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Starting a Nonprofit: Environmental as a 501(c)(3) Charitable Purpose

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Green Globe On Moss - Environmental Concept

An environmental purpose is not one of the seven exempt purposes specified in Section 501(c)(3) of the Internal Revenue Code (the “Code”). However, many environmental organizations qualify for exemption under 501(c)(3) because their activities further charitable, educational, and/or scientific purposes.

Although there is no explicit mention of environmental purposes in the statutes or regulations defining what is charitable under Section 501(c)(3) of the Code, the IRS has said that efforts to preserve and protect the environment for the benefit of the public serve a charitable purpose. However, not every activity directed at advancing environmental benefits is recognized as charitable. Additional factors may be required to show that the environmental activities are “lessening the burdens of government” and/or “combating community deterioration.” (See Starting a Nonprofit: What is “Charitable” under 501(c)(3)).

IRS rulings reveal that the IRS looks for activities that have a “significant” and “direct” impact on the environment when determining if an activity qualifies as charitable. In addition, the charitable aspects of the activity must outweigh any commercial or private benefits. Any private benefit conferred upon individuals or for-profit businesses that is more than incidental, quantitatively and qualitatively, to the environmental preservation activities will defeat the exemption. Some rulings suggest that credible studies and research should be provided to the IRS to demonstrate the direct and significant impact of the proposed activities.

Examples of environmental organizations that served charitable purposes according to the IRS include:

  • an organization that planted trees in public areas when the city did not have sufficient funds to do so, thus lessening the burdens of government and combating community deterioration (Rev. Rul. 68-14, 1968-1 C.B. 243);
  • an organization that acquired and maintained ecologically significant land, the IRS noting that the benefit to the public was guaranteeing “future generations … the ability to enjoy the natural environment” (Rev. Rul. 76-204, 1976-1 C.B. 152).

Examples of organizations that did not qualify for exemption because the impact on the environment was determined to be too indirect or resulting in too much private benefit, include:

  • an organization that provided particular solar panels to low and middle class income households, where the impact on the environment was “indirect and tangential” and the benefits flowed to a select group of homeowners rather than the general community (Priv. Ltr. Rul. 201210044 (2012);
  • an organization whose primary activity was beta testing green residential housing products to make those products market-ready, because the direct and primary beneficiaries were the private business manufacturing the products (Priv. Ltr. Rul. 201149045 (2011).

In Example 12 of IRS’s final regulations for program related investment (PRIs), effective April 2016, the IRS illustrates another instance where furthering an environmental interest is recognized as charitable so long as the private benefit is only incidental to the overall charitable nature of the activity. In the example, a private foundation is permitted to make an investment in a new business enterprise in a developing country whose only activity would be to collect recyclable solid waste and deliver those materials to recycling centers. Although the investment was benefiting a private business, the primary purpose for making it was to combat environmental deterioration, in furtherance of the foundation’s exempt purposes. The facts show that the business was unable to attract other funding because the expected rate of return was low, and thus, the IRS reasons, the foundation would not have made the investment but for its charitable purpose.

As more nonprofits are created to address new and continuing environmental concerns, it will be interesting to see how such activities are characterized as charitable or not by the IRS. Alternative energy, segments of the sharing economy, and eco-friendly products all pose several questions for the future.

The post Starting a Nonprofit: Environmental as a 501(c)(3) Charitable Purpose appeared first on Nonprofit Law Blog.


10 Significant News Events of 2016

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2016 has featured a number of major events that have affected, and will continue to affect, the nonprofit sector. Some might describe 2016 as a difficult year, featuring a long, turbulent election in the United States and unexpected results that have left many groups, including nonprofits themselves and the communities they serve, anxious and uncertain about their futures. Nonprofits such as the ACLU, the Sierra Club, Planned Parenthood, among others, saw record surges in donations following the election. On a judicial front, an empty seat on the Supreme Court resulted in the Court unable to decide on critical and controversial issues like immigration, and even though the Court upheld an affirmative action program at the University of Texas, the future of affirmative action and other major policy issues will likely depend on the next Supreme Court appointment. Abroad, Britons voted to leave the European Union, triggering financial and political uncertainty there as well. Here is a list of our 10 significant news events of 2016 affecting the nonprofit sector in the United States and a few links regarding each:

  1. The Election and President-Elect Donald Trump

    The 2016 Elections – Impact on the Work of Charitable Nonprofits [National Council of Nonprofits]
    Both Clinton and Trump Would Reduce Tax Incentives for Charitable Giving [Tax Policy Center]

    Trump’s White House Victory Could Spell Money Woes for Charities [Chronicle of Philanthropy]

    Nonprofits See Unprecedented Support Following Trump’s Win [Chronicle of Philanthropy]

  2. Brexit

    Historic UK “Brexit” Vote Raises Countless Issues for Nonprofits, Civil Society [Nonprofit Quarterly]

    What Lessons Does “Brexit” Hold for Social Innovators Worldwide? [Stanford Social Innovation Review]

  3. Dakota Access Pipeline

    Dakota Pipeline Update: When Resistance Is a Matter of Protection [Nonprofit Quarterly]

    American Indians Shouldn’t Get Shortchanged by Philanthropy [Chronicle of Philanthropy]

  4. Merrick Garland’s Nomination and the Empty Supreme Court Seat

    Obama nominates Merrick Garland to Supreme Court [CNN]

    The Supreme Court Needs a Ninth Justice Immediately [The Washington Post]

  5. Zika Epidemic

    Zika Spread Prompts Reexamination of Public Policy Re: Women’s Health in South America [Nonprofit Quarterly]

    Zika Is No Longer a Global Emergency, W.H.O. Says [New York Times]

  6. Black Lives Matter

    Black Lives Matter & the Road Ahead [Nonprofit Quarterly]

    How Philanthropy Can Show That Black Lives Matter [Chronicle of Philanthropy]

  7. Paris Global Climate Agreement

    Landmark Paris Climate Pact to Take Effect in 30 Days [Climate Central]

    100s of Businesses and Governments: Trump Should Uphold Climate Agreement [Nonprofit Quarterly]

  8. North Carolina “Bathroom Bill”

    DOJ and North Carolina File Lawsuits over NC’s Controversial LGBT Law [Nonprofit Quarterly]

    North Carolina Lawmakers Leave ‘Bathroom Bill’ in Place [The Washington Post]

  9. US Supreme Court Upholds Affirmative Action Program

    Supreme Court Upholds Affirmative Action Program at University of Texas [New York Times]

    Impact of Supreme Court’s affirmative action ruling could reach K-12, higher ed [PBS]

  10. Continued Conflict in Syria

    Starving in Place: Humanitarian Aid Still Blocked in Syria while Ceasefire Shaky [Nonprofit Quarterly]

    7 Experts To Read On The Desperate Health Crisis In Syria [Huffington Post]

    After Aleppo, what happens to Syria’s besieged towns? [Al Jazeera]

 

Editor’s Honorable Mentions:

Biggest Change to Nonprofit Financial Reporting in 20 Years Has Arrived [BDO Nonprofit Standard]

“The Financial Accounting Standards Board (FASB) has just released the Accounting Standards Update (ASU), Not-for-Profit Entities (Topic 958) – Presentation of Financial Statements of Not-for-Profit Entities, which you can find here. If you’ve been following our blog, you’ll know this marks the biggest change to nonprofit financial reporting in more than two decades.”

The Foreign NGO Law [ChinaSource]

“On January 1, 2017, China’s new Foreign NGO Management Law will go into effect, changing the landscape for foreign individuals and organizations working in China.”

The post 10 Significant News Events of 2016 appeared first on Nonprofit Law Blog.

Applying for the California Property Tax Welfare Exemption: An Overview

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Nonprofits exempt under 501(c)(3) of the Internal Revenue Code are not automatically exempt from property taxes. In California, depending upon ownership and use of the property, eligible nonprofit organizations may separately apply and receive an exemption from local property taxes. There are three common exemptions for nonprofits owning property in California: the Church exemption, the Religious exemption, and the Welfare exemption.

Very generally, the Welfare exemption is available for property of organizations that are organized and operated exclusively for qualifying religious, scientific, hospital, or charitable purposes, and that use the property exclusively for those qualifying purposes. While “educational” is not one of the enumerated qualifying purposes, “charitable” includes certain educational purposes and activities, and educational nonprofits owning property may qualify for the Welfare exemption if they have the proper references to California Revenue and Taxation Code Section 214 in their organizing document. (See Page 17 of BOE’s Publication 149 for more information.)

An organization seeking exemption for the first time must take the following two-step application process for the Welfare exemption:

  • File a claim for an Organizational Clearance Certificate with the California Board of Equalization (the “BOE”)
  • File a claim for the Welfare exemption with the county assessor in the county where the property is located or used

The BOE is charged with determining whether the organization itself is eligible for the exemption (i.e., whether the organization is organized and operated exclusively for religious, scientific, hospital, or charitable purposes). The assessor determines whether an organization’s property qualifies for the exemption based on the use of the property (i.e., whether the property is used exclusively for religious, scientific, hospital, or charitable purposes).

Step 1: Organizational Clearance Certificate (“OCC”)

Organizations must apply for an OCC by submitting Form BOE-277 and the following documents to the BOE:

  • Organizing Documents. For corporations, Articles of Incorporation and each amendment (if any), or for non-corporations, Constitution, trust instrument, etc., and each amendment (if any)
    • **Note: To be eligible for the welfare exemption, Revenue and Taxation Code section 214(a)(6) requires both that (1) property is irrevocably dedicated to religious, hospital, scientific, or charitable purposes, and (2) upon liquidation, dissolution or abandonment by the owner, property will not inure to the benefit of any private person except a nonprofit fund, foundation, or corporation organized and operated for religious, hospital, scientific, or charitable purposes. The organization’s organizational document must contain such statements in order to qualify. See Exhibit C in the BOE’s Publication 149 for more information.
  • Tax-exempt Status Letter. Copy of letter(s) evidencing exemption from federal income tax under Section 501(c)(3) of the Internal Revenue Code), and/or a copy of the letter evidencing exemption from state franchise or income tax under Section 23701d of the California Revenue and Taxation Code
  • Financial Statements. Operating statement (income and expenses), balance sheet (assets and liabilities), and any notes to financial statements for the calendar or fiscal year immediately preceding the claim year and each subsequent year to date;
  • Activities. Documentation supporting/describing the activities of the organization (for example, pamphlets, brochures, and web pages are acceptable forms of documentation).

Form BOE-277 may be filed at any time during the year. The organization should complete all parts of the form with sufficient detail to allow the BOE reviewer to understand the organization’s structure and purpose. Failure to submit all the necessary information may result in long delays or denial of the OCC.

Please note that additional steps, forms, and documentation may apply to a claim related to low-income housing.

