While “pay-for-play” is still prohibited by the NCAA,² these new rules have opened the door for college athletes to explore a new world of sponsorships, endorsements and compensation.  For example, college athletes can now earn money for commercials, appearances, speeches, social media posts, hosting sports camps, giving lessons, writing books and more — all without violating NCAA rules.

“NIL collectives” have emerged as the chief brokers of these opportunities.  This article discusses what NIL collectives are, their legal forms of organization, and the regulatory framework that governs them.

How are NIL Collectives Structured?
NIL collectives are entities that are structurally independent of a school, yet fund NIL opportunities for the school’s student-athletes. They are typically founded by well-known alumni and supporters of the school.  Collectives generate and pool revenue raised through contributions from a wide variety of sources, including boosters, businesses, fans and more.  They use these funds to create opportunities for student-athletes to leverage their NIL in exchange for compensation.

While a number of NIL collectives have been formed as for-profit entities,³ in a growing number of cases, they have been formed as nonprofits. Numerous nonprofit collectives have, in turn, sought and obtained 501(c)(3) public charity status from the IRS, which potentially allows donors to receive a tax-deduction for their contribution to the collective.⁴

Tax-exempt collectives typically use student-athletes as independent contractors to help further their charitable mission.  For example, some provide in-kind contributions of a student-athlete’s services to other charities, including speaking, appearances and other public relations services that help expand the charities’ reach and visibility in their communities.  The student-athlete is paid by the tax-exempt collective to provide the services, while the other charities receive these services on a pro bono basis.

Special Rules Governing Tax-Exempt NIL Collectives
Collectives that obtain tax-exemption should be mindful of special rules that apply to tax-exempt entities.  These rules are enforced not only by the IRS, but also by State Attorneys General, whose responsibility is to ensure that charitable funds are used for charitable purposes. These rules require that tax-exempt cooperatives operate differently from the typical NIL collective.

For example, NIL collectives commonly facilitate endorsement, merchandising and marketing deals that allow for-profit companies to promote their products and services using a student-athlete’s NIL, which helps these for-profit companies increase business and revenues.  Many NIL collectives have the flexibility to promote such commercial interests due to their structure as for-profit (and therefore, taxable) entities.

However, facilitating commercial deals does not constitute a permissible purpose for a charitable, tax-exempt organization.  Therefore, if a tax-exempt NIL collective engages in such activity, revenues from this activity could be taxed by the IRS as unrelated business income – i.e., income from a trade or business, regularly carried on, that is not substantially related to the collective’s charitable mission.

Also, if the IRS finds that these commercial activities constitute a primary or substantial non-exempt purpose of the organization, the IRS could revoke its tax-exempt status.⁵ State Attorneys General could bring enforcement actions for similar reasons.  Therefore, if a tax-exempt collective facilitates marketing or similar NIL arrangements, it should generally avoid arrangements promoting goods and services of for-profit companies.  However, it could use the NIL of student-athletes to help promote and amplify the charitable missions of nonprofits serving communities.⁶

NIL collectives are also becoming well-known for offering lucrative compensation to student-athletes in connection with promotional deals.  For many collectives, their status as for-profit entities give them the flexibility to do so.

But, in the context of a tax-exempt collective, these payments must be reviewed carefully to ensure they do not constitute “excessive compensation” for federal tax law purposes.  NIL collectives should therefore carefully structure athletes’ compensation in accordance with IRS rules to ensure it does not exceed fair market value.  Failure to do so could put the collective at risk of losing its tax-exemption, and lead to potential enforcement actions by State Attorneys General.

However, it should be noted that even if such compensation is determined to be reasonable, a tax-exempt NIL collective could nevertheless lose its exemption if the IRS determines that its primary or substantial purpose is to pay or recruit student-athletes.  For this reason, it’s important that tax-exempt collectives work closely with legal counsel to ensure they have well-constructed charitable programs.

Given the risks outlined above, an NIL collective seeking tax-exempt status should carefully consider whether any of its time and resources will be spent on pursuing commercial (non-exempt) activities.  Collectives considering such activities should consult with counsel to reconsider its structural options, and discuss whether it would be advisable to create a for-profit subsidiary to house any commercial activity.

NCAA Interim Rules
Aside from understanding the regulatory framework discussed above, NIL collectives (no matter their legal form) should have an understanding of the NCAA rules which, as of the time of this writing, consist of interim rules adopted in July 2021.  These interim rules will remain in effect until federal legislation creates a national standard (which is what the NCAA is calling for), or until new NCAA rules are adopted.  While the purpose of the interim rules is to suspend NCAA restrictions on athletes’ profiting off their NIL, the rules maintain certain guardrails to prevent “pay-for-play” and similar arrangements.  Subject to state law, the following is prohibited under the interim rules:

• NIL opportunities cannot be used as a recruiting tool for prospective student athletes.  Such an action is considered an “improper recruiting inducement.”  Therefore, NIL collectives should refrain from making offers of NIL opportunities contingent upon a student-athlete’s enrollment at a particular school.
• As discussed above, NIL arrangements that constitute “pay-for-play” are also prohibited.   This rule prohibits any kind of arrangement that constitutes compensation in exchange for a student-athlete’s participation or performance in college athletics.
• NIL agreements should be specific about the NIL work being performed by the athlete in exchange for compensation, and such compensation should be paid only for work performed.  Such compensation must be determined through an independent analysis, based upon the facts of each specific case and the value each athlete offers to an NIL arrangement.
• The NCAA interim rules prohibit compensation from any school in exchange for the use of a student athlete’s name, image or likeness.  In addition, schools may not direct how student-athletes use NIL compensation.  (For example, schools may not require a student-athlete to use NIL compensation for financial aid.) Athletic department staff are not allowed to represent student-athletes in marketing their athletic ability or reputation.  They also may not communicate with a recruit on behalf of an NIL collective.  In addition, such staff may not facilitate a meeting between an NIL collective and a student-athlete, including, for example, by sharing a recruiting list or watch list.

State Laws and School Policies
As noted above, the NCAA’s interim rules are subject to state law, which varies depending on the state.⁷  Therefore, NIL collectives should take steps to ensure compliance under any applicable state law, including any state law that applies to the collective, the school where the student-athlete is enrolled, as well as the state where the NIL activity will take place.

The collective should also look at any specific NIL policies established by the college.

Both state laws and school policies may include reporting requirements that NIL collectives should be aware of, and some state laws prohibit athletes from entering into a contract that conflicts with the student-athlete’s team contract.

Understanding the regulatory framework governing NIL collectives will help avoid missteps that can lead to punitive actions by the IRS, NCAA or State Attorneys General, or scrutiny from Congress, which has also taken an interest in these entities.  As the NIL’s regulatory environment continues to evolve, it is incumbent on both collectives and student-athletes to take affirmative steps, including consulting with legal counsel, to ensure compliance.

1 This dramatic shift by the NCAA also came on the heels of its loss before the U.S. Supreme Court in NCAA v. Alston 141 S. Ct. 2141 (2021). Though NIL compensation was not the subject of this case, Justice Kavanaugh wrote a concurring opinion which suggested that the NCAA’s NIL compensation rules could be in violation of antitrust laws, and stated that “the NCAA is not above the law.”  The NCAA’s change also follows action by numerous states that, since 2019, had led the way in creating NIL rights for student athletes.

2 As discussed later in this article, “pay-for-play” refers to any kind of arrangement that constitutes compensation in exchange for a student-athlete’s participation or performance in college athletics.

3 Other legal forms taken by NIL collectives have included formation as for-profit limited liability companies (“LLCs”), which provides more flexibility in a number of ways.  For example, unlike tax-exempt nonprofits, for-profit LLCs are not subject to a cap on what’s considered reasonable compensation.  They may therefore offer student-athletes NIL work at any compensation structure.  For-profit LLCs are also not subject to limitations on the type of activities they can facilitate.  Therefore, unlike tax-exempt entities, for-profit LLCs may facilitate NIL arrangements for student-athletes such as merchandising or endorsement deals which promote commercial activities.  NIL collectives should consult with counsel to discuss the various pros and cons of these options.

4 On September 29, 2022, Senators John Thune (R-S.D.) and Ben Cardin (D-Md.) introduced the Athlete Opportunity and Taxpayer Integrity Act which, if passed, would “prohibit individuals and organizations from using the charitable tax deduction for specific contributions that compensate college or incoming college athletes for the use of their [NIL].”   They argue that “[s]uch activity is inconsistent with the intended purpose of the charitable tax deduction, and it forces taxpayers to subsidize the potential recruitment of – or payment to – college athletes based on their NIL status.”  As of the time of this writing, this federal legislation is the latest of more than a handful of NIL proposals introduced, but not yet passed, in Congress.  Congress’ appetite for eventually passing NIL legislation is unclear, though these proposals do indicate that NIL collectives are facing increased scrutiny from Congress.

