I. State statutes governing contests in general

State laws regulating contests are found in Bus. & Prof. Code § 17539 et seq.  Section 17539.3 grants an exemption to some tax-exempt nonprofits. However, it is recommended that a nonprofit use these rules as a guideline when designing and publicizing a contest to help avoid violating false advertising and unfair trade practices laws.

The following summary is adapted from the CA Department of Consumer Affairs: Rules for Operation of Contests and Sweepstakes, available at: http://www.dca.ca.gov/publications/legal_guides/u-3.shtml

Generally, rules governing contests are found in CA. Bus. & Prof. Code 17539-17539.3, 17539.35.

A “contest” is any game, puzzle, scheme, or plan which offers prospective participants the opportunity to receive or compete for gifts or prizes on the basis of skill and/or chance, and which is conditioned on some payment of value.

The law requires every person who conducts a contest to disclose on each entry blank the submission deadline.

All contest and promotional puzzles and games must clearly and conspicuously include the following:

•           Contest description, number of anticipated contestants, and the nature and value of the prizes.

•           All the rules, regulations, terms and conditions of the contest.

•           The maximum number of puzzles or games which may be necessary to complete the contest and determine winners.

•           The maximum amount of money, including postage and handling fees, which a participant may be asked to pay to win each of the prizes offered.

•           The date(s) upon which the contest will terminate, and upon which all prizes will be awarded.

•           Whether future contests or tie-breakers, if any, will be significantly more difficult than the initial contest, and the method of determining prize-winners if a tie remains after completion of the last tie-breaker.

Misrepresenting in any manner the odds of winning any prize is prohibited. All prizes of the value and type represented must be awarded and distributed. The opportunity to win a prize cannot be conditioned on a minimum number of entries or contest participants.

Also, the contest sponsor must retain for at least two years following the completion of a contest the following information:

(1) Copies of all contest solicitations and puzzles.

(2) All puzzles and correspondence sent by a contestant or copies or records disclosing details thereof and records of replies thereto.

(3) Adequate records which disclose the names and addresses of all contestants, the approximate date each contestant was sent each puzzle or game, the number of prizes awarded, the method of selecting winners, the names and addresses of the winners, and facts upon which all representations or disclosures made in connection with the contest are based and from which the validity of the representations or disclosures can be determined.

II. Deceptive Mail Prevention and Enforcement Act (39 U.S.C. 3001 et seq)

•   Federal statute that regulates advertisements sent through U.S., including contest materials.

•   Requires the contest sponsors to disclose in a clear and conspicuous way:

•           the terms, rules and conditions of the contest.

•           how many rounds of the contest you must achieve to win the grand prize.

•           the time frame for the winner to be determined.

•           the name of the contest’s sponsor.

•           an address where you can reach the sponsor to request that your name be removed from the mailing list.

•           Mailings for skill contests or promotions must:

1.        State all terms and conditions, including rules and entry procedures in language that is easy to find, read and understand and;

2.        Provide a name and the business address where the sponsor can be contacted.

•           Skill contest mailings must disclose:

3.        The number of rounds or levels of the contest and the cost to enter each level;

4.        Whether subsequent rounds will be more difficult to solve;

5.        The maximum cost to enter all rounds;

6.        The estimated number or percentage of entrants who may win, or have won the sponsor’s last three contests;

7.        Qualifications of the judges if the contest is not judged by the sponsor;

8.        The method used in judging and;

9.        The date prizes will be awarded, how many, the nature and estimated value of each prize, and the payment schedule.

•           Ads for sweepstakes, skill contests, and facsimile checks that appear in magazines, newspapers and other periodicals can be mailed as long as the advertisements are not personalized and do not offer a way to make a payment or order a product or service.

About a quarter of the non-profit sector just got another chance.   The IRS is providing one-time relief that will allow small exempt organizations to come back into compliance and retain their tax-exempt status even though they failed to make required annual filings for three consecutive years.   This one-time relief benefits Form 990-N (e-Postcard) and Form 990-EZ filers only.

