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FFIRS_1 12/12/2012 1 Starting and Managing a Nonprofit Organization Starting and Managing a Nonprofit Organization: A Legal Guide, Sixth Edition. Bruce R. Hopkins. © 2013 Bruce R. Hopkins. Published 2013 by John Wiley & Sons, Inc. FFIRS_1 12/12/2012 3 Starting and Managing a Nonprofit Organization A Legal Guide Sixth Edition Bruce R. Hopkins John Wiley & Sons, Inc. FFIRS_1 12/12/2012 4 CoverDesign:JohnWiley&Sons,Inc. CoverImage:#KennethRivenes/GettyImages Copyright#2013byBruceR.Hopkins.Allrightsreserved. PublishedbyJohnWiley&Sons,Inc.,Hoboken,NewJersey. FiftheditionofStartingandManagingaNonprofitOrganization:ALegalGuidepublishedin2009byJohnWiley&Sons,Inc. PublishedsimultaneouslyinCanada. Nopartofthispublicationmaybereproduced,storedinaretrievalsystem,ortransmittedinanyformorbyanymeans, electronic,mechanical,photocopying,recording,scanning,orotherwise,exceptaspermittedunderSection107or108of the1976UnitedStatesCopyrightAct,withouteitherthepriorwrittenpermissionofthePublisher,orauthorization throughpaymentoftheappropriateper-copyfeetotheCopyrightClearanceCenter,Inc.,222RosewoodDrive,Danvers, MA01923,(978)750-8400,fax(978)646-8600,orontheWebatwww.copyright.com.RequeststothePublisherfor permissionshouldbeaddressedtothePermissionsDepartment,JohnWiley&Sons,Inc.,111RiverStreet,Hoboken,NJ 07030,(201)748-6011,fax(201)748-6008,oronlineathttp://www.wiley.com/go/permissions. LimitofLiability/DisclaimerofWarranty:Whilethepublisherandauthorhaveusedtheirbesteffortsinpreparingthis book,theymakenorepresentationsorwarrantieswithrespecttotheaccuracyorcompletenessofthecontentsofthis bookandspecificallydisclaimanyimpliedwarrantiesofmerchantabilityorfitnessforaparticularpurpose.No warrantymaybecreatedorextendedbysalesrepresentativesorwrittensalesmaterials.Theadviceandstrategies containedhereinmaynotbesuitableforyoursituation.Youshouldconsultwithaprofessionalwhereappropriate. Neitherthepublishernorauthorshallbeliableforanylossofprofitoranyothercommercialdamages,includingbutnot limitedtospecial,incidental,consequential,orotherdamages. Forgeneralinformationonourotherproductsandservicesorfortechnicalsupport,pleasecontactourCustomerCare DepartmentwithintheUnitedStatesat(800)762-2974,outsidetheUnitedStatesat(317)572-3993orfax(317)572-4002. Wileypublishesinavarietyofprintandelectronicformatsandbyprint-on-demand.Somematerialincludedwith standardprintversionsofthisbookmaynotbeincludedine-booksorinprint-on-demand.Ifthisbookreferstomedia suchasaCDorDVDthatisnotincludedintheversionyoupurchased,youmaydownloadthismaterialat http://booksupport.wiley.com.FormoreinformationaboutWileyproducts,visitwww.wiley.com. LibraryofCongressCataloging-in-PublicationData: Hopkins,BruceR. Startingandmanaginganonprofitorganization:alegalguide/BruceR.Hopkins.—SixthEdition. pagescm.—(Wileynonprofitauthorityseries) Includesindex. ISBN978-1-118-41345-6(pbk.)ISBN978-1-118-52062-8(ebk);ISBN978-1-118-52752-8(ebk);ISBN978-1-118-52048-2(ebk) 1. Nonprofitorganizations—Lawandlegislation—UnitedStates. 2. Nonprofitorganizations—Taxation—Lawand legislation—UnitedStates. I. Title. KF1388.H662013 346.73’064—dc23 2012041955 PrintedintheUnitedStatesofAmerica. 10 9 8 7 6 5 4 3 2 1 FFIRS_1 12/12/2012 5 To my parents, Frederick and Jane, who, as teachers, professional and otherwise, encouraged me, in their own way and in ways they may not realize, to write this book, with love. FTOC_1 11/20/2012 7 Contents Preface ix Acknowledgments xiii PART ONE STARTING A NONPROFIT ORGANIZATION 1 Chapter One: What Is a Nonprofit Organization? 3 Chapter Two: Starting a Nonprofit Organization 13 Chapter Three: Debunking Some Myths and Misperceptions 23 PART TWO BEING NONPROFIT, LEGALLY 31 Chapter Four: Nonprofit Organizations: Much More than Charity 33 Chapter Five: Nonprofits and Private Benefit 49 Chapter Six: From Nonprofit to Tax-Exempt 65 Chapter Seven: Charities: Public or Private? 79 Chapter Eight: Governance: Board Duties and Liabilities 93 Chapter Nine: Braving Annual Reporting 109 Chapter Ten: Tax Exemption: Not a Paperwork Exemption 119 Chapter Eleven: Charitable Giving Rules 129 Chapter Twelve: Government Regulation of Fundraising 147 PART THREE TAX-EXEMPT ORGANIZATIONS CAN BE TAXABLE, AND SO CAN THEIR MANAGERS 167 Chapter Thirteen: Related or Unrelated? 