5 Regs. Sec. 1.501(c)(3)-1(e)(1) and Sec. 1.501(c) (3)-1(c)(1).

6 One example of this approach is discussed in the previous section – i.e.,  tax-exempt collectives that provide in-kind contributions of a student-athlete’s services to other charities to help them promote their charitable missions.

7 As discussed above, the NCAA is lobbying Congress for legislation that would create a national standard, and thereby pre-empt differing state laws.

The post Seeking Tax-Exemption for a Name, Image and Likeness Collective (NIL)? What to Know. first appeared on Perlman Sandbox.

Current Trends and Issues in Charitable Regulation

Regulators
Conference panels presented by various state regulators covered ongoing trends and issues. Public trust of the charitable sector was a topic of general concern, based on surveys indicating a decrease in the trust in the nonprofit sector.  The regulators noted that they play an important role in enhancing trust by providing meaningful oversight of the sector.

Noteworthy topics included the importance of Board governance and oversight, particularly in monitoring the organization’s finances. The panelists noted a rise in for-profit entities soliciting in-kind disaster relief, particularly those that do not have a nonprofit partner. This trend has been largely observed in connection with the rise of natural disasters and the war in Ukraine.   Regulators are also troubled by the balloon and bust of opioid-crisis relief organizations. This is threatening given the importance these organizations play in their local communities. Such failures have been attributed to their overly rapid growth.

Several state regulators noted an increase in mergers and acquisitions filings of hospitals. Approval of these transactions generally turns on the question of whether the transaction is in the best interest of the community. As for charity care, regulators noted that nonprofit hospitals have a duty to provide subsidized care to patients in need, something they say they have seen too little of.

A notable increase of fraud, committed in the name of charities or directed at charities, is also of concern. It is reported that there has been a rise of bad actors using the name and information of known and respected charities to commit fraud.  One typical scheme is the impersonation of regulators claiming that registration fees are past due. Charities that receive such calls are admonished to use best efforts to confirm the identity of caller.

NASCO puts out an annual report detailing trends on state regulation and enforcement.

Nonprofit Sector and Practitioner Panelists
In the afternoon, other stakeholders in the charitable sector spoke on the trends they have observed during the past year. Jan Masaoka, CEO of the California Association of Nonprofits, discussed the Association’s concerns with donor-advised funds (DAFs) arising from the delay in time between donor benefit (i.e., the donor’s tax-deduction) and the donation reaching its target community. Erin Bradrick, Principal of NEO Law Group, spoke on the growth of fiscal sponsorships and the lack of sector education and oversight that exists. She observed that Decentralized Autonomous Organizations (DAOs) have the theoretical ability to seek 501(c)(3) status without having a governing body (the core distinguishing characteristic of DAOs).  Ms. Bradrick also noted an upward trend in the politicization of issues directly tied to key nonprofit areas, which have created a tension between state and federal law., naming the recent cannabis and abortion access laws as prime examples.

NFT and Cryptocurrency
Sara Hall, Chief Legal Officer and General Counsel of ALSAC, Andrea Kramer, Partner of McDermott, Will & Emory, Ruth Madrigal, Principal of the Exempt Organizations Group at KPMG, and Beth Short, Director of Outreach and Education, Charitable Law Section of the Ohio Attorney General’s Office, discussed cryptocurrencies, NFTs, and other emerging forms of donation.  The panel noted that these forms are not suitable for all organizations, as there is significant risk and several complex issues to consider in accepting donations of cryptocurrency.

It was noted that organizations that decide to accept NFT or cryptocurrency donations should ensure they have a detailed donation acceptance policy and procedure in place.  The policy should include how the organization will protect the security of the crypto wallets through which they accept the donation, how to appraise the cryptocurrency or NFT, and whether to use an intermediary service like a Donor Advised Fund (DAF). Including the development department on any decision on acceptance of these donations is critical.

Now and Next in Charitable Giving
In her keynote address, Dr. Una Osili, Associate Dean for Research and International Programs at the Indiana University Lilly Family School of Philanthropy, made a deep dive into the data to identify donor trends. Among those Dr. Osili highlighted are that giving is at an all-time high, that individuals remain the largest group of donors, and that fewer households are donating. She also pointed to a downturn in religious donations, historically the largest generator of donations, and an upturn in donations to racial identity and environmental groups. Donors are moving from a trend of making passive donations to getting more involved in the causes they support through active engagement and education.

Dr. Osili ended by sharing some of her key findings, notably that giving is the great equalizer. Adjusted for gross income, charitable giving is the same across all groups. Technology, specifically crowdfunding websites and social media, has become one of the strongest vehicles for attracting donations, making up 40% of all giving. Finally, charities should start thinking of the value of donating one’s testimonial and network of connection, not just time and gifts. For more information, visit the Indiana University website at Generosity for Life.

Establishing a Healthy Board
Dr. Gerri King, President of Human Dynamics Associates, taught board mediation and communication techniques. Her talk centered on the five states of group development: Forming, Storming, Norming, Performing and Adjourning. Dr. King explained that at each stage, there are unique challenges affecting Board dynamics, and that any change to the make-up of the Board can be a setback.

Dr. King emphasized the importance of creating a no blame, no gossip environment among the team and the organization, noting that although it sounds simple, it can be intensely difficult to achieve. The benefits, as she noted, are indispensable., creating higher accountability, cohesion, trust and efficiency.

Update on the California Charitable Fundraising Platform Law
Brian Armstrong, Deputy Attorney General of the California Attorney General’s Office, discussed Assembly Bill 488, which is set to take effect on January 1, 2023. This is the first law in the U.S. specifically designed to regulate online charitable fundraising platforms, including through a new registration and reporting requirement, specific required public disclosures, and other provisions designed to safeguard charitable donations received through these platforms.

The proposed regulation is currently in the “review of public comments” stage. Armstrong indicated that a second, 15-day period for public comments will open up again once the review is complete, but did not specify when that would be.  During the follow-up Q&A, our team learned that the registration portion of the law is not likely to go into effect on January 1, 2023. Still pending would be final regulations and the development of the new registration forms. However, the AG’s office intends to begin enforcement of those portions of the law which are not dependent upon the passage of final regulations (e.g., the disclosure requirements).

Charitable fundraising platforms and platform charities should take time to carefully review their current platform disclosures (including disclosures made throughout the user/donor flow, as well as the platform Terms of Use) and ensure they are in compliance with these new requirements.  For more details on the legislation, please read California Enacts New Law to Regulate Charitable Fundraising Platforms by firm partner Karen Wu.

The post Takeaways from the 2022 NAAG/NASCO Conference first appeared on Perlman Sandbox.

Navigating the types of activities that tax-exempt nonprofits are allowed to engage in (and how much) without jeopardizing their tax-exempt status can be tricky.  Many charities engage in types of activities that are important to the organization’s mission, donors, and people they serve.  Two activities that charities may use to influence public policy include “advocacy” and “lobbying.”  While advocacy and lobbying are terms that are sometimes used synonymously, the two are distinct in important ways, most notably because federal tax law limits the amount of lobbying that charities may engage in.

How Does Advocacy Differ from Lobbying?

Advocacy can take many forms that do not constitute lobbying, including: leading, directing, conducting, and publishing research; and disseminating educational information.  Charities may engage in many different types of advocacy, and so long as that activity does not constitute lobbying, 501(c)(3) organizations are generally not limited in the amount of time or money they can spend on advocacy.

Lobbying, on the other hand, is subject to specific, restrictive rules.  Charities may engage in only an insubstantial amount of lobbying, and must take care not to jeopardize their tax-exempt status or run afoul of other lobbying restrictions.  Lobbying is any attempt to influence legislation, which can include acts, bills, resolutions, or ballot initiatives by Congress, state legislatures, local councils, or similar governing bodies.  An organization whose employees contact or urge others to contact members or employees of one of these bodies for the purpose of influencing (by encouraging them to adopt, reject, support, or oppose) legislation, is engaging in lobbying.

State and Local Lobbying Registration, Reporting, and Disclosure Requirements

In addition to following the strict federal tax rules governing the type of lobbying and amount of lobbying an organization can engage in,  charities should also be aware of any state and local requirements to register (including registration of certain employees as lobbyists, or registration of the organization itself, which retains and pays lobbyists) and to report lobbying expenditures and activities on a regular basis.¹ Federal and state lobbying rules can be confusing and complicated, and often depend on several factors, including: (1) whether the organization employs an in-house lobbyist or an outside lobbyist; (2) whether any of the organization’s employees are lobbying; (3) the total amount of expenses the organization spends on lobbying activities; and (4) the timing of any contacts or communications made with federal or state officials.

After the organization makes a determination about which federal and state registration requirements apply to its lobbying activities, the organization and its lobbyists must file regular reports (often quarterly or semi-annually) until the registration terminates (the method by which registrations are terminated also varies from state to state), or otherwise expires.

If an organization decides to engage in lobbying activities, it is critical to ensure that executive staff are aware of the applicable requirements for registration, reporting, and disclosure.  Failure to comply can result in fines, censure from the regulatory agency, and possible negative press exposure for the organization.

