Tax-Exempt Organizations and Political Activity
As the 2024 election nears, now is a good time for your tax-exempt organization to review the rules and regulations regarding political activity.
A 501(c)(3) tax-exempt organization can engage in limited amounts of political activity so long as it remains nonpartisan, and it may also engage in legislative lobbying provided it is not a substantial amount of activity. These limitations also extend to grantee organizations that receive grant money from a 501(c)(3) organization, including 501(c)(4) organizations and fiscal sponsors.
501(c)(3) Grants and Fiscal Sponsors
When a 501(c)(3) makes grants or fiscally sponsors another organization, the funds dispersed are restricted for use to exclusively engage in the specific charitable, education, or other permissible activities under Section 501(c)(3) of the Internal Revenue Code (the “Code”.) Once the 501(c)(3) disburses any funds, it must receive reports or other documentation showing that this requirement has been honored so it does not jeopardize its tax-exempt status.
Political Activity
Under section 501(c)(3) of the Code, a tax-exempt organization must NOT participate in or intervene in any political campaign on behalf of (or in opposition to) a candidate for public office, nor publishing or distributing statements of the kind. A 501(c)(3) organization may, however, take positions on public policy issues, which include issues that divide candidates, so long as the organization avoids any advocacy issues that function as a political campaign intervention. Any “political” agitation either director or indirect is enough to revoke an organization’s tax-exempt status because that would cause the organization’s activity to fall outside it’s exclusively charitable purposes.
It is important that a 501(c)(3) organization take extra caution in their communication because even if a statement does not expressly tell an audience to vote for or against a specific candidate, a tax-exempt organization delivering the statement is at risk of violating political campaign intervention prohibited activity if there is any message factoring a candidate.
A 501(c)(3) organization can participate in specific voter education political activity so long as it remains neutral and nonpartisan.
If an organization posts something on its website that favors or opposes a candid for public office, the organization will be treated the same as if it is distributing printed materials or oral statements. A tax-exempt organization is responsible for the links that are on its website. When an organization establishes a link to another website, the organization is responsible for the consequences of establishing and maintaining that link, even if that organization does not have control over the content of the linked site. Be mindful of any links on your website that may may lead to prohibited political activity.
Lobbying Activity
A 501(c)(3) may engage in lobbying, which includes carrying out propaganda or otherwise attempting to influence legislation, so long as it does not constitute a substantial amount of the organization’s activity. Despite this limitation, the following activities are allowed and not counted toward the organization’s lobbying limits:
- making available the results of a nonpartisan analysis,
- providing technical advice or assistance to a governmental body, appearances before, or communication to a legislative body with respect to a possible decision which might affect the existence of the organization,
- communication between tax-exempt organization and its bona fide members with respect to legislation or proposed legislation, and
- any communication with a government official or employees other than the attempt to influence legislation.
There are two types of lobbying recognized by the law: direct lobbying and grassroots lobbying. Direct lobbying is an attempt to influence legislation by communicating directly with government officials, and grassroots lobbying is an attempt to influence legislation by communicating with the general public. If an organization engages in grassroots lobbying, it is limited to twenty-five percent (25%) of the organization’s total lobbying allowance.
Learn How an Experienced Attorney Can Assist with Any Questions Regarding Political Activity or Lobbying for a Tax-Exempt Organization
Ensuring that your organization is complying with the rules and regulations regarding political activity or lobbying is essential to maintaining its tax-exempt status. Even if it’s not an election year, a tax-exempt organization must still adhere to the rules and restrictions. At Abelaj Law, PC, we are committed to assisting tax-exempt organizations with all of their legal needs so they can focus on achieving their mission and purpose. Contact our experienced legal team today at 212-328-9568 to learn more.
Inherited Property: What is Step Up in Basis? Discussion with Cherie Williams, CPA of The Little CPA
Jennifer collaborated with Cherie Williams, CPA, founder of The Little CPA, on the topic of inheriting assets. Cherie created The Little CPA to empower purpose-driven professionals to make wise financial decisions that build diligent wealth.
Inherited Property: What is Step-Up in Basis? – The Little CPA
(The Little CPA empowers purpose-driven professionals to make wise financial decisions that build diligent wealth.)
