Top Ten Issues Affecting
Nonprofit Tax-Exempt
Organizations
Presented by
Lundy & Flynn LLP
Two Bala Plaza, Suite 300
Bala Cynwyd, PA 19004
610-660-7788
Federal and State Law Concerns
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“Nonprofit” is state law concept
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Not “owned” by anyone – those who control the organization do not
have an ownership interest in it
Prohibition on paying dividends or profits to shareholders, members or
other individuals
Reasonable compensation can be paid but surpluses must stay within the
organization and be used for the organization’s stated purposes
“Tax-Exempt” is generally a federal law concept
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Section 501 of the Internal Revenue Code provides exemption from
federal income tax for certain listed types of organizations
Currently there are listed 27 separate categories of exempt organizations
501(c)(3) organizations (churches, hospitals, universities, charities) are just
one type
1. Core Federal Charitable
Exemption Requirements

Public v. Private Foundation Status
All 501(c)(3) organizations are either “public charities” or “private foundations”
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Under 509(a), organizations that are considered publicly supported (churches,
hospitals, charities, etc.) are deemed “public charities” – those that are supported by a
small group are deemed “private foundations”

Public Charities generally deemed more favorable than private foundations
 501(c)(3) public charities can receive deductible contributions (deductible up to
50% of AGI), issue tax-exempt bonds
 Private foundations can also receive deductible contributions (but only up to 30%
of AGI) and are subject to more restrictive rules: have minimum distribution
requirements; taxes on net investment income; restrictions on certain transactions
with its board members, officers and other related persons
Core Federal Charitable Exemption
Requirements
Qualification Under 501(c)(3)
Requirements of 501(c)(3) status
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Must be organized and operated exclusively (primarily) for
religious, charitable, educational or scientific purposes
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Promotion of health is a recognized charitable
purpose
Core Federal Charitable Exemption
Requirements
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Organizational test -- satisfied by provisions in articles of
incorporation (clear reference to the provisions of section
501(c)(3) or the regs to operative terms like “religious,”
“charitable,” “scientific,” “educational,” etc.

Articles should limit authority to engage only in activities
furthering exempt purposes disclaim power to engage in
substantial activities not in furtherance of exempt
purposes
Core Federal Charitable Exemption
Requirements
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Operational test -- satisfied by showing that activities will:
 Be exclusively for charitable purposes (i.e., primarily
activities that accomplish exempt purposes, and no
more than an insubstantial part other than in
furtherance of exempt purposes),
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Not permit net earnings to inure to the benefit of
private shareholders or individuals (i.e., “insiders” -persons with personal and private interests in the
organization’s activities and in a position to exercise
influence over the organization’s affairs),
Core Federal Charitable Exemption
Requirements
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Not include participation in political campaigns
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Not consist of substantial lobbying, and
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Private inurement proscription buttressed by
corollary private benefit limitation -- 501(c)(3)
organization must serve a public interest rather
than a private interest – i.e., must not be operated
for the benefit or private interests
Core Federal Charitable Exemption
Requirements
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Private benefit limitation does not require participation of an
“insider”
Standard IRS formulation of private benefit test is that the benefit to
private persons must be “qualitatively” and “quantitatively” incidental
when compared to the benefit to the public
To be “qualitatively” incidental, a benefit must be “a necessary
concomitant of the activity which benefits the public at large” in the
sense that “the benefit to the public cannot be achieved without
necessarily benefiting certain private individuals” (e.g., the use of a
hospital’s facilities by private practice physicians on active medical
staff for treatment of their patients)
To be “quantitatively” incidental, the benefit must be insubstantial in
comparison with the benefit conferred upon the public
2. Fiduciary Issues for Nonprofit
Boards of Directors
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Duty of Care 15 Pa.C.S.A. section 5712
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Director as fiduciary – “Director shall perform his or her
duties as a director . . . in good faith, in a manner the director
reasonably believes to be in the best interests of the
corporation and with such care, including reasonable inquiry,
skill and diligence, as a person of ordinary prudence would
use under similar circumstances
Presumption: “Absent breach of fiduciary duty, lack of good
faith, or self-dealing, any act as the board of directors, a
committee of the board, or an individual director shall be
presumed to be in the best interests of the corporation
Fiduciary Issues for Nonprofit
Boards of Directors
If a bylaw of the organization so provides, a director
shall not be personally liable for monetary damages
for any action taken or any failure to take any action
as a director unless:
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1.
2.
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The director breached or failed to perform the duties of
his or her office; and
The breach or failure constitutes self-dealing, willful
misconduct or recklessness.
