Articles Posted in Non-Profit Organizations

As anticipated, the Internal Revenue Service announced a streamlined, much simpler and shorter version of Form 1023, the Application for Recognition of Tax Exempt Status.

Standard Form 1023

The standard Form 1023 is 26 pages long, not counting a 38-page instruction booklet, 3 additional pages of instructions the IRS has added to the front of the form making changes to the form and the instructions, and a 2-page checklist to make sure the entire submission package is complete and compiled in the correct order. But that’s not all — one of the most important sections of the form, Part IV, is only about a quarter-page long but it calls for the applicant to attach a detailed narrative description of the organization’s activities explaining how each of them supports the organization’s charitable purpose, and several other sections leave so little room to include all the necessary information that most applicants find it necessary to attach addtional pages. With all that, and with the other information that must be submitted, such as articles of incorporation and bylaws, Form 1023 submission packages can easily reach 50, 60, or 70 pages.

The IRS says that they currently have a nine-month backlog of Form 1023 applications, and it is possible that number is actually an understatement. Once received by the IRS, Form 1023 applications go through a sort of triage process. Applications that are complete and do not appear to pose significant obstacles to approval are directed into a queue to be processed more quickly than applications that will require the IRS to request significantly more information. Just this week our office received a determination letter for a Form 1023 that had been pending for more than seven months, and that application was, presumably, directed through the quicker process.

Form 1023-EZ

In contrast, Form 1023-EZ is less than three pages long, although that is a little misleading because it still requires an instruction booklet with 10 pages of instructions to explain how to complete the form, a 7-page worksheet that must be completed in order to determine if the organization is eligible to use the streamlined form, and a 3-page list of National Taxonomy of Exempt Entities (NTEE) Codes from which the applicant must select the code that best fits the organization. Nonetheless, Form 1023-EZ should be considerably less burdensome than the standard form.

After completing the worksheet, the applicant must file the form online at www.pay.gov, which requires a username and password obtained through free registration. Any applications submitted on paper are automatically deemed incomplete.

Eligibility

Most organizations with annual revenues less than $50,000 for the current year, each of the previous three years, and the next two projected years are eligible to submit Form 1023-EZ. However, some types of organizations must submit the standard Form 1023 regardless of revenues. Here is a partial list of organizations that are ineligible for Form 1023-EZ:

  • Those organized as limited liability companies.
  • Churches and associations or conventions of churches. (Note: Churches are not required to submit an application for recognition of tax exempt status, but if they do not, they will not have a determination letter from the IRS, which can be useful for various reasons. Those that wish to receive a determination letter will continue to submit Form 1023 rather than 1023-EZ.)Schools, colleges, and universities.
  • Hospitals, medical research organizations, and hospital organizations.
  • Health maintenance organizations (HMOs).
  • Accountable care organizations (ACOs).
  • Supporting organizations (i.e., charitable organizations that are derive their status as public charities from their supporting relationship to another charitable organization that is a public charity).
  • Credit counseling organizations.
  • Organizations that have previously had their tax exempt status revoked except organizations that have had their tax exempt status revoked for failing to file Form 990 (or 990-EZ or 990-N) for three consecutive years.

That last part is significant because many smaller organizations have lost their tax exempt status for failure to file Form 990, and Form 1023-EZ will be available to those wishing to have their tax exempt status reinstated.
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The Internal Revenue Service’s application for an employer identification number (or EIN) requires the applicant to submit the name and tax identification number (usually a social security number) of the applicant’s “responsible party.” That is true whether the application, Form SS-4, is submitted on paper or online, and it is true for any type of organization applying for an EIN, including corporations, limited liability companies, partnerships, trusts, and tax exempt organizations. That is the last time most organizations ever think about the “responsible party.” Until now.

On May 6, 2013, the Internal Revenue Service published a final rule that requires any business, nonprofit organization, trust, or other entity with an EIN to report any change in the entity’s responsible party. Here are the answers to some questions that essentially every business and tax exempt organization should know.

Who is a “responsible party”?

