NONPROFIT STARTUP & OPERATION

by

Curtis L. Harrington

HARRINGTON & HARRINGTON

6300 State University Drive, Suite 250

Long Beach, CA 90815

(562) 594-9784, Fax: (562) 594-4414

http:/www.patentax.com E-mail: curt@patentax.com PATENTAX®

A

PATENTAX®

PRESENTATION

Disclaimer: Educational Only: This outline is Educational Only and no part of this presentation can be considered as federal or state tax advice, opinion, or position and is not intended or written to be used, and may not be used, for the purpose of (I) avoiding tax-related penalties under the internal revenue Code or (ii) promoting, marketing or recommending to another party any tax-related matters addressed herein, nor (iii) constituting guidance on any tax or intellectual property matter.

I.	The Table of Contents

Page	Description

3	II.	Why a Table of Contents?

3	III.	Types of Nonprofits

A.	The main type of nonprofit is charitable nonprofit under §501(c)(3)

B.	Other entities are described

4	IV.	Overview of Nonprofits in the U.S.

A.	Federal and State Overlap & Interaction

5	B.	Independent Nature under both Federal and State

C.	The nonprofit sits across a line of deductibility

D.	Ownership

E.	Attorney General (or state agency) as Interested Member

F.	Economic Rationale for nonprofits

6	G.	General Prohibition on competing with for-profit businesses

H.	General Economics of having nonprofits associate with for-profit businesses

7	I.	Joint Ventures between for-profit organizations and nonprofits?

8	J.	Increased Level of Scrutiny (nosiness) with the new form 990

V.	Formation of a Nonprofit in California

A.	General Overall Steps Simplified - Many variations but these are basic steps

9	B.	Specific Aspects - Articles of Incorporation; Various elements

11	C.	Specific Aspects - Form 1023

D.	Specific Aspects - Bylaws

13	VI.	Operation of a Nonprofit in California

A.	Overall Budget Categories: Administrative, Fund Raising, & Program

B.	Optimum Efficiency is operation by unpaid volunteers & uncompensated boards

C.	Annual Reporting Requirements will include Form 990, 990EZ

14	D.	Transaction/Inurement Penalties

E.	Nonprofits are not given any special treatment for employment taxes

F.	Public can request and receive copies of the nonprofit's tax returns

G.	endorsemente of a candidate for public office can cause loss of the exempt status

H.	Continuously Exerting Oversight over fund raising

I.	Carefully monitoring the disposition of assets

15	J.	Realization of the type of category a given 501(c) fits within

K.	For Automatic exemption from private foundation, maintain requirements

16	L.	Monitor court decisions, new legislation and other factors

M.	Comply with "Good Governance" guidelines

N.	Some State issues:

18	VII.	Foreign Related Nonprofits.

A.	Since 9/11, the federal government has been highly conscious of abuse potential

B.	Generally foreign based nonprofits of the same type are respected by the U.S.

VIII.	Dissolution of a Nonprofit.

A.	Voluntary dissolution of nonprofit corporation by an election to dissolve

B.	A Certificate of Dissolution & letter from the Attorney General

C.	Property and assets of the nonprofit can only go to another nonprofit

II.	Why a Table of Contents?

A.	It enables Preview, Interview, Post View

1.	By reviewing all of the categories, you will be able to see what is coming in the presentation, and when it will be presented. It will help to mark your questions at coming categories, the questions to be asked if they were not already answered in advance in that category.

2.	The Table of Contents enables a quicker find, based upon the location in various aspects of the identity, formation and life cycle of a non-profit.

B.	It helps to organize a body of materials which are generally disjointed, in some logical way.

III.	Types of Nonprofits in the U.S.

A.	The main type of nonprofit which comes to mind is a charitable nonprofit under §501(c)(3) of the Internal Revenue Code. These include community chests, funds, and foundations which are organized and operated exclusively for religious, charitable, scientific, public safety testing, literary or educational purposes.

B.	Other entities are described beginning with §501(c)(4) and which can have various individualized rules and prohibitions, but which generally require that they are operated as a not operated for profit, and for the benefit of its members. The idea is that these types of entities should exist without an expectation that they produce a profit. Contributions to these organizations do not result in a §170(c) deduction to the donors. These include:

1.	§501(c)(4) civic leagues (social welfare promotion).

2.	§501(c)(5) labor, agricultural or horticultural organizations.

3.	§501(c)(6) business leagues & chambers of commerce.

4.	§501(c)(7) recreational clubs

5.	§501(c)(8) fraternal lodge societies and for life, accident, sickness benefits.

6.	§501(c)(9) employees beneficiary associations for life, accident, sickness benefits.

7.	§501(c)(10) fraternal societies which earn money for religious, charitable, scientific, literary, educational & fraternal purposes but which do not provide for life, accident, sickness benefits.

8.	§501(c)(11) teachers retirement fund associations

9.	§501(c)(12) local life insurance, irrigation, telephone associations

10.	§501(c)(13) cemetery companies for member's burial benefits.