This does not apply to the responsibility of a director
pursuant to any criminal statute or the liability of a
director for the payment of taxes
Fiduciary Issues for Nonprofit
Boards of Directors
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Bylaw Provisions for Nonprofit Corporations
Directors
Statute requires at least one director
 If the Bylaws do not fix a certain number, statute
mandates that there be three
 If no term of office stated, it is fixed by law at one
year
 If no mechanism for filling vacancies is specified,
vacancies are filled by a majority vote of (remaining)
directors (even if less than a quorum)
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Fiduciary Issues for Nonprofit
Boards of Directors
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Unless Bylaws provide otherwise, each director is entitled by
law to one vote
Meetings
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Statute provides that there must be an annual meeting of
directors for the election of directors and officers,
appointment of Standing Committees, and the transaction of
any other business which may be brought before the meeting
Unless Bylaws provide otherwise, regular meetings are held at
such place and time as shall be designated by resolution of
the Board
Special meetings may be called by the Chair, the President, or
any two directors upon five days notice
Fiduciary Issues for Nonprofit
Boards of Directors
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Quorum
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Unless the Bylaws provide otherwise, a majority of directors
shall constitute a quorum for the transaction of business.
The acts of a majority of the directors present and voting at
a meeting at which a quorum is present shall be the acts of
the Board
Officers
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The statute requires at a minimum, a President, a Treasurer
and a Secretary
Unless the Bylaws provide otherwise, officers are reelected
annually
Fiduciary Issues for Nonprofit
Boards of Directors
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Conflicts of Interest
By statute, transactions between a nonprofit
organization and its officers and directors (or
organizations in which the officers or directors are
involved) are not void if all material facts concerning
the relationship are made known to the Board and
the transaction is deemed fair to the nonprofit
organization at the time it is authorized.
 Having a Conflicts of Interest Policy is considered a
“best practice”
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Fiduciary Issues for Nonprofit
Boards of Directors
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Annual Report
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The statute requires the President and Treasurer to
present to the Board at its annual meeting a report,
verified by the President and Treasurer or by a
majority of the Board, showing in appropriate detail
the following for the immediately preceding year:
The corporation’s year end assets and liabilities
 The principal changes in assets and liabilities
 The revenue or receipts of the Corporation
 The expenses or disbursements of the Corporation
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Fiduciary Issues for Nonprofit
Boards of Directors
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Indemnification
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A nonprofit corporation may indemnify any representative
who was or is a party or is threatened to be made a party to
any threatened, pending or completed action or proceeding,
by reason of the fact that he or she is or was a representative
of the Corporation, against expenses (including attorneys’
fees), judgments, fines, and amounts paid in settlement
actually and reasonably incurred
The corporation may limit the indemnification by providing
that it applies only if the representative acted in good faith
Fiduciary Issues for Nonprofit
Boards of Directors
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Volunteer Protection Statutes
The Volunteer Protection Act of 1997, 42
U.S.C.A. § § 14501-14505 (1997)
VPA is intended to promote volunteerism by
giving protection from liability to volunteers
who serve nonprofit organizations
Fiduciary Issues for Nonprofit
Boards of Directors
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A volunteer is not liable for his/her actions if :
1.
2.
3.
4.
Volunteer was acting within scope of his/her responsibility
If required by law, the volunteer was licensed or authorized
by the appropriate authorities for the activities or practice
from which the harm resulted
The harm was not caused by “willful or criminal misconduct,
gross negligence, reckless misconduct, or a conscious,
flagrant indifference to the rights or safety of the individual
harmed by the volunteer; and
The harm was not caused by the volunteer operating a vehicle
for which applicable state law requires an operator to possess
an operator’s license or to maintain insurance.
Fiduciary Issues for Nonprofit
Boards of Directors
A volunteer will not be shielded from liability if
his/her misconduct:
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1.
2.
3.
4.
5.
Constitutes a crime of violence or an act of international
terrorism for which the volunteer has been convicted
Constitutes a hate crime under state law
Involves a sexual offence, as defined under applicable state
law, for which the volunteer has been convicted
Involves actions for which the volunteer has been found to
have violated federal or state civil rights law; or
Occurred at a time when the volunteer was under the
influence of drugs or alcohol
Fiduciary Issues for Nonprofit
Boards of Directors
Pennsylvania’s “Good Samaritan” Laws
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42 Pa.C.S. § 8332.2 Officer, Director or Trustee of Nonprofit Organization
Negligence Standard: “No person who serves without compensation, other
than reimbursement for actual expenses, as an officer, director or trustee of
any nonprofit organization under section 501(c)(3) of the [IRC] shall be liable
for any civil damages as a result of any acts or omissions relating solely to the
performance of his or her duties as an officer, director, or trustee, unless the
conduct of the person falls substantially below the standards generally
practiced and accepted in like circumstances by similar persons performing
the same or similar duties, and unless it is shown that the person did an act or
omitted the doing of an act which the person was under a recognized duty to
another to do, knowing or having reason to know that the act or omission
created a substantial risk of actual harm to the person or property. It shall be
insufficient to impose liability to establish only that the conduct of the person
fell below ordinary standards of care.