1 While this article is focused on the lobbying rules as they pertain to 501(c)(3) public charities, it is worth noting that 501(c)(4) organizations, which may engage in unlimited lobbying in furtherance of their tax-exempt missions, are more likely to trigger lobbying registration and disclosure requirements.

The post Is Your Charity Engaged in Lobbying? Make Sure You Know the Rules! first appeared on Perlman Sandbox.

Within a week, the group created the ConstitutionDAO, organized its followers on Discord (a messaging and community platform), and raised roughly $47 million in virtual currency.⁴ Armed with their new war chest, the group bid on, but ultimately failed to win, the Sotheby’s auction, losing out to a hedge fund billionaire who purchased the copy of the Constitution for $43.2 million (the Constitution DAO had withheld some funds to cover costs associated with winning the auction).⁵

Following their loss, the creators of the group were faced with what to do with the virtual currency sitting in the DAO’s treasury. Many of the community members sought refunds, only to learn that the transaction costs (also known as gas fees) would eat up much of their original contribution.⁶ Ultimately, the ConstitutionDAO’s founders decided to shut it down.⁷ The token issued in connection with the project, originally intended to be used to allow holders to vote on what the DAO would do in the future, lives on, with some holders still hoping to profit.⁸

What if the ConstitutionDAO had succeeded? Who would have “owned” the copy of the Constitution the group would have purchased? In a later interview one of the founders of ConstitutionDAO, Jonah Erlich, disclosed that the group had partnered with a traditional nonprofit organization that would have had legal custody of the Constitution.⁹ The fact that this new type of organization would be reliant on a traditional nonprofit provides excellent insight into the emerging world of DAOs. It also gives us an entry point to examine this new structure.

WHAT ARE DAOS?

In a traditional corporation or limited liability company, the organization is formed by filing paperwork with a government office, typically a state’s Department of State. By creating a legal entity, the people behind the organization are protected from liability. When someone sues a corporation over a contract dispute or other liability, the directors, officers, employees, members, and volunteers are not liable individually. Rather, it’s the corporation that must answer for its liabilities.

In a DAO, however, there is no formal legal entity. Built using the same blockchain technologies that underly the virtual currency ecosystem, DAOs are organizations that are never incorporated in any state (with limited exceptions). The founders create the DAO, and it simply exists.

While DAOs actual structures vary, most DAOs issue a token that gives members of the DAO voting rights. Once tokens are issued, in order to make decisions, all token holders are allowed to vote. The idea, touted by DAO supporters, is that this new structure democratizes organizational decision-making, placing it in the hands of the members. An oversimplified comparison would be a for-profit company that has no paid executives or board of directors, making every decision by allowing all shareholders to vote.

Although the ConstitutionDAO is a well-known example, DAOs are proliferating in the nonprofit community. Here are a few interesting examples: DiatomDAO is raising support to protect the oceans;¹⁰ KlimaDAO hopes to speed up solutions for climate change by increasing the price of carbon assets;¹¹ Bloomeria is using NFTs to increase biodiversity; ¹² and The Regen Network is issuing a token as part of a group of entities to realign the agricultural economy with ecological health.¹³

While each of the foregoing organizations uses the language of the DAO and decentralization, they also demonstrate how the DAO community encompasses many different structures. For instance, the Regen Network is comprised of a traditional C-Corporation, a traditional 501(c)(3) public charity, and a decentralized DAO program.¹⁴ The DiatomDAO is purely a decentralized entity, “owned and directed” by its token holders (see more on this below). The ConstitutionDAO, while operated as a decentralized DAO, would have relied on a traditional 501(c)(3) public charity (one named EnDAOment¹⁵) had it won the Sotheby’s auction and needed a legal entity with which to hold the copy of the Constitution. As you can see, while many groups use the mantle of “DAO”, the term encompasses many different structures.

WHAT ARE THE BENEFITS OF DAOS?

Now that we’ve discussed what DAOs are, and seen some examples, let’s step back to consider what DAO proponents like about the structure. In theory, a pure DAO offers each supporter the opportunity to participate in the group’s decision-making. If a member of a charitable DAO wants to make a grant, they would propose it to the rest of the DAO community. The members then hold a vote. Using this structure, a DAO represents a more direct form of organizational decision-making and, for donors, more direct-action philanthropy.

Further, by avoiding any legal structure, some DAO proponents believe this new structure will give DAOs greater flexibility. Without a state’s laws dictating how decisions have to be made or how boards have to be structured, a DAO might be nimbler. Some libertarians believe that DAOs, who have no real jurisdictional nexus to any state, might even be able to avoid generally applicable laws.¹⁶

WHAT ARE THE DRAWBACKS OF DAOS?

While there is a lot to be excited about by DAOs, they use an organizational structure in its infancy, with many more questions than answers. One critique is that the voting structure adopted by most DAOs (1 token = 1 vote) replicates existing problems with shareholder structures, namely, that the larger shareholders control organizational decision-making, alienating smaller shareholders. If one person holds 60% of the DAO’s tokens and the DAO implements a 50+1% vote threshold decision-making could be even more centralized than it would be in a traditional organization with a board and executives who can counterbalance a large shareholder’s interests. The DAO community has proposed some possible solutions to this problem, such as limiting votes to one per token holder, or creating non-transferable tokens to limit token holder hoarding. Each of these solutions have drawbacks, but they could drive decision-making closer to the idealized notion of the DAO.

Another issue is the legal uncertainty of DAOs. Assume that the libertarian notion that DAOs are legally unaccountable as organizations, since they are not organized in any state nor do they have any other jurisdictional nexus with any local, state, or federal government. That might put the DAO beyond the reach of regulators and law enforcement, but it would not exempt the individuals participating in or working for the DAO, all of whom are real people subject to normal laws. Actually, the idea of a group of people running an unincorporated organization isn’t new. In New York, for instance, such an entity would be deemed an “unincorporated association.” Under longstanding common law, an unincorporated association is not legally separate from the members who comprise it.¹⁷ That means that members of a DAO could be taking on direct legal risk from their participation in the DAO. If the DAO were to breach a contract, discriminate against an employee, or cause other real-world harm, the DAO’s members might be jointly and severally liable.

It’s also an open question whether regulators will share the libertarian view that DAOs are not subject to local, state, or federal laws. It wouldn’t be surprising to see the Securities and Exchange Commission (SEC) bring an enforcement action against a DAO, given that it has already notified the Decentralized Finance (DeFi) community that it considers many DeFI products analogous to products regulated by the Commission.¹⁸ The SEC has already brought an enforcement action against a Wyoming organization operating under the guise of a DAO, albeit only after the entity sought SEC approval to register two tokens as securities.¹⁹

Finally, DAOs in the philanthropic sector face the additional hurdle of providing tax-deductibility to donors. In general, a contribution to a non-charitable intermediary doesn’t allow a donor to take a tax-deduction. The answer to that question isn’t clear²⁰ as it depends on how the entity is treated for tax-purposes, whether its distributions would otherwise qualify for a tax-deductions, and whether it is considered an agent for the donors or beneficiary charities. A person hoping for a tax-deduction should contact a tax professional to examine the particular DAO’s structure and the taxpayer’s circumstances. To date, I’m unaware of any DAO specifically advertising the deductibility of contributions to its treasury, nor having considered tax-deductibility as part of their DAO structure (except, of course, for DAOs like Endaoment and Regen Network that operate using a traditional 501(c)(3) corporate structure).

WHAT’S NEXT FOR DAOS?

Despite the novelty of and the uncertainty surrounding DAOs, their popularity is undeniable. This was exemplified by the incredible enthusiasm around ConstitutionDAO. Taking advantage of the late 2021 surge in the value of many cryptocurrencies, DAOs provide an opportunity for the crypto community to put its assets to work in novel ways, including philanthropy. While they are evolving, DAOs will likely persevere, barring regulator intervention to shut them down.  Donors and charities looking to participate in the DAO community should do so carefully, and with the benefits of advisors familiar with the DeFi and DAO space.

1 https://www.sothebys.com/en/digital-catalogues/the-constitution-of-the-united-states

2 Id.

3 https://www.theverge.com/22820563/constitution-meme-47-million-crypto-crowdfunding-blockchain-ethereum-constitution

4 https://www.constitutiondao.com/

5 https://www.vice.com/en/article/qjb8xv/hedge-fund-ceo-who-bailed-out-gamestop-short-seller-bought-the-constitution

6 https://www.theverge.com/2021/11/24/22800995/constitutiondao-refund-progress-steep-gas-fees-cryptocurrency

7 https://www.theverge.com/2021/11/23/22799192/constitutiondao-shutting-down-lost-auction-refunds

8 The latest price quote for the PEOPLE token can be found at  https://coinmarketcap.com/currencies/constitutiondao/.

9 https://www.theverge.com/22820563/constitution-meme-47-million-crypto-crowdfunding-blockchain-ethereum-constitution.