When a tax-exempt organization that is required to file an annual return (e.g., Form 990) or submit an annual electronic notice to the IRS does not do so for three consecutive years, the organization automatically loses its federal tax exemption.  On April 22, the New York Times reported that as many as 25% of existing tax-exempt organizations were at risk of losing their exempt status because they had failed to make their annual filing.  This situation apparently developed because many managers of small organizations overlooked a change in the law.   In the past, organizations with gross annual revenues under $25,000 were exempt from annual filing requirements. The Pension Protection Act of 2006 imposed a new requirement that they make a brief electronic annual filing on From 990-N, also called the e-postcard.  http://www.irs.gov/charities/article/0,,id=169250,00.html

The IRS website has a list of organizations at risk of losing their tax-exempt status because, according to IRS records, they have not filed for 2007, 2008 and 2009. The list contains the name of the organization and its last-known address. Check this list to see whether your organization is at risk of automatic revocation and can avoid this consequence by following IRS guidance.  If an organization loses its exemption, it will have to reapply to regain its tax-exempt status. Any income received between the revocation date and renewed exemption may be taxable.

Note: The IRS website warns that the list may be incomplete, and the list may include organizations that were required to file Form 990 or Form 990-PF and are not eligible for the relief program.

Although raffles can be a great fundraising opportunity for some nonprofits, most states consider raffles to be a type of illegal gambling. Many states, including California, carve out an exception for nonprofits. The following is a brief summary of the California exception.

Charitable Raffles in California

California Penal Code section 320.5 carves out an exception to the general prohibition against gambling in California. This exception allows “eligible organizations” to “conduct raffles for the purpose of directly supporting beneficial or charitable purposes or financially supporting another private, nonprofit, eligible organization that performs beneficial or charitable purposes if the raffle is conducted in accordance with this section.”

Definition of an eligible organization

Generally, an eligible organization is a private nonprofit organization that is exempt from California income tax and has been qualified to conduct business in California for at least one year prior to conducting a raffle.

Definition of a raffle

A raffle is a scheme to distribute prize(s) by chance among people who purchase paper tickets that provide the opportunity to win the prize(s). The paper tickets must have a detachable stub/coupon. Each paper ticket and its corresponding stub/coupon must have a unique and matching identifier. The prizes are awarded by a random drawing from all the purchased tickets; the drawing must be conducted under the supervision of a natural person who is at least 18 years old.

Note: California law prohibits raffles from being operated or conducted over the Internet, although the organization conducting the raffle may advertise the raffle over the Internet. Also, federal law prohibits multi-state raffles, so a nonprofit should only sell tickets inside California.

The 90/10 rule

At least 90 percent of the gross revenue from the sale of raffle tickets must be used to benefit or provide support for beneficial or charitable purposes. “Beneficial purposes” excludes purposes that are intended to benefit officers, directors, or members of the eligible organization. The funds may not be used to fund any beneficial, charitable, or other purpose outside of California.

Registration and reporting requirements

Unless specifically exempted, nonprofits that want to conduct raffles must register with the California Department of Justice. They also have to comply with annual reporting requirements to disclose information such as gross raffle ticket sales, expenses, and how the revenue was spent. Registration and reporting forms are available at http://ag.ca.gov/charities/raffles.php.

Educational institutions, religious institutions, and hospitals are exempt from raffle registration and raffle reporting requirements but must otherwise comply with all the other regulations.

Taxes and withholding

A raffle ticket purchase is not tax-deductible. Prizes are considered taxable income to the winners.

Mailings and advertisements

The Federal Deceptive Mail Prevention and Enforcement Act prohibits deceptive mailing practices for sweepstakes, contests, and raffles. If the nonprofit plans to use the U.S. Postal Service to mail advertisements or raffle tickets, it must comply with this act, which requires certain disclosures on each mailing. When drafting the raffle rules, it is helpful to include these disclosures in the raffle rules. For more information, see http://www.dmaresponsibility.org/Sweepstakes/.

The recently enacted health insurance reform legislation includes a tax credit that helps many small businesses provide coverage for their employees.  Many tax-exempt non-profit organizations can also receive the health care tax credit, although at a reduced level.

To qualify, small businesses and exempt organizations must:

• Have fewer than  25 full-time equivalent (FTE) employees
• Pay average annual wages below $50,000, and
• Cover at least 50% of their workers’ health insurance premium costs.

Small businesses can receive a credit up to 35% of their 2010 employee premium costs.  This amount increases to 50% in 2014.  The non-profit credit starts at 25% in 2010, increasing to 35% in 2014.

The credit is effective January 1, 2010.  Eligible small businesses can claim the credit as part of the general business credit starting with the 2010 income tax return they file in 2011. For tax-exempt employers, the IRS will provide further information on how to claim the credit.

For more information click here.

In a recent Technical Advice Memorandum (TAM), the IRS determined that a major source of revenue for a 501(c)(6) trade association was unrelated business income and therefore taxable.