The answer differs a bit for various types of organizations. For companies with shares traded on a public exchange or securities registered with the U.S. Securities Exchange Commission, the responsible party is defined fairly unambiguously:

For corporations, the responsible party is the principal officer.
For partnerships, the responsible party is a general partner.
For trusts, the responsible part is the trustee, grantor, or owner.
For disregarded entities, the responsible party is the owner.

For other entities, the definition is more ambiguous:

The responsible party is “the person who has a level of control over, or entitlement to, the funds or assets in the entity that, as a practical matter, enables the individual, directly or indirectly, to control, manage, or direct the entity and the disposition of its funds and assets.”

For business corporations, the responsible party may be the president or chairman of the board; for LLCs, a member; for partnerships (including limited partnerships, such as family limited partnerships), a general partner.

The issue of identifying a responsible party for a nonprofit organization may be particularly problematic because, in many organizations, no single person who has the authority to control, manage, or direct the organization and — in particular — to control the disposition of its funds and assets. In fact, we often tell the boards of directors of our nonprofit clients that, collectively, they have full authority to control the organization but, individually, they have no authority at all. Even so, the IRS requires the designation of a responsible party, and the organization must decide who best fits the definition. For some organizations, that may be the executive director or CEO; for others, it may be the president or chairman of the board.

Our LLC has three members, all with the same rights and authority. Who is the responsible party?

If more than one person qualifies as a responsible party, the entity must select one of them by whatever criteria the entity chooses.

When and how must changes be reported?

As of January 1, 2014, any change in an entity’s responsible party must be reported on IRS Form 8822-B within 60 days after the change takes effect. Changes made prior to January 1, 2014 must be reported before March 1, 2014.

Our organization obtained an EIN years ago, and we have no idea who was listed as the responsible party. But Form 8822-B requires us to list not only the new responsible party, but also the old one. What do we do with that?

The best course is probably to submit Form 8822-B without the information about the old responsible party and attach a statement explaining what you have done to locate the information and why it is unavailable despite those efforts. [Revised February 21, 2014, to include the idea of attaching a statement — a suggestion from James W. Foltz, Attorney at Law, of Indianapolis, Indiana.]

Our nonprofit has filed Form 990 (or 990-EZ or 990-N) every year, and we always have to list the organization’s principal officer. Isn’t that good enough?

From what we know at the moment, probably not. Even if the responsible party and the principal officer are the same person, Form 8822-B calls for the responsible party’s social security number, but Form 990 does not. The same thing is true for the tax matters partner identified on Form 1065 filed by partnerships and by LLCs taxed as partnerships.

I called the IRS and tried to get some more specific information about the new reporting requirement, and the person I spoke with had never heard of this new requirement. Are you sure about it?

We had the same experience, but, yes, we’re sure. We hope the IRS will issue guidance that clarifies some of the details, but we’re sure the rule is in effect.

What happens if we do not file Form 8822-B or file it late?

That’s the good news. As far as we can tell, there is no penalty for failing to file or for filing late. Even so, everyone with an EIN, including small businesses and tax exempt organizations, should comply with the rule using the best understanding of the requirement and the best information available.
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Peter Orszag at Bloomberg wrote an interesting article about the growth of nonprofit organizations from 2008 onwards. One study cited was done by Nonprofit HR Solutions, entitled “Nonprofit Employment Trends Survey.”

The article and the survey both painted an optimistic picture about nonprofit organizations post-millennium. They were viewed as a source of jobs and growth (nearly 5% of GDP according to Mr. Orszag) in contrast to the for-profit sector which has contracted, according to a study performed by researchers at Johns Hopkins University.

One key finding of the Nonprofit HR Solutions study was that nonprofits are continuing to grow and expand with no signs of slowing down. A full 40+% of institutions plan to add positions in the upcoming year, an upwards trend from the 33% in 2011.

Another interesting observation is that nonprofits may be facing a leadership vacuum. As one generation heads for retirement, plans for succession are not clearly developed. Whether or not this affects organizational stability remains to be seen, as nonprofit growth may attract qualified individuals needed as the for-profit sector continues to contract.