11.	§501(c)(14) nonprofit credit unions.

12.	§501(c)(15) insurance companies other than life insurance.

13.	§501(c)(16) crop operations corporation.

14.	§501(c)(17) supplemental unemployment compensation benefit trust.

15.	§501(c)(18) pension plan benefits trust.

16.	§501(c)(19) armed forces or auxiliary post.

17.	§501(c)(20) nonprofit group legal service plan.

18.	§501(c)(21) black lung trust.

19.	§501(c)(22) multiemployer plan trust.

20.	§501(c)(23) prior armed forces insurance & benefits association.

21.	§501(c)(24) ERISA trust

22.	§501(c)(25) real property income trust benefiting a retirement plan.

23.	§501(c)(26) medical care membership insurance organization.

24.	§501(c)(27) workers compensation supplemental fund.

25.	§501(c)(28) National Railroad Retirement Investment trust.

IV.	Overview of Nonprofit Charities in the U.S.

A.	Federal and State Overlap & Interaction

1.	Treatment of non-profits is based upon Federal and State Overlap. It operates in much the same way that citizens are subject to federal taxation and state taxation. However, there is a bit more blending of characterization because of the fact that state law rules dictate the form of entity.

2.	California, for example, favors the shareholder-less C corporation form. It has provisions for an LLC form, but has rules which cause the LLC form to be subject to the minimum annual franchise tax unless and until it can satisfy the state that it is charitable in nature. The LLC form is generally a pass-thru entity and is philosophically at war with the "separateness" desired of nonprofits by both the federal and state authorities.

3.	Across the states and territories of the U.S. other forms are encouraged, including the trust form, and many others. Each form has an integration with the state's other laws, and is one aspect of nonprofits which tends to prohibit movement of the nonprofit from one state to the other.

4.	Riding on the Federal determination. Using the patent system as an example, it was not unusual for lesser technological countries in which a patent is filed, to simply wait until the more technological country (the U.S.) had performed its examination, and then simply "copy" the more technological country's rejections/approach/level of claim allowance at the time of the less technological country's examination. Most states follow this rule with respect to the Federal Determination of entitlement to exemption. The state jurisdiction typically contacts the nonprofit and says "I have your paperwork, and when you get your federal determination, send it to us".

B.	Independent Nature: Because of the tax advantages inherent in a nonprofit there is a natural tendency for entrepreneurs to want to "use" the nonprofit for their own benefit. This is not only prohibited by the rules (to be discussed), but the very formation and operation of the nonprofit needs to be independent of any individual entities control, and control should be had only to benefit the exempt purpose.

C.	The nonprofit sits across a line of deductibility, along with all nonprofits. As an entity, the nonprofit GENERALLY has the same benefits and rights as a for profit entity. It can sue and be sued; it can hold trademarks, patents and copyrights, and it can form contractual relationships with other entities.

D.	Ownership: Nearly all other entities have some form of ownership, be it shares of stock, or units of LLC ownership and the like. California nonprofit corporations don't have shares of stock, so particular attention should be paid to drafting articles and bylaws to insure the type and continuity of management desired. Some organizations do this by creating ex-officio management or board slots, as well as some mechanism for selection and approval of new and retiring board positions.

E.	Attorney General as Interested Member: The State Attorney General's office is considered to be an ultimate member of each California non-profit. That office has the ability to enter to enforce compliance with state law (which is more specific and narrow than federal law). The State Attorney General can't be written out of this role in the articles or bylaws. The State Attorney General even has oversight over unincorporated associations. See also California Govt Code §12584.

F.	Economic Rationale for nonprofits. There are a number of stated justifications for having nonprofits, with a major one being that nonprofits perform services which government would otherwise have to perform. It is also believed that even though many nonprofits are inefficient, that they achieve their purpose more efficiently than government would. It is also believed possible that nonprofits can appear in response to a public need much earlier than government legislation could provide and that it can change more rapidly with the changing times to serve the public much more effectively than government.

G.	General Prohibition on competing with for-profit businesses. Charities are expected to conduit funds in support of the main purpose. Charities are also allowed to Attorney General as Interested Member: The State Attorney General's office is considered to be an ultimate member of each California non-profit. That office has the ability to enter to enforce compliance with state law (which is more specific and narrow than federal law). The State Attorney General can't be written out of this role in the articles or bylaws.

As to the continuum between for profit and non profit businesses and for profit businesses, where the business is the central purpose of the organization see Goldsboro Art League, 75 T.C. 337 (1980).

H.	General Economics of having nonprofits associate with for-profit businesses. Generally this raises the issue of advertising as a business. Nonprofits are encouraged to seek for- profit organizations which will run ad campaigns showing the good works and donations the for-profits give to the nonprofit. Example? Say that an airline adopts the humane society and promises to give $1 each time a customer takes a flight if it is requested at the time that the reservation is made. So long as the total of the $1 contributions are within the airlines normal deduction limit (10% of annual profits), the airline is allowed to deduct the contribution, and the humane society has taken in a donation that it could have had from any source. The airline may gather more business than it would have otherwise, but this results in more taxable income, and more tax to the government.

