Law 603: Becoming a Nonprofit Corporation State and Federal Rules and 501 (c)(3) Exemptions
Roadmap • How to incorporate • State requirements • Federal requirements • Tax exempt rules and summary – 501 (c)(3) rules • Tax deductibility for the donor at both the federal and state level • State forms • Federal Forms
How to Start a Nonprofit Business There are four basic elements: 1. Determine that you really need to start a charitable enterprise. 2. Determine the State requirements 3. Determine if you need and meet Federal tax exemption rules (Section 501) 4. Meet State Tax exemption rules
Step 1: Do You Really Need to be a Nonprofit? • Develop an idea or rationale for your group, finding and identifying others with similar interests • Would you be better to file as a small business or for-profit corporation? • Conduct a scan of existing nonprofit organizations and seek out a partnership. • Define the purpose and mission of your nonprofit. You will be required to disclose this to state and federal regulators. • Draft a business plan for your nonprofit organization. • Recruit board members and other supporters.
Step 2: Michigan Requirements • A nonprofit organization is a corporation created under state law. • It remains a legal entity until it is dissolved. • It is eligible to contract, to sue on its own behalf, and to be sued by an outside party. • Income from a nonprofit organization does not belong to its members or board of directors. Thus members do not have a right to the organization's income or assets, as they could from for-profit, or private, companies. • The federal government grants certain nonprofits corporation's tax-exempt status. • Check for availability of a name and reserve it with the Michigan Department of Consumer and Industry Service - Corporation Division. http://www.cis.state.mi.us/bcsc/forms/corp/corp/540.pdf; http://www.michigan.org/medc/services/startups//
More on Step 2 • Draft the corporate bylaws. • Prepare and file articles of incorporation with the Corporation Division, State of Michigan, Department of Consumer and Industry Services – see sample for NPO at http://www.cis.state.mi.us/bcsc/forms/corp/corp/502.pdf
Step 3: Federal Requirements • Receive tax identification number from the IRS. Forms needed is IRS Form SS-4 titled Application for Employer Identification Number (EIN) • Check out http://www.irs.gov/pub/irs-pdf/fss4.pdf and http://www.irs.gov/pub/irs-pdf/iss4.pdf • Seek tax exempt status from the IRS by filing IRS Form 1023. Need to include filed articles of incorporation. The following IRS Forms are needed: • IRS Package 1023, titled Application for Exemption, which includes forms 1023 and 872-C. • http://www.irs.gov/pub/irs-pdf/f1023.pdf • Instructions for 1023 is at http://www.irs.gov/pub/irs-pdf/i1023.pdf
More on Step 3 • Check out http://www.irs.gov/charities/article/0,,id=96109,00.html, and follow the process at http://www.irs.gov/charities/article/0,,id=96210,00.html • IRS Form 8718 titled User Fee for Exempt Organization Determination Letter Request: http://www.irs.gov/pub/irs-pdf/f8718.pdf • IRS Publication 557 titled Tax Exempt Status for Your Organization. This will assist you. • IRS Publication 583 titled "Starting a Business and Keeping Records” • Search for charities to check on status: http://www.irs.gov/charities/article/0,,id=249767,00.html
Step 4: Michigan Sales and Use Tax Exemption • Apply for sales tax exemption from the State of Michigan, Department of Treasury: • http://www.michigan.gov/documents/taxes/3372_216612_7.pdf • Sales Tax Basics: • 6% tax on the seller for the privilege of engaging in the business of making sales at retail in Michigan. • The tax applies to sales of tangible personal property which take place in Michigan. • Tax will not apply to purchases where the tangible personal property is shipped by mail or common carrier to the nonprofit organization from a location outside of Michigan. This relates to the use tax.
Sales to and By NPOs • Sales TO NPOs • The NPO needs a Certificate of Exemption AND a copy of the Federal exemption letter indicating 501(c)(3) or 501(c)(4) exempt status received from the Internal Revenue Service. • Sales BY NPOs • Public Act 156 of 1994 exempts from sales tax sales at retail made by certain organizations from tax if aggregate sales at retail for the calendar year are less than $5,000. If sales are more than $5,000, ALL sales are subject to tax.
Michigan Use Tax • Use tax in general: http://www.michigan.gov/documents/48f_2907_7.pdf • Michigan's 6% use tax is imposed on a purchaser for the act of storing, using or consuming tangible personal property in Michigan. Use is defined as the exercise of any right over tangible personal property incident to ownership of that property. • Public Act 424 of 1994 established an exemption in the Use Tax Act which was identical to that placed in the General Sales Tax Act by Public Act 156 of 1994 for sales to nonprofit organizations. The exemption was expanded to all federal income-tax-exempt organizations under section 501 (c)(3) or 501 (c)(4) of the Internal Revenue Code (IRC).