Step 2: Claim for the Welfare Exemption

The county assessor where the property is located is responsible for reviewing claims for the Welfare exemption to determine whether the property of an organization qualifies for exemption based on its use. While it is best to apply after receiving an OCC from the BOE, some county assessors’ offices permit organizations to submit the Claim for the Welfare Exemption while the OCC is pending. This can be helpful because an organization must complete the exemption claim form and return it to the county assessor on or before Febru­ary 15 of each year to be eligible for the 100 percent exemption. Filing after February 15 may result in some taxes, fees, or penalties coming due instead of receiving the 100 percent exemption.

Claims for the Welfare exemptions may be made using the following forms which are generally available on each county assessor’s website (the following links are to the San Francisco County Assessor’s forms):

  • BOE-267, Claim for Welfare Exemption (First Filing), if the claimant is a new filer in a county or is seeking exemption on a new location in the county
  • BOE-267-A, Claim for Welfare Exemption (Annual Filing), if the claimant is requesting exemption on an annual basis after initial exemption was granted for that property location

It is important the read the instructions to the forms carefully and to provide all of the requested information to avoid delays in processing or a denial of the claim. For first time filers, the organization will need to attach a copy of its OCC, or note that it is pending and will be forwarded to the county assessor upon receipt. Financial statements are also required for each claim. The forms request copies of the organization’s operating statement (income and expenses) and balance sheet (assets and liabilities) for the calendar or fiscal year preceding the claim year, which relate exclusively to the operation of the property listed on the claim form. A claimant filing a timely claim in February 2017 would enter “2017-2018” at the top of the form, and would submit financial statements for its last calendar or fiscal year.

Additional information, including a supplemental claim form, may be required if the property:

  • Is used to operate a store, thrift shop, or other facility;
  • Is used as a rehabilitation program (See BOE 267-R);
  • Is used as low-income housing (See BOE 267-L);
  • Is used as a facility for the elderly or handicapped (See BOE 267-H);
  • Is leased, rented, or used by others (See BOE 267-O and more information below, this is new as of January 2017); and/or
  • Is used for activities that produce income that is unrelated business taxable income.

Organizations And Persons Using Claimant’s Real Property, Form BOE 267-O

While owners and operators are often one in the same, sometimes, a nonprofit property owner will allow another person or organization to use the property. An “operator” is a user of the property on a regular basis, with or without a lease agreement. If the operator is not an exempt organization, the portion of the owner’s property used by such operator is not eligible for exemption. However, if the operator is an exempt organization, the property may still receive the benefit of the Welfare Exemption.

In the past, in order to receive the Welfare Exemption on the entire property used for qualifying purposes, both the owner and any operator(s) had to apply for the Welfare Exemption by each obtaining an OCC from the BOE and then submitting a BOE-267 claim form to the county assessor. However, a recent court case (Jewish Community Centers Development Corp. v. County of Los Angeles, 243 Cal.App.4th 700 (2016)) held that only the owner of the property is required to file, and that the operator of the property is not required to obtain an OCC.

As a result of the case, the BOE developed form BOE 267-O, which must be filed by an owner when another organization or person uses the property. Since this process is fairly new, there are varying instructions regarding what information is required to be submitted along with BOE 267-O, and the form itself is not clear. According to the San Francisco County Assessor’s website, the BOE 267-O form instructions, and a presentation by the LA County Assessor to the Nonprofit Organizations Standing Committee of the Business Law Section of the State Bar of California, certain additional documentation about the operator may be required, depending on the operator’s use:

If the property is used by an operator once per week or less, the owner must file:

  • BOE 267 or 267A (along with owner financials and the other required information specific to the owner);
  • BOE 267-O;
  • Copy of the operator’s IRS and/or FTB tax exempt letter; and
  • Copy of lease or agreement (unless submitted with a previous filing).

If the property is used by an operator more than once per week, the owner must file:

  • BOE 267 or 267A (along with owner financials and the other required information specific to the owner);
  • BOE 267-O;
  • Copy of operator’s IRS and/or FTB tax exempt letter;
  • Copy of lease or agreement (unless submitted with a previous filing);
  • Copy of operator’s Articles of Incorporation or Bylaws; and
  • Copy of operator’s operating statement (income and expenses) and balance sheet (assets and liabilities) for the calendar or fiscal year preceding the claim year.

Even still, the county assessor may ask for additional information about each operator of the property. The assessor may also conduct a field inspection of the property to verify the accuracy of information provided on the claim forms. It may be best to contact the county assessor where the property is located to make sure you are submitting all the necessary documentation for a complete claim for the Welfare Exemption.

Further Reading*:

BOE Publication 149: Property Tax Welfare Exemption

BOE Publication 48: Property Tax Exemptions for Religious Organizations

Assessors’ Handbook Section 267: Welfare, Church and Religious Exemptions

*These publications have not been updated since BOE 267-O was introduced.

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Converting a For-Profit into a Nonprofit

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Increasingly, for-profit corporations are expanding their goals beyond profit-maximization and pursuing social or charitable goals. For owners of some of these corporations whose sole focus becomes a charitable purpose, conversion into a nonprofit organization can provide new sources of financial and social capital. However, whether a corporation should convert its structure into a tax-exempt, nonprofit corporation requires consideration of several factors, including the loss of ownership, potential restructuring of activities and purpose, and the future use of the organization’s assets.

Loss of individual control.

Since a nonprofit corporation is a legal entity that has no ownership (subject to a few exceptions we will not cover here), conversion from a for-profit to a nonprofit corporation will require the existing shareholders to give up their ownership. The corporation‘s board will remain ultimately responsible for the governance and oversight of the corporation but will no longer be responsible for considering the interests of any shareholders, which may or may not be consistent with the shareholders’ desires. While the required number of board members may vary depending on state law, we generally recommended that a nonprofit corporation have a minimum of 3 directors before applying for 501(c)(3) status. Additionally, for California nonprofit public benefit corporations, not more than 49% of the board may be composed of “interested persons,” which includes any person receiving compensation from the nonprofit for services rendered within the past 12 months and anyone related to the compensated person. This, too, may limit the original shareholders’ control over the corporation if they are hoping to be compensated and therefore must add disinterested directors to the board in order to comply with the California law.

Primary goal must be charitable.

While the board of a for-profit corporation may have an obligation to increase shareholder value, the board of a charitable nonprofit corporation has no such obligation and instead has a duty to advance the corporation’s charitable purposes. Although making a profit may be one objective of the nonprofit corporation, it can no longer be the ultimate goal. The activities of the nonprofit corporation must be consistent with its 501(c)(3) tax-exempt status, and the nonprofit corporation may not confer any benefit, monetary or otherwise, on any individual or entity that is not incidental, quantitatively and qualitatively, to furthering the organization’s exempt purpose. For the former for-profit corporation, this may mean changing the nature of its activities, limiting its services to a specific charitable class of beneficiaries, such as low-income individuals, and/or providing its services for free or at substantially below cost. It is important to recognize that the conversion to a nonprofit corporation should not be aimed merely to expand the corporation’s market share to include customers or clients paying a lower than market rate made possible by donations. Instead, the transition typically involves a more radical change in the corporation’s purpose and its targeted markets.

Assets locked in charitable trust.

If a corporation converts from a for-profit to a charitable nonprofit, upon such conversion, all of its assets will be impressed with a charitable trust, meaning that they may only be used in furtherance of the nonprofit’s charitable purposes. Even if the corporation later dissolves or changes its purpose, those assets must still be used for the stated charitable purpose in its governing documents at the time of the conversion. Assets may include intellectual property such as curriculum, books, music or art, which cannot be taken back by the original shareholders after the conversion except in return for payment of at least their fair market value.

Convert the existing entity or form a new entity?

Another consideration for shareholders of a corporation interesting in converting it into a nonprofit corporation is whether to (1) convert the corporation through an amendment to its articles of incorporation or (2) form a new nonprofit corporation and transfer the for-profit corporation’s assets and programs to the new nonprofit. Regardless, the for-profit corporation will need to consider shareholder rights, including minority shareholders, and whether any will need to be bought out. The nonprofit corporation, whether the result of a conversion or newly formed, will need appropriate governing documents and typically desire federal tax exemption under 501(c)(3). It will also need to consider charitable registration and state tax exemption among other things.

If a new nonprofit corporation is formed, the for-profit corporation may gift its assets and programs to the new nonprofit or it may dissolve and its former shareholders may make gifts of the distributions they received in the dissolution to the nonprofit. Generally, it may be simpler for a new nonprofit corporation, as opposed to a converted entity, to obtain tax exemption from the IRS, particularly if the corporation applies within 27 months of incorporation. In that case, the effective date of exemption will be the same as the date of incorporation. This would not be possible in the case of a converted for-profit entity. In either case, the corporation should pay particular attention to Schedule G of Form 1023, Successors to Other Organizations, when applying for tax exemption with the IRS.

The post Converting a For-Profit into a Nonprofit appeared first on Nonprofit Law Blog.

Duties of the Secretary of a Nonprofit Corporation

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The secretary of a nonprofit organization plays a critical role in fostering communication and ensuring proper management and utilization of important organizational records. Generally, an organization’s bylaws will set the duties of the secretary, however, duties may change from time to time as may be assigned by the board. A secretary will be most useful to an organization when his or her role is shaped to meet the unique structure and needs of the organization, rather than filling a standard job description.

Typically, the secretary should be equipped to handle the following matters:

Communication – A Primary Role of the Secretary

The secretary of the corporation is an active conduit for communication between the board, management, and members (if any), by giving proper notice of any meetings and timely distribution of materials such as agendas and meeting minutes. The secretary should be knowledgeable of the organization’s records and related materials, and should be able to provide advice and resources to the board on relevant topics at issue, such as particular governance matters being addressed at a meeting or a new amendment to state corporate law, for example. The secretary should aim to be helpful to the board as they discharge their fiduciary duties.

Scheduling, Notice, and Materials

The secretary is tasked with knowing and complying with notice requirements and scheduling meetings to accommodate the directors. Notice requirements can be particularly important and should be complied with strictly, as improper notice can open the organization up to challenge. The secretary is responsible for scheduling board meetings and should ensure an adequate number of meetings are held per year, in accordance with the organization’s bylaws. Generally, a board can more efficiently and effectively hold a board meeting when the secretary prepares and sends meeting materials far enough in advance of the meeting for each director to review such materials, correct any errors, and prepare questions and comments.

Minutes of Meetings

The secretary is also charged with recording minutes of meetings. Minutes are an important organizational document and provide a memorialized chronology of key information such as board actions, elections of officers or directors, and certain reports from committees and staff. Meeting minutes can have vital legal significance in an IRS examination and as evidence in courts if, for example, someone challenges the validity of certain actions or positions. The secretary should be well-equipped to record accurate minutes and be aware and sensitive to any special or confidential information discussed at a meeting. For more information about minutes generally, see Board Meeting Minutes – Part I and Part II.