The trade association’s purpose was to promote a particular sport within a region.  Individuals can only play the sport at sports facilities that charge a fee to play.  The trade association sold discount coupons for use of such facilities.

In the TAM, the IRS listed the requirements for a Section 501(c)(6) organization:

(1)    It must be an association of persons having a common business interest,

(2)    Its purpose must be to promote that common business interest,

(3)    It must not be organized for profit,

(4)    It should not be engaged in a regular business of a kind ordinarily conducted for a profit,

(5)    Its activities should be directed toward the improvement of business conditions of one or more lines of business as opposed to the performance of particular services for individual persons, and

(6)    Its net earnings, if any, must not inure to the benefit of any private shareholder or individual.

The Internal Revenue Code imposes a tax on income to a nonprofit organization derived from any unrelated trade or business regularly carried on.  An unrelated trade or business is any trade or business which is not substantially related to the organization’s exempt purposes.

The trade association argued that the discount coupon program is substantially related to its exempt purposes because it encourages more people to engage in the sport.

The IRS disagreed.  The question turned on whether the sale of coupons promotes general interest and involvement in the sport or if it constitutes the performance of particular services for individual persons or businesses.  The IRS concluded that the sale of coupons only benefited those facilities that chose to participate and not the sport as a whole and therefore the sale of coupons was basically an advertising service for individual businesses.

The IRS states, “Advertising campaigns . . . that name and promote specific businesses rather than the industry as a whole constitute the performance of particular services for individual persons” which is an unrelated trade or business.

We know of many 501(c)(6) organizations that promote their members by maintaining business directories, spotlighting their members on their web sites, etc.  These organizations need to be careful that their activities don’t start to look like the sale of advertising (or else pay tax on the revenue associated with those activities).  (Note that occasional highlighting of members such as for a special event is not a problem because the tax on unrelated business income only applies to a trade or business that is regularly carried on.)

The following are some examples of activities that have been found to be taxable as unrelated business income to a 501(c)(6):

• Advertising of products and services in an association journal, even if those products and services are related to the purpose of the organizations
• Promotions that mention particular businesses
• Promotion of members to the exclusion of non-members in the same industry when members and non-members meet similar standards
• Fee-based services for members and/or non-members that are similar to what might be provided by a commercial business
• Providing discounted parking for patrons of only certain businesses in a downtown area.

The following are some examples of activities that have been found to be substantially related and therefore not taxable as unrelated business income:

• Publication of educational information that incidentally promotes specific businesses
• Providing discounted parking for all visitors to a downtown area
• Sponsorship of tournaments to promote interest in a sport and sale of broadcasting rights to those tournaments
• Promotion of an entire industry or line of business such as Washington apples or the use of plywood as a building material.

Note that a nonprofit can lose its exempt status if a significant amount of its revenue is derived from and/or a significant amount of its resources is devoted to an unrelated activity.

The most well known type of nonprofit is a public charity that conducts charitable and/or educational activities, is tax exempt, and is eligible to receive tax deductible donations.  If this is the type of nonprofit you wish to form, then your choices are straightforward – you would form a California nonprofit public benefit corporation (assuming you are forming it under California law) and apply for federal tax exemption under Internal Revenue Code Section 501(c)(3).  But if you want to form some other type of nonprofit, things can get a bit complicated.

California Classifications: Public Benefit versus Mutual Benefit

At the state level, it is necessary to choose from among several types of nonprofit corporation (there are other options as well such as unincorporated associations, but I will not cover those here).  The two most common types are the nonprofit public benefit corporation and the nonprofit mutual benefit corporation.

A public benefit corporation can be either one of the following:

(1)    organized primarily for religious (however, it is also possible to form a religious organization as a California nonprofit religious corporation), charitable, scientific, testing for public safety, literary, or educational purposes, or for the prevention of cruelty to children or animals; OR

(2)    a civic league or social welfare organization.

A public benefit corporation may be tax exempt under one of two sections of the California Revenue and Taxation Code: 23701d or 23701f (these sections correspond with the two types described above).

California nonprofit public benefit corporations exempt under 23701d must meet the following requirements:

• no part of the net earnings may benefit any private shareholder or individual
• no substantial part of the organization’s activities may include influencing legislation
• the organization may not participate in political campaigns of candidates for public office
• upon dissolution, the organization’s assets must be donated to another nonprofit charity or government agency.

