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.

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.

Virtual currency is gaining mainstream attention with each passing day. Nonprofits such as the American Red Cross, UNICEF, and American Cancer Society leverage platforms including The Giving Block and other services to accept a wide range of virtual currencies, as part of their overall fundraising strategies.

At our firm, we continue to work with nonprofit clients as they consider whether and how to fundraise using cryptocurrency. Here are a few questions we have been asked and other questions charities should be asking of potential fundraising platform partners.

Frequently Asked Questions

Should we accept virtual currency?

For many organizations, this is an easy answer – yes. There are few risks to accepting donations of virtual currency, especially if nonprofits immediately liquidate those donations.  Donors of virtual currency typically skew younger, possibly opening up a new demographic of supporters for the organization. The board should consider including virtual currency in its Gift Acceptance Policy, a document every organization should have to guide its board, executives, and staff in their development work.

Should we immediately liquidate donations of virtual currency, or hold onto them?

This is more difficult to answer, as it is based on how much risk the organization can tolerate. Virtual currency is highly volatile – its value can skyrocket or plummet within a matter of hours or days, making it a risky asset to hold onto. Whether to hold onto virtual currency is a decision that should be made with the input of a nonprofit’s board and executive team. If virtual currency is held as part of the organization’s investments, or if a donor asks the organization to hold the virtual currency as an endowment or long-term investment, the organization should consider how that fits within the organization’s overall investment strategy and portfolio, and the applicability of state laws governing the prudent management of institutional funds/assets.

One concern is volatility – few organizations want to see their donations halve in value. For many organizations, the potential upside isn’t worth the potential risk.

A second concern is regulatory risk. As the Chinese central bank, SEC, FINCEN, IRS, and other domestic and international regulators grapple with how to regulate virtual currency, the liquidity and accessibility of virtual currency markets is up in the air. Even major players like Coinbase and Ripple have been subject to or threatened by regulatory action.

Charities are often cautious when holding virtual currency, concerned that the regulatory environment could shift in a way that devalues or freezes their holdings. If a nonprofit is using a virtual currency account on a platform that is subject to an SEC action, for instance, the platform might be forced to freeze transactions until such time as the SEC allows it to continue operations.

Organizations that are highly diversified and have the financial cushion to absorb a zeroing out of their virtual currency donations, taking into account the diversification of risk across the organization’s entire investment portfolio,  might be comfortable with the risks of virtual currency. The potential upside of assets like Bitcoin are hard to ignore – despite volatility, Bitcoin’s value has been on a consistent march upward. Other coins, like Ethereum, have not been far behind. If your organization is willing to take the risk, and has considered the prudent investment regulatory considerations, you can create a wallet at a prominent, legally-compliant platform, and park your virtual currency there and “Hold On for Dear Life” (HODL, as some in crypto-world like to say).

Fortunately, the major virtual currency fundraising platforms allow immediate liquidation of donations. Again, this is the option chosen by most nonprofit organizations. As I mentioned above, nonprofits should include virtual currency in their Gift Acceptance Policy and Investment Policy to help guide their development professionals as they consider whether and how to accept virtual currency donations.

How do we treat virtual currency for accounting purposes?

Despite continued regulatory action in other parts of the crypto market, IRS rules around donations of virtual currency have been relatively stable. Since 2014, the IRS has been clear that virtual currency should be treated as property. A taxpayer donating virtual currency they have held for more than a year may deduct the fair market value of the currency at the time of its donation, similar to other forms of property, such as publicly-traded stocks. This provides a tax benefit to donors who invested in virtual currency in its infancy – they can support their favorite charities without being taxed on the gains they’ve enjoyed on paper.

This consistent treatment from the IRS means that charities can rest assured that they can accept virtual currency in the same way that they can accept donations of appreciated stock or other forms of property. The accounting department or external accountants should be able to handle booking donations of virtual currency without much trouble. A caveat is that, in a nonbinding FAQ, the IRS has said that nonprofits must fill out Form 8282 whenever the nonprofit sells, exchanges, or otherwise disposes of its virtual currency. This is a departure from the IRS’s treatment of virtual currency as akin to stocks, which a nonprofit can sell without filing Form 8282. While not insurmountable, nonprofits and their fundraising platforms should discuss how to operationalize capturing the information required for filing Form 8282.