Maintenance of Corporate Records

As the custodian of the organization’s records, the secretary is responsible for maintaining accurate documentation and meeting legal requirements, such as annual filing deadlines. It may be helpful for the secretary to have a calendar of filing deadlines, which may include a filing with the corporation’s Secretary of State, the Attorney General, the state tax agency, and the IRS. The secretary is responsible for reviewing and updating documents as necessary and ensuring all documents are safely stored and readily accessible for inspection by directors and/or members. In California, an organization’s articles of incorporation and bylaws, as amended to date, should be available at the corporation’s principal office for inspection. Additionally, it is required that a nonprofit’s exemption application and past three annual returns with the IRS are available for public inspection.

The secretary position has wide-ranging responsibilities, requiring much more than simply being present at all board meetings. These duties likely will increase if the corporation has a voting membership structure, which requires additional notice procedures and voting. Each board should carefully consider how the secretary can best serve their organization.

Tips for Being an Effective Secretary

  • Develop and distribute a board calendar before the start of each year
  • Understand what to record and what not to record when taking minutes
  • Maintain a board binder containing the governing documents, key governance policies, minutes of board meetings, and written consents
  • Consider using appropriately secured electronic storage of key documents as a backup
  • Ensure adequate comparability data is attached to board actions which rely on such information (e.g., for purposes of getting a rebuttable presumption of reasonableness)

Traps to Avoid

  • Noncompliance with provisions in the governing documents and applicable law for giving notice of meetings, sending and receiving electronic communications, nominating and electing directors and officers
  • Recording minutes as if they are transcripts of the meeting
  • Recording executive session discussions in meeting minutes that will be open to inspection to all members
  • Storing minutes and other sensitive documents without adequate security

See Duties of the President and/or Chair of the Board and Duties of the Treasurer of a Nonprofit Corporation.

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Duties of the Treasurer of a Nonprofit Corporation

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A Treasurer is typically charged with overseeing the management and reporting of an organization’s finances. Generally, as with other officer positions, the specific duties of the Treasurer are stated in an organization’s bylaws.

Since an organization’s financial management is directly tied to the Treasurer’s responsibilities, the Treasurer’s execution of her responsibilities will have a strong impact on the public’s perception, trust, and assurance in the nonprofit as a whole. With this in mind, organizations should seek Treasurers with desirable skills such as financial literacy, attention to detail, timeliness in completing tasks, clear and accurate record keeping, and a willingness to ask questions.

Duties and Responsibilities of the Treasurer

Typically, the Treasurer’s duties include the following:

Financial management and/or oversight. A Treasurer may manage or oversee the management of the financial affairs of the organization, often including such basic tasks as selecting a bank, reconciling bank statements, and managing cash flow. In some organizations, the Treasurer may also be responsible for investing funds consistent with applicable laws. The Treasurer should be knowledgeable about who has access to the organization’s funds and any outstanding bills or debts owed. The Treasurer should create and maintain systems for ensuring the organization’s ongoing solvency and oversee the development of the organization’s financial policies. Helpful policies to consider include check signing authority, expense reimbursement, credit card usage, and petty cash policies, if applicable.

Budgets. The Treasurer may be responsible for preparing, or facilitating the preparation of an annual budget, as well as regularly monitoring and comparing the actual revenues and expenses incurred against such budget. The development of a budget that supports the organization’s goals and drives decision-making is an important part of an organization’s success in effectuating its mission. The budget should be reviewed and approved by the board, however, the Treasurer should be prepared to explain and justify the document.

Reports. The Treasurer should have thorough knowledge and understanding of the organization’s financial reports and important financial ratios. The Treasurer should keep the board apprised of key financial events, trends, and concerns, and her assessments of the organization’s fiscal health. The Treasurer is also generally responsible for completing, or ensuring the completion of, required financial reporting forms (including the IRS Form 990) in a timely manner and making these forms available for the board’s review.

Financial Liaison. A skilled Treasurer should be able to translate financial concepts and information for board members who do not have financial backgrounds or substantial financial experience. The Treasurer should spend time learning the particulars of the organization’s finances and the applicable laws, which may include laws related to earned income, the unrelated business income tax, appropriate expenditures, and prudent investments. The Treasurer can be most effective to the board when she is facilitating and encouraging the board’s strategic thinking about the short and long term financial vitality of the organization in relation to its advancement of the organization’s mission.

California nonprofits must also be cognizant of California law, which requires nonprofit organizations to have a Treasurer and/or a Chief Financial Officer (CFO). Organizations may elect to have both a Treasurer and a CFO, with, for example, a board member Treasurer operating supplementary to the staff member CFO. In such case, the board Treasurer’s duties and responsibilities may be more focused on broader policies and oversight.  Where an organization has a Treasurer but has not designated a CFO in its bylaws, the Treasurer will be considered the CFO by operation of law.

Ultimately, while financial management is the primary focus of the Treasurer, the entire board shares the responsibility of financial oversight and accountability.

Tips for Being an Effective Treasurer

  • Develop and enforce strong internal controls and financial management policies
  • Ensure accurate and complete financial reporting and proper maintenance of financial records and information/tax returns
  • Regularly assess risks and whether and how such risks should be mitigated
  • Keep a calendar of filing requirements and deadlines and have clear assignments (with backups) to help ensure they are all met in a timely manner
  • Have the organization’s financials audited whenever required or advisable

Traps to Avoid

  • Neglect to wisely limit access to and control of the organization’s funds
  • Fail to keep and share with the board accurate and timely financial records
  • Treat the Form 990 merely as a financial report and not a critical marketing communication
  • Give legal or tax advice to donors about the deductibility of contributions

Resources

See Duties of the President and/or Chair of the Board and Duties of the Secretary of a Nonprofit Corporation.

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Starting a Nonprofit: Voting Membership Structure

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The term “member” is a term of art defined in California Nonprofit Corporation Law (the “Law”). Generally, a member under the Law (sometimes referred to as a “statutory member” or “voting member”) means any person who, under a provision of a corporation’s articles of incorporation (“articles”) or bylaws, has the right to vote on (1) the election of directors, (2) the dissolution of the corporation, (3) a merger, or (4) a disposition of all or substantially all of the corporate assets; or any person identified as a member in a corporation’s articles or bylaws who has a right, under either governing document, to vote on changes to either document.

A California nonprofit corporation is not required to have members. If a corporation has no members, actions that would otherwise require membership approval requires only board approval, and rights that would otherwise vest in the members are vested in the directors.

Note that these voting members are different than a nonvoting “membership” that may be offered in return for a donation or dues, such as the membership at a typical museum or other arts or cultural organizations. While such nonvoting members may receive certain benefits such as discounts or exhibit previews, nonvoting members do not have voting rights or statutory rights and should not be confused with voting members.

Rights of Voting Members

Generally, voting members have the following rights under California Nonprofit Public Benefit Corporation Law:

  • To elect elected directors (designated directors need not be approved by the members);
  • To remove directors without cause (subject to the rights of the designator to consent to such removal of a designated director);
  • To fill vacancies caused by a removal of a director (unless the bylaws explicitly state otherwise);
  • To approve any amendment of the articles (except for certain mostly ministerial provisions);
  • To amend the bylaws;
  • To approve the amendment of any provisions of the bylaws that materially and adversely affect their rights on voting or transfer;
  • To approve any amendment of the bylaws that would change the authorized number of directors or change it from a fixed number to a variable number (with a minimum and maximum) or vice versa;
  • To approve any amendment of the bylaws that would extend one or more director’s term of office;
  • To approve any amendment of the bylaws that would adopt, amend, or repeal provisions for designating directors;
  • To approve any amendment of the bylaws that would increase the quorum for membership meetings;
  • To approve any amendment of the bylaws affecting proxy rights of members;
  • To approve any amendment of the bylaws terminating membership rights;
  • To approve the sale, exchange, transfer or other disposition of all or substantially all of the corporation’s assets (not in the usual and regular course of the corporation’s activities);
  • To approve a merger;
  • To amend a merger agreement;
  • To approve most kinds of volunteer elections to wind up and dissolve;
  • To inspect corporate books and records for reasons reasonably related to the requesting member’s interest in the corporation;
  • To inspect and copy or receive a copy of the membership list (subject to exceptions);
  • To participate in nominating elected directors (doesn’t apply to designated directors);
  • To receive an annual report for years in which gross revenues are $25,000 or more;
  • To receive copies of certain reports that must be filed with the Attorney General;
  • To have fair disciplinary procedures before being suspended or expelled; and
  • To sue directors derivatively (on behalf of the corporation) for breach of fiduciary duties.

Corporations may provide voting members with additional rights. However, in considering whether to provide such members with additional rights or authority, the board should determine whether it is unreasonably giving important powers to individuals who have no fiduciary duties to exercise care and loyalty in using such powers. If a quorum for a membership meeting is relatively low, it can also allow a very small group of members to take actions and sometimes take over the corporation (including by removing and replacing the entire board and changing the corporation’s mission).

Decision to Create a Voting Membership Structure

While voting members can make sense for certain organizations, having voting members adds a significant amount of procedural complexity and substantial compliance costs for an organization and also increases potential litigation risks, as voting members generally have standing to sue the organization or sue on behalf of the organization.

Below are some pros and cons to consider when determining if your organization should have a voting membership structure:

Pros

  • Gives a voice to certain stakeholders, creating a democratic election process.
  • May help develop financial support among the public and encourage community involvement.
  • May serve as a check and balance in managing the corporation for personal gain by the founders or directors.

Cons

  • Members have enforceable rights that add significant expense and risk, may distract the directors and officers, and otherwise may frustrate the organization’s goals.
  • Factional divisions can be created among the members, making decisions and progress difficult.
  • Administratively, organizing periodic meetings, providing certain notices, and obtaining consents can sometimes delay important corporate objectives such as amending the articles or bylaws, or dissolving the corporation.

Overall, it is important to clarify whether a voting membership structure is desired for an organization, because it is possible to inadvertently create a voting membership class by not clearly describing the rights and obligations of certain individuals, regardless of whether they are called “members.”

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International Grantmaking: Equivalency Determinations

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Private foundations in the United States are often interested in funding promising organizations and projects that are based outside of the country. When doing so, these foundations are required to follow certain rules and procedures promulgated by the IRS to help ensure that the foreign grantees are properly using those funds for charitable purposes. Currently, when a private foundation engages in international grantmaking, it has two options for complying with these rules: exercising expenditure responsibility or conducting an equivalency determination.

What is an Equivalency Determination?