169 Chapter Fourteen: Lobbying Constraints—And Taxes 185 Chapter Fifteen: Political Campaign Activities—And More Taxes 197 Chapter Sixteen: Donor-Advised Funds, Tax Shelters, Insurance Schemes—And Still More Taxes 205 PART FOUR HELPFUL HINTS AND SUCCESSFUL TECHNIQUES 211 Chapter Seventeen: Subsidiaries: For-Profit and Nonprofit 213 Chapter Eighteen: Joint Venturing and Other Partnering 223 n vii n FTOC_1 11/20/2012 8 CONTENTS Chapter Nineteen: Wonderful World of Planned Giving 233 Chapter Twenty: Putting Ideas into Action 241 PART FIVE SIDESTEPPING TRAPS 251 Chapter Twenty-One: Watchdogs on the Prowl 253 Chapter Twenty-Two: Potpourri of Policies and Procedures 267 Chapter Twenty-Three: Commerciality, Competition, Commensurateness 283 Chapter Twenty-Four: IRS Audits of Nonprofit Organizations 293 Chapter Twenty-Five: Avoiding Personal Liability 313 PART SIX CONSTITUTIONAL LAW PERSPECTIVE 319 Chapter Twenty-Six: Nonprofit Organizations and the Constitution 321 Glossary 341 Index 353 n viii n FPREF_1 11/20/2012 9 Preface Thisbookwasconceivedabout25yearsago;theconceptionremainsavividlymemo- rable experience. Its genesis occurred during a speech before managers of relatively small nonprofit organizations. I had been assigned some esoteric topic on the law of tax-exempt organizations and was about five minutes into my presentation when suddenly—tomychagrin—Irealized,fromtheglazed-overlooks,thatfewpeoplein the audience had even the faintest idea what I was talking about. The remainder of them did not seem to care. Preservation instincts took over. The assignment was hopeless, so I abandoned my intended remarks. (I literally threw my notes on the floor, at least generating—to my relief—a little laughter.) Instead, we talked about whatmyaudiencereallywantedtohear:someofthebasicsofthelawsaffectingnon- profitorganizations. The experience was not a measure of the level of intelligence of that particular audience;rather,itreflectsthefactthatthosewhomanagenonprofitorganizations— particularlythesmallerones—oftenlackunderstandingofthebasicsofthelawsthat regulate their operations and the legal problems that may be awaiting them in their blissfulignorance.Amassivegapexistsbetweentheprogramplanningandthelegal expertiseofmanyofthoseresponsibleforthefateofnonprofitorganizations.Thelaw caneitherhelpthemachievetheirgoalsorpreventthemfromsucceeding. I was struck by the thought that there was a need for a book providing a basic summaryofthelaws thataffecttheoperationofnonprofitorganizations. The bookI envisionedwouldhavenocitationsorfootnotes—justreadabletext. I had no shortage of questions from my practice, speeches over the years, and 21yearsofteachingalawschoolcourseontax-exemptorganizations.Ibeganrecall- ing and noting these questions and was surprised to realize how the same ones are askedagainandagain.EventhoughIhavepracticed lawinexcessof40years,Istill find myself asked many of the same basic questions. This book has been written to provideanswerstothosequestions. The questions are fundamental and important, but they reveal tremendous con- fusion. The confusion is understandable: The law in this field is confusing—even overwhelming. The ultimate purposes of this book are to decipher the Internal Revenue Code as it affects nonprofit organizations; to translate the intricacies of the law in these areas and try to make them understandable to nonlawyer managers of ‘‘nonprofits’’;andotherwisetohelptoclosethegapbetweengoalsandknowledgein nonprofitorganizations. Thelawaffectingnonprofitorganizationsisvolatile.Ongoingchangeinthisfield oflawisaconstant,andmanyregulatorychangeslieahead.Ihavetriedtomakethe booksufficientlygeneraltowithstandmostofthischange.Yet,oncethebasicsinthis fieldaregrasped,somereadersmaywantmoredetailandmorecurrentinformation. My monthly newsletter, Bruce R. Hopkins’ Nonprofit Counsel (Wiley), is a useful resourceforkeepingupwithlegaldevelopmentsthataffectnonprofitorganizations. For some readers, there