10 https://diatom.fund/

11 https://www.klimadao.finance/

12 https://bloomeria.org/

13 https://www.regen.network/

14 https://www.regen.network/faq/organization

15 https://endaoment.org/

16 For instance, in his conversation on the Deep Background podcast, Erik Voorhees argued that a DAO could avoid the difficulties of employment law because no states employment laws would apply. https://www.pushkin.fm/episode/whats-the-deal-with-decentralized-autonomous-organizations/

17 See, generally, New York Elec. C. Assn. v. Local Union No. 3, (NY Sup. Ct. 1941), available at https://casetext.com/case/new-york-elec-c-assn-v-local-union-no-3

18 https://www.sec.gov/news/statement/crenshaw-defi-20211109

19 https://www.sec.gov/news/press-release/2021-231; https://www.coindesk.com/policy/2021/11/11/sec-stops-wyoming-based-dao-from-registering-2-digital-tokens/.

20 For an excellent discussion, see Prof. Samuel Brunson’s blog post https://lawprofessors.typepad.com/nonprofit/2021/11/charitable-daos-revisited.html.

The post DAOs and the Nonprofit Sector – How Can they Work Together? first appeared on Perlman Sandbox.

Nonprofits and for-profits (in this article, “Brands” for easy reference) can collaborate in a number of ways to benefit both organizations. Nonprofits benefit by receiving financial support and access to a wider audience. Brands benefit from the goodwill generated by supporting a charitable cause, while simultaneously furthering their own purposes. These collaborations may take a number of forms. (For further reading, see  articles on our website , Selfish Giving, and Engage for Good’s online resource Cause Marketing and the Law).

We’ve recently seen a number of nonprofits expand their efforts to more consciously address online collaboration. In this article, I provide a refresher to clarify where the IRS draws the line on these types of partnerships. Understanding this line can help Brands to maximize their benefits and charities to avoid unwanted tax consequences.

What are Qualified Sponsorship Payments?

A typical strategy for Brands and nonprofits to collaborate is through sponsored events. While the pandemic has thrown traditional fundraising events for a loop, many nonprofits have pivoted to digital engagements or are now beginning to plan live events again as vaccination rates rise. Whether an event is digital or live, many nonprofits underwrite their events with support from Brand sponsors. In exchange for this support, Brands typically receive certain benefits. Those benefits may include a page in the event program, placement of their logo on the step-and-repeat, or a booth at the event. In the virtual context, Brands may get a shout-out or other acknowledgment during the event, in thank-you emails to attendees, or in press releases issued by the nonprofit.

If a nonprofit wants to avoid tax on the sponsorship payments that are received in exchange for certain benefits to the Brand, one strategy is to ensure that the payments qualify as “Qualified Sponsorship Payments”, the term used in Section 513(i) of the Internal Revenue Code. In order to be categorized as a Qualified Sponsorship Payment, the payment must be made without any arrangement or expectation of a “substantial return benefit.” Payments made in return for advertising or marketing services may constitute a substantial return benefit, and cause the payment to be subject to tax under the IRS’s Unrelated Business Income Tax (“UBIT”) rules.

So when does including a Brand’s logo in the nonprofit’s event, or allowing the Brand to have a booth or table at the event, constitute a “substantial return benefit”? Fortunately, the IRS has provided guidance on this question. According to the IRS, one way to avoid providing the Brand a “substantial return benefit” is for the Brand and nonprofit to avoid language that “promotes or markets any trade or business”. The IRS goes on to provide several examples of activities that are allowable under the qualified sponsorship rules, including:

• Distributing a Brand’s products to the general public at the event, either for free or purchase
• Including a Brand’s logo, slogan, address(es), telephone number, descriptions of a Brand’s product line or services, PROVIDED that all the foregoing do not include any comparative or qualitive descriptions of the Brand’s goods and services.
• Exclusive sponsorship arrangements (i.e., having a Brand be the only bakery sponsoring the event. NOTE – this is different than an exclusive provider arrangement, described below)

The IRS, in its guidance, also describes what types of messaging and activities are considered “substantial” return benefits for Brands and therefore NOT qualified sponsorship activities, including:

• Advertising for the Brand (messaging that promotes or markets a Brand, including messaging that contains comparative or qualitative descriptions of the Brand’s goods/services)
• Exclusive provider arrangements that limit the sale, distribution, availability, or use of competing products/services in connection with the nonprofit’s event/activities (i.e., having a Brand be the sole provider of cookies for an event. NOTE – this is different from the exclusive sponsorship arrangements, described above)

Social Media Considerations

Many Brands and nonprofits have begun to include social media posts as part of their messaging around events and partnerships. In addition to concerns about UBIT and qualified sponsorships, Brands and nonprofits have to be wary of rules implemented by the social media platforms (Instagram, Twitter, and TikTok, for instance) and guidelines issued by the Federal Trade Commission.

Nonprofits often thank their Brand sponsors for their support. It’s important that the language included in those posts is agreed upon by the Brand and nonprofit, and is vetted to make sure it doesn’t amount to an advertisement or endorsement of the Brand’s products or services. Similarly, when a Brand posts to highlights its support of the nonprofit, the parties should ensure that the post doesn’t create the implication that the nonprofit is endorsing the Brand’s products.

Brands and nonprofits also have to make sure their posts include appropriate disclosures to put their respective followers on notice that the content they are posting is part of a partnership. How those disclosures should be structured depends on the platform and the nature of the post, but has to be clear enough so that the posts comply with the platforms’ rules and the FTC’s guidelines.

If the Brand and nonprofit have brought a celebrity or influencer into the event to help raise its profile, the same general principles apply to the influencer’s posts. The Brand and nonprofit should make sure there are contractual provisions as well as practical guidelines provided that clarify what the influencer can and cannot post, how those posts should be timed and structured, and what material disclosures must be included.

Advice for Brands and Nonprofits

Brands and Nonprofits need to carefully review their contracts and social media posts to ensure they are not violating the rules regarding Qualified Sponsorships or social media platform disclosures. All posts made by the nonprofit thanking the Brand should avoid any qualitative language. Here are two sample statements to differentiate between comments that could be considered advertising vs. those that are just acknowledgments:

• Acknowledgment – NONPROFIT thanks BRAND for their steadfast support of our event. With BRAND’s support, we raised $100,000 in furtherance of our mission to end childhood hunger.
• Advertising – NONPROFIT thanks BRAND, purveyor of the best chocolate chip cookies in the NYC-area, for their support of our event. BRAND is one of the best companies and we thank them for their continued support. Find their cookies available for delivery at [WEBSITE].

In the second statement, the nonprofit used qualitative language around the Brand and its products. It also made a general comparative characterization of the Brand and linked to the Brand’s website, not for general informational purposes but to encourage viewers to order the Brand’s products. The second statement would be considered advertising, and could trigger UBIT for the nonprofit. The first statement merely identifies the Brand as a supporter of the nonprofit and its mission, and would be considered an acknowledgment.

In the contract governing the sponsorship or collaboration, the nonprofit should include restrictions on the Brand’s ability to use the nonprofit’s name and trademarks. For instance, the nonprofit should include a clause that prohibits the Brand from using pictures and videos from a nonprofit’s event in the Brand’s television, print, or social media advertising to promote its products or services. If a Brand seeks to incorporate the nonprofit’s photos and videos into content that highlights the Brand’s social mission and corporate responsibility, the nonprofit should carefully define the limits of that right to avoid an inadvertent endorsement.

The Brand and nonprofit should also consider how to enforce their contractual rights with regard to one another and any social media personalities that are part of the event. Payments can be delayed until after certain deliverables, to ensure all parties remain in sync in the run-up to the event. The parties should also consider the duration of their contractual rights –event contracts often terminate immediately upon the completion of the event, but if the parties are allowed to use each other’s names and logos even after the event is over, the contract should cover that ongoing use.

In order to manage the logistics of the event and the many deliverables that are included in sponsorship agreements, Brands and nonprofits can designate point people to review and approve deliverables. Specifying in the contract who the points-of-contact will be, as well as the required turnaround times, will help ensure the parties remain on good terms and maximize the event’s potential.

The post Qualified Sponsorship Payments, UBIT, and Social Media – A Reminder For Nonprofits first appeared on Perlman Sandbox.

The Basics
For purposes of this post, by “nonprofit” we mean a public charity exempt under § 501(c)(3) of the Internal Revenue Code, the most common type of nonprofit. Eligible to receive tax-deductible donations, 501(c)(3)s are prohibited from engaging in political campaign activity. Donations to political campaigns and committees are prohibited, whether monetary or in-kind (based on federal and local law). The rules apply at the primary stage of the campaign as well as the general election – wherever this piece or other guidance refers to different political parties, the guidance is really the same for the primary, and should be interpreted to refer to the various candidates.

Just because nonprofits cannot engage in political campaign activity doesn’t mean they can’t get involved in elections at all. Nonprofits, even 501(c)(3)s, can partake in voter education activities and voter mobilization, assuming both are conducted in a nonpartisan manner.  We’ve gone into greater detail, below, but the basic question nonprofits should ask themselves when considering whether an activity is permissible is – is this designed to help (or hurt) a particular candidate? If the answer is “no”, then the activity may be allowed.