An equivalency determination generally refers to the review and evaluation by a private foundation of whether a potential grantee is the foreign equivalent to a U.S. public charity. This involves a review of its organization (governing documents) and operations to ensure it meets the following requirements described in Section 501(c)(3) of the Internal Revenue Code (IRC):

  • It is organized exclusively for a charitable, educational, or other 501(c)(3) exempt purpose;
  • It is operated primarily for a qualified exempt purpose;
  • It does not engage in any transactions that would result in private inurement or a prohibited private benefit;
  • Its assets, upon dissolution, would be distributed to another nonprofit for a qualified exempt purpose or a government instrumentality;
  • It does not engage in substantial lobbying; and
  • It does not engage in prohibited political campaign intervention.

In addition, the review must generally ensure that the foreign grantee would qualify as a public charity (and not a private foundation) if it were to apply for IRS recognition of exemption under 501(c)(3). Most public charities qualify as such because they are “publicly-supported” (i.e., they receive a significant portion of their financial support from public sources). For such organizations that do not receive a significant amount of earned income, this may be proven using one of two tests referenced in IRC Sections 509(a)(1) and 170(b)(1)(A)(vi).

First, an organization can demonstrate that it receives at least 1/3 of its total support from governmental units or the public. If the organization cannot meet this first test, it may pass an alternative facts and circumstances test, which requires the organization to establish that, under all of the facts and circumstances, it normally receives a substantial part of its support from government units or the general public.  (For more information about public support, see Adler and Colvin’s Qualifying For Public Charity Status).

For organizations that receive a significant amount of earned income, sufficient “public support” may be proven by meeting the requirements referenced in IRC Section 509(a)(2). In addition, a qualifying public charity also includes certain supporting organizations described in IRC Section 509(a)(3).

The equivalency determination process, outlined in the new IRS Revenue Procedure 2017-53 (released September 14, 2017), which modifies and supersedes IRS Revenue Procedure 92-94, requires the grantmaker to collect comprehensive information about the foreign organization’s operations and finances and, through one or more foundation managers, make a “good faith determination” of whether the grantee would be given tax-exempt, public charity status in the U.S., including whether it is publicly supported.

Often, these requirements can be difficult to satisfy because of differences in a foreign grantee’s accounting system, language, and sometimes governing legal system and reporting procedures in the grantee’s own country.

Basic Requirements

An equivalency determination is based on detailed information from the foreign grantee, including financials for the current and previous years, governing documents (a translated copy is now required), details about the board of directors, and descriptions of program activities. More specifically, in order for a grantee to be equivalent to a public charity based on its level of public support, it must provide the grantor with a financial support schedule for the current year as well as the four most recently completed years. The schedule must be detailed and include information such as grants and contributions received, net income from unrelated business activities, and gross receipts for services performed. Furthermore, the schedule must show contributions from donors that are in excess of 2% of the total support received (because such excess is not included as public support in the public support test).

Private foundations may rely on “current” written advice from a “qualified tax practitioner,” such as an attorney, a certified public accountant (CPA), or an enrolled agent who is subject to the standards of practice before the IRS set out in Circular 230. This no longer includes an opinion of foreign counsel of the grantor or grantee. While a grantee’s affidavit remains a good source of information on which qualified practitioners may rely when making the determination, the affidavit alone is no longer enough for the private foundation to rely on.

In order for the written advice to be “current”, the relevant law on which the advice is based must not have changed since the date of the written advice and the factual information on which the advice is based must be from the grantee’s current or prior taxable year (or the current or prior annual accounting period if the grantee does not have a taxable year for United States federal tax purposes). Therefore, the guidance states that a grantor may rely on written advice for a period of up to two years after the advice is provided, depending on when within the grantee’s taxable year the advice was provided.

Preferred written advice that meets the guidelines in Rev. Proc. 2017-53 must set forth the qualified tax practitioner’s own application of the law to the facts and own conclusion that the grantee would qualify as a qualifying public charity as of the date of the advice. Preferred written advice and any attachments (e.g., articles of organization, bylaws, or other organizing or enabling document or documents by which the grantee is formed and governed) must be written in or translated into English and must contain sufficient information to support the qualified tax practitioner’s conclusion. Further, preferred written advice must include verification that the grantee has not been designated or individually identified as a terrorist organization by the United States Government.

Repository

While the regulations aim to simplify and expand equivalency determinations, the process is quite burdensome and costly. For many years, there was no mechanism for sharing information about foreign grantees among grantmakers, and no uniform standard for collecting and processing the equivalency determination information. Thus, grantees were, and many continue to be, asked to provide affidavits and supplemental materials to multiple grantmakers in various forms. The regulations required each grantmaker to use its own reasonable judgment and good faith determination based on the materials collected. Therefore, foundations were not permitted to rely upon each other’s determinations.

To address these issues, several leading organizations such as The Council on Foundations, InterAction, the Foundation Center, and Independent Sector, worked to create a centralized repository of information to improve the efficiency of international grantmaking. The product of this effort, NGOsource, launched an online equivalency determination service and repository . NGOsource members can easily access which projects and organizations are approved for grantmaking purposes, thus eliminating redundant determinations and lowering costs for both the grantmaker and the foreign grantee.

For information about how NGOsource’s equivalency determination service works, click here.

Underlying Law

[Grants to] Certain foreign organizations. If a private foundation makes a grant to a foreign organization which does not have a ruling or determination letter that it is an organization described in section 509(a)(1), (a)(2), (a)(3) or in section 4940(d)(2), the grant will nonetheless be treated as a grant made to an organization described in section 509(a)(1), (a)(2), or (a)(3) (other than an organization described in section 4942(g)(4)(A)(i), or (ii)) or in section 4940(d)(2) if the grantor private foundation has made a good faith determination that the grantee organization is an organization described in section 509(a)(1), (a)(2), or (a)(3) (other than an organization described in section 4942(g)(4)(A)(i) or (ii)) or in section 4940(d)(2). A determination ordinarily will be considered good faith determination if the determination is based on current written advice received from a qualified tax practitioner concluding that the grantee is an organization described in section 509(a)(1), (a)(2), or (a)(3) (other than an organization described in section 4942(g)(4)(A)(i) or (ii)) or in section 4940(d)(2), and if the foundation reasonably relied in good faith on the written advice in accordance with the requirements of § 1.6664-4(c)(1) of this chapter. The written advice must set forth sufficient facts concerning the operations and support of the grantee organization for the Internal Revenue Service to determine that the grantee organization would be likely to qualify as an organization described in section 509(a) (1), (a)(2), or (a)(3) (other than an organization described in section 4942(g)(4)(A)(i), or (ii)) or in section 4940(d)(2) as of the date of the written advice… See paragraphs (b)(5) and (6) of this section for additional rules relating to foreign organizations. – Treasury Regulation §53.4945-5(a)(5)

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National Network of Fiscal Sponsors Gathering 2017

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The National Network of Fiscal Sponsors held its Annual Gathering in New Orleans on October 26 and 27. Approximately 120 leaders of fiscal sponsors and other professionals from across the country came to share experiences and to learn about common issues, best practices, and new developments. One common question throughout the gathering was whether the term “Fiscal Sponsorship” should continue to describe the relationship between a sponsor and project, or whether there is a better term (e.g., “incubation”) that is more accessible and understood outside of the fiscal sponsorship community.

Many charities begin engaging in fiscal sponsorship without knowing what it really means or how it needs to work. Based on some of the conversations that occurred at the gathering, here are a few legal tips and best practices for sponsors:

Mission Consistency

Every fiscal sponsor should review its purpose statement in its governing documents (e.g., Articles of Incorporation and Bylaws). A purpose statement should be consistent across such documents, as well as on the sponsor’s website and other solicitation materials. It is especially important for sponsors to review the purpose statement to ensure that the sponsor’s fiscally sponsored projects fit squarely within such purposes.

Generally, under the charitable trust doctrine, use of charitable funds is limited to the activities specified in the corporation’s governing documents and possibly on its solicitation materials at the time such funds were received. If the purposes of a sponsor are described in its Articles as “providing support to performance art projects in California,” then funds donated to the corporation generally cannot be used towards performance art projects in another state, or arguably, towards a different art medium, such as fine arts. A sponsor may want to consider amending its Articles and Bylaws if its purpose statement is not broad enough to cover the types of projects it hopes to sponsor. See Starting a Nonprofit: Articles of Incorporation and Specific Purpose Statements and Changing a Nonprofit’s Mission for additional information.

Selection of Projects

As a rule of thumb, each fiscally sponsored project (in a comprehensive or Model A fiscal sponsorship relationship) should stand alone in meeting the tax law requirements of a charity. When reviewing whether to select a project, the sponsor might consider whether the project would receive a favorable determination from the IRS under IRC 501(c)(3) if it applied. To best protect itself, a sponsor should not accept a project that is too commercial in nature, or that engages in substantial commercial activities that are in direct competition with for-profits entities. See Starting a Nonprofit: What is “Charitable” under 501(c)(3)?; Arts Projects: Charitable or Not?; and Commerciality Doctrine: Denial of Exemption for additional information.

The project leaders’ plans, expertise, and experience also matter. While it may be difficult for a sponsor to reject certain well-intentioned individuals planning to do important work, some may not be prepared to properly manage a charitable project and their deficiencies can ultimately hurt the sponsor. For example, a poorly organized event by a project could result in bad PR for the sponsor or worse, an injury for which the sponsor will be liable. In terms of efficiency, some charitably inclined individuals might do better working with an existing charity instead of running a project. Project leaders have the burdens of program design and management, and their charitable goals may be better suited working with an existing successful program helping the same targeted beneficiaries. Of course, there are also those project leaders who are trying something different or targeting a very underrepresented class of beneficiaries and who have the skills, expertise, and experience to engage in program design and management, fundraising, and the ability to operate within a budget. Those would be favorable factors in a sponsor’s project approval process.

Registration and Qualification

If a sponsor enters into a comprehensive fiscal sponsorship with a project operating in another state, the sponsor itself will then be operating in that state, since the project will become an internal program of a sponsor. A sponsor should make sure that it is properly registered and qualified to do business in any state in which it operates.  In California, for example, this means registering with the California Attorney General and qualifying to do business with the California Secretary of State. Other states may have different rules and required registrations.

Lobbying vs. Political Activity

Common misconceptions about public charities include that a public charity cannot engage in lobbying, or that lobbying and partisan political activity are one in the same. While it is true that there is an absolute prohibition on engaging in partisan political activities (which generally refers to supporting or opposing any candidate for public office), it is also true that charities can lobby, or engage in activities that attempt to influence specific legislation, so long as those activities represent an “insubstantial” part of their overall activities (note that the lobbying limits are fairly generous, particularly if a charity makes the very simple 501(h) election). For sponsors, the limits will be based on their cumulative activities and would not be viewed on a project by project basis. It would be prudent for sponsors to review and understand the definitions and rules regarding these activities, and to help educate their projects as well. Lobbying and issue advocacy are often underutilized tools for sponsors and projects working to advance their missions. See Charities and Issue Advocacy: Doing it Right Part One and Part Two, and Starting a Nonprofit: The Value of Making the 501(h) Lobbying Election for more information.