Valuation Of Hard To Value Assets
It is difficult to determine the value of hard to value assets, hence their name. Hard to value assets, also referred to as HTVAs, can make appraisals in estate planning and business valuation more complicated and time-consuming. There are different methods for valuing hard to value assets, but the appropriate methodology depends on the type of asset and the circumstances surrounding the valuation. A consultation with a knowledgeable estate planning attorney may be beneficial for a proper and accurate valuation of hard to value assets. At the Jennifer V. Abelaj Law Firm, we assist clients in New York with a wide range of estate planning needs. You can request more information by calling 212-328-9568 and scheduling a consultation.
Methods for Valuing Hard to Value Assets
The methods for valuing HTVAs differ from one case to another. Choosing the appropriate methodology requires a thorough understanding of appraisal regulations and available valuation approaches. When selecting the method for a valuation of hard to value assets, it is vital to consider the purpose of the valuation, the asset’s competitive properties, and the nature of the local market. When valuing HTVAs, appraisals need to apply a comprehensive framework, follow the accepted guidelines, use professional judgment, and consider all factors to ensure an accurate valuation.
A Guide to Valuation of Hard to Value Assets
As mentioned, the appropriate method for valuing hard to value assets depends on the type of asset and reason for the valuation. For example, is the valuation necessary as part of a sale, gift or death. What follows are general guidelines for valuing these HTVAs:
- Real estate and automobiles
- Stocks
- Bonds
- Life insurance
- Annuities
- Business
- Personal property
- Debts
Real Estate and Automobiles
Often, people seek the help of an experienced real estate agent to estimate the value of their real property. An agent who knows the local market will be able to provide a rough estimate. However, this approach may not work with hard to value real estate. Similarly, certain automobiles, such a collectibles or rare versions, may have a value which depends on whether it is part of a collection. If the asset requires a more thorough analysis, the owner of the property will most likely have to hire an appraiser and collect all available information about real estate and any automobiles in order to obtain an accurate valuation.
Stocks
Valuing closely-held stocks often involves computing the company’s price-to-earnings ratio. However, an amateur may not be able to determine the value of stocks accurately. If the owner of stocks dies, the personal representative of the decedent’s estate may choose to get in touch with the company that managed the decedent’s stocks or consult with a financial expert well-versed in stock valuation. Title 26 of the Code of Federal Regulations (CFR) § 20.2031-2 provides guidelines for the valuation of stocks and bonds based on selling, bid, and asked prices.
Bonds
The approach to valuing bonds is similar to the method for valuing stocks. Determining the value of a bond usually involves calculating the bond’s cash flow and face value. The individual or firm performing a valuation of a bond may also need to add accrued interest that has not been paid after the decedent’s death.
Life Insurance
When determining the value, the appraiser may calculate the policy’s face value and cash value. The policy’s face value is the amount of money beneficiaries of the policy receive upon the owner’s death. The cash value, on the other hand, is the accrued amount that can be accessed outside of the death benefit. For life insurance that is part of a gifting transaction, sometimes the value is based on the interpolated terminate reserve (ITR). The ITR is similar to the cash value, but the calculation is based on various other factors.
Annuities
A valuation of hard to value assets may also include valuing annuities if the decedent owned any. In order to determine the value of annuities, the personal representative of the decedent’s estate may need to contact the company that sold the annuities to valuate them as of the date of the owner’s death.
Business
Often, determining the value of a business is the most challenging part of valuing hard to value assets because businesses may include both tangible and intangible assets and liabilities. A business is also difficult to value if the deceased person was not the only owner of the business. In this case, the personal representative of the estate may need to contact a certified public accountant to estimate the value of the deceased person’s interest. However, business and other valuations may be easier if planned in advance. At the Jennifer V. Abelaj Law Firm, we offer estate planning and business succession planning services tailored to each client’s needs.
Personal Property
Certain types of personal property may be considered hard to value assets. Common examples of HTVAs among personal property include cryptocurrency, digital assets, works of art, jewelry, and antiques. While many people choose to visit eBay and similar platforms for estimating how much personal property is worth, it may be necessary to reach out to an auction house, art museum, gemologist, or other expert who specializes in valuing antiques, artworks, and jewelry.