California nonprofit public benefit corporations exempt under 23701f must meet the requirements of an organization exempt from taxation under Section 501(c)(4) of the Internal Revenue Code (described below).  Its assets must be irrevocably dedicated to 501(c)(4) compliant purposes – this means that upon dissolution, the assets cannot be distributed to anyone for any other purpose.

Note that if you choose to form as a nonprofit public benefit corporation, you cannot easily convert to a mutual benefit corporation.  The only way to do such a conversion is to first ensure that all of the assets of the organization are donated to another nonprofit or government agency with exempt purposes.

California nonprofit mutual benefit corporations can be many types of organizations such as labor, agricultural, or horticultural organizations; fraternal orders; business leagues; chambers of commerce; social or recreational clubs; voluntary employees’ beneficiary associations; teachers’ retirement fund associations, homeowners associations, etc.

Federal Classifications: 501(c)(3) versus exemption under other sections of the Internal Revenue Code

Once you have chosen from among the options at the state level, you will need to decide under what federal code section you will apply for tax exemption.  Note that you do not need to apply for state or federal tax exemption.  Some organizations choose not to for various reasons.  For example, many medical marijuana collectives are formed as California mutual benefit corporations.  They do not apply for federal tax exemption because trafficking in marijuana is not legal under federal law.  Often they choose not to apply for tax exemption under state law either because they want to give back to the state by paying taxes.

If you do choose to apply for federal tax exemption, you have more than 25 classifications to choose from.  As noted above, the most well known federal classification is 501(c)(3) – a charitable or educational organization.  In this post I will describe two of the other most common options: 501(c)(4) and 501(c)(6).

An organization exempt under 501(c)(4) is known as a civic league  or social welfare organization.

It operates primarily to further the common good and general welfare of the people of the community.  Here are some examples from the IRS web site:

• An organization operating an airport that is on land owned by a local government, which supervises the airport’s operation, and that serves the general public in an area with no other airport,
• A community association that works to improve public services, housing and resi­dential parking, publishes a free commu­nity newspaper, sponsors a community sports league, holiday programs and meetings, and contracts with a private se­curity service to patrol the community,
• A community association devoted to preserving the community’s traditions, ar­chitecture, and appearance by represent­ing it before the local legislature and administrative agencies in zoning, traffic, and parking matters,
• An organization that tries to encourage in­dustrial development and relieve unem­ployment in an area by making loans to businesses so they will relocate to the area, and
• An organization that holds an annual festi­val of regional customs and traditions.

An organization exempt under 501(c)(6) is known as a business league or chamber of commerce.  The purpose of the organization must be to promote the common business interest of a group of persons.  It may not engage in a regular business of a kind ordinarily carried on for profit.  The organization must receive support from its members.

An organization does not qualify for exemption under section 501(c)(6) if any of its net earnings inures to the benefit of any member.  Members may nevertheless receive some kinds of benefits from the organization, such as newsletters and similar material.  Moreover, the profitability of the members’ individual enterprises may be enhanced by the successful promotion of the common business interest.

Both Section 501(c)(4) and (6) organizations may engage in political campaign activities on behalf of or in opposition to candidates for public office but the organization must ensure that its political campaign activities do not constitute the organization’s primary activity.  Also such activities are subject to a tax.

In general, section 501(c)(4) and(6) organizations may engage in an unlimited amount of lobbying, provided that the lobbying is related to the organization’s exempt purpose.

Both types of organizations must ensure that no part of its net earnings benefit private individuals or businesses.  For example, the organization should never pay more than fair market value for any goods or services it receives from an individual or business.

In general, contributions to 501(c) organizations other than organizations described in section 501(c)(3) of the Code are NOT deductible as charitable contributions for federal income tax purposes.

All nonprofit organizations are subject to what is called the “private inurement” doctrine.

Simply put, private inurement is income or other financial gain from a nonprofit to an individual [or entity] for which the nonprofit does not receive a comparable benefit in return (in other words, the value of the financial gain the individual receives from the organization exceeds the value of the services he or she provides to the organization). Persons engaging in private inurement are usually “insiders’ who are in a position to divert nonprofit assets or income to their own benefit.

The private inurement doctrine does not forbid financial relationships between nonprofit organizations and insiders. Instead, it requires that the organization receive in return a benefit more or less equal to the financial gain to the insider.