Conversely, what if a nonprofit adopted an airline? The nonprofit starts spending its money toward advertising how great the airline is because the more people who fly the airline and mentions the humane society, the more money the charity will collect. In many ways, though not to the extent of 100% of its airline budget, the non-profit has become an advertising agency for the airline. The airline's contribution to the charity would be deducted by the airlines as would any money that the airline spent on advertising. However, an AD agency would earn profits and be taxed on them, whereas the charity, a nonprofit, would not. In essence the nonprofit is usurping a non-charitable advertising business.

In general, a charity can list its donors on a donor list, or sponsors of an event on a sponsor list. However, any touting which goes beyond simple listing is subject to an "Unrelated Business Income Tax", or UBIT. The UBIT tax rate is imposed at the corporate rate (which will depend upon total income) except for charitable trusts which are subject to the tax rate for estates and trusts IRC §511, 512, 513. A key component, however, is the "unrelatedness" requirement. A museum which operates a souvenir shop which is related to the theme of the museum, is not "unrelated", and would not have its gross margins (income minus cost of goods sold) taxed by UBIT. Further, a small souvenir shop, as a commercial enterprise, is likely "incidental" to the main purpose of running a museum. It probably generates only a fractional contribution to the overall expenses of the museum.

I.	Joint Ventures between for-profit organizations and nonprofits? As strange as this may seem, and as dangerous as it might be in triggering a dozen potential penalties and taxes, this has been addressed in Rev. Rul. 2004-51, as well as in Rev. Rul. 1998-15. In Rev. Rul. 2004-51 a nonprofit education provider made a joint operating agreement with a video production company as an LLC. It is my belief that all of the provisions of the joint venture could have been accomplished by a simple licensing agreement. The joint venture, which acts as somewhat of a proxy for the nonprofit, risks:

1.	Performing activities that do not further exempt purposes and which may not necessarily be limited to a level which is an insubstantial part of the organization's activities (Better Business Bureau of Washington, D.C. v. United States, 326 U.S. 279, 283 (1945),

2.	Becoming an organization is not organized or operated exclusively for exempt purposes unless it serves a public rather than a private interest as required in the Regulations § 1.501(c)(3)-1(d)(1)(ii), i.e. loss of its exempt status.

3.	Failure of the Joint venture to further its charitable purposes on mutually beneficial terms, especially if the nonprofit organization does not thereby impermissibly serve private interests of its for-profit partner (Redlands Surgical Services, 113 T.C. 47, 92-93 (1999), aff'd 242 F.3d 904 (9th Cir. 2001))

4.	Failure of the charitable partner ensure that the partnership operations further its charitable purposes, irrespective of whether the joint venture partnership provides some charitable services. St. David's Health Care System v. United States, 349 F.3d 232, 236-237 (5th Cir. 2003)

5.	The potential attraction of UBIT income under IRC §512.

6.	The potential for UBIT based upon the manner in which the exempt organization operates its business as a determiner of UBIT's "unrelatedness" function. See United States v. American College of Physicians, 475 U.S. 834, 849 (1986).

Even more dangerously, the entities described in Rev. Rul. 2004-51 made a general 50/50 agreement on sharing investment and profits. The ruling seems to further point out that because the relationship between the profit & nonprofit was one of proportion, that any activity of the joint venture partnership were attributed to the nonprofit partner. The ruling was based upon the facts before it, but it at least may leave open a suggestion that a strictly drafted joint venture where only some activities are controlled and attributable to the nonprofit, might make the relationship "safer". I still contend that nearly any partnership joint venture can be replaced by a commercial contract structured to provide in a better way, the same objectives.

J.	Increased Level of Scrutiny (nosiness) of the Federal government via the new form 990 annual informational filing requirement. As a result of 9/11 and the potential for abuse of nonprofits, both domestically and for nefarious international purposes, the federal reporting requirement requires a lot more operating details to be reported each year. Further, by asking pointed questions on several new categories of information, the federal government is strongly inferring that the nonprofits make themselves able to answer affirmatively to the new categories of questions, and with sufficient detail to show that each area of inquiry is sufficiently embraced. New Areas included in the June 20077 revisions include:

1.	Governance, Management and Disclosure invite an annual overt discussion of employee compensation, corporate/organizational conflicts of interest, whistle blower protection and more.

2.	The extent to which the directors are "independent". In California, the corporate code has a more stringent standard than elsewhere in the U.S., and the answers to this question could trigger problems with the FTB. See California's "Nonprofit Integrity Act of 2004 affecting California Government Code §12585, 12586, & 12599.

3.	Answers on Policies include detailed questions on conflict of interest policies including their internal processes for dealing with them. Another policy inquiry is the Joint Ventures policy whose most invited answer, in lieu of endless lists a specific aspects of this policy, would be a simple policy on prohibition of same.