Debts
According to the Federal Trade Commission, the personal representative of the estate is responsible for settling the deceased person’s debts. Once the valuation of hard to value assets is complete, it is essential to identify all debts that the debtor owes and determine their value. Common types of debt include mortgages, credit cards, loans, and debts associated with the deceased person’s medical treatment prior to the death.
Is an Appraisal Necessary for a Valuation of Hard to Value Assets?
An appraisal may be necessary for some of the hard to value assets mentioned above. Usually, people choose to hire a professional appraiser for an accurate appraisal. It is recommended to request the appraisal as soon as possible after the decedent’s death. A valuation of hard to value assets can become even more difficult if a significant amount of time has passed after the owner’s death. The Date of Death Appraisal is necessary for several purposes, including taxes. The appraisal will be used to establish whether an estate tax should be paid to the Internal Revenue Service (IRS) and to determine the amount of estate tax if any.
Contacting an Estate Planning Attorney
For assistance with the valuation of hard to value assets, consider seeking legal guidance from an estate planning attorney at the Jennifer V. Abelaj Law Firm. We help executors and personal representatives of estates in the efficient settling of the decedent’s affairs, including valuation of the assets. We also assist people with creating a comprehensive estate plan that takes into account the hard to value assets in order to protect them and minimize taxes. To schedule a case review, call 212-328-9568.
The IRS Now Mandates Electronic Filing For All Non-Profits
Even though the Internal Revenue Service (IRS) has long accepted electronic tax filings, tax-exempt organizations have been able to rely exclusively on paper returns and filings until recently. The IRS now mandates electronic filing for all non-profits. The new mandate is designed to streamline the filing process, modernize technology, and improve tax compliance in the tax-exempt sector. To help your non-profit organization comply with the new mandate, consider contacting the Jennifer V. Abelaj Law Firm at 212-328-9568 before the next tax deadline.
New Requirements for Non-Profit Electronic Filing
In the years prior to 2019, exempt organizations were only required to electronically file returns if they had at least 245 employees or reported assets of $10 million or more. However, on July 1, 2019, President Donald J. Trump signed the Taxpayer First Act into law, requiring all tax-exempt organizations to e-file their returns.
Smaller exempt organizations were initially provided some relief by being allowed to file paper returns if they filed Form 990-EZ, Short Form Return of Organization Exempt for Income Tax. However, the IRS has stopped accepting paper returns even for this purpose as of July 31, 2021. Due to the new IRS update, all exempt organizations, including those that filed Form 990-EZ, must file their returns electronically.
Forms to Be Electronically Filed
Since the IRS now mandates electronic filing for all non-profits, the following Form 990 series must be electronically filed:
- Form 990, Return of Organization Exempt from Income Tax
- Form 990-EZ, Return of Organization Exempt from Income Tax (Short Form)
- Form 990-PF, Return of Private Foundation or Section 4947(a)(1) Trust Treated as Private Foundation
- Form 990-N, Electronic Notice
- Form 990-T, Exempt Organization Business Income Tax Return
Additionally, tax-exempt organizations that file any of the following forms must now file them electronically:
- Form 8872, Political Organization Report of Contributions and Expenditures
- Form 1120-POL, United States Income Tax Return for Certain Political Organizations
- Form 4720, Return of Certain Excise Taxes Under Chapters 41 and 42 of the Internal Revenue Code
- Form 1065, United States Return of Partnership Income
About Form 990
The IRS Form 990 series provides transparency and accountability for the non-profit sector. These forms can generally be viewed and inspected by the public and are the primary source for basic information about the non-profit organization. However, the filing of paper returns often created a lag between the time when the non-profit organization submitted its required forms and when the public had access to view the contents. That made it difficult for the public to have accurate and timely information about many organizations in the non-profit sector. The new mandate is expected to provide more timely data for donors, regulators, and other stakeholders.
The IRS does not require certain non-profit organizations to file Form 990 or even Form 990-EZ. These include:
- Certain religious organizations
- Certain government organizations
- Certain political organizations
- Organizations with gross receipts less than $50,000 (although they must file Form 990-N)
- Certain organizations that file different kinds of annual information returns, such as private charitable entities exempt under section 501(c)(3) and described in section 509(a), private charitable entities terminating their status by becoming a public charity, religious or apostolic organizations described in section 501(d), and stock bonus, pension, or profit-sharing trusts that qualify under section 401.
