and addresses of the board of directors and an agent for service of process. This form must be filed within 90 days of formation and every two years thereafter.
The corporation must also register with the Attorney General’s Registry of Charitable Trusts within thirty days of receiving assets (e.g. the first donation). This is done on a form CT-1 and must include a copy of the articles of incorporation, the bylaws, and of course, a fee. This registration is then renewed annually using the Attorney General Form RRF-1 (the “Registration Renewal Free Report”).
If a tax-exempt entity owns real property, it may need to apply with the county assessor and the State Board of Equalization for a “welfare exemption” from property taxes.
Although the corporation’s goal is to be tax-exempt, the corporation will still need a tax identification number. This is obtained by filing a Form SS-4 online with the IRS which will then assign the corporation a number.
Once the corporation is formed and the tax ID number is obtained, the organization is a “non-profit public benefit corporation” but that doesn’t mean it’s tax-exempt or can receive tax-deductible donations. To do that, the organization must apply for tax-exempt status with the IRS and any state in which it plans to do business.
IRS tax exemption is applied for using Form 1023, or Form 1023-EZ if the organization expects its gross receipts to be $50,000 or less annually. California tax exemption is applied for using Form 3500, or Form 3500A if it has already received the IRS exemption (note: this is the much easier route to take).
Even once an organization obtains federal and state tax-exempt status, it is still required to file annual information tax returns. Failure to file returns for three years will result in the revocation of tax-exempt status.
A tax-exempt charitable organization files a federal tax return using either Form 990, or Form 990-EZ if its gross receipts are under $200,000 and it owns assets valued at less than $500,000. If its gross receipts are less than $50,000 the organization may file Form 990-N, also known as an “E-postcard,” online. (Tax-exempt churches are exempt from filing tax returns.) In California, a tax-exempt charity must also file Form 199 tax return, or Form 199-N if its gross receipts are less than $50,000.
The tax returns require reporting of more than just the money in and out. Certain transactions between board members and other interested parties and the organization must be reported, as must the hiring of professional fundraisers, salaries paid to top executives and/or board members, what type of assets are owned, how the organization is funded, and whether there is unrelated business taxable income on which the organization must pay taxes.
Forming and operating a charity is serious business and must be carefully attended to. Multiple government entities monitor the activities and have enforcement authority to assure that an organization exists truly for the benefit of the public. The public also has a right to significant amounts of information on the organization (including financial information and who are board members).
While joining the board of or founding a non-profit organization is admirable, it’s important to always keep in mind that the organization must exist for the common good of the public at large. Straying from this purpose can result in serious repercussions for you and the organization.
Note: This is not legal advice to you individually, and you should rely on your own family law and estate planning attorneys to advise you.
Teresa J. Rhyne is an attorney practicing in estate planning and trust administration in Riverside and Paso Robles, CA. She is also the #1 New York Times bestselling author of “The Dog Lived (and So Will I)” and “Poppy in The Wild.” You can reach her at Teresa@trlawgroup.net.