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Fiscal Sponsorship – Exit and Transfer of Assets

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A fiscal sponsorship relationship may, at some point, come to an end. Whether the project leaders have found a new sponsor, created a new nonprofit entity with its own exempt status under 501(c)(3) of the Internal Revenue Code, or decided to move on in order to focus on other ventures, the parties should properly terminate their fiscal sponsorship agreement and transfer the project’s assets and liabilities, if applicable.

Generally, having a fiscal sponsorship exit and transfer or termination agreement is a good practice to adopt. Typically, it should be an agreement signed by the sponsor, the successor, as well as the advisory committee of the project being transferred. In practice, the transfer of assets is a grant that the sponsor should ensure is made consistent with its 501(c)(3) purposes and with reasonable care consistent with the termination provisions of its fiscal sponsorship agreement. This is also true when the project is not being transferred, but rather is ending operations and the remaining assets are being granted out in furtherance of the project purposes by the sponsor to another organization.

The parties involved in a fiscal sponsorship exit and transfer of assets may want to consider the following issues:

Vetting the Successor. Prior to transferring charitable assets to a successor fiscal sponsor, the current sponsor should properly vet the contemplated successor sponsor and reflect such vetting in the exit and transfer agreement. For example, the current sponsor may want to check the IRS database to make sure that the successor sponsor is currently recognized by the IRS as exempt under 501(c)(3) and has not had such status revoked (e.g., for failure to file its annual returns). Current sponsors should ask for the successor’s governing documents to ensure that the project will fit squarely within the successor’s exempt purposes. The exit and transfer agreement might require the successor to represent and warrant that it is in good standing under the laws of its state of incorporation, registered and qualified to transact business in each jurisdiction in which it and/or the project operates, and qualified as exempt under federal tax laws.

Transfer. An exit and transfer agreement should articulate what exactly is being transferred from the current sponsor to the successor sponsor. For comprehensive fiscal sponsorship arrangements, in addition to cash assets, the agreement should describe other assets to be transferred such as equipment, furniture, materials, supplies, mailing lists, and other intellectual property associated with the project. Leases and other contracts to be assigned to, and assumed by, the successor should also be included. Note that some contracts and leases may prohibit or restrict assignments, in which case there may be some work to do to negotiate and amend or terminate those agreements. If notice is required to be given to another party, the sponsor should make sure that is done appropriately to avoid the possibility of a breach of contract.

Liabilities. In a comprehensive (Model A) fiscal sponsorship relationship, the sponsor may want to assign to the successor fiscal sponsor, and have the successor assume, any liabilities incurred in connection with the operation of the project before or after the transfer. However, the successor fiscal sponsor may only want to assume those liabilities it knows of. Accordingly, the current and successor fiscal sponsors may need to negotiate this matter. On the one hand, it makes sense that the project’s liabilities should follow where the assets are transferred, since project assets should be used to pay for project liabilities. On the other hand, a successor fiscal sponsor may not want to take on liabilities that may be greater than the amount of project assets, particularly if the liabilities are still unknown. For example, a person who suffered a personal injury from a project activity may not come forward to report or file a lawsuit until later, and such liability may be unknown to the parties. A possible compromise may be for the successor fiscal sponsor to accept all liabilities incurred in connection with operation of the project before the transfer, but only up to the value of the project assets transferred to the fiscal sponsor pursuant to the exit and transfer agreement.

Holding Back Assets. In some cases, a sponsor may want to determine whether it will hold back any project assets for project-related expenses not previously identified. This may include unknown liabilities, such as legal bills or other invoices that may be sent to the sponsor after the project has been transferred. If there is a holdback, the assets are generally held for a period of time (e.g., three months) before such assets are transferred to the successor.

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10 Significant News Events of 2017

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The past 12 months have featured many major events that have affected, and will have long-term implications for, the nonprofit sector. In January, women all over the world marched for gender, racial and economic equality, and throughout the year, women shared stories of sexual harassment and assault, illuminating how pervasive such behavior is in every industry. A wave of destructive and deadly natural disasters hit in 2017, unfortunately during the same period the Trump Administration began rolling back environmental regulations. Notably for the nonprofit sector, the Tax Cuts and Jobs Act, renamed the Amendment of 1986 Code, was signed into law by President Trump on December 22, 2017, and contains a number of provisions that will likely negatively impact charitable giving, nonprofits, and the communities they serve.

Here is a list of our 10 significant news events of 2017 affecting the nonprofit sector in the United States and a few links regarding each:

  1. Tax Reform

    Charities Fear Tax Bill Could Turn Philanthropy Into a Pursuit Only for the Rich [Washington Post]

    Tax Bill Causes Alarm for Some Charities and Tax-Exempt Organizations [JDSupra]

  2. Women’s March

    A Women’s March Only Just Begun [Nonprofit Quarterly]

    Pictures from the Women’s March on Every Continent [New York Times]

    In Women’s March, Nonprofit Leaders See Galvanizing Moment [Chronicle of Philanthropy]

  3. Trump’s Immigration Policies

    ACLU and Other Groups Challenge Trump Immigration Ban After Refugees Detained at Airports Following Executive Order [ACLU]

    In Wake of Travel Ban, Nonprofits See Support Surge [Chronicle of Philanthropy]

    What DACA Really Means for Dreamers—and What’s Next [Nonprofit Quarterly]

  4. Hurricanes

    Charities Respond To Harvey [Nonprofit Times]

    Nonprofits Lead Puerto Rico’s Recovery, But What’s in Their Future? [Nonprofit Quarterly]

    Why This Hurricane Season Has Been So Catastrophic [National Geographic]

  5. California Wildfires

    Why the 2017 fire season has been one of California’s worst [LA Times]

    A Planner’s Dilemma: What Comes after the Fires are Out? [Nonprofit Quarterly]

  6. Spotlight on Sexual Harassment and Assault, #metoo Movement

    After Weinstein: 47 Men Accused of Sexual Misconduct and Their Fall From Power [New York Times]

    Sexual Harassment Is Common In the Fundraising World—And Often Goes Unpunished [Inside Philanthropy]

    Creator of the Me Too Movement Calls on Foundations to Support Grass-Roots Activists [Chronicle of Philanthropy]

  7. Acts of Domestic and International Terrorism

    Nationwide Solidarity Rallies Assemble In Charlottesville Aftermath [Huffington Post]

    Las Vegas Relief Tops Eight Figures [Nonprofit Times]

    White American Men are a Bigger Domestic Terrorist Threat Than Muslim Foreigners [Vox]

  8. Colin Kaepernick and Silent Protests of the National Anthem

    Kaepernick Leads a Movement within the NFL but Remains Unsigned [Nonprofit Quarterly]

    Harvard Scholars Deconstruct the Questions at the Heart of the Recent NFL Protests [Harvard Gazette]

  9. Russian Influence in 2016 Presidential Election

    Here’s the Public Evidence that Supports the Idea that Russia Interfered in the 2016 Election [Washington Post]

    Trump, Comey and the Russia investigation: What We Know So Far [LA Times]

  10. Rise of Donor-Advised Funds

    Donor-Advised Funds Are Catching Up To Foundations As The Most Powerful Givers [Fast Company]

    A Philanthropic Boom: “Donor-Advised Funds” [The Economist]

 

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Updated Form 1023 – New User Fee

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The IRS has released an updated Form 1023, revised December 2017. Form; Instructions.

For organizations submitting the full Form 1023, the user fee is now $600. The instructions indicate that organizations should refer to Rev. Proc. 2017-5, 2017-1 I.R.B. 230, or a later revision for updates to user fees, which are revised in the first Internal Revenue Bulletin issued each year. Alternatively, an organization can call Customer Account Services at 1-877-829-5500 for current user fee information.

If an organization is eligible to submit Form 1023-EZ, the user fee remains $275. For more information about the Form 1023-EZ, see Starting a Nonprofit: Form 1023 or Form 1023-EZ?

 

 

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New Form 1024-A for 501(c)(4) Organizations

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On January 16, 2018, the IRS released the final version of Form 1024-A, Application for Recognition of Exemption under Section 501(c)(4) of the Internal Revenue Code (“IRC”). While organizations that believe they are properly classified as a 501(c)(4) organization may self-declare their tax exempt status, organizations that choose to apply for IRC Section 501(c)(4) exemption with the IRS may no longer use the same Form 1024 as other non-501(c)(3) organizations.

The Form 1024-A requires similar information as the existing Form 1024 (which organizations should use to apply for recognition of exemption under 501(c)(5), (6), (7), and others) including but not limited to:

  • Organizational structure of the entity;
  • Information about the organization’s officers, directors, employees, and independent contractors, and whether such individuals are compensated;
  • A narrative of the organization’s past, present, and planned activities;
  • Whether the organization will engage in electioneering activities;
  • Information about the organization’s membership, if any;
  • Whether the organization has a relationship with or is connected to another exempt or nonexempt organization;
  • Whether the organization receives payment for services;
  • Whether the organization plans to lease property;
  • Whether the organization plans to engage in foreign activities or grantmaking; and
  • Financial data

It is important to read the instructions to Form 1024-A carefully to determine if additional attachments are required.

Filers of Form 1024-A must include Form 8718, User Fee for Exempt Organization Determination Letter Request, and the correct user fee, which is $600.

Also note that, whether or not 501(c)(4) organizations choose to apply for exemption with Form 1023-A, each must file Form 8976 to notify the IRS of their intent to operate within 60 days of formation.

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Update: New Exemption Application Not Required When Organization Changes Its Form or State of Incorporation

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In the new Revenue Procedure 2018-15, effective for tax years beginning on or after January 1, 2018, the IRS has indicated that it will generally not require a new exemption application from a domestic Internal Revenue Code (“IRC”) Section 501(c) organization that changes its form or place of organization.

Under prior guidance (Rev. Ruls. 67-390 and 77-469), the IRS required organizations to file new exemption applications (e.g., Form 1023, Form 1024) when, for example, an already-exempt unincorporated association decided to incorporate, or when an already-exempt corporation decided to re-incorporate in a different state, even when these entities would not otherwise have to obtain a new federal Employer Identification Number (“EIN”). Similarly, when one corporation merges into another corporation under state law, the surviving corporation does not have to obtain a new EIN.

Rev. Proc. 2018-15 now generally eliminates the requirement for corporations to file a new exemption application after a corporate restructuring, if certain conditions are met. The Rev. Proc. notes that requiring a new exemption application after a corporate restructuring is often unnecessary and duplicative, since the IRS already requires exempt organizations to report significant organizational changes and new programs on their annual Forms 990.