4.	More disclosures are sought in order to try and make the operation of the nonprofit as transparent as possible. The IRS also wants to insure that the new 990 form is seen by management and the board before it is filed, to insure that any answers would be adopted and assented to by the nonprofit's management.

V.	Formation of a Nonprofit in California

A.	General Overall Steps Simplified - Many variations but these are basic steps

1.	Prepare Corporate Filing Papers, including Articles of Incorporation.

2.	Prepare By Laws which are consistent with the Articles of Incorporation.

3.	File the Articles of Incorporation with the Secretary of State with fee.

4.	Upon acceptance of filing, and upon grant of a corporation number for exacting identification, file for a tax ID number for the entity. (Form SS-4)

5.	Once the tax ID number is available, prepare and file an Application for Federal Exemption Determination (Form 1023) & Determination Letter Request (Form 8718) and user fee ($400 where gross receipts are expected not to exceed $10,000 and $900 for all others).

6.	Prepare and File an Application for State of California Exemption Determination (Form 3500) & fee & include all material sent to the U.S. Government. Remember that since the state generally wants to follow the federal determination, having a copy of all that was sent federally puts them a bit more at ease and reduces the state's later need for "information about the federal exemption basis".

7.	Expect receipt from the IRS or FTB or both, a packet of material which contemplates withholding for employees of the exempt organization; regardless of any indications made on the applications for exemption.

8.	Expect some sort of communication from the FTB, either before or after the federal exemption application is acted upon, requesting that any federal determination be made available to the state if, when & as received.

9.	Expect a call from the IRS requesting more information. In some cases the call will request information which seems either to have already been supplied, or asking some general question. This may be a check call to see if the applicant is still there and viable (and represented). The amount of information requested is in direct proportion to the questionability of the nonprofit's focus. Where a significant number and type of activities are described, the questions and inquiries will be similarly complex.

10.	Once the IRS is satisfied about its inquiries, the Federal Exemption Application should then be approved and a "Federal Recognition of Exemption Letter" "Letter 947" will be issued which will indicate (a) whether you have been approved for exempt status, and (b) whether you have avoided private foundation status. (More about this later). Copies of this letter may be provided to donors to assure them of the nonprofit's status.

11.	A copy of the "Federal Recognition of Exemption Letter" should be forwarded to the FTB nonexempt unit as soon as possible.

12.	The FTB Exempt Organizations Business Entities Section should, absent any further questions, forward a similar letter stating that the entity is "exempt from franchise or income tax".

B.	Specific Aspects - Articles of Incorporation; Various elements

1.	Articles of Incorporation must be drafted to include all the provisions required by the California Corporations Code. The Secretary of State provides "sample" nonprofit articles which exemplify some of the requirements of the state and federal statutes. Although compliance with nonprofit law could be achieved without any special inclusions in the articles, the requirement to include such provisions adds the element of an "ultra vires" to an unlawful act of a nonprofit organization where the act contravenes the provisions of the articles of incorporation.

2.	Articles of Incorporation Provision: "This corporation is a nonprofit Public Benefit Corporation and is not organized for the private gain of any person." This emphasizes the state and federal principle that the money is to be used exclusively for the charitable purpose and that the benefits are not to "inure" to any person. This does not necessarily mean that a staff cannot be hired, but it does mean that the staff or anyone else associated with the nonprofit must deliver reasonable services, in exchange for a justifiable provable proper amount of compensation.

3.	Articles of Incorporation Provision: "The specific purpose of this corporation is to.....". It is the norm in for-profit corporations to state that the purpose is "any business purpose". For nonprofits, it is important that the articles express a specific charitable focus. The specificity of the charitable purpose is tested at startup to see if it benefits the public generally (even if its a limited segment of the public), and this is tested throughout the operational life of the charity. One reason that this is important is that there needs to be a correspondence between the donative intent of a donor and the purpose to which any donated funds are put. In addition, every action of the nonprofit board will be tested against the stated purpose to see if the nonprofit is operating within its mandate.

Generally it is easily conceivable as to why this requirement is important. Most founders of nonprofits have directed their charitable passion in a particular direction, and desire that the direction be maintained. The articles of incorporation can be amended, but it may be more difficult when the nonprofit has assets which were given for purpose in effect at the time of the donation. It is more likely expected that changes in the purpose are expected to be quantum changes rather than gross changes, and it is preferable that any change chan be justified due to changed circumstances. Where the change is major, or where there is some worry that a change might trigger an objection from any quarter, it may be desired to obtain a court order directing the change. The "cy pres" doctrine has been used in the past to change a purpose of a charity in direct opposition to the purpose stated by the originator/incorporator of the charity.

4.	Articles of Incorporation Provision: "This corporation is organized and operated exclusively for charitable purposes within the meaning of Internal Revenue Code section 501(c)(3)." This sample provision has a couple of effects. First, where the internal revenue code sections, including 501(c)(3) and modifying sections are changed, it automatically forces the nonprofit to change with them, and that change is fundamental -- at the level of the articles of incorporation. Second, the "exclusively for charitable purposes" reinforces the prohibition on private inurement rule.