The private inurement doctrine has three main implications for chief executive compensation at all tax-exempt organizations:

1. Compensation should be clearly tied to the chief executive’s performance in leading the organization toward achievement of its mission (“accomplishing exempt purposes”).
2. Compensation should be reasonable and not excessive
3. Because there is no equity available in a nonprofit organization, compensation committees should be wary of any compensation arrangement that looks like the distribution of profits.

Nonprofits should collect data such as salary surveys to use when setting executive compensation.  The use of such data should be documented in board meeting minutes.

Click here for an IRS report on executive compensation by tax-exempt organizations.

California Government Code Section 12599 defines “a commercial fundraiser for charitable purposes” as any individual, corporation, unincorporated association, or other legal entity who for compensation does any of the following:

(1) Solicits funds, assets, or property in California for charitable purposes.

(2) As a result of a solicitation of funds, assets, or property in California for charitable purposes, receives or controls the funds, assets, or property solicited for charitable purposes.

(3) Employs, procures, or engages any compensated person to solicit, receive, or control funds, assets, or property for charitable purposes.

Anyone who meets this definition is required to register with the Attorney General’s Registry of Charitable Trusts and must also do annual filings with the Attorney General.  Before hiring a commercial fundraiser, it is wise to check the California Attorney General’s web site to determine whether the fundraiser is registered and current with the required filings.

Not less than 10 working days prior to the commencement of each solicitation campaign, event, or service, a commercial fundraiser must file a notice describing the planned campaign.

State law requires that there be a written contract between a commercial fundraiser and a charitable organization for each solicitation campaign, event, or service.  The contract must be made available for inspection by the Attorney General.

The following provisions must be included in the contract:

(1) The legal name and address of the charitable organization as registered with the Registry of Charitable Trusts, unless the charitable organization is exempt from registration.

(2) A statement of the charitable purpose for which the solicitation campaign, event, or service is being conducted.

(3) A statement of the respective obligations of the commercial fundraiser and the charitable organization.

(4) If the commercial fundraiser is to be paid a fixed fee, a statement of the fee to be paid to the commercial fundraiser and a good faith estimate of what percentage the fee will constitute of the total contributions received.  The contract shall clearly disclose the assumptions upon which the estimate is based, and the stated assumptions shall be based upon all of the relevant facts known to the commercial fundraiser regarding the solicitation to be conducted by the commercial fundraiser.

(5) If a percentage fee is to be paid to the commercial fundraiser, a statement of the percentage of the total contributions received that will be remitted to or retained by the charitable organization, or, if the solicitation involves the sale of goods or services or the sale of admissions to a fundraising event, the percentage of the purchase price that will be remitted to the charitable organization. The stated percentage shall be calculated by subtracting from contributions received and sales receipts not only the commercial fundraiser’s fee, but also any additional amounts that the charitable organization is obligated to pay as fundraising costs.

(6) The effective and termination dates of the contract and the date solicitation activity is to commence within the state.

(7) A provision that requires that each contribution in the control or custody of the commercial fundraiser shall in its entirety and within five working days of its receipt comply with either of the following:

(A) Be deposited in an account at a bank or other federally insured financial institution that is solely in the name of the charitable organization and over which the charitable organization has sole control of withdrawals.

(B) Be delivered to the charitable organization in person, by United States express mail, or by another method of delivery providing for overnight delivery.

(8) A statement that the charitable organization exercises control and approval over the content and frequency of any solicitation.

(9) If the commercial fundraiser proposes to make any payment in cash or in kind to any person or legal entity to secure any person’s attendance at, or sponsorship, approval, or endorsement of, a charity fundraising event, the maximum dollar amount of those payments shall be set forth in the contract.

(10) A provision that includes all of the following statements:

(A) The charitable organization has the right to cancel the contract without cost, penalty, or liability for a period of 10 days following the date on which the contract is executed.

(B) The charitable organization may cancel the contract by serving a written notice of cancellation on the commercial fundraiser.

(C) If mailed, service shall be by certified mail, return receipt requested, and cancellation shall be deemed effective upon the expiration of five calendar days from the date of mailing.

(D) Any funds collected after effective notice that the contract has been canceled shall be deemed to be held in trust for the benefit of the charitable organization without deduction for costs or expenses of any nature.

(E) The charitable organization shall be entitled to recover all funds collected after the date of cancellation.

(11) A provision that includes all of the following statements:

(A) Following the initial 10-day cancellation period, the charitable organization may terminate the contract by giving 30 days’ written notice.

(B) If mailed, service of the notice shall be by certified mail, return receipt requested, and shall be deemed effective upon the expiration of five calendar days from the date of mailing.