More specifically, Rev. Proc. 2018-15 generally provides that in a corporate restructuring of a domestic business entity that is classified as a corporation under Reg. section 301.7701-2(b)(1) or (2) (which includes an unincorporated association that is not a disregarded entity) and is recognized as an organization described in section 501(c), the surviving organization will not be required to file a new exemption application if it is carrying out the same purposes as the exempt organization that engaged in the corporate restructuring.

The restructuring organization must also be in good standing in the state in which it is incorporated or formed.

This general rule will not apply to any corporate restructuring in which the restructuring organization or the surviving organization is a disregarded entity, limited liability company, partnership, or foreign business entity, or if the surviving organization obtains a new EIN. In these cases, a new exemption application is still required.

Some additional guidance may be necessary to explain the example provided of a merger of one exempt entity (“Corporation I”) into a disregarded LLC and subsidiary of another exempt entity (“Corporation J”). In the example in Section 7.08 of Rev. Proc. 2018-15, Corporation J is required to file another exemption application, which seems peculiar. If the LLC is disregarded, then for federal tax purposes, the merger should be viewed as a merger of Corporation I into Corporation J, which expressly does not require a new exemption application.

Lastly, while a new exemption application with the IRS may not be required under the circumstances described above, a new state tax exemption application may still be required after a corporate restructuring. For example, in California, the Franchise Tax Board’s website states: “an unincorporated association that has tax-exempt status must reapply for exemption if it incorporates.”

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Serving as the Chair of the Board

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The chair of the board of directors (the “chair”) plays an extremely important role for a nonprofit organization. At the core of the chair’s duties, he or she generally presides over meetings of the board, collaborating with the chief executive to create a purposeful agenda and to set priorities, and helping to ensure sound and compliant governance of the organization.

Additionally, an effective chair goes beyond leading the board at board meetings. While the chair’s role is often filled by a strategic thinker who is equipped to follow-through on ideas, an effective chair must also engage and facilitate participation from each board member and make sure the ideas, and the decisions, are collective. A board may easily become a rubber-stamp board when the chair possesses the power to frame the discussion and drive the outcome. As a Harvard Business Review article titled How to be a Good Board Chair (written about for-profit chairs, but containing thoughtful overarching principles for nonprofits as well) articulately states: “To be effective, chairs must recognize that they are not commanders but facilitators. Their role is to create the conditions under which the directors can have productive group discussions. Good chairs recognize that they are not first among equals. They are just the people responsible for making everyone on their boards a good director.”

Below are a few additional issues and tips to consider when serving as the chair of the board of a nonprofit corporation:

Partnership with the CEO

A good chair understands the importance of creating a fruitful and supportive partnership with the organization’s CEO, who is separately charged with managing the organization and effectuating the board’s direction. (For more information about the differences between the chair, the president or executive director, and who serves as CEO, see Duties of the President and/or Chair of the Board; Who is the Chief Executive Officer – the Executive Director or the Board Chair?; Executive on the Board: Some Pros and Cons). Common tips to help create an effective partnership with the CEO include meeting or speaking routinely and creating and maintaining an open, honest line of communication. (See National Council of Nonprofits’ Insights into Great Relationships: Board Chairs and Executive Directors.)

Board Chair as a Director

While the law may not require that the chair also be a board member, the bylaws of an organization should make clear that the chair must be a board member. This is necessary for the chair to preside over board meetings, including when the board enters into executive session. Some nonprofits require that the chair not vote on matters before the board except to break a tie. While this may take into account the chair’s role as a facilitator, in order for the chair to meet his or her fiduciary duties as a director, he or she should vote on all matters before the board. In order to avoid unduly influencing a vote, the chair often votes last.

Note that the board should be mindful of the separate director and officer terms specified in the organization’s bylaws. Commonly, the term of an officer and the term of a director do not align. For example, if a director with a 3-year term is elected as chair in her third year as a director, and the chair position has a 2-year term, the director will have to be re-elected as a director the following year (assuming there aren’t consecutive term limits for directors in the bylaws.) As this can be complex, one solution may be to make the chair an ex officio director in the bylaws, at least after the chair’s initial election for the duration of his or her elected term as chair. Ex officio in this context means “by virtue of one’s office,” and gives the chair the right to be a director for as long as he or she holds the position of chair.

Chair Job Description

Nonprofits and individuals considering serving as chair should also review any chair of the board job description or list of duties in their bylaws or other organizational documents. If a board chair accepts the position subject to a very large number of duties, she or he may be held responsible for abdicating those duties if such duties are not fully executed. Thus, while a detailed job description can be a good tool for direction and recruiting purposes, such descriptions can also subject the chair to a lengthy list of duties required that may not be feasible.

Fiduciary Duties of an Officer

In California, while the Nonprofit Corporation Law provides specific standards of conduct for directors in performing their duties, there is no similar provision for officers. Thus, the chair may be held to a higher standard of care than a director to conduct diligent inquiry in making decisions. It’s also unclear whether a chair would get the benefit of the business judgment rule, which generally provides that a court will not second guess the decisions of a board member as long as they are made in good faith, with reasonable care, and with reasonable belief that the board member is acting in the best interests of the corporation. At a minimum, a chair should understand her responsibilities, discharge those duties with appropriate care in good faith in the best interests of the organization, ask questions and investigate further as may reasonably be prudent, and seek professional assistance when necessary or desirable for a particular action.

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Protecting Your Nonprofit from Sexual Harassment

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Sexual harassment has long been an epidemic whose immense scope we, as a society, have only recently recognized. No industry has been spared, as Hollywood, government, media, food, tech, and nonprofits have struggled, and continue to struggle, with sexual and other harassment scandals.

Harassment in the workplace harms more than its direct victims. For nonprofits, a harassment scandal will not only erode public trust, a vital aspect of an organization’s support and success, it will also demoralize employees in a way that contravenes our shared values of equal opportunity. The harm reaches beyond lawsuits and fines — it can devastate an entire organization and the communities the organization works with and serves.

The nonprofit sector, the third largest employer by industry, is associated with serving the public interest and seeking to address and alleviate vast societal problems. The public expects nonprofits to go beyond simple legal compliance with respect to preventing and addressing sexual harassment. Such expectation, and more importantly, the values of social good espoused by most nonprofits, demand that nonprofits strive to be exemplary in how they create and cultivate an organizational culture that does not tolerate harassment of any kind.

Leaders of nonprofits cannot passively hope that their workplaces are free of harassment, in reliance on the belief that only good people work in the nonprofit sector. Harassment can occur in any workplace, and it will not stop on its own. Nonprofits must address harassment willfully and take thoughtful and reasonable steps to mitigate the risks.

Create an Environment Where Reporting Can Happen

As a first step, an organization should seek to create an environment that strongly supports reporting. One key here is to eliminate barriers that discourage victims from reporting, such as fear of blame, retaliation, and inaction on, or disbelief of, their claim.

Nonprofits should create open door reporting policies, where victims of harassment have a variety of identified mechanisms to report exploitative behavior to supervisors, a human resources department (HR), and/or the board. Among the considerations in creating appropriate reporting mechanisms is how an employee might best report harassment by the executive director, president, board chair, or CEO. Even before harassment reaches a legally-actionable level, managers and supervisors should know how to respond judiciously and effectively to behavior that they observe themselves, is reported to them by a victim or a witness, or of which they have knowledge or information by other means.

Workers will feel more supported if, based on policies and action, they are certain that accountability extends to managers and supervisors. For example, performance review criteria should include how well the manager or supervisor established a respectful team culture and, where applicable, responded to reports of harassment. Soliciting employee feedback about how well their managers and supervisors (including the CEO) perform in these areas, and rewarding managers for dealing with complaints reasonably and responsibly, can send a message throughout the organization about what is truly valued.

A growing practice, both formally by organizations and informally by employees who are frustrated by inaction, is to conduct a confidential survey to determine whether harassment is occurring in the workplace and, if it is, how severe is the problem. Even where harassment is not being reported, continually evaluating the environment, addressing risks preemptively, and establishing a dialogue between employees and leadership are important steps in creating a healthy workplace culture.

Implement Effective Anti-Harassment Policies

One of the most important ways to protect an organization from liability for workplace harassment is to have, and enforce, a coherent anti-harassment policy. In creating an anti-harassment policy, an organization should first look to its mission and values and review its history on harassment. Are there specific situations in which harassment has occurred? If there are, how do they inform current risks and preventative steps? Keeping the organization’s practices, norms, and values in mind, what types of conduct will not be tolerated? Anti-harassment policies are not one-size-fits-all, and once in place, allowing exceptions to the policy (e.g., for certain high performing individuals) can render it meaningless.

Beyond harassment occurring purely in an employee context, consider how the organization might address harassment by donors (e.g., should the organization’s gift acceptance policy also include a provision about refusing a gift in such situation?). How will the organization handle harassment by (or directed at) volunteers, including board members, who are not employees? While, generally, under California law, employers must protect volunteers from workplace harassment and discrimination (see, e.g., Cal. Gov. Code §12940), other states may not require such protections. However, the risks associated with tolerance of harassment go beyond breaking the law, and reasonable protections should be in place for all of its agents. We will address harassment outside of the pure employee context in a future post.

As a baseline for employee-related harassment, the Equal Employment Opportunity Commission (EEOC) recommends that a policy generally include:

  • A clear explanation of prohibited conduct, including examples;
  • Clear assurance that employees who make complaints or provide information related to complaints, witnesses, and others who participate in the investigation will be protected against retaliation;
  • A clearly described complaint process that provides multiple, accessible avenues of complaint;
  • Assurance that the employer will protect the confidentiality of harassment complaints to the extent possible;
  • A complaint process that provides a prompt, thorough, and impartial investigation; and
  • Assurance that the employer will take immediate and proportionate corrective action when it determines that harassment has occurred, and respond appropriately to behavior which may not be legally-actionable “harassment” but which, left unchecked, may lead to same.

Importantly, an organization should ensure that its policies are clear and written in such a way that is understandable to the reader, including in other languages used within the organization. Organizations may also want to review whether their whistleblower policy is broad enough, and reinforces, the organization’s policy to protect whistleblowers of sexual harassment from retaliation.

Educate through Trainings

In California, employers (including nonprofits) with at least 50 employees are required to provide regular and legally compliant sexual harassment and abusive conduct prevention training for all supervisors. Regardless of whether your organization is required to provide training under the law, now is a good time to review whether the organization is simply checking a box with respect its training requirements, or really putting thought and resources behind its efforts to educate employees, supervisors, and leadership.