Questions to Ask a Fundraising Platform

Now that we have considered some of the frequent questions nonprofits ask their advisers, let’s consider questions nonprofits should ask a prospective fundraising platform as part of their due diligence.

Are you registered as a professional fundraiser?

Fundraising is regulated in most states, with each state using its own regulatory regime. Individuals and organizations that support charities are often subject to laws regulating charitable solicitation (here’s an excellent overview from my colleague Tracy Boak). Charities are affected by these regulations and are obliged to make sure they only partner with organizations that are properly registered and licensed, if required.

Many fundraising platforms (both traditional and those dealing with virtual currency) take the position that they are not professional fundraisers, due to the way they structure their platforms and services, e.g., because they don’t affirmatively solicit donations on behalf of any charity and don’t take custody of donations. Regardless, a platform should be able to tell you why it isn’t subject to fundraising registration requirements. By asking the question, nonprofits can rest assured their fundraising platform partner is on top of its compliance obligations.

Are you registered as a Money Service Business or Money Transmitter?

Money Service Business (MSB) and Money Transmitter (MT) regulations are implemented at the federal and state levels. Their purpose is to weed out fraud and money laundering in the money transmission business. Generally speaking, MSB and MT laws create licensing structures that require licensed entities to do some due diligence on their customers, including “KYC” (know your customer) and “AML” (anti-money laundering) requirements.

Since 2013, the Financial Crimes Enforcement Network (FinCEN) has applied money transmitter regulations to some entities within the virtual currency ecosystem. According to FinCEN, if a person or organization accepts money or another instrument with monetary value from one person and transmits it to another person, that person may be classified as a money transmitter under federal regulations. (A comprehensive rundown of FinCEN’s guidance is found here). This means that any entity that accepts virtual currency from one party and transmits it to another party could be considered a money transmitter subject to the federal rules. The same rules apply if the entity accepts virtual currency, converts it to fiat currency (i.e., U.S. dollars), and transmits the fiat currency to another person or entity.

FinCEN does provide some exceptions, including those entities that only provide network access or serve as payment processors, exceptions which largely do not apply to crypto-fundraising. Whether a person or entity will be treated as a money transmitter is a facts-and-circumstances determination, but FINCEN clearly intends to define money transmission broadly and interpret its exceptions narrowly (see the discussion on pages 12-22 of the guidance linked above).

Nonprofits considering crypto-fundraising options should ask the potential partner whether it is registered as a money transmitter. If not, ask how they ensure that their services aren’t used inappropriately – do they work with a partner that is a licensed entity? Who does their KYC and AML compliance work?

Do you accept anonymous donations?

Anonymous donations are nothing new – charities have received anonymous donations large and small since long before the birth of cryptocurrency. But many charities are wary of the “dark side” of cryptocurrency and its reputation (rightly or wrongly earned) for facilitating illicit activity. Nonprofits should check with their potential fundraising platform to confirm whether they allow anonymous donations. If so, ask whether the donations are anonymous to the platform, or only to the charity. If the donation is anonymous to the platform, ask whether and how the platform ensures the anonymous donations aren’t connected with illicit activity. The answer may be that the platform does not, or cannot, do anything else to ascertain the identity of donors who wish to remain anonymous. If that is the case, the nonprofit should consider whether it is comfortable with the risks of accepting anonymous donations.

Those risks are generally the same as accepting any other high-value anonymous donation – that a donation of virtual currency could be traced back to illicit activity or a potential clawback, if the virtual currency that is donated doesn’t belong to the donor.  One difference with anonymous donations of cash or other types of property is that the virtual currency environment is highly transparent, even if it may be highly anonymized. Bitcoin transactions are viewable on the blockchain, even if the participants in the transactions may remain anonymous.

Do you issue donation receipts? Do you fill out Form 8282? Will we get a donor list?

One of the core tasks in charitable fundraising is issuing receipts to donors. Donors need to keep those receipts on file, in case they want to claim a charitable deduction. Many platforms will create automatic receipts. Nonprofits should confirm that the receipts issued by its platform partners are compliant with IRS requirements, and ask for copies for your records.

Nonprofits should also ensure that the fundraising platform will provide you with a list of your donors, to make sure you can build out your donor base.

The post What Nonprofits Should Be Asking About Virtual Currency Regulation and Fundraising 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.