Nonprofit Leaders
Nonprofit leaders tend to be leaders in their communities as well as leaders of their organizations. As such, their opinions and endorsements hold extra weight. While nonprofits themselves may be subject to restrictions (or outright prohibitions) on their ability to endorse a candidate, nonprofit leaders have a First Amendment right to speak their mind on the politics of the day, provided that the leaders are speaking in their personal capacities and not on behalf of their nonprofits.

Nonprofits
Further below we provide a list of activities that 501(c)(3)s may and may not engage in. The most popular activities in the run up to a high-profile election are generally candidate fora and voter education activities.

While public charities can host a candidate forum, the structure of the forum is important to ensure the nonprofit preserves its tax-exemption. The forum should be carefully thought through, from the selection of the moderator, the invitations to the candidates, the composition of the audience, and the questions that are asked of the candidates. With such a large field of candidates, nonprofits will have to make decisions about who to invite and how much time each candidate is allotted. It’s important to ensure that candidates are given comparable opportunities to voice their positions and respond to questions.

Some nonprofits also like to put together educational materials to distribute to their stakeholders. While this is permissible as well, it has to be done in a nonpartisan way to avoid violating federal, state, and city rules. Everything from the topics that are profiled and how candidates’ positions are communicated to voters has to be done carefully, and nonprofits should consult with counsel.

Other Types of Nonprofits
Other types of nonprofits (501(c)(4)s, 501(c)(6)s, etc.) do not face the same federal prohibitions on political campaign activity and therefore have more freedom to make statements about candidates and campaigns. However, NYC has strict campaign finance rules that prohibit contributions from corporate entities, meaning that nonprofits cannot donate (either cash or in-kind services) to a candidate’s campaign. While political action committees (PACs) may make certain donations and expenditures, a PAC cannot circumvent the prohibition on corporate donations by accepting a nonprofit’s money and then sending it on to the candidate. Campaign finance issues are closely monitored by the NYC Campaign Finance Board and any nonprofit that is considering creating a PAC or otherwise participating in political activity should consult with counsel before entering into the political fray.

What 501(c)(3)s Can and Cannot Do
Nonprofits are allowed to engage in non-partisan activities in the run-up to an election, such as voter registration drives or education around a particular issue – see our list below for a breakdown of specific activities that a 501(c)(3) can engage in. In addition, a 501(c)(3) is allowed to engage in lobbying (attempting to influence legislation) so long as the lobbying activity does not constitute a “substantial” part of its activities. Of course, “substantial” is a fuzzy term, so the IRS allows most nonprofits (but not churches) to set a monetary limit to their lobbying activity (called a 501(h) election) below which no tax penalties will be assessed, so that nonprofits have some certainty when their lobbying activities will trigger tax consequences. In addition, if a nonprofit focuses on lobbying around issues that are highly salient to the campaign, the lobbying may be considered by IRS as political campaign intervention. The IRS has given some guidance on the factors it considers when deciding if issue-advocacy may be considered political campaign intervention (see the section titled “Issue Advocacy vs. Political Campaign Intervention” and example 14).

What 501(c)(3) Organizations CAN Do
501(c)(3) organizations may safely engage in the following activities:

• Conduct or participate in a nonpartisan candidate forum, so long as the forum: (a) is open to all candidates, (b) is run in a balanced way, and (c) includes a broad range of nonpartisan questions for the candidates.
• Conduct voter registration drives and nonpartisan get-out-the-vote efforts, subject to the following limitations:
  • Drives must be designed to educate the public about the importance of voting.
  • Activities cannot be biased for or against any candidate or party.
  • Nonprofits can target areas in nonpartisan ways. For instance, nonprofits may target low-turnout areas, low-income populations, minority populations, and students.
  • Nonprofits may target registration and turnout efforts to the areas or people they serve.
• Educate the public on issues and generally encourage participation in the political process.
• Make presentations on your organization’s issue to platform committees, campaign staff, candidates, media, and the general public.
• Educate all candidates and political parties on your issues.
• Continue your normal lobbying on issues, subject to the limitations described above.
• Rent or sell mailing lists to candidates at fair market value, if made available to all candidates.

What 501(c)(3) Organizations CANNOT Do
To maintain 501(c)(3) tax exempt status, organizations may not undertake the following activities:

• Endorse or oppose a candidate—implicitly or explicitly.
• Contribute money, time, or facilities to a candidate.
• Coordinate activities with a candidate.
• Restrict rental of your mailing list and facilities to certain candidates.
• Set up, fund, or manage a Political Action Committee (PAC), established under section 527 of the tax code mainly for electoral activity

These restrictions do not in any way prohibit officers, members, or employees from participating in a political campaign as private citizens, assuming those individuals ensure their actions or statements are not attributed to the organization.

If you are in any doubt regarding whether your organization’s activities might risk revocation of tax-exempt status, be sure to reach out to a lawyer with knowledge of the non-profit sector for specific advice.

The post The Mayor’s Race and Nonprofits first appeared on Perlman Sandbox.

The cases are founded on the similar legal challenges to California’s insistence on nonpublic filing of donor information. The cases have been consolidated and the question presented for consideration is: Whether the scrutiny this Court has long required of laws that abridge the freedoms of speech and association outside the election context—as called for by NAACP v. Alabama ex rel. Patterson, 357 U.S. 449 (1958), and its progeny—can be satisfied absent any showing that a blanket governmental demand for the individual identities and addresses of major donors to private nonprofit organizations is narrowly tailored to an asserted law-enforcement interest.

Freedom of Association and Free Speech
A discussion of government infringement of donor privacy inevitably begins with the seminal case on the First and Fourteenth Amendments rights of freedom of association. In 1958, the National Association for the Advancement of Colored People (NAACP) challenged an Alabama state court order that required the NAACP to reveal the names and addresses of its local Alabama affiliate’s members. When they refused to comply, the Court issued an order preventing the NAACP from conducting business or further activities in the State and levied a $100,000 fine for contempt of court.

Behind this refusal was the justified fear of violent retaliation from white supremacists against members of an organization actively fighting to overthrow Jim Crow laws. The NAACP appealed the decision to the Supreme Court[2] which overturned the State Court decision ruling on grounds that as applied to the NAACP, the disclosure requirement violated the First Amendment right to association, which is ” an inseparable aspect of…freedom of speech.”[3]

Some sixty years later, Citizens United (a 501(c)(4) advocacy organization) and the Citizens United Foundation (a 501(c)(3) charitable organization) brought a challenge to enforcement by the New York Office of Attorney General of the requirement to submit an unredacted copy of the annual IRS 990 Information filing required of most 501(c)(3) and (c)(4) organizations.[4] The Form 990 contains a disclosure schedule listing the donors to the organization whose gifts exceeded $5,000 in the reported fiscal year. This section of the Form 990 is known as Schedule B. While federal law requires that the Form 990 be made public, it specifically exempts public disclosure of the donors listed in Schedule B.[5]

Importantly, the compliance registration required of most nonprofits soliciting in New York State must be made prior to seeking support from New York State residents. Such appeals are often inseparably intertwined with persuasive speech and as such they are fully protected under the First Amendment as a core free speech right.[6]

The Citizens United groups argued that enforcement of the reporting regulations violated their First Amendment rights in two ways: 1) by creating a climate of fear among donors that limits their ability to raise the funds to promote controversial causes and 2) by operating as a prior restraint on their ability to ask for money. They also argued that these regulations are preempted by the Internal Revenue Code’s disclosure rules and that the Attorney General went beyond his authority by including 501(c)(4) organizations in the regulations’ definition of ” charitable organization.”

Challenges were brought on First Amendment grounds as a facial challenge (the regulation is unconstitutional regardless to whom it is applied), as applied (it is unconstitutional as applied the Citizens United organizations) and due process (the change in the enforcement regime was made without proper notice to those effected).  The United States Second Circuit Court of Appeals held “It is well established that the Schedule B policy must satisfy exacting scrutiny, [b]ecause the Schedule B policy is a disclosure requirement and there is a substantial relation between the disclosure requirement and a sufficiently important governmental interest.”[7]

The Court applied the intermediate or exacting scrutiny test rather than the more stringent strict scrutiny test used to determine content-based restrictions of governmental regulation of free speech activities. The latter requires that such government action be narrowly tailored using the least restrictive means possible to serve a substantial government interest. Exacting scrutiny requires only that the government demonstrate “a substantial relation between the disclosure requirement and a sufficiently important governmental interest”[8] citing an earlier decision in the same case. [9]

Notably, prior to the New York’s enforcement of its regulations requiring the filing of the full Form 990, including an unredacted version of Schedule B, no other state had attempted to enforce such a requirement. (Currently, New York, California and New Jersey require disclosure of the Schedule B – pending the outcome of the current case before the Supreme Court.)