There are various types of training for an organization to consider. Compliance training is intended to clearly educate workers about the organization’s anti-harassment policy (e.g., what to do if they experience unwelcome behavior, how to report such behavior and to whom, how the organization will investigate it and keep the worker informed) and the forms of unacceptable conduct in the workplace. Workplace civility or sensitivity training goes further to teach employees about interpersonal communication, such as how to be respectful of colleagues, how to provide feedback about unwelcome behavior, and how to respond if they receive such feedback themselves. Managers and supervisors, in particular, should be trained on emotionally intelligent responses to complaints of harassment and how to speak with workers who are initiating problematic behavior. An organization might also consider bystander intervention training, which can help employees further identify unwelcome and offensive behavior when not directed at them, and to encourage intervention with appropriate responses, and reporting, and without fear of retaliation.

Employers have a legal obligation to conduct prompt and thorough investigations of claims of harassment, regardless of the manner or method the organization learns of the conduct. Very generally, the obligation to act is triggered as soon as a manager or supervisor learns of a complaint. A “formal complaint” (i.e., requiring that the victim reduce the complaint to writing) is not required. It’s therefore critical that all managers and supervisors communicate the complaint consistent with a documented policy to allow for the organization to properly and timely respond to the complaint and determine appropriate next steps, including the nature, scope, and time of the investigation.

Managers and supervisors should also be trained on how best to deal with some common situations, such as when the victim asks to keep the complaint confidential, wants the manager to promise no action will be taken or that no one will get in trouble, or fears imminent harm. Likewise, it’s helpful if employees are trained to understand that even unsolicited verbal complaints of harassment will be taken seriously by the organization, and that while the investigation will be kept confidential to the extent possible, a manager or supervisor has an obligation to notify appropriate individuals within the organization of the facts of the complaint for investigation.

Communicate

Effective communication can go a long way to prevent, and promptly address, workplace harassment. An organization may create an HR committee to establish a direct line of communication between the board and management about harassment issues and policies. If the nonprofit is large enough to employ an HR supervisor, consider giving such person a seat at the table on the leadership team with direct reporting to the CEO and, under certain circumstances, the board.

Once an employee reports harassment, keep that employee informed about the status of the investigation. Alienating a victim from information about the progress of her or his claim can cause further anxiety and frustration. Furthermore, providing appropriate updates can sometimes help to diffuse the situation and demonstrate that the organization is taking the complaint, and corresponding inappropriate behavior, seriously.

As the #metoo movement has proven, there is a public distaste for confidentiality with respect to workplace harassment. “No comment” is no longer an acceptable response. While an organization may have defamation concerns to consider and manage, if an investigation has found that harassment actually occurred, such risk may be minor compared to the harm that may result from the perception that the organization is hiding the problem or protecting the perpetrators. Organizations should be prepared, seeking assistance when necessary (e.g., from an employment discrimination attorney and a public relations professional), to equitably comment about instances of harassment to the organization’s workforce, its donors, and the public.

Work Towards Diversity Across the Organization

Not surprisingly, the EEOC stated in a recent report that harassment is more likely to occur where there is a lack of diversity in the workplace. The EEOC also identified risk factors that tend to increase the likelihood that employees will be harassed including, a homogenous workforce, having only a minority of employees who don’t conform to societal stereotypes or workplace norms, workplaces with significant power disparities, workforces made up of many young workers, among others. Thus, striving for diversity organization-wide, from the board to the leadership team to the employees, may be one of the most important steps forward.

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Nonprofits should devote sufficient resources to harassment prevention efforts, not only to help ensure that such efforts are effective, but also to reinforce the organization’s commitment to creating a workplace free of harassment. It is imperative that a nonprofit’s treatment of its staff align with its mission and core values.

Resources

Select Task Force on the Study of Harassment in the Workplace – EEOC

Managing #MeToo – Harvard Business Review

 

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Erin Bradrick Awarded Outstanding Young Lawyer Award by ABA

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The American Bar Association Nonprofit Organizations Committee of the Business Law Section has announced the 2018 Outstanding Nonprofit Lawyer Award recipients.  NEO Law Group is very proud to share that Erin was awarded the Outstanding Young Lawyer Award for distinguished service by a young attorney in the nonprofit sector. Congratulations, Erin!

From the press release:

Erin Bradrick is Senior Counsel at NEO Law Group, where she provides corporate, governance, charitable trust, and tax counsel solely to nonprofits and exempt organizations. Erin also writes extensively on legal issues impacting the nonprofit sector, including as a columnist for The Daily Journal, California’s largest legal news provider. She has written articles published by Taxation of Exempts, The Nonprofit Quarterly, The Chronicle of Philanthropy, and the ABA’s Business Law Today, among others.

 

Erin is deeply committed to supporting and strengthening nonprofits and the sector at large and has led various advocacy efforts to this end. She also frequently speaks on nonprofit legal issues to various audiences and has been a speaker at multiple BoardSource Leadership Forums, the Western Conference on Tax Exempt Organizations, the ABA Business Law Section Conference, the State Bar of California’s Section Convention, Northern California Grantmakers, and the Foundation Center – San Francisco. She often conducts trainings for nonprofit staffs on lobbying, advocacy, and election-related activities and for nonprofit Boards of Directors on a range of governance issues.

 

Prior to joining NEO Law Group, Erin was a litigator with Simpson Thacher & Bartlett LLP and also clerked for the Honorable Dana M. Sabraw in the U.S. District Court for the Southern District of California. Erin is a graduate of UCLA, summa cum laude in Women’s Studies and Political Science, and Yale Law School, where she was Submissions Director and Symposium Coordinator of the Yale Journal of Law and Feminism. In 2017, Erin was awarded the American Bar Association’s “On the Rise – Top 40 Young Lawyers” by the ABA Young Lawyers Division.

The other 2018 Outstanding Nonprofit Lawyer Award recipients included:

  • Gregory L. Colvin, Vanguard Award
  • Ellen P. Aprill, Outstanding Academic Award
  • Eve Borenstein, Outstanding Lawyer Award
  • Aaron Stemplewicz, Outstanding In-House Counsel Award
  • Marla K. Conley, Outstanding Young Lawyer Award

Congratulations to each of the recipients of this prestigious award!

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Diversity, Equity, and Inclusion in Nonprofit Bylaws

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Nonprofits should be at the forefront of encompassing diversity, equity, and inclusion (“DEI”) into their governance and operations. While discussions regarding DEI are increasingly prevalent in the nonprofit sector, the next, more difficult, step forward is to turn the discussions into action. How do we, as part of the nonprofit community dedicated to the benefit of the public, effectuate our commitment to DEI? What steps can we take to make our organizations more diverse, equitable, and inclusive?

Commitment to DEI may be demonstrated through leadership, governance policies, recruitment, power-sharing, and importantly, accountability. From a corporate law perspective, one way to lock DEI in as a core value of an organization is to include DEI principles and language into an organization’s Bylaws. As a manual for the Directors and officers in governing the organization, Bylaws that include DEI provisions function as a sign that the organization will devote meaningful resources to those values.

In considering where and how DEI principles might be incorporated into the Bylaws, a Board might review the document section by section, focusing on how each may impact, or be modified to impact, DEI favorably or adversely. For an organization whose mission is racial justice-oriented, it may be especially important to set forth specific DEI-related goals (rather than just aspirational language), that if not met, will cause the organization to be out of compliance with its Bylaws.

The following list is intended to help a Board generate its own discussion on how it might incorporate DEI in the Bylaws:

    • Purpose Statement – Practitioners differ in their opinion about whether an organization should include a specific purpose statement in their Bylaws. Generally speaking, including a specific purpose statement can create more legal risk if the organization diverts from that specific purpose. However, if DEI is part of an organization’s mission, locking a purpose statement in the Bylaws will evidence that the organization is committed to operating within that mission. A Board might begin by considering whether its mission and purpose statement (if any) accurately reflect the values of the organization and discuss how it might be improved.
    • Selection of Directors – If the Board is serious about DEI, it must set the tone at the top. When a nonprofit’s Board reflects the diversity of the community it serves, the organization will be better suited to serve that community and attract a diverse staff to implement its programs. Changing the composition of a Board can be very difficult; however, setting a goal through a provision in the Bylaws, whether aspirational or a specific, can tie the organization to said goal. Each organization should determine for itself what its Board diversity target is, how it plans to achieve it, when it plans to achieve it (e.g., 3 years? 5 years?), and by what method (e.g., set numbers, percentages). Admittedly, the following is an over-simplistic example, but if an organization’s goal is to increase representation of a certain group of individuals, they might include a provision in the Bylaws that states that Board must be made up of at least X% of that group within a stated time frame. Among the many challenges to discuss, carefully consider, and thoughtfully address are avoiding tokenism and ensuring any new directors have ample opportunities for meaningful contribution.
    • Qualifications of Directors – The organization should be sensitive to who it may be excluding through its qualifications for the position of a Director. Does the organization have Get or Give requirement or a qualification regarding the individual’s educational background? Such requirements may be important for many reasons, but the Board should also consider how those requirements exclude individuals from an array of backgrounds, which could ultimately harm the organization.
    • Principal Office – An organization might consider how the location of its office may have some DEI consequences and whether it is important to include specific considerations in determining where the office location is. For example, the Bylaws might include language such as, “We aspire to locate this corporation’s principal office in an area that is consistent with the mission of this corporation” or “We will consider the following factors in determining the principal office of this corporation: [e.g., beneficiaries, staff, mission].”
    • Compensation – The Board might consider including in the Bylaws certain provisions regarding compensation, such as a statement that the corporation must pay all employees a fair and reasonable wage, as to both the corporation and the employees. Additional external and internal compensation equity principles might also be added.
    • Meetings – In most states, including California, Board meetings are permitted to be held by “conference telephone, electronic video screen communication or electronic transmission” so long as each Director can hear one another or can communicate concurrently, depending on the medium. In consideration of the organization’s DEI values, a Director’s ability to participate in meetings remotely (in accordance with state law) should not necessarily be discouraged. Such form of participation may improve the Board’s geographical diversity and also might help in the recruitment and retention of a Director who might otherwise have an access barrier in serving as a Director.
    • Conduct of Meetings – Traditionally, a Chair of the Board presides over Board meetings and is responsible for setting the tone and guiding discussions and Board actions. One way to encourage diversity in thought and possibly deliberate through a different lens is to consider a provision in the Bylaws permitting other Directors to chair meetings. In addition, from time to time, allowing different Directors to prepare agendas and/or preside over certain Board meetings can also advance the organization’s DEI values.
    • Committees – While Bylaws may not include detailed committee descriptions to provide for greater flexibility, they may provide general descriptions of certain standing committees the Board is committed to maintaining. A DEI Committee may be one such committee. By making it an advisory committee instead of a Board committee (which must be composed of only Directors), the DEI Committee itself can maintain a diverse composition and be better positioned to have big picture discussions about the organization’s DEI priorities. A DEI Committee might also be charged with performing a DEI audit of the organization, as further discussed below.
    • Officers – Commonly, the corporate officers listed in the Bylaws include the Chair of the Board or President (or both), the Secretary, and the Treasurer. An organization might also consider requiring a Diversity Officer, which may be filled by a Director or possibly an employee. Alternatively, the organization might require a Vice President to assume DEI oversight responsibilities. Additionally, co-leadership models are becoming more common and may offer an opportunity for an organization to benefit from diverse perspectives in the management of the organization.
    • DEI Audit The organization may commit to tracking how it is doing on DEI-related goals by requiring a DEI audit. The Bylaws may require that an annual DEI audit report be provided to the Board to hold itself accountable to its values. The report might examine the organization’s employees, beneficiaries, goods, Directors, officers, and vendors to see if there has been improvement and determine the areas needing more work. The Board might also consider whether to require that the DEI audit report be made public on the organization’s website.
    • Amendments To protect the DEI provisions in the Bylaws, consider increasing the required number or percentage of Directors necessary to approve an amendment to those provisions.