5.	Articles of Incorporation Provision: " No substantial part of the activities of this corporation shall consist of carrying on propaganda, or otherwise attempting to influence legislation, and the corporation shall not participate or intervene in any political campaign (including the publishing or distribution of statements) on behalf of any candidate for public office." This provision, which is typically is included in the articles of a public charity, states several principles. First, propaganda and influencing legislation is a lobbying activity. Generally lobbying is a for-profit business activity, and its deductibility is extremely limited by IRC § 162(e) . Moving away from the private business of lobbying, the next type of entity is a political organization which has its own separate provisions in IRC §527. For political parties, their expenditures and donation receipts there are a myriad number of federal, state and local law requirements (not mentioned here).

Charities are allowed some small amounts of lobbying if it touches on their purpose, but IRC §4912 imposes a special excise tax of 5% of the amount of such expenditures to be paid by the organization, and an additional 5% to be paid by the management of the organization if the management willful. Second, intervening an any political campaign between candidates is absolutely forbidden.

C.	Specific Aspects - Form 1023

1.	Recent changes (w/in last two years):

a.	Address; all requests have been relocated to Covington, Kentucky.

b.	More burdensome requirement to wait several years before a showing that the non-profit is expected to be a publicly supported nonprofit are eliminated. A showing based upon reasonable expectation can be shown from the start (more on private foundation versus publicly supported nonprofit will be shown later).

c.	Increased financial data now required. Previously required was current year + 2 more years, where in existence for less than 5 years. Current is 3 years if less than one tax year completed, but 4 years if one tax year is completed.

d.	As an example, the base application in 2001 had 9 pages. The current application is expanded to 12 pages. The new pages include a lot of the inquiry of the new 990 form. These include questions on foreign connections, the elimination of space for the description of charitable activities since it is naturally expected to be quite lengthy, a dedicated compensation section, and other aspects similar to the 990 annual reporting form which strongly suggests adoption of policy and the like.

D.	Specific Aspects - Bylaws

1.	Remember that the bylaws have to accompany the Form 1023 request for exemption recognition. Therefore it MUST be consistent with the program description which accompanies the Form 1023.

2.	The bylaws have to create stability in an organization, despite having no ownership. Where an organization has ownership, the ownership creates both stability through ownership and preservation of valuable shares, and stable voting of those shares by individuals who have a strong desire to preserve their investment, and thus the organization. You have to be more creative with the by laws.

a.	Consider a mechanism which limits board members to those who are approved by a majority of a small board.

b.	Consider other limits for board membership to individuals who have shown a level of loyalty to the organization.

c.	Where your organization would benefit from support of local government, consider "ex officio" board positions in which local leaders take positions on your board. This should be done only if the organization is such that it would always be supported by the ex officio board member.

d.	Consider other "poison pill" provisions to prevent hostile takeover. Just because its a nonprofit doesn't mean that it won't be raided by another non- profit for its assets. A local case in Long Beach, "Khmer Buddhist Association v. Larry SAR" is an example of a Buddhist church owning a significant real estate asset, and which did not remain as organized as it otherwise might have, only to have another non-profit attempt to take it over in order to get control of its assets. This should be a reminder that nonprofits can benefit not only from public donations and government grants, but also from corporate raiding.

e.	Bylaws are the perfect place to include major policies. This should include:

I-.	Auditor Standards.

ii.	Audit committees

iii.	Mismanagement/ Sarbanes Oxley provisions.

iv.	Conflicts of Interest Policies

v.	Internal & External Disclosures policy.

vi.	Internal procedures and internal timing to make sure that all board members see and are familiar with all reporting. No significant reporting or significant action should be performed without board member oversight.

vii.	Define the officers fully and their annual duties. Apprise any officers of their duties before having them take office.

viii.	Solicitation and Fund Raising policies. These are critical. There are special rules, procedures, applications and approvals imposed by the State Attorney General and the IRS. For example, raffles, bingo, casino games and the like sound trivial, but there are stringent requirements for holding these types of events. By laws should identify that these requirements will be met, and identify the person or persons responsible for complying with the rules.

ix.	Document Retention. This policy is more important than ever given the heightened involvement and responsibility of nonprofits for keeping track of the donors, keeping track of donors who donate in- kind property, insuring that the in-kind property is tracked to determine when it stops being used for the exempt purpose, and if sold is reported back to the donor and to the IRS.

VI.	Operation of a Nonprofit in California

A.	Overall Budget Categories. In general, the budgetary categories for a nonprofit include Administrative Costs, Fund Raising Costs, and Program Expenditures. Nonprofits are continuously examined for how well they score in each category. The split between Administrative Costs and Fund Raising Costs may depend upon how much staff time is spent fund raising. However Program Expenditures compared to all money collected give some measure of the efficiency. Don't fail to understand that Program Expenditures can result in graft and waste -- a program to feed the homeless which purchases $1000 gourmet meals is not operating efficiently, even if its Administrative Costs and Fund Raising Costs are zero. Program Expenditures and their efficiency represent the most

B.	Of course, the optimum efficiency of a non-profit occurs when it is operated by unpaid volunteers, managed by uncompensated boards, and which have 100% of its donations spent directly upon its nonprofit purpose. Where it is necessary to compensate either boards or staff, the key is being able to justify the most extreme scrutiny on equivalent salaries. Annual surveys for each employee in the organization is the norm. Their classification, education, talents and equivalent jobs are measured, and justified. Data is available by several services and give not only the average in several locations, but special percentile data. Instead of a situation where the employer and employee are on opposite sides of the bargaining table, the nonprofit is more closely aligned with and are continually trying to justify the salaries paid to staff.