Enter California
In 2010, the California Registry of Charitable Trusts began issuing deficiency letters to charities demanding that they submit their Schedule B as part of their annual registration renewal.  The Registry sent about eight thousand Schedule B deficiency letters to various charities, creating a de facto requirement that the tens of thousands of charities registered in California must annually submit Schedule B to the State in order to renew their registrations. California assured the charities that the confidential donor information contained in Schedule B would remain confidential and would not be publicly disclosed. Despite such assurances, litigation brought by the Center for Competitive Politics (now the Institute for Free Speech), Americans for Prosperity Foundation and the Thomas More Law Center uncovered at least 1,778 Schedule Bs that the Registry had posted online. In one notable instance involving a well-known controversial cause, the Registry posted the Schedule B for Planned Parenthood Affiliates of California, Inc. which included the names and addresses of hundreds of large donors.

The Americans for Prosperity Foundation won at the district court level after Judge Manuel Real agreed that the documented history of violent threats against the group’s members, donors, and leadership meant it should not be forced to turn over its list. That decision was later overturned by the U.S. Court of Appeals for the Ninth Circuit, having consolidated both the Americans for Prosperity and Thomas More Law Center cases. After reviewing the evidence, The Ninth Circuit held that neither organization had established that the requirement to submit to the State, on a confidential basis, the same limited information they must report to the IRS each year would have a chilling effect on charitable contributions.

The Ninth Circuit also determined that collecting Schedule Bs serves the State’s interests in detecting fraud and other abuses and that the alternatives of case-by-case audits or subpoenas would compromise the State’s law enforcement interests. The State’s confidential reporting requirements thus survived “exacting scrutiny”.

Petitioners, in their appeal to the Supreme Court, argued that the court departed from decades of precedent and the Attorney General must show such a blanket demand is narrowly tailored to advancing the government’s purported law-enforcement interests. The decision prompted sharp disagreement on the Ninth Circuit, with five members of that court dissenting from denial of rehearing en banc when additional evidence of harm was presented by the charities.  The Ninth Circuit purported to apply “exacting scrutiny,” while jettisoning any requirement that California “narrowly tailor” its chosen means to fit its asserted ends as required by the “strict scrutiny” test.

State Donor Disclosure Landscape
According to the Philanthropy Roundtable, in 2020, fifteen states have considered twenty-nine donor-disclosure bills that would threaten donor privacy for 501(c)3 organizations. Just four of these bills remain active, with the rest failing to advance in the legislative process.

On the other side, seven states advanced donor-privacy legislation in 2020—six of them using the “Personal Privacy Protection Act,” which prevents state and local officials from demanding nonprofit donor information without a subpoena, or nonprofits from disclosing donor information they might possess. Similar legislation was originally passed by the Michigan Legislature in late 2018, though it was vetoed by the outgoing governor. Mississippi passed the Personal Privacy Protection Act in 2019 as did four other states which introduced similar legislation in 2020: Louisiana, Oklahoma, Utah, and West Virginia. In each, it was supported by broad bipartisan majorities and coalitions of organizations spanning the ideological spectrum, including state chapters of the American Civil Liberties Union and Americans for Prosperity. In addition, in three states, Iowa, Nebraska, and Tennessee, lawmakers have introduced bills that would bar public agencies from publicly disclosing identifying information about nonprofit donors. The bills would prohibit public agencies from: (1) requiring tax-exempt 501(c) groups to provide public agencies with personal identifying information about their donors, members, supporters or volunteers, and (2) releasing any personal identifying information public agencies might possess.

In a recent case focused on political advocacy, the Rio Grande Foundation (a free-market think tank in New Mexico, organized as a 501(c)(3) charity) filed a lawsuit in December 2019 challenging a law that would force it and other nonprofits to disclose donors if an organization engaged in issue advocacy mentioning anyone who is a candidate for office. An additional wrinkle in the universe of donor disclosure regulations.

And the Winner is….
Despite some legislative and judicial victories, Philanthropy Roundtable and other organizations argue that the vital right to donor privacy remains under assault in a variety of venues across the country.  Thus, the philanthropic sector needs to be vigilant and ready to act quickly whenever activists and politicians seek to diminish the right to donate anonymously to charitable organizations and civic causes.

Whether the Supreme Court will find in favor of donor privacy no one knows for sure. A number of leaders in the philanthropic arena and various other pundits predict that the Court, with its conservative majority, will rule against California in a 5-to-4 decision. But Free Speech cases bring together unusual bedfellows, so my prediction is that the decision will not break along lines of political ideology and the Court will rule against California by a 7-to-2 majority.  The one thing that is certain, the outcome of this interesting and important case will set the future course for state oversight of donor disclosure and privacy.

[1] Also see: Center for Competitive Politics v. Harris, 784 F.3d 1307 (9th Cir. 2015)
[2] National Association for the Advancement of Colored People v. State of Alabama ex rel. Patterson, 357 U.S. 449, 78 S.Ct. 1163, 2 L.Ed.2d 1488 (1958)
[3] Id. at 460, 78 S.Ct. 1163
[4] Citizens United v. Schneiderman, 203 F.Supp.3d 397 (S.D.N.Y. 2016).
[5] 26 U.S.C. § 6104(d)(3)(A).
[6] See Vill. of Schaumburg v. Citizens for a Better Env’t, 444 U.S. 620, 632, 100 S.Ct. 826, 63 L.Ed.2d 73 (1980)
[7] Citizens United v. Schneiderman, 203 F.Supp.3d 397, 407 (2016)
[8] Citizens United v. Schneiderman, 115 F.Supp.3d 457, (2015)
[9] See also Ctr. for Competitive Politics v. Harris, 784 F.3d 1307, 1312 (9th Cir. 2015)

The post Schedule B Disclosure Cases Head to the Supreme Court – Is Donor Privacy Threatened? first appeared on Perlman Sandbox.

The IRS prohibits tax-exempt organizations from engaging in activities that are illegal or contrary to public policy. Given the nature of the rally (an attempt to rally support to overturn the results of a presidential election) and its aftermath (an illegal and violent insurrection at the Capitol), some nonprofits that helped organize the rally could have their tax-exempt status revoked under the illegality and public policy doctrines. In this piece, I review the IRS’s rules, discuss how they might apply to the rally, and offer suggestions for nonprofits that want to avoid getting in trouble with IRS.

The Background
Under longstanding IRS rules, tax-exempt organizations must be organized and operated for exempt purposes. An organization is deemed to NOT be organized and operated for exempt purposes if its activities are illegal or contrary to public policy. (For a more detailed discussion of Illegality & Public Policy, see the IRS’s EO CPE Texts from 1985 and 1994). The illegality doctrine acts as a check to assure that the federal government does not support through tax exemption an organization engaged in behavior the government is charged with preventing. Similarly, the public policy doctrine ensures that the federal government isn’t supporting behavior that adds to government’s burdens. To determine whether a nonprofit might lose its exemption, the IRS looks to the nature and extent of the activities carried on by the organization.

The centrality of the improper activities to the nonprofit’s overall purpose is important. If the nonprofit is organized to accomplish an illegal purpose, it should never qualify for tax-exemption in the first place. In other words, if any of the nonprofits that sponsored the January 6 rally had as their central purpose “the armed overthrow of the U.S. government”, they would never have been recognized by IRS as tax-exempt in the first place.

Even if a nonprofit qualifies for tax-exemption, if its activities are illegal or contrary to public policy, the nonprofit may have its tax-exemption revoked. In determining whether illegal activity will lead to revocation of tax-exempt status, the IRS looks at whether the illegal activities were “substantial”, both in terms of how much time and attention were spent on the illegal activity, including the extent to which the illegal activity can be attributed to the organization by virtue of the involvement of its directors or officers or through clear ratification of the organization’s governing body (i.e., quantitatively substantial), as well as the seriousness of the illegality involved (qualitatively substantial). If a group is organized around a permissible exempt purpose, but engages in an isolated egregious illegal act, it could have its tax-exempt status revoked, notwithstanding the fact that a majority of its other activities are law-abiding.

The Seminal Case – Bob Jones University (461 U.S. 574 (1983))
The case that is often cited to explain the illegality doctrine is Bob Jones Univ. v. United States, a case from the 1970s and early 1980s, in which the Internal Revenue Service sought to revoke the University’s tax-exemption because it denied admission to applicants who were either “engaged in interracial marriage or known to advocate interracial marriage or dating.” The case was joined with another, involving the Goldsboro Christian Schools, which maintained “a racially discriminatory admissions policy based on its interpretation of the Bible, accepting… only Caucasian students.”

In the combined Bob Jones cases, the IRS had laid the groundwork by first telling all tax-exempt organizations in a Revenue Ruling that it could no longer justify tax-exempt status for any school that operated in a racially discriminatory manner. (Rev. Rul. 71-447). The IRS determined that to qualify under traditional understandings of the term “charity”, an organization must not act illegally or contrary to public policy. In the IRS’s opinion, the United States had a compelling interest in eradicating racial discrimination in schools.