By reviewing the Bylaws and considering where DEI principles can be included, the Board will be forced to think through what level of commitment to DEI is desired for the organization. Of course, the Board shouldn’t include requirements that it cannot meet; however, the Board can show its commitment and readiness to be held accountable when the goals it sets out in the Bylaws are not met.

Additional Reading

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10 Significant News Events of 2018

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2018 has featured many major events that have affected, and will continue to affect, the nonprofit sector. On January 1, 2018, the Tax Cuts and Jobs Act, the most comprehensive overhaul of the U.S. tax code in over 30 years, went into effect, leaving nonprofits with many unanswered questions about how to comply. Youth advocates demonstrated their power and influence with the March for Our Lives movement and their large voter turnout in the midterm elections. On a judicial front, Brett Kavanaugh was confirmed to the Supreme Court, ushering in a more conservative court and an understanding that there is much more progress to be made in believing women. Here is a list of 10 significant news events of 2018 affecting the nonprofit sector in the United States and a few links regarding each:

  1. Tax Cuts and Jobs Act
  2. Mass shootings and March for Our Lives
  3. Brett Kavanaugh hearings and confirmation
  4. Murder of Jamal Khashoggi
  5. Midterm elections
  6. California fires
  7. Migrant family separation and detention of children
  8. General Data Protection Regulation takes effect
  9. Donor information disclosure rules
  10. Supreme Court decisions

 

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Rebuttable Presumption of Reasonableness Procedures

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The Rebuttable Presumption of Reasonableness procedures, described in Treasury Regulation Section 53.4958-6(a), were promulgated to help charities avoid overpaying certain individuals and entities (known as disqualified persons) that might be able to exercise influence on the charity’s decision-making. Among those included as disqualified persons (DQPs) are:

  1. Directors (board members), trustees, presidents, CEOs, COOs, treasurers, CFOs, and other persons who were, at any time during the 5-year period ending on the date of such transaction, in a position to exercise substantial influence over the affairs of the organization (which typically include founders, substantial contributors over the past five years, and persons whose compensation is primarily based on revenues derived from a part of the organization that the person controls);
  2. Family members of those individuals described in (1) above, including spouses, siblings, the spouses of siblings, ancestors, children, grandchildren, great grandchildren, and the spouses of children, grandchildren, and great grandchildren; and
  3. 35-percent controlled entities, which are corporations in which individuals described above own more than 35% of the combined voting power, partnerships (including LLCs) in which individuals described above own more than 35% of the profits interest, and trusts and estates in which individuals described above own more than 35% of the beneficial interest; provided however, that entities exempt under 501(c)(3) and most entities exempt under 501(c)(4) are not disqualified persons.

While the Rebuttable Presumption of Reasonableness procedures were designed to apply only in cases in which an economic benefit is provided by a charity, directly or indirectly, to or for the use of a DQP, these procedures serve as a best practice to implement wherever significant payment is being made by the charity that might be considered excessive in relation to the goods, services, or rights being received in return. Even if the person or entity benefiting from the excessive payment is not a DQP, such payment may represent a prohibited private benefit and diversion of charitable assets. Accordingly, procedures that help assure that the payments are reasonable as to the charity, if carefully observed in good faith, will be protective to the charity and to the board. But practically speaking, following the Rebuttable Presumption of Reasonableness procedures may in some cases, particularly for smaller charities, be unduly burdensome and unnecessary where the payment made to a DQP is very obviously below fair market value.

Excess Benefit Transactions

Codified in section 4958 of the Internal Revenue Code (“IRC”), the excess benefit transaction rules impose penalty taxes on DQPs that receive excessive payments from a charity. These rules are meant to prevent the unjust enrichment of a DQP at the expense of the charity. If an excess benefit transaction has occurred, the IRS can levy taxes, commonly referred to as intermediate sanctions, on both the DQP who received the excess benefit and the organizational manager(s) (e.g., directors, officers) who knowingly approved the excess benefit transaction. This issue often comes up in the context of executive compensation.

If a DQP is found to have benefited from an excess benefit transaction, the DQP will need to return to the charity the portion of any payment considered excessive and pay to the IRS a first tier penalty tax (intermediate sanction) of 25% of the excessive amount and, if not timely corrected, a second tier penalty tax of 200% of the excess benefit. In some cases, the entire payment may be considered an excess benefit (e.g., where compensation to the DQP was not properly reported to the IRS), and the penalty can be extremely steep. For an example of such cases, see Automatic Excess Benefit Transactions (David Levitt, Adler & Colvin).

If the charity engaged in an excess benefit transaction, the organizational manager(s) (e.g., directors, officers) who knowingly approved the excess benefit transaction may also be subject to a penalty tax of 10% of the excess benefit. An organizational manager participates in a transaction knowingly only if the person –

  • Has actual knowledge of sufficient facts so that, based solely upon those facts, such transaction would be an excess benefit transaction;
  • Is aware that such a transaction under these circumstances may violate the provisions of Federal tax law governing excess benefit transactions; and
  • Negligently fails to make reasonable attempts to ascertain whether the transaction is an excess benefit transaction, or the manager is in fact aware that it is such a transaction.

Generally, if the IRS penalizes a DQP under the excess benefit transaction rules, such individual bears the burden to prove that the transaction was reasonable. However, if the organization follows the Rebuttable Presumption of Reasonableness procedures described below, the burden of proof shifts to the IRS to show that the transaction resulted in an excessive payment to the DQP.

Three Steps to the Rebuttable Presumption of Reasonableness

The Rebuttable Presumption of Reasonableness procedures consist of three steps:

  1. The compensation arrangements are approved in advance by an authorized body of the organization composed entirely of individuals who do not have a conflict of interest with respect to the compensation arrangement;
  2. The authorized body obtained and relied upon appropriate comparability data prior to making its determination; and
  3. The authorized body adequately documented the basis for its determination concurrently with making that determination.

1. Authorized Independent Body Free of Conflicts

The authorized body charged with approving the transaction may be made up of the full board of directors or a smaller authorized board committee, so long as all members of the body do not have a conflict of interest with respect to the transaction. The regulations identify five conditions that must be satisfied in order to establish the requisite absence of a conflict of interest. Generally, the members of the authorized body should not consist of:

  • A DQP or anyone related to the DQP who is, or will, participate in, or economically benefit from, the transaction or arrangement (hereafter, referred to as “Person X”);
  • A person in an employment relationship subject to the direction or control of Person X;
  • A person who receives compensation or other payments subject to approval by Person X;
  • A person who has a material financial interest affected by the transaction or arrangement; or
  • Any person who receives or will receive from a DQP approval of a transaction benefiting such person in turn for such person’s approval of the transaction providing economic benefits to the DQP (i.e., a “you-scratch-my-back, I’ll-scratch-yours-type reciprocal transaction).

The authorized body may invite the DQP to come to a meeting and answer questions with respect to the transaction or arrangement, so long as that person recuses themselves from the meeting and is not present during debate and voting of the transaction or arrangement.

2. Appropriate Comparability Data

The requirement for reviewing comparability data helps the authorized body determine what economic benefit (payment) is fair and reasonable as to the charity, particularly when what would constitute such amount under similar circumstances is not well-known. It may also be thought of as an extension of a director’s duty of care, which includes reasonable inquiry. One way to show that a transaction or arrangement is fair and reasonable to the charity, does not provide an excess benefit to any private individuals or companies, and overall is in the best interest of the charity, is to look at other similar transactions or arrangements for comparison. We’ve previously written a post on appropriate comparability data for compensation arrangements. Note that, for transactions involving property, the regulations provide that appropriate comparability data may include “current independent appraisals of the value of all property to be transferred; and offers received as part of an open and competitive bidding process.” See Treas. Reg. § 53.4958-6(c)(2)(i).

Generally, the regulations do not specify the types of information or number of comparables that must be reviewed in order to benefit from the presumption; instead they state that the authorized body must use its judgement, given the knowledge and expertise of the body’s members, to determine whether the information gathered is sufficient to satisfy the standard set in the regulations (i.e., that “the compensation arrangement in its entirety is reasonable or the property transfer is at fair market value”). Thus, it will be a matter of facts and circumstances in determining whether sufficient and/or appropriate and current data was obtained and reviewed by the authorized body when making its decision. One exception to this general rule is for charities with annual gross receipts of less than $1 million (based on an average of its gross receipts during the three prior taxable years). For those small charities, there is a special rule that provides that consideration of three comparables of similarly situated organizations and positions will be appropriate.

Comparability data must be gathered and presented to the authorized body in advance of, or at, the meeting at which the arrangement or transaction is being considered. As a best practice, the data should be in writing and sent to the members of the body prior to the meeting so that each member has time for review and analysis.

3. Concurrent Documentation of Basis for Determination

To satisfy the third requirement of the rebuttable presumption, that the authorized body adequately documented the basis for its determination concurrently when making it, the regulations require that the documentation includes the following:

  • the terms of the transaction and the date it was approved;
  • the members of the authorized body who were present when the transaction was debated and those who voted on it;
  • the comparability data obtained and relied on by the authorized body and how the data was obtained; and
  • any actions taken by a member of the authorized body who had a conflict of interest with respect to the transaction (e.g., abstention).

Such documentation belongs in the minutes of the authorized body’s meeting or a written consent. The records must be prepared before the authorized body’s next meeting or 60 days after the body’s final actions are taken, whichever is later. Records must be reviewed and approved by the authorized body as reasonable, accurate, and complete within a reasonable time period.

If an organization satisfies the rebuttable presumption of reasonableness requirements, the IRS may rebut the presumption, “only if it develops sufficient contrary evidence to rebut the probative value of the comparability data relied upon by the authorized body.” Treas. Reg. § 53.4958-6(c)(3)(ii).

Ensuring that your organization’s conflict of interest policy conforms to these standards, as well as any other potential standards governing self-dealing transactions under state law, is one way to mitigate providing excess benefits to insiders in the future.

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