C.	Annual Reporting Requirements will include Form 990, 990EZ (organizations with gross receipts of under $25,000 need not file the 990's but may be required to file a "post card" type electronic form which is "simplified." Penalties for non filing required information returns can include $20 per day with a maximum of $10,000 or 5% of gross receipts for the year (IRC §6652(c)(1)(A).

D.	Transaction/Inurement Penalties. Nonprofit officers and board members (and others) may be "disqualified persons". Transactions by which a "disqualified person" receives improper benefits are subject to penalties as an excise tax of 25% of the excess benefit. Managers would get an excise tax of 10% of the excess benefit up to $20,000 maximum. IRC §4958. But the idea is truly to have these transactions reversed at the earliest possible moment. If the excess benefit is not corrected within the taxable period, an additional penalty of 200% of the excess benefit is imposed.

E.	Nonprofits are not given any special treatment as to failure to withhold taxes for staff. In fact, nonprofits will suffer more severely than a for-profit corporation. In a for-profit corporation, the corporation is liable, as well as officers who knew or should have known that the withheld taxes were not paid. However, with the requirements of the 990 form, the requirement that the board and officers be intimately involved in knowing everything and every policy in organization, the persons who "knew or should have known" within a nonprofit will include all of the board and all of the officers. This is one reason that volunteering to serve on a board is something that should be done with eyes wide open. Simply "riding along" on a board, and without asking hard questions, may result in your "volunteer service" turned into a guarantor for the debts of the nonprofit.

F.	Another reason to keep a nonprofits financial "health" well maintained is that the public can request and receive copies of the nonprofit's tax returns. Moreover, the IRS has been working on a project which will make the nonprofits returns readily available on the world wide web so that those returns can be inspected by anyone simply by identifying and clicking on the corresponding link.

G.	As previously discussed, nonprofits which endorse a candidate for public office will potentially cause loss of the exempt status for the organization. However, nonprofit organizations that lobby in manner which is local and/or related to their own interest are not penalized. The key is determining and setting parameters so that the lines are drawn brightly and so that the nonprofit does not exceed its permitted level of lobbying. See IRC §4911, "Tax on Excess Expenditures to Influence Legislation". The tax is 25% of expenditures over the nonprofit's "grass roots nontaxable amount". IRC §4911(c) has a table setting forth the corresponding "nontaxable amount" and its based upon and proportional (but not linearly) to the level of "exempt purpose expenditures".

H.	Continuously Exerting Oversight over fund raising, and especially gaming. Contracts with fund raisers are required to be in writing. Gaming activities are required to be permissible under state law, and not a principal activity of the nonprofit. This requirement meshes with overseeing fund sources which might attract Unrelated Business Income Tax (UBIT).

I.	Carefully monitoring the disposition of assets. Any asset owned by a nonprofit has to be either sold for fair market value, with the proceeds of the sale taken back into the non-
profit, or it must be donated to another nonprofit. Once an asset or its financial equivalent is created on the nonprofit side of the money line, it, or its benefit must be maintained on the nonprofit side. It is generally the position of the IRS (and once remarked by its counsel) that once the assets move into the nonprofit realm, that the IRS doesn't really care which nonprofit eventually ends up with it so long as the rules (i.e. core purpose, or adjusted basis to the donee upon sale) are observed. IRC §170(e) requires that an in-kind donation of personal property get special attention from the nonprofit.

For charitable donations, the donor has previously been able to write off the fair market value of tangible personal property, perhaps the theory being that a donor should not be forced to sell an appreciated item even at a 15% capital gains rate and then donate the leftover cash to the charity, especially where such a sale followed by cash donation might result in a limitation on the deduction where the amount exceeds the 50%, 30% or 20% limits. IRC §170(e)(7) includes a provision for recapture of deduction of certain dispositions of exempt use property. The "recapture period" extends for three years beginning on the date of contribution of he property. The recapture will be the amount of deduction allowed to the donor over the donor's basis. The triggering event is a disposition, unless the donee nonprofit makes a certification that the use of the property by the nonprofit was substantial and related to the exempt purpose of the nonprofit. As a result of §170(e), there will be a 3 year umbilical cord between the nonprofit and the donor as to tangible personal property.