may be more in the book than they need at this time, particularlyiftheyarejustbeginningtoestablishanonprofitorganizationortheyare n ix n FPREF_1 11/20/2012 10 PREFACE thinking about doing so. Let me offer this perspective for the newcomer to the world, and the law, of nonprofit organizations. There are many types of nonprofit organizations. Nearly always, those who start a nonprofit organization want it to be tax-exempt. At a minimum, they want it to be eligible to receive tax-deductible contributions.Theyequatenonprofitorganizationswithtax-exemptorganizations and perhapswithcharitableorganizations. Forthosewhoalreadyknowthattheywantacharitableentity,Chapter4canbe skimmed as a review. For others, Chapter 4’s inventory of the various types of tax-exemptorganizationsistheplacetobegin. A fictional ‘‘Campaign to Clean Up America’’ is used throughout as an illustra- tion of how to organize and qualify a tax-exempt charitable organization. Most individuals, when planning to establish a nonprofit organization, are thinking in terms of a charity, even if that thinking is only subconscious. Rarely have they selectedbetweenapublicversusaprivatecharity.Usually,theyarethinkingaboutthe establishmentofafoundation. Thefirstquestion for anindividualinterestedinestablishinganonprofit organi- zationshouldbe:What isthenonprofit organization goingto do? Justlike starting a for-profit business, the first step is to determine the organization’s functions, then match the category of tax-exempt status (if any) to the organization’s purposes and functions.Toooften,individualsstartwitharound-pegnonprofitorganization(usu- ally,acharitableone)andtrytoforceitintothesquare-holerequirementsofthelaw imposedonthattypeoforganization. Acharitywillnotfittherequirementsofall.Herearesomeoftheotherchoices: (cid:1) Advocacy organizations. These groups attempt to influence the legislative pro- cessorthepoliticalprocess,orotherwisechampionparticularpositions.They may call themselves social welfare organizations or political action commit- tees.Notalladvocacyislobbying.andnotallpoliticalactivityispoliticalcam- paignactivity.Someofthisprogramcanbeaccomplishedthroughacharitable organization, but that outcome is rare where advocacy is the organization’s primaryundertaking.Insomeinstances,twononprofitorganizationsareused, tohaveitbothways—ablendofcharitableandadvocacyactivities. (cid:1) Membership groups. Some nonprofit organizations—associations, veterans’ groups,andfraternalorganizations—are structured as membership organiza- tions.Thisisnottosaythatacharitableorganizationmaynotbestructuredas a membership entity; it can, but there are other categories of membership groups.Frequently,thesearebusinessleagues. (cid:1) Socialorrecreationalorganizations.Nonprofitorganizationsmaybeorganizedas formal social clubs (like country clubs, and tennis and golf clubs), or hobby, garden, or sports tournament organizations. The key factor is their primary purpose; some social activity can be tolerated in charitable groups. There is someoverlapwithothercategories—forexample,asocialorganizationcanbe structuredasamembershipentity. (cid:1) Satelliteorganizations.Somenonprofitorganizationsaredeliberatelyorganized asauxiliariesorsubsidiariesofotherorganizations.Examplesoftheseorgani- zationsincludetitle-holdingcompanies,thevarioustypesofcooperatives,and n x n FPREF_1 11/20/2012 11 PREFACE retirement and other employee benefit funds. The parent organization may beafor-profitentity,suchasabusinesscorporationwitharelatedfoundation. (cid:1) Employee benefit funds. The world of compensation is intricate, regardless of whethertheemployerisafor-profitornonprofitorganization.Variouscurrent and deferred benefits for employees are provided, including retirement and profit-sharing programs. These programs—or ‘‘plans’’—are often financially supported by benefit funds. When properly organized and operated, these fundsaretax-exemptentities. Once the category of tax-exempt organization has been decided, the reader can turntoChapter5,whichdiscussestheconceptsofprivateinurementandprivatebenefit. Among other things, it offers an explanation of