Both Bob Jones University and Goldsboro Christian Schools claimed that their religious beliefs required the racially discriminatory policies. The Supreme Court nonetheless found that national policy was clearly in favor of racial nondiscrimination and, therefore, the IRS was justified in its requirement that schools operate without discriminatory policies. In other words, the Court determined that the government’s interest in overseeing racially nondiscriminatory schools was so compelling that it overrode the First Amendment interests asserted by the schools.

Holding Groups Responsible For Actions by Members
Next, we should look at whether and how the IRS would hold an organization responsible for the actions its members (or attendees) take. As a general matter, an organization is not responsible for the actions of its members except where the organization “authorizes, advocates for, or ratifies” the members’ acts. If an organization urges its members to commit illegal acts, the organization may find itself subject to consequences, either through revocation of its tax-exempt status or civil action. The standard used in at least one IRS ruling (Rev. Rul. 75-384) was that those illegal activities “which violate the minimum standards of acceptable conduct necessary to the preservation of an orderly society, are contrary to the common good and the general welfare of the people in a community” would disqualify an organization from exemption under 501(c)(4). Similarly, if an organization “induces or encourages the commission of criminal acts by planning or sponsoring” events and, through criminal acts committed by its members, increases the burden on government, the IRS may revoke exemption under 501(c)(3).

Much of the guidance on illegality and public policy revocations is dated, but a new case related to protest activity and liability is instructive to see how our modern courts view organizer liability for actions by attendees at a protest event. A civil case currently winding its way through the courts, McKesson v. Doe, deals with the bounds of First Amendment protection for organizers. In the McKesson case, a police officer was injured by a rock thrown by an unknown protestor at an event where the attendees illegally occupied a roadway. There was no allegation that the organizers intended or foresaw that a rock would be thrown at the protest, but the court recognized that a jury may find that blocking the roadway was authorized, directed, or ratified by the organizers. The Fifth Circuit determined that because rock throwing was a consequence of the illegal activity that the organizers “authorized, directed, or ratified” (blocking the roadway), the organizers could potentially be held liable.

While McKesson v. Doe is far from finished and rests heavily on Louisiana civil law, the discussion by the Fifth Circuit and Supreme Court is instructive for the organizers of the March to Save America who may try to invoke the First Amendment as a shield from being held responsible for their attendees’ actions, whether in a civil case or for possible action by the IRS. If the violence that erupted at the March was more foreseeable than the rock throwing in the McKesson case – if the March’s organizers had notice that violence was a likely consequence of their event and if the March’s organizers invited speakers who they knew, or should have known, would increase the risk of violence – the McKesson case suggests that the First Amendment may not shield the March’s organizers from liability.

The March To Save America
Organized and supported by tax-exempt 501(c)(3) and 501(c)(4) organizations, among others, much of the content of the speeches at the March was a continuation of what those speakers and the nonprofits’ leaders had been saying since the November election – that the election result was somehow invalid (despite no evidence), should be overturned (despite numerous failed attempts in court to do just that), and that supporters of the outgoing President should “fight” to make sure the electoral college votes were tallied appropriately. This history is important under the IRS’s tests to determine whether the attendees’ violent and illegal insurrection at the Capitol is attributable to the organizers (discussed above). If the attendees’ behavior was “authorized, advocated for, or ratified by” the organizers, the IRS may try to attribute the violence in the Capitol to the organizing groups as it assesses whether to revoke their exemption. This might also be the case if a civil litigant injured in the melee and seeks recompense.

The nonprofits involved in the March might argue that the attendees’ later violent behavior should not be attributed to them.  As discussed earlier, the default rule is that organizations are not held accountable for unauthorized activities of their members. Should the IRS pursue any action against the groups, some important considerations will be whether the March’s nonprofit organizers can demonstrate that they did not authorize, advocate for, or ratify the violent actions of their attendees. How they must show this is less clear; they may try to show that they took steps to consider and minimize the likelihood of violence when they invited certain speakers, to try to avoid inflammatory rhetoric at the event, or simply miscalculated the levels of security and other precautions typically required of an event of this size.  Because many of the groups and their leaders have condemned the violence at the Capitol, it could undercut IRS’s argument that the groups condoned or ratified the resultant violence.  Whether that is sufficient to avoid liability or a revocation by IRS remains to be seen.

It’s important to note that the illegality and public policy doctrines are related, but separate.  Consider, then, whether the nonprofits’ peaceful and intentional activities at the March, namely a rally to protest a free and fair election, could be sufficient reason for a revocation as a violation of public policy. The Bob Jones case established that a nonprofit’s exemption can be revoked where no illegality is alleged but because the nonprofit’s activities are so contrary to public policy that they should not be condoned by the federal government with tax exemption. Challenging the tallying of the electoral votes without any real basis, even without illegality and acts of violence, may amount to a violation of the public policy doctrine – it is hard to think of a more central public policy in a democracy than the peaceful transfer of power. The IRS would never provide tax-exemption to an applicant whose stated purpose was to “challenge federal elections and undermine public faith in our democratic institutions, regardless of whether there is any basis to do so.” Yet that appears to be what those groups did, notwithstanding that they would argue they were simply ensuring all “legal” votes were counted.

Lessons to Be Learned
A nonprofit that plans to organize an event that deals with a topic likely to inflame the passions of its supporters must carefully consider how they will manage the risk of aggressive behavior by participants.  The goal is not only to avoid violence, but also to avoid any attribution of it to the organization.  The following are suggested steps to ensure both the protection of the public and the nonprofit organization.

1. Carefully vet the speakers

It may be tempting to invite a popular figure who is supportive of the cause.  If that person has a history of advocating violence, illegal behavior, or is prone to fiery language, it will likely creates a greater risk of inciting the crowd to dangerous behavior. Researching potential speakers before invitation is crucial, including a review of news coverage, social media accounts and other speaking engagements.

2. Develop written guidelines for the speakers

This is useful in many contexts (for instance, many nonprofits want to ensure their events don’t stray into politics, which is strictly prohibited for 501(c)(3) organizations). The guidelines will differ based on the nature of the event, but in general make should sure that speakers specify whether they are speaking on behalf of any organization and that they avoid topics or statements that could get the nonprofit in trouble (or are otherwise contrary to the views or interests of the organization).

3. Monitor the speech and have a plan to pull the plug on any speakers who violates the guidelines.

This step is a last resort in case the speaker makes statements that are inflammatory, advocate illegal activity, or otherwise overstep the guidelines the nonprofit has established. The organizers must monitor the speakers’ statements and be prepared to step in the immediately. If improper statements are made, the nonprofit should swiftly disavow any language considered improper if it were spoken by the nonprofit or its executives.

4. Make sure other safeguards are in place.

Large events require infrastructure.  A reliable vendor can help assess how best to safeguard participants and the public.  However, the organization that sponsors the event bears the ultimate responsibility for ensuring that basic issues are taken care of – the safety and security of the attendees, speakers, and surrounding community being the foremost concern. The organizers should give ample notice to potential attendees that certain guidelines must be followed – for instance, no weapons. And the organizers should coordinate with local authorities not just to secure any necessary license but also to ensure that adequate manpower is available to oversee and support the event.

Conclusion
We don’t know yet whether there will be any consequences for the organizations involved in the January 6 March for America. If IRS chooses to enforce its illegality and public policy doctrines, the nonprofits may have left themselves vulnerable. Nonprofit professionals can use the episode as a learning experience to avoid such catastrophe in the future and protect their organizations.

The views expressed here are those of the author which, do not necessarily represent the views of the Firm.

The post Nonprofits and the “March to Save America”– Lessons for Responsible Nonprofits first appeared on Perlman Sandbox.

Due to Constitutional concerns the term “church” may be found, but is not defined, in the Internal Revenue Code (IRC). To determine whether a religious organization is a church for federal tax purposes, the IRS reviews a set of fourteen (14) characteristics, together with any other relevant facts and circumstances, including whether the organization has an established place of worship, a congregation, and regular religious services.[2]  No single characteristic is controlling nor is there a particular number of characteristics that will guarantee that the organization is a “true” church.

The subjective nature of the IRS’s “facts and circumstances” test for distinguishing churches from other religious organizations makes it challenging to draw a definitive line between churches and religious organizations for federal tax purposes. That said, religious organizations that are not churches generally are not places where a congregation regularly worships and attends religious services. Instead, they may be non-denominational ministries organized to study or advance religion or organizations with a mission that stems from a religious text or sincerely held and deeply-rooted religious belief.

The following is a discussion of several federal and state laws that provide different treatment to churches when compared to the broader category of religious or faith-based organizations.

Recognition of Federal Tax-Exempt Status

In order to be exempt from federal income tax, religious organizations and churches must be organized and operated exclusively for religious purposes and comply with the IRC’s prohibition on private inurement and political campaign activity as well as its limitation on lobbying activities.

Religious organizations must submit an application for recognition of exemption (Form 1023) to the IRS.