E-Filing Deadline
The electronic filing deadline for non-profit organizations is July 31. Although smaller exempt organizations were provided with transitional relief to give them more time to switch over from filing paper returns to electronic filing, all tax-exempt organizations except those with a specific exemption must now prepare electronic filings. All entities, including the ones that previously used Form 990-EZ, were required to electronically file forms 990 and 990-EZ with tax years ending July 31, 2021, and later.
How to Comply with the New Mandate
Organizations that previously filed paper tax forms were sent a letter from the IRS notifying them that the IRS now mandates electronic filing for all non-profits. If organizations filed a paper return after the applicable deadline, the IRS might have responded by saying that they needed to redo the return electronically. The IRS might have flagged the return as late when providing this notification. To abide by the new tax law, exempt organizations can engage the services of an outside tax professional or use one of the IRS’s pre-approved software providers to prepare their electronic return.
Because tax-exempt organizations may have complex reporting requirements that are substantially different than for regular taxpayers, they may wish to work with a tax consultant or legal professional who has more experience with the system. The Jennifer V. Abelaj Law Firm works closely with non-profit organizations and is well-versed in the laws and regulations that affect them. Consider contacting the office for help with tax filings and answers to any questions you have.
Contact a Non-Profit Lawyer for Help
If you are uncertain about how to comply with the current requirements for tax filings since the IRS now mandates electronic filings for all non-profits, you might consider reaching out to a lawyer who focuses in this area of the law. The Jennifer V. Abelaj Law Firm has years of experience working with various non-profit organizations, including public charities, private foundations, social welfare organizations, business associations, and more. We also assist with estate planning so that your non-profit organization can benefit from legacy gifts. Numerous charities and non-profit organizations depend on us for help with their creation, governance, transaction assistance, advocacy, tax compliance, and dissolution. We are also prepared to handle any potential legal issues that arise during tax filing season. Because we know all about the new mandate, we can help to ensure compliance and help you achieve your non-profit’s objectives by explaining whether the new mandate applies to your organization, how to transition from paper returns to electronic returns, and how to electronically file a return. Consider contacting the Jennifer V. Abelaj Law Firm at 212-328-9568 to discuss your non-profit organization’s current challenges, tax filing status, and goals.
Fiscal Sponsorships and Your Non-Profit Organization
Having a philanthropic mission is a laudable goal. However, establishing a non-profit organization to fulfill that mission can be much more difficult. A fiscal sponsorship may be a way that you can accomplish your goal in less time. The knowledgeable attorneys at the Jennifer V. Abelaj Law Firm can discuss fiscal sponsorships and your non-profit organization during a confidential consultation.
What Is a Fiscal Sponsorship?
To receive tax-exempt status from the Internal Revenue Service, a charitable organization must be considered a 501(c)(3) organization. The organization must meet various requirements, including:
- It must be organized and operated exclusively for Internal Revenue Service (IRS) tax exempt purposes
- Its earnings cannot inure to private shareholders or individuals
- It cannot attempt to secure legislative influence as a significant portion of its activities or participate in any campaign activity for or against a political candidate
Some people may want to advance charitable goals but may not want to create their own 501(c)(3) nonprofit organization. A fiscal sponsorship can serve as a viable alternative to creating a nonprofit organization. Through a fiscal sponsorship, an existing nonprofit organization can extend its tax-exempt status to others related to the organization’s mission. The fiscal sponsor agrees to accept tax-deductible donations and grants on behalf of the sponsored organization. To meet IRS guidelines, the sponsor must have full discretion and control over the donated funds, according to the American Bar Association. The sponsor is responsible for ensuring the funds are used for charitable purposes and comply with any additional donor restrictions. In exchange for providing its services, the fiscal sponsor charges a fee, usually around five to fifteen percent of the donated funds it helped raise.
What Do Fiscal Sponsors Do?