Fiduciary Issues for Nonprofit
Boards of Directors
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Director & Officer Liability Insurance
Volunteer protection statutes provide volunteers
with a defense in the event they are sued
 Even though a volunteer may have a viable defense,
D&O liability insurance helps to cover the costs of
mounting such a defense
 D&O insurance can be helpful to attract new board
members
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3. Annual Information Reporting
Requirements
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New Reporting Requirements
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Tax-exempt organizations whose “gross receipts” are
“normally $25,000 or less” are not required to file Annual
Information Return - “Form 990”
New for 2008 – For tax years ending after 12/31/07, such
organizations are required to electronically submit “Form
990-N,” known as the “e-Postcard”
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Due by the 15th day of the 5th month after close of tax year
Include: EIN, name, address, name & address of principal officer, etc.
Visit http://www.irs.gov/charities/article/0,,id=169250,00.html to
complete and file the e-Postcard
For 2010 tax year, filing threshold increased to $50,000
Annual Information Reporting
Requirements
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No significant changes to 2007 Form 990 from
2006
A redesigned Form 990 has been introduced for
tax years ending on or after 12/31/08 (e.g., if
your tax year ends on 12/31/09, the new Form
990 is due to be filed by 5/15/09 unless an
extension is granted)
The redesigned form consist of a “core” and a
series of schedules
4. Charitable Fundraising
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Charitable Solicitation Registration
Fundraising in PA regulated by the Solicitation of
Funds for Charitable Purposes Act 10 P.S. § 162.2 et
seq.
Requires registration of charitable organizations,
professional fundraisers and professional solicitors
Penalties for noncompliance include fines (up to
$1,000 for each act and up to $100/day during which
violation continues); revocation or suspension of
registration; cease & desist orders
Charitable Fundraising
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Charitable Solicitation Registration
Must submit application form (Form BCO-10)
within 30 days of receiving $25,000 in gross
national contributions or prior to compensating
anyone to solicit contributions from
Pennsylvania residents
Must file with the application a copy of IRS
Form 990 and appropriate financial statements
for the most recently completed fiscal year
Charitable Fundraising
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Internet Fundraising
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Charleston Principles developed by NASCO
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Advisory only!
Out-of-state websites not required to register if they
only passively solicit donations and do not
affirmatively target residents of a particular state
 If, after receiving an out-of-state “passive” donation,
the charity solicits that donor for another donation,
the charity must register in the donor’s state
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Charitable Fundraising
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Acknowledging Charitable Contributions
Donor must have bank record or written
communication from charity to claim charitable
contribution deduction
Donor is responsible for obtaining written
acknowledgment from charity for any single
contribution of $250 or more
Payroll Deductions – When donor makes single
payment of $250 or more by payroll, donor can use
either: (i) pay stub, W-2, etc; or (ii) a pledge card that
includes statement that organization does not provide
goods or services for contributions by payroll
Charitable Contributions
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Charitable organization must provide written disclosure
to donor who receives goods and services in exchange
for single payment greater than $75 (quid pro quo
contribution)
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Donor can only take deduction to extent contribution
exceeds FMV of goods and services received
Written disclosure not required where goods or services meet
“token exception,” “membership benefits exception” or
“intangible religious exception”
Charitable Contributions
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Token Exception
the fair market value of the benefits received does
not exceed the lesser of 2 percent of the payment or
$89, or
 the payment is at least $44.50, the only items
provided bear the organization’s name or logo (e.g.,
calendars, mugs, or posters), and the cost of these
items is within the limit for “low-cost articles,”
which is $8.90
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Charitable Contributions
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Membership Benefits Exception
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An annual membership benefit is also considered to be
insubstantial if it is provided in exchange for an annual
payment of $75 or less and consists of annual recurring
rights or privileges, such as:
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free or discounted admissions to the charitable organization’s facilities
or events
discounts on purchases from the organization’s gift shop
free or discounted parking
free or discounted admission to member-only events sponsored by an
organization, where a per-person cost (not including overhead) is
within the “low-cost articles” limits
Charitable Contributions
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Intangible Religious Benefit Exception
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If a religious organization provides only “intangible religious
benefits” to a contributor, the acknowledgment does not
need to describe or value those benefits. It can simply state
that the organization provided intangible religious benefits to
the contributor.
“Intangible Religious Benefits” are benefits provided by a taxexempt organization operated exclusively for religious
purposes, and are not usually sold in commercial transactions
outside a donative (gift) context (e.g., admission to religious
ceremony).