(C) In the event of termination under this subdivision, the charitable organization shall be liable for services provided by the commercial fundraiser up to 30 days after the effective service of the notice.

(12) A provision that, following the initial 10-day cancellation period, the charitable organization may terminate the contract at any time upon written notice, without payment or compensation of any kind to the commercial fundraiser, if the commercial fundraiser or its agents, employees, or representatives do any of the following:

(A) Make any material misrepresentations in the course of solicitations or with respect to the charitable organization.

(B) Are found by the charitable organization to have been convicted of a crime arising from the conduct of a solicitation for a charitable organization or purpose punishable as a misdemeanor or a felony.

(C) Otherwise conduct fundraising activities in a manner that causes or could cause public disparagement of the charitable organization’s good name or good will.

The commercial fundraiser must disclose the percentage of total fundraising expenses of the fundraiser upon receiving a written or oral request from a person solicited for a contribution.

Charitable organizations and commercial fundraisers may not misrepresent the purpose of the charitable organization or the nature or purpose or beneficiary of a solicitation.  A misrepresentation may be accomplished by words or conduct or failure to disclose a material fact.

The charitable organization must establish and exercise control over any fundraising activities conducted for its benefit, including approval of all written contracts and agreements, and must assure that fundraising activities are conducted without coercion.

The following acts and practices are prohibited in the planning, conduct, or execution of any solicitation or charitable sales promotion:

(1) Operating in violation of, or failing to comply with, any of the requirements of this act or regulations or orders of the Attorney General, or soliciting contributions after registration with the Attorney General’s Registry of Charitable Trusts has expired or has been suspended or revoked.

(2) Using any unfair or deceptive acts or practices or engaging in any fraudulent conduct that creates a likelihood of confusion or misunderstanding.

(3) Using any name, symbol, emblem, statement, or other material stating, suggesting, or implying to a reasonable person that the contribution is to or for the benefit of a particular charitable organization when that is not the fact.

(4) Misrepresenting or misleading anyone in any manner to believe that the person on whose behalf a solicitation or charitable sales promotion is being conducted is a charitable organization or that the proceeds of the solicitation or charitable sales promotion will be used for charitable purposes when that is not the fact.

(5) Misrepresenting or misleading anyone in any manner to believe that any other person sponsors, endorses, or approves a charitable solicitation or charitable sales promotion when that person has not given consent in writing to the use of the person’s name for these purposes.

(6) Misrepresenting or misleading anyone in any manner to believe that goods or services have endorsement, sponsorship, approval, characteristics, ingredients, uses, benefits, or qualities that they do not have or that a person has endorsement, sponsorship, approval, status, or affiliation that the person does not have.

(7) Using or exploiting the fact of registration with the Attorney General’s Registry of Charitable Trusts so as to lead any person to believe that the registration in any manner constitutes an endorsement or approval by the Attorney General.

(8) Representing directly or by implication that a charitable organization will receive an amount greater than the actual net proceeds reasonably estimated to be retained by the charity for its use.

(9) With respect to solicitations by commercial fundraisers for charitable purposes on behalf of law enforcement personnel, firefighters, or other persons who protect the public safety, issuing, offering, giving, delivering, or distributing any honorary membership cards, courtesy cards, or similar cards, or any stickers, emblems, plates, or other items that could be used for display on a motor vehicle, and that suggest affiliation with, or endorsement by any public safety personnel or a group comprising such personnel.

(10) Soliciting for advertising to appear in a for-profit publication that relates to, purports to relate to, or that could reasonably be construed to relate to, any charitable purpose without making the following disclosures at the time of solicitation:

(A) The publication is a for-profit, commercial enterprise.

(B) The true name of the solicitor and the fact that the solicitor is a professional solicitor.

(C) The publication is not affiliated with or sponsored by any charitable organization.

(11) Representing that any part of the contributions solicited by a charitable organization will be given or donated to any other charitable organization unless that organization has consented in writing to the use of its name prior to the solicitation.  The written consent shall be signed by one authorized officer, director, or trustee of the charitable organization.

(12) Representing that tickets to events will be donated for use by another, unless all of the following requirements have been met:

(A) The charitable organization or commercial fundraiser has commitments, in writing, from charitable organizations stating that they will accept donated tickets and specifying the number of tickets they are willing to accept.

(B) The donated tickets will not, when combined with other ticket donations, exceed either of the following:

(i) The number of ticket commitments the charitable organization or commercial fundraiser has received from charitable organizations.

