Judith G.H. Edington Russell J. Stein Boston Bar Association Tax-Exempt Fundamentals October 9, 2012

 State statute controls formation. ◦ Generally is an entity organized under a state statute or common law of trusts. ◦ In Massachusetts, non-profit corporations are organized under MA G.L. ch  No prohibition from making a profit. ◦ If a non-profit spends more then it brings in, it will have difficulty surviving, therefore “profit” is generally a necessity.  Tax-exemption is determined under IRS rules. 2

For-ProfitNon-Profit Has owners who hold equity in the entity. Generally does not have “owners” (although may have “members”). Operated for the benefit of its shareholders / owners. Operated for the benefit of its “charitable class.” Legally able to generate a profit. Profits passed on to its owners.Profits cannot pass on to any owners or members. 3

 Non-profit organizations are also sometimes referred to as tax-exempt organizations.  Many non-profit organizations benefit from tax exemption but are not charitable organizations. ◦ Some of the better known of these include  Labor organizations – 501(c)(5)  Business leagues (c)(6)  Social clubs – 501(c)(7) 4

Non-profit orgs Social welfare orgs All tax-exempt orgs 5

 A 501(c)(3) organization is one that is organized and operated for one or more of the following exempt purposes: ◦ Religious ◦ Charitable ◦ Scientific ◦ Testing for public safety ◦ Literary ◦ Educational ◦ Prevention of cruelty to children or animals 6

◦ Both are 501(c)(3) charitable organizations. ◦ Private foundation is the default 501(c)(3) classification. ◦ An organization has to “earn” public charity status.  broad public financial support -- e.g. American Red Cross, United Way, Boston Symphony Orchestra  status based – e.g. school, hospital, church ◦ Why does it matter?  public charities enjoy more favorable rules with respect to the charitable income tax deduction  private foundations are subject to a strict code of behavior not applicable to public charities 7

 Primary Purpose Test ◦ Organization must be organized and operated exclusively for an exempt purpose.  “Exclusively” has been interpreted as “primarily.”  Organizational Test ◦ Organization’s formation documents must set out charitable purpose. ◦ Assets must be dedicated to an exempt purpose. Upon dissolution, assets must be distributed in furtherance of exempt purpose.  Operational Test ◦ Must engage primarily in activities that accomplish one or more of its exempt purposes. ◦ Will not meet the test if more than an insubstantial part of its activities is not in furtherance of an exempt purposes. 8

 Charitable assets must be used for the benefit of the public and not for any particular private use. ◦ No “private inurement.” No income or asset may unduly benefit a person that is closely related to the organization. ◦ Only incidental “private benefit” is permitted. A private benefit is a non-incidental benefit accruing to an outside party. 9

 A charitable class is a group of individuals that may properly receive assistance from a charitable organization.  A charitable class must be either large enough that the potential beneficiaries cannot be individually identified, or sufficiently indefinite that the community as a whole, rather than a pre-selected group of people, benefits when a charity provides assistance.  The concept of charitable class is another way of unpacking the public versus private benefit concept. 10

 In addition to the prohibition against private inurement and private benefit, charities may not ◦ Devote more than an insubstantial part of its activities to lobbying. ◦ Participate in elections. 11

 Tax law encourages financial support of 501(c)(3) charitable organizations because of their public rather than private focus.  Contributions are deductible for income tax purposes only if made to domestic charitable organizations.  Charitable deductions are itemized deductions on an individual’s tax return. ◦ Subject to income limitations:  50% / 30% / 20% limitations  Contributions must be properly substantiated. 12

 Supporting Organizations ◦ SOs obtain public charity status by virtue of their close relationship with another public charity.  Donor advised funds ◦ An account held at a public charity over which the donor retains advisory privileges with respect to charitable grants from the fund.  “Friends of” organizations ◦ When properly structured, enable tax deductible contributions to support the work of foreign charities. 13

 Incubation  Bridge (until 501(c)(3) status obtained)  Ongoing sponsorship of charitable program ◦ A charitable activity may not require a new charitable organization with all of the ongoing legal and financial compliance responsibilities that come with a separate legal entity. ◦ Consider partnering with an existing organization with similar charitable goals. 14

 Hybrid Organizations ◦ L3Cs ◦ Benefit corporations  G.L. ch. 156E  B Corps (a branding tool) 15

 The IRS:  Massachusetts office of the Attorney General Charities Division: massachusetts/public-charities-or-not-for- profits/  Nonprofit law blog:  Nonprofit law prof blog:  ABA Tax-exempt listserve  Guidestar: 16

 November 13 ◦ Formation of a charitable organizations  January 8, 2013 ◦ Governance and fiduciary duties  February 12, 2013 ◦ Taxes for the tax-exempts  March 12, 2013 ◦ Dissolution of a non-profit organization  Year 2: Oct 2013 – March 2014 ◦ Focus will be on private foundations 17