What is a fiscal sponsorship?  A fiscal sponsorship generally refers to a contractual arrangement in which one entity that is a 501(c)(3) tax-exempt organization (the “fiscal sponsor”) serves as the fiscal and legal “host” of a charitable project.  While the term fiscal sponsor is not officially defined in the federal tax code, the IRS has generally approved of the function of fiscal sponsors. The critical requirement is that the fiscal sponsor must retain the legal right to ensure that the project funds are used to accomplish the tax-exempt purposes of the sponsored project.

Benefits of a Fiscal Sponsorship

There are many benefits to using a fiscal sponsorship to conduct a charitable project. Here are a few key reasons that frequently drive the decision to set up a fiscal sponsorship.

1. Ability to receive tax-deductible contributions. Donors will only receive a charitable tax deduction for financially supporting the project if the legal recipient of the donation is a 501(c)(3) tax-exempt organization.  A fiscal sponsor’s tax-exempt status and role as the legal fiduciary of the donated funds qualify them as tax-deductible.  Tax-deductible contributions, whether from the project organizer or from the public, are typically critical to funding the requirements of the project.
2. Piloting an innovative new program. Project organizers often seek to test a new approach to solving an issue, but are uncertain whether the project will have long-term viability and be worth the time and money it takes to establish a nonprofit organization.  A fiscal sponsorship can provide a convenient vehicle to pilot the project more quickly and at less cost than setting up a new tax-exempt entity.
3. Receiving the legal, financial, and administrative support of a fiscal sponsor. A fiscal sponsor takes on the legal responsibility for the funds raised. In the Direct Project Model (discussed below), it also takes on all of the legal obligations of the project. Having the benefit of a fiscal sponsor’s team to handle the legal, financial and administrative aspects of the project can allow the project organizers to focus on fundraising and implementation of the program.
4. Temporary fiscal sponsorship while awaiting independent 501(c)(3) tax-exempt status. Some organizations decide to enter into a fiscal sponsorship while their tax-exempt application is pending review. This allows them to begin receiving tax-deductible donations for the project much sooner. As of August 19, 2021, the IRS website says that applications postmarked after January 15, 2020 have not yet been assigned for review.  That seven-month queue doesn’t include the additional time needed for review once the application is assigned.  Although expedited application processing is available under limited circumstances, there is no guarantee that it will be granted.  Setting up a fiscal sponsorship may take time as well, but generally should not take as long as the IRS tax-exempt application review process.

What are the Roles and Responsibilities of a Fiscal Sponsor?

1. Project selection responsibilities
   1. Mission fit. The fiscal sponsor must ensure that any project it sponsors is consistent with, and within the scope of, the fiscal sponsor’s legal and tax-exempt mission and purposes. For example, a fiscal sponsor whose legal purposes are focused on environmental conservation will generally only take on projects that are consistent with that core mission.
   2. Written fiscal sponsorship agreement. The terms of the relationship between the fiscal sponsor and the sponsored project should be clearly outlined in a written agreement detailing the terms and expectations of the parties. Key terms include: (1) the duration of the fiscal sponsorship; (2) a clear description of the project; (3) fiscal sponsorship service fees, if any; (4) confirmation of which party will be responsible for key compliance obligations on behalf of the project; (5) the timing and process for distributing funds to, or using funds for, the sponsored project; (6) ownership of intellectual property; and (7) a clear outline of how the project will be transitioned at end of the relationship.
2. Financial responsibilities
   1. Use of project funds. The fiscal sponsor should only utilize funds raised for the project for the stated charitable purposes of the project.
   2. Donation tax receipts. The fiscal sponsor is responsible for issuing tax receipts to all donors in accordance with applicable law.
3. Legal oversight responsibilities
   1. Compliance with laws. The fiscal sponsor should comply with all applicable federal, state, and local laws and regulations. This includes annually filing its Form 990 with the IRS, and maintaining its registration with applicable state charity regulatory agencies, based on where the fiscal sponsor (including all of its projects) are operating and soliciting charitable contributions.  Project organizers should ensure that they select a fiscal sponsor that is aware of and willing to comply with all of the compliance requirements necessary to support the needs of the project.

What are the Most Common Types of Fiscal Sponsorships?

The two most common types of fiscal sponsorships are the Direct Project Model and the Pre-Approved Grant Model.