(ii) The total attendance capacity of the site of the event.

The IRS has been paying increasing attention to the governance of nonprofit organizations.  Here are some guidelines for a “governance tune up” for your nonprofit.

Step 1: Read your governance documents and revise if necessary

Gather together your articles of incorporation, bylaws, policies, and any meeting minutes documenting important decisions.  Make sure all board members, officers, and key employees have copies and read them.  Pay special attention to provisions about whether or not the organization has members, how directors are elected, number of directors, how officers are chosen, qualifications for officers and directors, terms and term limits for officers and directors, notice requirements for meetings, and whether the board is authorized to create committees that have some decision making authority.

Note that if the articles or bylaws state that the organization has members, the organization is subject to a large number of additional legal requirements regarding the rights of members to elect directors, receive information, participate in major decisions, etc.  Many organizations have people that they call members but who are not members according to the strict legal definition contained in the nonprofit statute under which they were formed.  It is essential to understand whether your nonprofit has members as defined in the statute because it will have major implications for governance.

Make sure that the governance documents are clear and easy to follow.  You may want to compare them to the statute the organization was formed under (e.g. the California nonprofit public benefit statute) to make sure there is nothing in your governance documents that conflicts with legal requirements.  If anything is inconsistent or unclear, it is time to amend the document(s).  Also, if your actual practice is different from the written policies, either the practice or the policy will need to be changed.

Step 2: Review practices for meetings

Meetings of the members (if any), board of directors, and committees (if they have any decision making authority) are where important decisions are made.  It is very important to ensure proper meeting notice (as required by the statute and bylaws) and to take accurate meeting minutes.

Step 3: Understand the powers of key players

There are few hard and fast rules about who is required to make a particular decision.  It is advisable for the board to determine in advance what decisions it will make versus those decisions that can be made by officers, committees, or staff.  For example, will the board review and approve the annual budget?  Will the board be required to approve expenditures greater than a certain dollar amount?  Having written policies regarding who has authority to make which decisions is advisable.

Some bylaws authorize the board to create an executive committee that has almost all of the authority of the board.  While this is allowed under most nonprofit statutes, the board should carefully consider whether it is advisable to delegate board authority to a committee.

Step 4: Understand duties of board members

Board members have the following duties (from the California Corporations Code and legislative committee comments):

• Duty of Care – A director shall perform the duties of a director, including duties as a member of any committee of the board upon which the director may serve, in good faith, in a manner such director believes to be in the best interests of the corporation, and with such care, including reasonable inquiry, as an ordinarily prudent person in a like position would use under similar circumstances
• Duty of Inquiry – A director may not close his/her eyes to what is going on about him/her in the conduct of the corporate business and, if he/she is put on notice by the presence of suspicious circumstances, he/she may be required to make such reasonable inquiry as an ordinarily prudent person in his/her position would make under similar circumstances
  • Directors may rely on information, opinions, reports, or statements, including financial statements, prepared or presented by the following: (1) One or more officers or employees of the corporation whom the director believes to be reliable and competent in the matters presented; (2) Counsel, independent accountants, and other persons on matters that the director believes to be within such person’s professional or expert competence; (3) A committee of the board on which the director does not serve, as to matters within the committee’s designated authority
  • In relying on the opinions or reports of others, the director must act in good faith and conduct reasonable inquiry when the situation indicates a need for such inquiry. The director must also be free of any knowledge that would cause reliance on data received from others to be unwarranted.
• Duty of Loyalty – A director must act in a manner that the director believes to be in the best interests of the corporation and all of its members, including the members of minority factions, and to administer their corporate powers for the common benefit
• Corporate Opportunity Doctrine – If a director becomes aware of an opportunity or a transaction that would be of interest or benefit to the corporation, the director must disclose the opportunity to the corporation and permit it to take advantage of the opportunity, if it so desires

Board members and key staff should be trained on their duties and responsibilities.

Step 5: Properly document changes in mission and activities

It is important to review the purposes statement in your articles, bylaws, original application for tax exempt status, and annual information returns.

If the organization’s actual mission and/or activities have changed, this should be reflected in amended documents and should be reported to the IRS on the annual information return.