Sales Tax Issues • Purchases of property used in fund-raising activities are taxable (Bingo materials, Las Vegas night equipment). • To be exempt, the purchase of tangible personal property must be used or consumed primarily in carrying out the purposes of the institution or agency • Bingo is allowed, but fundraising is not the stated purpose of the charity. An organization would not receive federal 501(c)(3) or 501(c)(4) nonprofit status if its stated purpose was to run a bingo game. • The sale of a vehicle to the exempt nonprofit organization may or may not be exempt from sales tax • Exempt if sold to the ED and used for the charity’s purpose • Not exempt if sold to the ED and used for her personally • Sales made BY the Charity. The following are exempt (if under 5k) • schools (preschool, elementary, middle, high school) • churches and hospitals • hospitals and • 501 (c)(3) and 501 (c)(4) tax exempt entities • Affiliated clubs, associations, or other organizations are not allowed a separate exemption under this provision
More Step 4: Michigan Charitable Solicitation • If fundraising, register with the Charitable Trust Section of the Michigan's Office of Attorney General. There are several thousand such organizations in Michigan. • Charitable Organization Requirements requires an organization to obtain a charitable solicitation license if it solicits or receives contributions in Michigan in excess of $8,000 or if it compensates any person for fund raising services, including employees or independent contractors. • CHARITABLE ORGANIZATIONS AND SOLICITATIONS ACT Act 169 of 1975
Charitable Applications • See application form at • http://www.dnmichigan.org/documents/SolicitationLicense.pdf • Application for a professional fundraiser is at: http://www.michigan.gov/ag/0,4534,7-164-17337_18095-45037--,00.html#Professional_Fundraiser_Requirements • Application for sale of beer or wine at http://www.michigan.gov/documents/CIS_LCC_lc510_100178_7.doc • Bingo License: http://www.michigan.gov/documents/BSL-CG-1335_1335_7.pdf and at http://www.michigan.gov/documents/BSL-CG-720_110389_7.pdf (includes a primer on how to play Bingo)
501 Procedure • Does the Organization Have an Appropriate Legal Form? • Must be organized as a trust, corporation, or association • See publication 57 • Does the Organization have a tax exempt purpose? 501(c)(3) • Corporations, and any community chest, fund, or foundation, organized and operated exclusively for Religious, charitable, scientific, testing for public safety, literary, educational purposes, foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals • No part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.
Deductibility to the Donor: Federal Level • Contributions TO the 501c3 are tax deductible at the: Federal Level per section 170 • http://www.law.cornell.edu/uscode/uscode26/usc_sec_26_00000170----000-.html • http://www.irs.gov/app/pub-78/ searches for organizations that apply
Deductibility to the Donor: State Level • Michigan Level per Section 206.260 http://www.legislature.mi.gov/(lb2dymep3av1fz45aemc2hqr)/mileg.aspx?page=getobject&objectname=mcl-206-260&userid • Only a tax credit equal to 50% of the charitable contributions made to certain organizations • The maximum amount of the credit is $100, or $200 if married filing jointly. • This is now REPEALED
More 501 Procedure • File Form 1023 (http://www.irs.gov/pub/irs-pdf/f1023.pdf) • Who does not have to file 1023? • Churches, religious school, mission society. They are exempt automatically if they meet the other requirements of 501(c)(3) • Private foundations • Any organization normally having gross receipts < $5,000. This is met if: • During its first year, gross receipts < $7,500 • Less than $12,000 total during the first two years • For organizations in existence at least 3 years, if less than $15,000 over the most recent 3 years
Educational Purpose • Most schools are cool • The method may indicate the purpose is not educational: • The presentation of viewpoints unsupported by facts is a significant part of the organization’s communications • The organization makes substantial use of inflammatory and disparaging terms and expresses conclusions based more on emotion than objective evaluation – see Nationalist Movement Case • College book stores and cafeterias can be exempt if they are controlled by and operate for the convenience of the faculty and student body • Private schools can be exempt, but they must have a racially nondiscriminatory policy as to students and applicants
Religious Organizations and 501(c)(3) • To meet the religious purpose test: • The particular religious beliefs must be sincerely held • The practices and rituals are not illegal or contrary to clearly defined public policy • For other organizations under section 501, see the organizational chart which is on pages 72-73 of IRS Publication 557, at http://www.irs.gov/pub/irs-pdf/p557.pdf
Private Foundations vs. Public Charities • Every organization that qualifies as a 501(c)(3) is presumed to be a private foundation, unless it qualifies as a public charity per section 509. • There is an excise tax on the net investment income of private foundations, and must be reported in Form 990-PF. http://www.irs.gov/pub/irs-pdf/f990pf.pdf(page 4) • Restrictions on self-dealing between private foundations and their substantial contributors (section 4941) http://www.fourmilab.ch/ustax/www/t26-D-42-A-4941.html
More on Private Foundations • Other restrictions of being a Private Foundation: • Requirements that the foundation annually distribute income for charitable purposes (section 4942): http://www.law.cornell.edu/uscode/uscode26/usc_sec_26_00004942----000-.html • Provisions that investments must not jeopardize the carrying out of exempt purposes (section 4944) • Provisions to assure that expenditures further exempt purposes (section 4945): http://www.law.cornell.edu/uscode/html/uscode26/usc_sec_26_00004955----000-.html
How do you get to be a Public Charity? • Per section 509a, meet the support test http://www.fourmilab.ch/ustax/www/t26-A-1-F-II-509.html • At least 1/3rd of total support comes from the public • If you do not meet the 1/3rd test, you can meet the facts and circumstances test: • 10% public support requirement AND • The attraction of public support requirement, from governmental units or the general public • 509(a)(1) organizations include • Churches and educational institutions • Hospitals • University endowment funds • Governmental unit • Organizations that typically meet the 1/3rd test • Museums and libraries • Centers for the arts • 501(c)(3) is at http://www.fourmilab.ch/ustax/www/t26-A-1-F-I-501.html
Summary of 6 Requirements for 501c3 Exemption • (1) be organized • (2) be operated exclusively for charitable purposes • (3) have no part of its earnings inure to any private party • (4) not engage in substantial amounts of lobbying • (5) not participate in any political campaigns for or against candidates for public office. • The common law has added the requirement (6) that no part of the organization's purposes or activities may be illegal or violate fundamental public policy. Bob Jones Univ. v. United States, 461 U.S. 574, 591-92 (1983). • Public charity and Private Foundation Examples