J.	Realization of the type of category of 501(c) fits, and keeping the books accordingly. For example, a "Private Foundation" has a less beneficial tax treatment than a public charity because it is more suspect that it is not being operated for the public benefit. A general nonprofit can be a "public charity if it meets two tests:

1.	One-Third of Donations and support are from public sources, i.e. donations, memberships, sale of goods & merchandise.

2.	Less than One-Third of the donative support is from a single source, investments , or UBIT classified income.

Private Foundations must spend 85% of its income or investment returns on its program expenditures.

K.	If the nonprofit is one of the types of organizations which are automatically exempt from being a private foundation, care should be taken to make certain that any aspect necessary to meet that exception is maintained. For example, educational institutions must offer education on a regularly scheduled basis. Categories which are automatically excluded from the threat of "foundation status" are:

1.	Churches.

2.	Hospitals.

3.	Medical Research Organizations.

4.	Educational Institutions.

L.	Focus on maintaining exempt status at all times by monitoring court decisions, new legislation and other factors. Notify donors properly about the status of the nonprofit. Where exemption is removed, or not yet granted, inform the donors that their donation may not be allowed as a deduction. Donors should demand to see a valid exemption letter issued by the IRS. Nonprofits are not generally required to file a request for an exemption (subject to some exceptions), but if donors are enticed to donate and are not able to deduct the donation, the nonprofit may be liable for fraud. Organizations who perform specific activities (such as bingo) are required to apply.

M.	Comply with "Good Governance". The IRS released, in January/February 2007 "Suggested Guidelines of Good Governance Practices for 501(c)(3) organizations. It includes topics far deeper into the Maslow's hierarchy than the minimum. It includes topics such as "mission statement", "Code of Ethics and Whistle blower policies", "Due Diligence", "Duty of Loyalty", "Transparency", "Fundraising Policy", "Financial Audits", "Compensation Practices" and "Document Retention Policy".

This is somewhat a realization that even the categories set forth in the 990 can be minimally met and surreptitiously circumvented, and that only a culture of openness can and transparency can truly achieve an ideal of highly efficient public service. Federal and State government desires, but cannot micro manage a nonprofits efficiency.

However, the new 990, and these aspirational "governance" guidelines has spawned a cottage industry of "nonprofit management consultants" who are either hired to come into the nonprofit and beat the staff over the head, or either provide a series of educational vignettes in a teaching setting. We contend that anything that improves can't hurt, but this type of consultancy is less needed where the nonprofit organization is 100% volunteer and small. In a large organization, it is much easier to lose focus on the mission, and end up to a point where employees consider it "just another job".

N.	Some State issues:

1.	Collateral Estoppel may be raised where state litigation has occurred regarding a nonprofit's standards for exemption where they are substantially the same as the federal standards. Syanon Church v. United States, 820 F2d 421 (DC Cir. 1987)

2.	State, County, & City permits for fundraising. These often overlap and conflict. The nonprofit organization has to take special care as to the areas in which it performs fundraising activities and insure that all levels of permit are obtained.

.	3.	Where donations are made for a stated purpose, the nonprofit must honor those requests within state law. Federal law on "donative intent" is much more broadly couched in favor of nonprofit organizations. Remember generally that tax exemptions and exempt organizations is an area where federal and state rules are highly interrelated. The federal authorities can and will act upon an activity done in violation of state law (like bingo), but the state subsumes most of the federal requirements into its own requirement for recognition of exemption. The federal- state relationship is therefore not pre-emption, and is not isolated co-existence, I contend that it is a form of interrelated dual authorization. This generally differs from other areas of federal-state tax law. For example, in Private Letter Ruling 9110016, the IRS ruled that a donor can't deduct a premium paid on a life insurance policy intended to irrevocably be assigned to a charity where the purchase violated New York Insurance Law. This example of a "charitable effect" from violation of a non-charitable unrelated law illustrates the extent to which both states and federal government react "double-negatively".

4.	State Exemption excludes the nonprofit from property tax both real and personal. In instances where the physical facilities are significant, obtaining the state exemption is quite valuable, and losing the state exemption can bankrupt a nonprofit. There are many real property issues which arise from the method of ownership of real property and the uses to which the real property is put. Partial denial of a tax exemption may be denied where the property is put to nonexempt uses. Sales and use tax exemptions are also granted in some states, but not California ( Cal. Rev. & Tax Code §§ 6361, 6363, 6365, & 6366. Strangely, CA does exempt from tax food served to students of educational institutions.

5.	California State Corporation Code Sections 5914 and 5915 restricts transfer of a lease, option or conveyance of a health facility subject to Attorney General consent.

6.	California State Corporation Code Section 5000 and following set up special rules for nonprofit "members" with similar characteristics as shareholders, establishing rights, insulation from liability of the nonprofit organization and more.

7.	California State Government Code section 12580 & following sets forth the Attorney General rights with regard to a trust created when a donor makes a donation for a specific purpose.

8.	Aspects of California Trust law in the Probate Code are applicable to nonprofits. Sections of the unfair Competition Law applicable to nonprofits include Business & Professions Code Section 17,200; & 17,500 and following.