5. Purely Public Charity Status
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To qualify as an “Institution of Purely Public
Charity” a charity must:
Advance a charitable purpose;
 Operate entirely free from private profit motive;
 Donate or render gratuitously a substantial portion
of its services;
 Benefit a substantial and indefinite class of persons
who are legitimate subjects of charity;
 Relieve the government of some of its burden
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Purely Public Charity Status
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Benefits of being a Purely Public Charity
Can obtain a sales tax exemption from the PA Dept.
of Revenue for purchases made by the charitable
organization
 Can obtain an exemption from real estate taxes
(from the local authority) for property owned and
used by the charitable organization for charitable
purposes
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6. Corporate Governance Issues
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IRS Best Practices –
Recommends adoption
of some or all of the
following
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Mission Statement
Code of Ethics
Due Diligence
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Duty of Loyalty
Transparency
Fundraising Policy
Financial Audits
Compensation Practices
Document Retention
Policy
7. Lobbying
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No substantial part of the activities of 501(c)(3) public
charity may be carrying on propaganda or attempting to
influence legislation (except as provided in 501(h))
“No substantial part” not defined
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5% considered safe (although IRS not bound by a specific
percentage and method for measuring activities unclear)
Private foundations not permitted any lobbying activity
Lobbying
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IRC § 501(h) permits organizations to elect an objective standard to measure
lobbying activities
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Once the election is in effect, an organization can spend the following amounts
(up to an annual maximum of $1 million) on lobbying activities:
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(i) 20% of the first $500,000 of the organization's annual charitable purpose
expenditures;
(ii) 15% of the next $500,000;
(iii) 10% of the next $500,000; and
(iv) 5% thereafter
This limitation is further subdivided so that only 25% of the basic limit may be
spent for "grass roots lobbying" (i.e., any attempt to influence legislation through
an attempt to affect the opinion of the general public or any segment thereof)
Amounts spent in excess of the permitted lobbying or grassroots expenditures are
subject to a 25% excise tax
File Form 5768 to elect under IRC 501(h)
Lobbying
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Safe Harbors
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An electing organization will not be treated as influencing
legislation if it:
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Makes available the results of nonpartisan analysis, study or research
Provides technical advice or assistance at the request of the
government
Testifies or communicates about legislation that would affect the
organization’s existence, powers, duties, or tax-exempt status, or the
deductibility of contributions;
Communicates with its members (only) about specific legislation of
direct interest to the organization, but without urging them to lobby
or to urge others to lobby; or
Communicates with government employees on non-legislative
matters and without any purpose to influence legislation
8. Political Intervention
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All IRC 501(c)(3) organizations are prohibited from
directly or indirectly participating in, or intervening in,
any political campaign on behalf of, or in opposition to
any candidate for elective office
Violation may lead to revocation of tax-exempt status
and imposition of certain excise taxes
Political campaign intervention includes any and all
activities that favor or oppose one or more candidates
for public office.
501(c)(3) organizations are permitted to engage in
certain voter education activities if carried out in a nonpartisan manner
9. Unrelated Business Income
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Unrelated Business Income (IRC §§ 511-515)
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A tax on the net income of
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trade or business
regularly carried on, and
not substantially related to exempt purposes other than through the
production of income,
subject to modifications, exceptions, and exclusions
Key modifications include
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Dividends, interest, royalties, certain rents and capital gains
However, above items are included in the case of debt-financed
property (although schools, qualified pensions and similar
organizations may, under certain circumstances, exclude rents from
debt-financed property)
10. Joint Ventures

Reasons for Joint Ventures
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Increasing capital needs
Reduced reimbursements/payments
 Technological advances
 Expansion refurbishment of physical facilities
 Preferable to borrowing (lower cost of capital – reaching
creditor limits)
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Joint Ventures
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Nature of problematic transactions
Tax-exempt organizations in joint ventures/partnerships
with private, for-profit or taxable, business organizations
 Organization serving as general partner in a partnership
or managing member of a limited liability company
(“LLC”)
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The organization’s participation must further its exempt
purposes, and
The partnership must not prevent the organization from acting
in furtherance of its exempt purposes and cannot result in
inurement to insiders or more than incidental private benefit to
the for-profit partners
Limited partner status typically only raises UBI issues
Joint Ventures
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If exempt organization enters into an “ancillary” joint
venture that is related to the organization’s exempt
purposes, the partner’s distributive share of income
usually treated as exempt function income
If exempt organization enters into an “ancillary” joint
venture that is unrelated to the organization’s exempt
purposes, the partner’s distributive share of income
usually treated as unrelated trade or business income

If unrelated trade or business were substantial enough, it
could jeopardize 501(c)(3) status because it would be
evidence of substantial non-exempt purpose