The specific responsibilities of a fiscal sponsor depend on the agreement between the sponsor and the sponsored organization. Some of the more common functions of fiscal sponsors include:
- Receiving and acknowledge charitable donations from third parties
- Retaining discretion and control over donated funds
- Overseeing the use of funds to ensure compliance
- Performing back-office functions
The Jennifer V. Abelaj Law Firm can help create an agreement regarding fiscal sponsorships and your nonprofit organization that clearly delineates your responsibilities and that of the fiscal sponsor.
Reasons to Use a Fiscal Sponsorship
There are many common reasons for using fiscal sponsorships, including:
- A newly formed nonprofit needs to raise funds during their start-up phase before the IRS recognizes them as tax-exempt
- The need to attract funding that is tax-deductible to donors
- A philanthropist anticipates that the project will only have a short lifespan, so they do not want to go through the extra work of establishing a separate 501(c)(3) organization
- To receive grants from a private foundation that explicitly requires the grantee to be recognized by the IRS as tax-exempt
- The need to test out ideas to determine if there is an available market for projects
- To take advantage of an established nonprofit organization’s existing network of donors and improved access to funding
- The ability to leverage an established nonprofit organization’s credibility
- To concentrate on core functions while outsourcing administrative functions
- To gain access to low-cost financial and administrative services
Benefits of Fiscal Sponsorships
A significant benefit of fiscal sponsorships is the ability for a charitable project to use the sponsor’s 501(c)(3) status to advance its mission. The project can receive tax-deductible donations from donors, which attracts more funding for the mission. Additionally, the sponsored project may have access to better fundraising options by leveraging the network and expertise of the fiscal sponsor. Some fiscal sponsors are well-established charitable organizations that have a large network of donors and solid experience with raising funds for philanthropic purposes.
Another benefit of using a fiscal sponsor is that it allows a charitable group to start up and begin advancing their mission more quickly than they would if they had to establish a separate 501(c)(3) organization. The group is not required to incorporate or obtain its own charitable group status simply to use a fiscal sponsor. It is also much more affordable for the group to get started. Fiscal sponsorship can benefit the fiscal sponsor as well because the organizations are managed from a common administrative platform. The fee they receive can also enable them to have a greater reach than if they had to do everything singularly.
Possible Services from a Fiscal Sponsor
The fiscal sponsor may provide numerous services to the sponsored organization in exchange for their fee. This may include:
- Administrative support
- Accounting
- Grant writing
- Payroll
- Employee benefits
- Fundraising assistance
- Publicity
- Marketing
- Training services
Some fiscal sponsors also provide office space and logistical support. A fiscal sponsor may be able to purchase a blanket liability insurance policy to make insurance more affordable for both entities than it would be if the entities purchased insurance separately.
How Fiscal Sponsorships Work
Donations to projects that have a fiscal sponsor are directed to the sponsor, who typically has 501(c)(3) exempt status. The donations for this project are considered to be restricted funds by the fiscal sponsor. The fiscal sponsor decides how to use the funds. It cannot give control or decision-making authority regarding the funds to the organization, or the pass-through option can be lost.
However, the fiscal sponsor can delegate the management of the project’s funds to specific employees, contractors, or volunteers, if they set up the arrangement in this manner. This approach is known as a “comprehensive fiscal sponsorship.” As an alternative, the fiscal sponsor may be able to grant funds to a pre-selected grantee to administer. This type of arrangement is called a pre-approved grant relationship fiscal sponsorship.
Contact Us for Help with Fiscal Sponsorships and Your Nonprofit Organization
If you would like more information about fiscal sponsorship and your nonprofit organization, contact a knowledgeable attorney at the Jennifer V. Abelaj Law Firm. We work closely with nonprofit organizations on legal matters such as acquiring 501(c)(3) status, forming agreements with fiscal sponsors, and crafting customized legal solutions. Contact us today by calling 212-328-9568.
Ongoing Tax and Governance Compliance for Tax-Exempt Organizations
Existing not-for-profit organizations (“NPO”) must ensure that they annually comply with corporate and tax laws. The failure to do so may impact the NPO is minor ways or in significant ways.