Step 6: Review policies and consider adopting additional policies

The annual information return that nonprofits must file with the IRS (Form 990) was revised recently to reflect the IRS’ growing concern regarding governance.  The new form asks many questions about governance and policy issues. It is important to be aware of these new questions so that you are well-prepared to answer them before the deadline for filing the form.  In preparation, you will want to review what policies are already in place and what additional policies you may want to consider adopting.  The following are the primary policies that are asked about in the new Form 990:

• Process for determining compensation of the top management employees including review and approval by independent persons, use of comparability data (such as salary surveys), and contemporaneous substantiation of the deliberation and decision
• Process for board review of Form 990 prior to filing
• Conflict of interest policy
• Process for determining the independence of board members
• Process for determining family and business relationships among board members including annual disclosures
• Whistleblower  policy
• Document retention and destruction policy
• Process for review and audit of financial statements
• Process for making key documents available to the public
• Gift acceptance policy
• Policy regarding acceptance of conservation easements
• Policy regarding participation in joint ventures
• Policies and procedures governing the activities of chapters, branches, and/or affiliates
• Process for keeping meeting minutes

In May 2009 the IRS delivered trainings on nonprofit organizational governance to its Exempt Organizations examination agents and determination specialists.  These individuals review charitable organizations’ applications for exemption and annual Form 990 information returns.  They also determine which organizations should be subject to further review via an audit.

Although (as detailed below) the IRS has recommendations regarding tax-exempt organizations in general, the training materials emphasize that each organization may choose its own governance regime.

In the materials, the IRS defines governance as “the exercise of authority and control over an organization.”  The agency notes that tax-exempt organizations’ governance varies based on the size, type, structure and culture of organizations, and repeatedly stresses that “one size does not fit all.”

Highlights of the IRS’s recommendations include that the board should:

• Consist of active and engaged members;
• Have a substantial majority of independent members who do not have familial or business relationships with employees;
• Actually govern the organization’s affairs;
• Meet regularly and document meetings, committee meetings, and decisions;
• Implement policies relating to conflicts of interest, whistleblower claims, document retention and destruction, compensation, and investments;
• Employ term limits;
• Recruit board members with diverse subject matter expertise in the following areas: budget and financial management, investments, personnel, public relations and marketing, governance, advocacy, and leadership (with particular emphasis on financial management);
• Only receive compensation as reasonable and necessary for the functioning of the organization;
• Ensure compensation decisions are made by knowledgeable individuals with no financial interest in such decisions;
• Ensure that they understand any joint venture or investment of the organization.
• Ensure that fundraiser compensation is commensurate with the fundraiser’s knowledge, background, and activities performed, rather than based upon a percentage of the funds raised.

Click here to see the IRS’ complete training materials on governance.

The IRS is especially concerned that organization insiders not receive any kind of benefit in excess of the value of what such persons are providing to the organization.  The IRS calls insiders “disqualified persons.”  The definition of a disqualified person is someone who is in a position to exercise substantial influence over the affairs of the organization.

If a disqualified person receives such an “excess benefit,” the IRS may revoke the organization’s tax exempt status.  Because this remedy was seen as unduly harsh in some situations, the IRS developed “intermediate sanctions,” whereby the IRS may impose an excise tax on excess benefit transactions instead of revoking the organizations’ tax exempt status.

The excise tax is imposed on both the disqualified person that receives the excess benefit and the board members, officers, or managers that knowingly approved the transaction.

Most of this is not news to nonprofit managers.  However, many nonprofits are not aware that if they provide non-monetary compensation to a person who is in a position to exercise substantial influence over the affairs of the organization (a disqualified person), such as the use of a car, reimbursement of personal expenses, etc., the result could be an AUTOMATIC excess benefit transaction. Reg. 53.4958-4(c)(1).

If a nonprofit provides a benefit to a disqualified person as part of the person’s salary and benefits package, the organization must substantiate its intention that this benefit is being provided as part of the person’s compensation at the time the benefit is provided by either reporting the benefit as compensation on the employee’s W-2 or passing a board resolution authorizing the benefit as compensation.

So, nonprofit board members and managers have to look carefully at the benefits they are providing to high level employees and make sure the value of the entire package is included in the employee’s W-2.  If this has not happened in previous years, the organization should consider amending the W-2.

How much is the excise tax if the IRS finds an excess benefit?

The person who receives the excess benefit must not only return the excess benefit but must pay an additional 25 percent of the amount of the excess benefit.

If the transaction is not corrected promptly, the recipient must pay a second tax of 200 percent of the excess benefit.

Organization managers (i.e. board members, officers, and high level managers) may be taxed at 10 percent of the excess benefit, up to $20,000 each, if they knew that the transaction involved an excess benefit.