Direct Project Model:  In this model, the project has no separate legal existence from that of the fiscal sponsor.  That said, the fiscal sponsorship agreement outlines how the fiscal sponsor provides ultimate oversight of the project, in accordance with its fiduciary duties, while delegating the day-to-day operation of the project to the project organizers.  All revenues/expenses and assets/liabilities of the project are attributed to the fiscal sponsor, and are incorporated into the fiscal sponsor’s financial reports, and all legal compliance obligations (e.g., federal and state compliance filings; execution of contracts; hiring of employees) are undertaken by the fiscal sponsor.  Project organizers should consider whether the fiscal sponsor has appropriate insurance policies reflective of the activities and risks associated with the project (e.g., employer practices liability insurance; cybersecurity insurance).

Pre-Approved Grant Model: In this model, the fiscal sponsor is the legal recipient of all donations in support of the project, and issues donation tax receipts to the project donors.  The fiscal sponsor distributes the funds raised as a grant to a separate project grantee.  The fiscal sponsor must pre-determine that the project grantee, a separately incorporated entity lacking 501(c)(3) tax-exempt status, is an appropriate recipient of grant funds to carry out the purposes of the project.  Once funds have been raised for the project, the fiscal sponsor grants the funds to the project grantee, pursuant to certain oversight requirements.  For example, the project grantee must provide reports to the fiscal sponsor on how granted funds have been used in furtherance of the charitable purposes of the project.  This model is often used by organizations that are in the process of applying to the IRS for 501(c)(3) tax-exempt status.

Beginning at the End

While the start of a new project is exciting, one of the most important steps in selecting a fiscal sponsor is to plan for the end of the relationship.  The fiscal sponsorship agreement should outline a clear process for the project to be transitioned to a successor tax-exempt organization (including a newly formed organization whose 501(c)(3) tax-exempt status has been approved), subject to the fiscal sponsor’s ultimate discretion to ensure that the successor is capable of carrying out the project.

[1] For many people who have a long-term vision for their charitable program, the best approach may be to set up your own separate tax-exempt organization. An FAQ on setting up a new nonprofit organization is available here.

The post Should We Use a Fiscal Sponsorship for our Charitable Project? first appeared on Perlman Sandbox.

This article answers five key questions about private operating foundation status that can help philanthropists determine if it is the right tax-exempt vehicle for their charitable objectives, including:

• What are the key characteristics of a private operating foundation?
• How does private operating foundation status differ from public charity status and private non-operating foundation status?
• What are the financial tests that must be met in order to maintain private operating foundation status?
• What expenditures are considered “directly for the active conduct of” an operating foundation’s tax-exempt activities?
• What if the organization meets the private operating foundation tests initially, but fails to meet it in a given future year?

(1)  What are the key characteristics of a private operating foundation?

A private operating foundation is a 501(c)(3) tax-exempt private foundation that devotes most of its resources (i.e., earnings and/or assets) toward the active conduct of its tax-exempt activities.  More specifically, a private operating foundation is any private foundation that spends at least 85 percent of its adjusted net income or its minimum investment return (whichever is less) directly for the active conduct of its exempt activities – this is known as the income test.  In addition to meeting the income test, the foundation must also meet one of the following tests: (1) the assets test; (2) the endowment test; or (3) the support test. Questions 3 and 4 of this blog post explain these requirements in greater detail.

A private operating foundation is a type of private foundation because it is funded by one or a few sources, however, since it operates more like a public charity (e.g., by conducting programs rather than focusing primarily on grantmaking), the Internal Revenue Code treats the organization partly like a private nonoperating foundation and partly like a public charity.

When seeking 501(c)(3) tax-exempt status, the default classification is that of a private non-operating foundation. Non-operating foundations must distribute a certain amount of their assets annually to support charitable purposes, but those distributions can be solely in the form of grants to other charitable organizations. Organizations seeking private operating foundation status must affirmatively explain or demonstrate to the IRS at the time of applying for tax-exempt status that they meet or will meet the requirements of private operating foundation status, and must annually provide financial disclosures to the IRS demonstrating that they continue to meet those requirements.[2]

(2)  How does private operating foundation status differ from public charity status and private non-operating foundation status?