Churches, on the other hand, are automatically recognized as exempt and are not required to submit an application to the IRS. Even so, some churches choose to apply since an IRS determination letter can make it easier to apply for exemptions from state taxes or registration requirements and provide assurance to donors that contributions to the church are tax-deductible.

Lobbying and the 501(h) Election

An organization, including a religious organization or a church, may not qualify for exemption from federal income tax if a substantial part of its activities is attempting to influence legislation (i.e., lobbying).  Generally, whether an organization’s attempts to influence legislation constitute a substantial part of its activities (and therefore jeopardizes its tax-exempt status) is determined by a “facts and circumstances” test, by which the IRS considers a number of factors including the time and expenditures devoted to lobbying (“the substantial part test”).

Religious organizations have the option to elect the “expenditure test” rather than the substantial part test. Under the expenditure test, the extent of a religious organization’s lobbying activity won’t jeopardize its tax-exempt status, provided its expenditures, related to the activity, do not normally exceed an amount specified in IRC Section 4911. Ultimately, the expenditure test provides more clarity regarding how much lobbying an organization is permitted to engage in before jeopardizing its tax-exempt status. Churches, by contrast, are not eligible to elect the expenditure test. 

Annual Information Return

Religious organizations must file an annual information return (Form 990, Form 990-EZ or Form 990-N e-Postcard) with the IRS providing information to the IRS and to the public about the organization’s finances and activities for the year.[3] Churches are exempt from this requirement[4] though some churches choose to file an annual information return in order to increase transparency.

Federal and State Unemployment Tax

Churches and religious organizations are not required to pay federal unemployment taxes because services provided to 501(c)(3) organizations are generally exempt from the definition of “employment” under the Federal Unemployment Tax Act.[5] States collect unemployment insurance tax under their own unemployment tax acts and the requirements to file vary by state. Some religious organizations may be required to pay state unemployment tax, whereas, churches are generally exempt from paying state unemployment tax. Some churches voluntarily elect to pay such taxes so that employees terminated without good cause will be eligible to collect unemployment benefits.

Social Security & Medicare Taxes

Churches and religious organizations are generally required to collect, pay and report employment taxes under the Federal Insurance Compensation Act (FICA) for their employees. A church that opposes payment of Social Security and Medicare taxes for religious reasons can elect exemption from the payment of the employer’s share of FICA taxes by filing Form 8274. The church must file Form 8274 before the first date on which the church is required to file its first quarterly employment tax return (Form 941). If the church so elects, employees will, like ministers, be responsible to pay Social Security and Medicare taxes on their salary under the Self-Employment Contributions Act (SECA).

Ministers[6] are subject to unique rules when it comes to employment taxes. Although a minister is considered an employee under the common law rules, payments for services as a minister are considered income from self-employment.[7] Therefore, a minister, unless exempt, pays social security and Medicare taxes on his salary and housing allowance under SECA and is not subject to FICA taxes or income tax withholding. SECA employment tax payments are typically made in quarterly estimates, using coupons or vouchers. Churches are not permitted to pay the SECA tax for their ministers, but many churches assist ministers by providing them a “Social Security Allowance” of at least 50% of the SECA tax. This allowance is often approximately equal to the amount of FICA tax a church would pay if the minister were treated as an employee for purposes of employment taxes.

IRS Audits

In general, the IRS is authorized to conduct examinations of tax-exempt organizations, including religious organizations, in order to ascertain whether they are in compliance with all applicable requirements of the IRC. However, the authority of the IRS to audit churches is restricted. It is important to note that these restrictions do not apply to integrated auxiliaries of churches. The IRS may only initiate a church examination if an appropriate high-level Treasury Department official reasonably believes, based on a written statement of the facts and circumstances, that the church, (1) may not qualify for federal tax-exemption, or (2), may not be paying tax on an unrelated business or other taxable activity. This restriction does not apply to all inquiries or examinations. For example, the IRS can still make a routine request for information. In addition, restrictions on church inquiries do not apply to criminal investigations or investigations of the tax liability of a person connected with the church (such as a donor or minister).

Affordable Care Act

Generally, religious organizations and churches are subject to the provisions of the Affordable Care Act. However, churches and religious organizations with a sincere religious objection to establishing or maintaining a health insurance plan that provides coverage for contraceptive services are exempt from the Affordable Care Act’s mandate that employers provide access to health insurance to employees that covers women’s preventative services.[8] 

State Taxes and Registration Requirements

Generally, churches are subject to the same rules for state property tax and sales and use tax as religious organizations. Many states exempt churches and religious organizations from payment of property tax on land owned by the organization and used for religious purposes. Whether this exemption is available and the requirements for eligibility vary by a state. For example, in New York real property owned by a nonprofit corporation organized or conducted exclusively for religious purposes and used exclusively for carrying out the organization’s religious purpose is wholly exempt from taxation and, for certain purposes, from special ad valorem taxes.[9]

In addition, some states have broad sales and use tax exemptions applicable to churches and religious organizations. For example, in New York, organizations established and operated exclusively for religious purposes are exempt from sales and use tax.[10] Other states, however, only exempt certain purchases or sales made by churches or religious organizations. For example, Mississippi requires churches and religious organizations to collect and pay tax on purchases and sales except on purchases of electricity, gases, other fuels and potable water used on property primarily used for religious or educational purposes.[11]

Finally, some states have a broad exemption from the requirement to register to solicit charitable contributions for churches and religious organizations while others only exempt churches and their integrated auxiliaries. For example, New York exempts all corporations organized under the Religious Corporations Law, other religious organizations, and charities and organizations operated, supervised, or controlled by or in connection with a religious organization.[12] By contrast, West Virginia exempts only churches, synagogues, associations or conventions of churches, religious orders or religious organizations that are an integral part of a church which qualify as tax exempt under IRC 501(c)(3) and are exempt from filing an annual information return with the IRS.[13]

[1] “Church” includes similar institutions of all faiths, including temples, mosques, synagogues, etc. Also, unless otherwise stated, for purposes of this article, “church” includes “integrated auxiliaries” and a “conventions or associations of churches.” An “integrated auxiliary” of a church is a public charity affiliated with a church and that receives financial support primarily from internal church sources as opposed to public or government sources. Common examples are men’s and women’s organizations, seminaries, mission societies and youth groups.

[2] The full list of characteristics includes (1) a distinct legal existence; (2) a recognized creed and form of worship; (3) a definite and distinct ecclesiastical government; (4) a formal code of doctrine and discipline; (5) a distinct religious history; (6) a membership not associated with any other church or denomination; (7) ordained ministers ministering to its congregation; (8) ordained ministers selected after completing prescribed studies; (9) a literature of its own; (10) established places of worship; (11) regular congregations; (12) regular religious services; (13) schools for the preparation of its ministers; (14) and schools for the religious instruction of the young. The organization must demonstrate that, on balance, it has the characteristics of a church. In making its determination, the IRS does not evaluate the content of a church’s professed beliefs as long as those beliefs are sincerely held and not illegal or against public policy.

[3] 26 U.S.C. 6033(a)(1).

[4] 26 U.S.C. 6033(a)(3)(A)(i).

[5] 26 U.S.C. 3306(c)(8).

[6] This term includes members of clergy of all religions and denominations (e.g., priests, rabbis, imams, etc.).

[7] 26 U.S.C. 1402(c), 3121(b)(8)

[8] 82 Fed. Reg. 47812 (2017). See also, Little Sisters of the Poor Saints Peter Saints Peter and Paul Home v. Pennsylvania, Doc. No. 19-431 (U.S. July 8, 2020) (court held the Departments of Health and Human Services, Labor, and the Treasury had the authority under the ACA to promulgate the religious and moral exemptions, and they promulgated those exemptions consistent with the manner required under the Administrative Procedure Act).

[9] RPTL §420-A.

[10] N.Y. Tax Law §1116(a)(4).

[11] Miss. Code Ann. §27-65-19(1)(a)(ii).

[12] N.Y. Executive Law §172-a(1).

[13] W. Va. Code, § 29-19-6(5).

The post What is the Difference between a Church and a Religious Organization? first appeared on Perlman Sandbox.

The PPP loan application requires applicants to make the following certification: “Current economic uncertainty makes this loan request necessary to support the ongoing operations of the Applicant.” The Small Business Administration (SBA) has stated that this certification must be made in good faith and take into account the applicant’s “current business activity and their ability to access other sources of liquidity sufficient to support their ongoing operations in a manner that is not significantly detrimental to the business.”

The SBA has indicated that loans made over $2 million are likely to be audited.  In that event, there is the possibility that organizations with large endowments which obtained PPP loans of over $2 million end up being subject to civil and criminal penalties.

The SBA has created a safe harbor regarding the certification if the loan was under $2 million.  This means the SBA will assume the certification was made in good faith.  However, organizations with endowments, especially those with seven to ten figure endowments, may run the risk of serious harm to their reputation from constituents and the press.

The post Charities with Large Endowments May Face Government and Public Scrutiny for Taking PPP Loans first appeared on Perlman Sandbox.