Tax Compliance
Annual Tax Return Filing (Form 990)
An existing NPO must file a Return of Organization Exempt from Income Tax (Form 990) as soon as it completes its first fiscal year of existence. Occasionally, the NPO may still be awaiting a determination letter from the IRS approving its tax-exempt status. However, the NPO must file the appropriate Form 990 based on the activities and gross receipts within the first year.
An amended return can be filed if the IRS determines that the NPO is tax-exempt under a tax section which differs from the application request. For example, an NPO may apply for exemption as a public charity. However, the IRS may approve the application as a private foundation. In such a case, the organization would be able to file an amended Form 990-PF for the year in question.
Following receipt of the determination letter, and assuming the NPO agrees with the IRS’s determination, the NPO must file an annual Form 990. In some cases, it may be as simple as the online filing of Form 990-N for organizations with gross receipts of less than $50,000 in the taxable year (and less than $250,000 in assets). An NPO that requires a full Form 990 must ensure that they provide their CPA with annual financials necessary for timely and complete preparation.
Failure to file a Form 990 for three consecutive years automatically revokes the organization’s tax-exempt status. The process to reinstate tax-exempt status requires the assistance of your attorney and accountant.
Estimated Tax Payments on Unrelated Business Income
If an NPO has unrelated business income in excess of $500 a year, it is required to pay quarterly taxes on Form 990-W. Unrelated business income is a complex area and beyond the scope of this article, but it is generally an investment by the NPO that is not related to its charitable activities in which it expects to receive an income. The IRS allows an NPO to receive UBI without losing its tax-exempt status if the UBI is not significant. The challenge is that there is no formula to determine the amount is not significant.
Failure to monitor UBI could place the organization in jeopardy of losing its tax-exempt status.
Tax Payments on Net Investment Income for Private Foundations
A private foundation must pay taxes on its annual net investment income. The payment may be done at the time of filing the tax return (Form 990-PF) or in quarterly estimated payments.
Governance Compliance
Registration and Filing with the Office of Attorney General
NPOs that fundraise within New York State must register with the Charities Bureau of the New York State Office of Attorney General (“Charities Bureau”). The initial registration is completed contemporaneously with filing of the Application for Tax-Exempt status or shortly following receipt of the IRS determination letter.
An NPO must file an annual report with the Charities Bureau, along with a copy of their Form 990. A filing fee may be required as determined by the NPO’s annual gross receipts. The annual filing, including the Form 990, is publicly available on the Charities Bureau’s website. Religious organizations are not required to register or to submit an annual filing.
Annual Meetings
New York State requires that an NPO hold a membership meeting at least once each year. NPC-L 603(b). The membership meeting generally includes voting of directors or officers, discussion of the Board’s annual activities and financial reports, and ratification of certain actions, such as changes in the Bylaws.
Although the NPO does not require an annual meeting of directors, it is likely that the NPO’s Bylaws mandate an annual Board meeting. Discussions include long-term strategy for the NPO, goals on how to effectuate the NPO’s charitable purposes, financial and tax considerations, and building a team of advisors and support for the Board.
Annual Compliance Makes NPO Management Easier in the Long Run
Taking small steps each year to maintain compliance with the tax and governance laws applicable to your NPO has a big impact for the success of the organization. Regular communication with your Board, members and advisors ensures that the NPO is proactively managing its activities to avoid potential troubles.
If you have questions about ongoing governance or tax compliance, please contact us to discuss how we can assist your organization.
Substantial Contributors to Public Charities: With Reward comes Some Risk
Charitable organizations are created and operated for a public good and not for purposes of making a profit for investors. But there is a cost to operating and carrying out a charity’s goals. The cost is covered by a portion of the contributions received by the charity.
It’s great when a charity is the potential recipient of an unusually large contribution. It will help the charity carry out its objectives and pay the expenses necessary to do so. But such a large gift may place the organization in jeopardy of losing its tax-exempt status, as described in this article.
Impact of Substantial Contributor on Governance and Taxation
If a donor makes a large contribution to an organization, the donor may be classified as a “substantial contributor” to the charity. A substantial contributor impacts the charity in two important ways: (i) determining whether the substantial contributor is a disqualified person, and (ii) determining whether the charity meets the public support test for IRS purposes. The tentacles of a substantial contributor classification reach very long lengths.