Private operating foundations are subject to a number of the same regulations as public charities on a few key matters, which are generally more favorable than the rules applicable to non-operating foundations:

• Greater tax-deductibility of donations than non-operating foundations: Private operating foundations are subject to the more generous donation deductibility limits applicable to public charities (whereas donations to non-operating foundations have lower deductibility limits). Because wealthier donors are sensitive to the deductibility cap, the more generous tax-deductibility limits available to private operating foundations is typically the primary motivation for founder-philanthropists to seek private operating foundation status over non-operating foundation status.
  • Like public charities, cash contributions to operating foundations are deductible up to 60%[3] of a taxpayer’s adjusted gross income (“AGI”) (compared with 30% for non-operating foundations).
  • Like public charities, donations of long-term capital gain property (e.g., artwork; real property) to operating foundations are deductible up to 30% of the taxpayer’s AGI (compared with 20% for non-operating foundations).[4] In addition, the deduction for long-term capital gain property for an operating foundation is typically based on the fair market value of the property on the date of the contribution, whereas for non-operating foundations, the deduction for long-term capital gain property (other than qualified appreciated stock) is deductible only to the extent of the donor’s tax basis in the property.
• Differing requirements with respect to annual distributions: Private nonoperating foundations are required to make “qualifying distributions” (most typically in the form of charitable grants) each year equal to at least five percent (5%) of the fair market value of the foundation’s assets.[5] Non-operating foundations are subject to a tax on their failure to distribute income as “qualifying distributions.” Private operating foundations are subject to a different “qualifying distribution” requirement — they are required to devote most of their resources to the active conduct of tax-exempt activities (instead of through grantmaking), as further discussed in Question 3, below.
• Private operating foundations can obtain grants from private non-operating foundations more easily than non-operating foundations: The federal tax laws make it easier for an operating foundation to receive grants from a non-operating foundation compared to a non-operating foundation grantee.[6]  As such, this more favorable treatment of grants to operating foundations than non-operating foundations is a distinct advantage of operating foundation status over non-operating foundation status.  This benefit might not be that important to all operating foundations because many (and perhaps most) operating foundations are fully funded by their founder(s), and as such, may not be seeking external funding.

Now that we’ve reviewed some of the key “advantages” of private operating foundation status, we should also recognize that operating foundations are still subject to many of the stricter tax regulations applicable to all private foundations, which are not applicable to public charities.  The penalties for violating these rules are in the form of tax penalties.  In some cases, those penalties are significant enough that the restricted activities are effectively viewed as prohibited.  Private foundations (including both operating and non-operating foundations) are subject to the following taxes:

• Taxes on Self-dealing: The taxes on self-dealing are designed to prevent “disqualified persons” (e.g., directors, officers, and managers of the foundation, and their related businesses and family members) from benefiting personally from any transactions that the foundation engages in.[7]
• Taxes on Excess Business Holdings: A significant tax is assessed against any private foundation where the combined holdings of the private foundation and all of its disqualified persons exceeds 20 percent of the voting stock in a business enterprise that is a corporation.[8]
• Taxes on Jeopardizing Investments: Certain excise taxes are imposed on foundations that engage in risky investments, with the goal of discouraging such investments, which may detract from a foundation’s ability to further its charitable purposes.
• Tax on Net Investment Income: Operating foundations are subject to the tax on net investment income and to the other requirements and restrictions that gener­ally apply to all private foundations. [9]
• Taxes on Failure to Distribute Income (generally, grants): As discussed earlier, non-operating foundations that fail to distribute the required annual minimum qualifying distributions are subject to a tax. However, the types of distributions that constitute “qualifying distributions” differ for operating vs non-operating foundations.

(3)  What are the financial tests that must be met in order to maintain private operating foundation status?

To obtain and maintain private operating foundation status, operating foundations must meet a combination of financial tests on an ongoing basis, explained further below.

(Mandatory) Income Test

The one universal requirement applicable to every private operating foundation is that it must spend at least 85% of its adjusted net income or minimum investment return, whichever is less, directly for the active conduct of its exempt activities. This is known as the “income test.”

In addition, all operating foundations must also annually meet one of the following three financial tests: (1) the assets test, (2) the endowment test, or (3) the support test.  These three tests reflect different approaches by which a foundation can devote most of its resources towards the active conduct of its tax-exempt activities.

(a)  Assets Test: A foundation will meet the assets test if at least 65% of its assets:

1. Are devoted directly to the active conduct of its exempt activity, a functionally related business, or a combination of the two,
2. Consist of stock of a corporation that is controlled by the foundation (by ownership of at least 80% of the total voting power of all classes of stock entitled to vote and at least 80% of the total shares of all other classes of stock) and at least 85% of the assets of which are so devoted, or
3. Are any combination of (1) and (2).