According to the survey, many nonprofits are ill prepared to deal with turnover, particularly in leadership positions. They have not developed succession plans or implemented measures to prevent key employees with needed knowledge, skills, or qualifications from leaving – either laterally to another nonprofit or to the for-profit sector or to government employment. A lack of a retention strategy could, in theory, lead to a brain drain or a boom-bust phenomenon where growth sectors lack the knowledge needed most as the lucrative lure of the private sector exacerbates the problem at precisely the wrong time.

Nonprofits, according to the survey, continue to explore social networking sites as a recruitment tool. Although non-traditional, such sites like Facebook and LinkedIn offer inexpensive, almost ubiquitous tools. There is also potential for growth in this sector, as it relates to another survey finding: the difficulty of attracting and retaining employees in the under-30 demographic.

As job markets in the for-profit sector contract, candidates who might have otherwise never considered a job in the non-profit sector take positions at these institutions. This creates a benefit for these non-profits in that they have a larger applicant pool to choose from. Due to corporate cost-cutting and austerity measures, the phenomenon is not limited to entry-level jobs but encompasses all levels of seniority.

Ironically, the success of nonprofit organizations may ultimately lead to a darker spot on the horizon. As Mr. Orszag points out, some politicians question whether tax-exempt status gives nonprofit organizations an unfair advantage over for-profit businesses that offer similar services. Although some nonprofits provide the same or similar services that are also provided by for-profit businesses (hospitals are an example that often comes to mind), many tax exempt organizations satisfy needs that would go entirely unmet if left to the private sector. Regardless of one’s political views, it is an area to watch in future discussions of tax reform.

Despite some uncertainties, if nonprofits can continue to expand, retain, and plan for leadership transitions, the future is bright indeed.
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The “Indiana Smoke Free Air Law,” which was passed last year by the Indiana General Assembly and took effect on July 1, 2012, bans smoking in most Indiana businesses and nonprofit organizations. We thought the General Assembly might reconsider some of the details this year, but that hasn’t happened. Based on our non-scientific observations, it seems that Indiana businesses and nonprofits have not been very diligent about implementing the law, particularly those regarding signs. So we think it’s a good time to review the requirements, or at least some of them.

“Does the smoking ban affect my business?”

Smoking is now prohibited by law in “public places” and “places of employment,” as well as the area within 8 feet of public entrances to either of them. “Public places” and “places of employment” sound as if they encompass a lot, and they do. A public place includes any enclosed area of a structure in which the public is permitted or invited, and a place of employment includes any enclosed area of a structure (excluding a private vehicle) that is a place of employment. Lest we forget, there’s one other category — smoking is also banned in government vehicles being used for governmental purposes.

There are some exceptions, but the bottom line is that the smoking ban affects most businesses and nonprofit organizations in Indiana.

“Okay, my office is covered. What do I have to do?”

  • Not surprisingly, you must inform your employees and prospective employees that smoking is prohibited.
  • You must post conspicuous signs that read “Smoking is Prohibited by State Law,” or something to that effect. The law has a specific requirement that restaurants must have a conspicuous sign at each entrance informing the public that smoking is prohibited in the restaurant.
  • You must also post signs at each entrance (logically, the sign should be outside or at least visible from the outside) stating “State Law Prohibits Smoking Within 8 Feet of this Entrance” or something similar.
  • If someone smokes on the premises anyway, you must ask him or her to refrain, and if he or she refuses to stop, you must have him or her removed from the premises. (Note: Don’t try to do it yourself! In the unlikely event it becomes necessary, call the police.)

“I own a bar. Does the smoking ban REALLY apply to my business?”

It depends. There are some exceptions to the smoking ban, and one of them is for bars and taverns, but you have to meet certain requirements. For example, you may not have any employees under 18, and you must exclude anyone else under 21. There are more exceptions for several other types of places of employment and public places, each subject to particular qualifications or additional requirements.