the basic distinctions between non- profit and for-profit organizations. An understanding of the private inurement doc- trine is necessary because it applies to most tax-exempt organizations. The private benefit doctrine, by contrast, applies only to charitable organizations (although theIRSistryingtoapplyitinothercontexts).Alsointhischapterisasummaryofthe intermediatesanctionsrules—asignificantpackageofstatutorylawthataffectscharita- bleandsocialwelfareorganizations,andcertainnonprofithealthinsuranceissuers. Iftheorganizationwillengageinattemptstoinfluencelegislation,ajumpahead, for a reading of Chapter 14, is essential. If the organization is to engage in efforts to intervene or participate in political campaign activities, a perusing of Chapter 15 is necessary. For charitable organizations, another jump ahead in the book may be in order. Because all charitable organizations are presumed to be private foundations and because there is little advantage in being so classified, most charitable entities strive to avoid private foundation status if they can. A review of the basic differences betweenpublicandprivatecharities,includedinChapter7,isimportantattheoutset. In addition to being tax-exempt, an organization may have charitable donee status.Noteverytax-exemptorganizationcanreceivetax-deductiblegifts,butmany can. Chapter 4 identifies those that are charitable donees; Chapter 11 provides the basiccharitablegivingrules.Anorganization’scharitablegivingprogramideallywill include at least the rudiments of a planned giving program; this type of giving is describedinChapter19.Ifacharitablegiftsolicitationprogramisplanned,theorgan- izationmustkeepinmindthestateandfederallawspertainingtofundraising.These lawsaresummarizedinChapter12. Nearly all charitable organizations must obtain a ruling from the Internal Revenue Service (IRS) that they are tax-exempt and eligible to receive deductible gifts. Most other categories of tax-exempt organizations may wish to obtain IRS rulings but are not required to do so. The process of obtaining such a ruling is the subject of Chapter 6, obviously a necessary chapter for new organizations. Readers will find it helpful to have a copy of IRS Form 1023 at hand when they reach this chapter.(ThecurrentformisdatedJune2006.) AnotherkeychapterisChapter9,whichoutlinesthevariousreturnsandreports thatatax-exemptorganizationmustfile,underbothfederalandstatelaw.Theprinci- palforminthisregardisForm990.Thisreturnrecentlywassignificantlyredesigned. Readersshouldhavethemostcurrentformathandwhenreadingthischapter. n xi n FPREF_1 11/20/2012 12 PREFACE Thesedays,thematterofgovernanceisthehottestlawissuefornonprofitorgan- izations.Thus,Chapters8and22areessentialreading. Chapter 25 may be the most riveting chapter for those who are serving (or are thinking of serving) on boards of directors and/or as officers in nonprofit organiza- tions. The chapter deals with personal liability (as does Chapter 8) and how to avoidit. The balance of the book can be read when the topics are relevant for particular situations.Forexample,Chapter11focusesonthecharitablegivingrules,Chapter12 concernsfundraisingregulation,Chapter13pertainstotheunrelatedbusinessrules, andChapter17dealswiththeuseofsubsidiaries.Chapter18detailsinvolvementsin partnerships. Other chapters (16, 21, and 23) pertain to somewhat more esoteric topics— principally, donor-advised funds, tax shelters, insurance schemes, commerciality, and competition with for-profit organizations. Chapter 24 addresses a subject non- profitentitiesdreadthemost:anIRSaudit.Chapter26summarizestheprinciplesof constitutionallawapplicableinthecontextofnonprofitorganizations. Nobookisasubstituteforgoodlegalorotherprofessionaladvice.Somemanag- ers of nonprofit organizations are afraid to seek advice—out of embarrassment for asking ‘‘dumb questions’’ or fear of the costs involved. An operator of a nonprofit organization may not even realize the presence of a legal problem. This book is intendedtoeasethosefearsandclosethosegaps. BRUCER.HOPKINS KansasCity,Missouri December2012 n xii n

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