9.	The state of California allows "foreign" (other state) corporations to qualify for recognition using special nonprofit forms. The converse problem of a nonprofit entity in one state moving to another (unlike a typical corporate reorganization) can't happen as smoothly because the IRS causes the new state organization to "start over" by filing a Form 1023 as if it were applying for exemption for the first time.

VII.	Foreign Related Nonprofits.

A.	Since 9/11, the federal government has been highly conscious of the potential for abuse of nonprofits in financing international terrorism. The "new 990" came into existence largely due to the concerns.

B.	The general rule for nonprofits is that any organization which is foreign based and which would meet U.S. standards for exemption, can itself be treated as an exempt organization. However, donors to such organizations who have not qualified in the U.S. may face an uphill task in obtaining deductibility. Likewise, U.S. based nonprofits that make donations to other overseas nonprofits will be subject to extreme scrutiny from the IRS as well as homeland security. Any donation from a U.S. based nonprofit to a foreign entity which is held not to be an exempt organization can trigger a domino effect of violations for the donor nonprofit. These would include diverting money for private use, punitive tax on the management for diversion and the 200% tax if the money is not replaced within a year. The aforementioned does not even consider the potential criminal sanctions.

VIII.	Dissolution of a Nonprofit.

A.	Voluntary dissolution of a domestic nonprofit corporation is initiated by an election to dissolve made by the vote of a majority of all the members of the corporation or, if there are no members, by the board of directors. Dissolution is governed by California Corporate Code section 9680 which dictates filings with the Secretary of State.

B.	A Certificate of Dissolution may issue and must be accompanied by a letter from the Attorney General that either waives objections to the distribution of the corporation's assets pursuant to California Corporations Code section 6716(c) or confirms that the corporation has no assets. (California Corporations Code sections 6615 and 9680.)

C.	Inasmuch as property and assets of the nonprofit can only go to another nonprofit, it can be readily seen that the dissolution process would be helped by, and it would be natural for the dissolving nonprofit to donate its remaining assets to the nonprofits of its choice.

Curtis L. Harrington

Office:	Harrington & Harrington; 6300 State University Drive, Suite 250, Long Beach, CA

90815; Tel. (562) 594-9784; Fax (562) 594-4414

curt@patentax.com PATENTAX®	http://www.patentax.com

Specialty:	High Technology Patent / Trademark / Intellectual Property Law & Taxation

Education:	B.S. Chemistry - Auburn University (1974)

M. S. Electrical Engineering - California State University Long Beach (1990)

M.S. Chemical Engineering - Georgia Institute of Technology (1977)

J.D. - University of Houston School of Law (1983)

M.B.A. - University of Oklahoma (1985)

LL.M. Taxation - University of San Diego School of Law (1997)

Admitted	Supreme Courts of California, Arizona, Texas, & Nevada

to Practice:	U.S. Supreme Court;	U.S. District Court, Central District of California

Internal Revenue Service	U.S. Patent and Trademark Office

U.S. Court of Appeals for the Federal, Fifth & Ninth Circuits

California Department of Real Estate - Broker

Los Angeles County California EMT-Basic

U.S. Tax Court	FCC-Commercial & Amateur Extra

Certified by The State Bar of California Board of Legal Specialization: Taxation

Languages	Japanese Language Proficiency Examination, Approved by Japan Foundation, Level 4; Kanji Proficiency Exam of the Japan Kanji Aptitude Testing Foundation, passed Level 7, recognized by the Japan Ministry of Education, mastery of 640 kanji; some technical Russian reading ability.

Patents	Prepared and prosecuted more than 100 patents, in the electrical and

Prepared	chemical technologies; specialty areas include optics, fiber optics, cryogenics electromagnetics, natural gas processing and computers, & trademark and copyright preparation and prosecution. Patents include: Chemical: 4,957,634; 4,851,077; Electrical: 4,876,892; 4,833,351; 4,837,525; Mechanical: 4,879,895; 4,906,199; and Optical: 4,919,512; 4,898,468.

Litigation	Associate counsel in patent matters, trade secret litigation; Judge pro tem, Long Beach Municipal Court; Superior Court Mediation program, Long Beach; Attorney-Client fee Dispute Arbitrator, Long Beach Bar Association; Patent Panel, American Arbitration Association.

Teaching	Adjunct Law Professor, Golden Gate University School of Law, LL.M. Taxation Program; Georgia Institute of Technology - previously taught heat and mass transfer laboratories, and analog and digital computer laboratory.

Member:	State bars of California, Arizona, Texas and Nevada; Vice Chair of the California Board of Legal Specialization Taxation Advisory Committee (member 2006-2011). Fellow, National Tax Practice Institute; Former Memberships: Long Beach Bar Association (Board of Governors, 1994-95); Orange County Bar Association, Taxation Section, (Co-Chair Technology Law Section 1996); Orange County Chapter of California Society of Enrolled Agents - President 2003-2004; California Bar Association: CEB committee (1999-2000); Income & Other Tax subcommittee (Chair 2000-2002); Taxation Section Executive Committee (2002-2005).