Identifying a Substantial Contributor
A substantial contributor is any person or entity (other than a 501(c)(3) pubic charity or government entity) who contributes or bequeaths a total amount of more than $5,000 to the charity if the amount is more than 2% of the total contributions and bequests received prior to the end of the year. Substantial Contributor Private Foundation | Internal Revenue Service (irs.gov).
If an officer or director’s family member makes a substantial contribution, that officer or director is considered to be a disqualified person.
A corporation or partnership is a disqualified person if a substantial contributor has a 35% interest in the corporation (i.e., total voting power) or partnership (i.e., ownership of profit interest in partnership). In addition, if a corporation/partnership is a substantial contributor, then any person who has an interest of 20% or more therein is also a disqualified person. This includes employees of the substantial contributor.
Once a person meets substantial contributor status, she remains a substantial contributor for 10 years, even if she does not meet substantial contributor status in subsequent years.
(i) Disqualified Person
Most charities understand that a director of officer has a special relationship with the organization and are aware to avoid any conflicts of interest. In the IRS’s view, these persons are considered “disqualified persons,” such that they must recuse themselves from certain actions or decisions that may create a conflict of interest.
The IRS also considers a substantial contributor to be a disqualified person.
A substantial contributor may be on a charity’s Board, but too many substantial contributors may place the charity’s tax-exempt status in jeopardy. The voting power of a disqualified person (whether as a substantial contributor, director, officer or key person) must be a MINORITY (i.e., specifically 49% or less, of the board’s total voting power). Further, the combination of the voting power of multiple disqualified persons must be 49% or less.
Any disqualified person is deemed to have control over the Board if her voting power, in combination with the voting power of another disqualified person, exceeds the 49% rule.
This is a big deal when you combine it with the 10-year rule mentioned above.
(ii) Public Support Test
A charitable organization, unlike a private foundation, must be publicly supported. Although there are various formulas to satisfy the public support test, a commonly used formula is that at least 1/3 of annual contributions received are received from the general public.
In determining the contributions that are counted toward the 1/3 calculation, contributions received from disqualified persons is excluded. This may impact the organization’s ability to satisfy the public support test and be treated as a private foundation for tax purposes.
Consider the following simple examples for a charity that has annual contributions of $100,000.
Example 1. Satisfies Public Support Test. Of the $100,000 received, a contribution of $10,000 was from one disqualified person (i.e., a director, officer, or family member), which is 10% of the total contributions received. A portion of the contribution must be excluded from the total support test because it is greater than $5,000 and the amount is more than 2% of the total support received (i.e., $2,000). The amount excluded from the total support test is $8,000, which is the contribution in excess of 2% of total contributions ($2,000) (i.e., $10,000 minus $2,000). Total support for the 1/3 test is $92,000 (i.e., $100,000 minus $8,000). The charity satisfies the public support test because 92% of its contributions are from the general public.
Example 2. Fails Public Support Test. Of the $100,000 received, a contribution of $10,000 was from one disqualified person (i.e., a director, officer, or family member), $15,000 was from a partnership in which an officer’s family member has at least 35% income interest, and various $50,000 substantial contributions carried over from the prior 5-year period. A portion of all these contributions must be excluded from the total support test because they are more than 2% of the total support received for the year ($2,000). The amount excluded is approximately $69,000 ($10,000 minus $2,000 = $8,000; $15,000 minus $2000 = $13,000; $50,000 minus $2000 = $48,000). Total support for the 1/3 test is $31,000 (i.e, $100,000 minus $69,000). The charity fails the public support test because 31% of its contributions are from the general public.
2-Year Rule for Failure to Satisfy Test
Although it is beyond the scope of this article, the IRS provides that a public charity fails to meet the public support test for 2 consecutive years loses its public charity status and must file as a private foundation. This is important to note in order to forecast when and what amount of substantial contributors a charity can receive to safeguard its charitable tax status. 26 CFR § 1.509(a)-3(c)(1)(i).
Final Thoughts
An excise tax may be imposed for a charity that fails the public support test after two consecutive years. It is advisable for a charity to take note of who is a disqualified person and whether any substantial contributor rules may impact the charity’s fundraising effort.
A charity should work closely with their CPA to monitor the organization’s finances and charitable tax calculations.