“Does the law apply to our nonprofit organization?”

Probably. There is an exception that covers some social clubs and fraternal organizations or lodges that are tax exempt under Internal Revenue Code Sections 501(c)(7), (c)(8), or (c)(10), and it’s possible that some other types of nonprofits fit into an exception, but most nonprofits are subject to the smoking ban.

“I have a home office. Is smoking banned there, too?”

Again, it depends. The ban does not apply to a business located in the business owner’s residence, but only if all the people who work there live in the residence. Let’s assume that only you (the owner) and your spouse work in your office. In that case, you’re allowed to smoke, but if you have any employees who don’t live in your home, smoking is prohibited.

“Are there other exceptions?”

Yes. For a complete list see Ind. Code 7.1-5-1-5.

“My facility falls within an exception to the smoking ban, so I’m home free. Right?”

Well, not entirely. There are some other requirements that apply to public places and places of employment in which smoking is permitted. Here’s an interesting one — you have to post signs that state “WARNING: Smoking is allowed in this establishment.” You must also certify to the Indiana Alcohol and Tobacco Commission that your bar qualifies for the exception.

Moreover, even if most of your facility or building is exempted from the ban, smoking is prohibited in halls, elevators, and common areas where people under 18 are permitted or in rooms intended for use by people under 18.

And don’t forget that even if the state law does not ban smoking in your business, it may be prohibited by local no-smoking laws — such as the Indianapolis Ordinance — which are allowed to be more restrictive than the state law.

Other resources

NOTE: This is not a comprehensive analysis of the Indiana Smoke Free Air Law. There are other exceptions and other requirements that may apply to your business or nonprofit (even if it is exempt from the ban itself) that we have not discussed. Here are some other resources:

  • The full text of the statute can be found at Ind. Code 7.1-5-1.
  • Signs that comply with the state law are readily available from a number of suppliers.

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The Internal Revenue Service has announced the following standard mileage rates used to calculate income tax deductions for business travel expenses and for travel expenses incurred while serving charitable organizations.

  • Business, $0.565 per mile
  • Charitable service, $0.14 per mile

[Note: The Department of Labor guidance, Fact Sheet #71, discussed in this article has been superseded as it applies to the use of unpaid interns by businesses.  See the discussion of the revised policy here. The guidance as it applies to the use of unpaid interns by nonprofit organizations appears to be unchanged.]

As our last post explained, for-profit businesses are very limited in their ability to use unpaid interns legally. Unless the internship program meets six different criteria to qualify the intern as a trainee, the intern is an employee subject to the Fair Labor Standards Act or FLSA.

For nonprofits, however, there is a third possibility. The intern may qualify as a volunteer, in which case the intern is not an employee under FLSA and not subject to the minimum wage and overtime compensation requirements. The footnote to Fact Sheet #71 issued last year by the Department of Labor’s Wage and Hour Division recognizes an exception to FSLA for individuals who volunteer their time to nonprofit organizations for religious, charitable, civic, or humanitarian purposes, provided they do so freely and without expecting any compensation. In those situations, unpaid internships are generally allowable.

Earlier this week, Friendly Family Productions, LLC, the company that produced the television series Little House on the Prairie settled its lawsuit against a nonprofit corporation that operates a small museum outside Independence, Kansas. The museum is located at the site of the original house that Laura Ingalls Wilder wrote about in her book of the same title. Friendly Family Productions alleged that the museum infringed the trademark LITTLE HOUSE ON THE PRAIRIE. According to complaint filed in U.S. District Court in Los Angeles, the predecessor to Friendly Family Productions acquired rights to that trademark from the author’s descendants in 1974.