Example: Assets such as real property, physical facilities or objects (such as museum artwork that is publicly displayed, classroom fixtures, and research equip­ment) and intangible assets (such as patents, copyrights, and trademarks) are directly de­voted to the extent they are used by the founda­tion in directly carrying on its exempt activities or program. Museums and research organizations are likely to meet the Assets Test.

(b)  Endowment Test: A foundation will meet the endowment test if it normally distributes at least two-thirds of its annual minimum investment re­turn for the active conduct of its exempt activities

Example: An organization whose founder funds the foundation with a significant endowment in the form of cash as well as stocks or other investments held primarily for the production of income, is likely to meet the Endowment Test.

(c)  Support Test: A private foundation will meet the support test if: (1) at least 85 percent of its support (other than gross investment income) is normally received from the general public and 5 or more unrelated exempt organizations; (2) not more than 25 percent of its support (other than gross investment income) is normally received from any one exempt organiza­tion; and (3) not more than 50 percent of its support is normally received from gross investment income.

Example: This test is used by operating foundations that are funded by fairly diverse sources of support (including at least five unrelated exempt organizations) rather than just by their founder-donor, but whose funding sources may not be diverse enough to consistently meet the public support tests required for public charity status. This is the least used financial test for meeting private operating foundation.

To qualify as an operating foundation in a given tax year, a foundation must meet the income test and either the assets, endowment, or sup­port test for any three years during a four-year period (“three-out-of-four-year method”), or based on a combination of all pertinent amounts of income or assets held, received, or distributed during the four-year period (“four-year combination method”). The four-year period consists of the tax year in question and the three years immediately preceding that year.

(4)  What expenditures are considered “directly for the active conduct of” an operating foundation’s tax-exempt activities?

Let’s look more closely at the principle that private operating foundations must devote most of its resources “directly for the active conduct of the activities” constituting the foundation’s tax-exempt purposes.  The following are examples of expenditures that would be considered “directly for the active conduct of the” foundation’s tax-exempt activities:

• Amounts paid to buy or maintain assets used directly in the conduct of the foundation’s exempt activities, e.g., the operating assets of a museum, public park, or historic site.
• Pro rata allocations of staff compensation, travel, overhead costs (office space, supplies) based on a reasonable allocation of use towards direct program activities.
• An amount set aside by a foundation for a specific project, e.g., to buy and restore or build buildings/facilities to be used by the foundation directly for the active conduct of the foundation’s exempt activities, if the set-aside meets certain requirements.

Under certain circumstances, payments or grants to individuals (including scholarships) made in conjunction with ongoing supervision by the foundation and certain grantee reporting requirements may qualify as “active conduct” expenditures.  If a foundation awards grants or scholarships, or makes other payments to individuals (including program-related investments[10], such as to support active programs to carry out its exempt purpose, the payments will be treated as qualifying distributions made directly for the active conduct of exempt activities only if the foundation maintains some significant involvement in the programs. Whether the foundation is considered to maintain significant involvement sufficient for these grants to individuals to be treated as “active conduct” expenditures depends on the facts and circumstances in each case.

Examples of “significant involvement” in a program involving grants to individuals include: (1) a grant program in which the recipients, in addition to independent study, attend classes, seminars, or conferences sponsored or conducted by the foundation, or (2) a grant to engage in social work or scientific research projects which are under the general direction and supervision of the foundation.

If, however, a foundation’s role in the grant process is limited to selecting, screening, and seeking out applicants for grants or scholarships, pursuant to which the recipients perform their work or studies alone or exclusively under the direction of some other organization, such grants or scholarships will not be treated as expenditures made directly for the active conduct of the foundation’s exempt activities.

(5)  What if the organization meets the private operating foundation tests initially, but fails to meet it in a given future year?

For any year in which a foundation that has been approved as qualifying for private operating foundation fails to meet the income test and one of the other three tests in a given tax year, the foundation must report as a non-operating foundation on its Form 990-PF.

The deductibility of contributions to an operating foundation will not be affected until notice of a change in the status of the foundation is made to the public (such as by publication in the Internal Revenue Bulletin), unless, at the time of the contribution, the donor was aware that the IRS would remove the foundation’s operating foundation status, or the donor was responsible for, or was aware of, the act or failure to act which caused the foundation to be unable to qualify as an operating foundation.

[1] Philanthropists who do not have the time, interest, or intention to conduct direct programmatic activities on a continuous basis may find it more appropriate to establish a non-operating foundation or even a donor-advised fund. Note that private non-operating foundations can also conduct direct charitable activities, but are not required to do so.

[2] Public charities must also demonstrate to the IRS that they are not a private foundation, but that is not the subject of this article.

[3] The limitation was previously 50% of AGI, but the limit was temporarily raised to 60% as part of the Tax Cuts and Jobs Act of 2017 through January 1, 2026, but was increased to 100% of AGI for 2020 and 2021 under the CARES Act.

[4] 26 U.S.C. § 170(b)(1)(B). The deduction for long-term capital gain property is typically based on the fair market value of the property on the date of the contribution.

[5] 26 U.S.C. § 4942.

[6] A grant by a non-operating foundation to an operating foundation counts towards the non-operating foundation’s annual minimum qualifying distribution requirement, whereas a similar grant to a non-operating foundation generally would not.  26 U.S.C. § 4942. Note, however, that a non-operating foundation must still exercise expenditure responsibility with respect to grants to most operating foundations, whereas it would not have to do so for grants to public charities.

[7] See IRC §4941. The following transactions are generally considered acts of self-dealing between a private foundation and a disqualified person: (1) sale, exchange, or leasing of property; (2) leases; (3) lending money or other extensions of credit; (4) providing goods, services, or facilities; (5) paying compensation or reimbursing expenses to a disqualified person; (6) transferring foundation income or assets to, or for the use or benefit of, a disqualified person; and (7) certain agreements to make payments of money or property to government officials.

[8] The rules governing excess business holdings were designed to prevent individuals from retaining control of businesses by transferring a significant amount of ownership in the businesses to their private foundation.

[9] Effective January 1, 2020 following enactment of new legislation, the net investment income tax applicable to private foundations is a flat, one-tier rate of 1.39%. This is not an excise tax aimed at restricting any type of transaction, like some of the other taxes, but is simply applicable to all private foundations.

[10] An example of a program-related investment that can constitute the “active conduct of” an operating foundation’s exempt purposes is a low-interest loan program designed to stimulate the local economy and create jobs in an economically depressed area, where the foundation has significant involvement in the form of staff who design, implement, and supervise the program, and the provision of technical assistance and training to borrowers. In that case, the loan funds as well as the expenses of conducting such program would be considered qualifying distributions for the active conduct of the operation foundation’s exempt purposes. See, e.g., PLR 9826048.

The post Private Operating Foundations: An Option for Hands-On Philanthropists 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 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.

That means that organizations and companies that choose to take this payroll tax deferral would then withhold additional amounts from those affected employees’ paychecks from January 1, 2021 through April 30, 2021 to repay that deferred tax obligation.  The payroll tax deferral would not excuse the requirement of payment of such taxes. Additionally, the deferral is not retroactive meaning that an employer may only defer payment of taxes prospectively through December 31, 2020 (it may not include deferral of taxes or reimbursement of taxes to employees that were already withheld starting September 1).

There remain questions about the legality of President Trump’s memorandum in the absence of approval from Congress which constitutionally holds the power over the federal “purse strings”— to tax and spend public money for the national government. Although the Internal Revenue Service (IRS) issued guidance on August 28, 2020 (Notice 2020-65), employers are still awaiting further IRS guidance regarding how the deferral would be implemented, including whether (or how) an employee’s obligation to pay those deferred taxes or an employer’s obligation to withhold will be forgiven in the absence of Congressional approval, written confirmation that the choice of whether to implement deferrals rests with the employer, not the employee, and employer obligations with respect to such taxes if an employee is no longer employed with that employer at the time that repayment is due.

The payroll tax deferral is simply a deferral, not a forgiveness of taxes.  If an employer does not pay the deferred payroll tax to the IRS by April 30, 2021, it could potentially be liable for penalties, interest and late fees.

Organizations should confer with their legal counsel and accountant before deciding to defer payroll tax withholding and to discuss structuring any agreements with affected employees concerning repayment if those organizations do decide to defer payroll tax withholdings.

The post Employee Payroll Tax Deferral Causes Confusion and Uncertainty for Employers first appeared on Perlman Sandbox.