What got Friendly Family Productions all riled up (to use a term that Ms. Wilder would have been comfortable with) was the use of the trademark on merchandise that the museum sold, including the merchandise that it sold through a website with the domain name www.littlehouseontheprairie.com. Friendly Family Productions acknowledged that it had no quarrel with the museum using the words “little house on the prairie” to describe the homesite or the museum, because a purely descriptive use like that does not infringe a trademark. On the other hand, Friendly Family Productions had considerable quarrel with the museum putting those words on merchandise (caps, T-shirts, magnets, note cards, key chains, and other items typical of promotional merchandise) and selling them over the internet. Friendly Family Productions claimed that the use of those words implied that the merchandise came from the owner of the trademark, when it did not. That is, in a nutshell, the reason trademarks exist — to identify the source of the goods that bear the mark.

According to an article in the Topeka Capital-Journal and other sources, Friendly Family Productions originally offered to pay the museum $40,000 if it would stop using the trademark. The museum refused the offer, choosing instead to fight the lawsuit. The terms of the settlement agreement are confidential, but we know that the nonprofit corporation has changed its name from Little House on the Prairie, Inc. to the more descriptive Little House on the Prairie Museum, Inc., and www.littlehouseontheprairie.com is no longer active.

There’s no way to know how much the two-year litigation cost the parties.
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Unlike Indiana, most states require that non-profit organizations register with an agency such as the Attorney General’s office before soliciting any charitable donations within the boundaries of that state. In addition to initial registration, those states typically have annual reporting requirements as well. Although Indiana is not one of the 40 states requiring registration, non-profits located in Indiana that solicit contributions outside the state cannot ignore the requirements.

The primary purpose of registration is to protect citizens from potential scams put on by fraudulent charities. To that end, some states, such as Illinois, provide an online index of registered non-profit organizations and encourage their residents to “investigate” before they make any donations. If a non-profit is not listed there, it is likely that a potential donor will decide not to make a contribution.

Because Indiana does not currently require non-profit registration, some non-profit organizations located in Indiana may be unaware of the registration requirements in other states. However, all four states that surround Indiana — Illinois, Kentucky, Michigan, and Ohio — require this type of registration for non-profits engaging in fundraising within their borders.

States that require registration insist non-profits register BEFORE conducting any fundraising efforts in their jurisdiction. If your nonprofit organization is not currently registered but has been soliciting charitable donations within a state that requires registration, you should take immediate steps to get in compliance.
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Internal Revenue Service Form 1023 is entitled “Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code,” which is why most people call it simply “Form 1023.” Most types of nonprofit organizations that fall within Section 501(c)(3) must submit Form 1023 within 27 months of their formation, along with a user fee that depends on the amount of revenue that the organization anticipates.

Last year the user fees for Form 1023’s increased significantly. For 2011, they remain the same as in they were in 2010. The fees are:

  • $400 for organizations with annual gross revenues less than $10,000
  • $850 for organizations with annual gross revenues equal to or greater than $10,000

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As discussed in my post of November 24, businesses and nonprofit organizations face a significant increase in the requirements to issue 1099 forms beginning with payments made after December 31, 2011. However, a lot could change between now and then. Several legislators introduced bills during the previous session of Congress that would have dramatically reduced the new reporting requirements or even repealed them altogether. Although none of them passed, similar bills are being introduced again in the new session.

Representative Dan Lungren (R. California) originally introduced a repeal measure last April, just one month after the original legislation was passed, but was unable to obtain the signatures necessary for a vote on the matter. Rep. Lungren re-introduced his bill to repeal the 1099 tax provision earlier this week and plans to continue fighting against the new tax provisions. The bill, referred to as “The Small Business Paperwork Mandate Elimination Act,” has 180 co-sponsors and was one of the first bills to be introduced during the 112th Congressional Session.

Other members of Congress have sought to lighten the impact of the reporting changes without repealing them altogether. Senator Mary Landrieu (D. Louisiana) introduced a bill last September that would increase the reporting threshold from $600 to $5,000. Senator Landrieu has yet to re-introduce the bill, but it is likely that similar efforts will begin to surface in the new Congress.

Many organizations representing small business owners have also shown great concern about these changes, which increases the possibility of amendments or a total repeal before next year. Continue checking back here for updates on the 1099 reporting requirements and how they will affect your small business or non-profit organization.
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