Advanced Exemption
Issues: 501(c)(3)
NFP2011, Session 102, Wednesday, June 8, 8 AM
Speaker Biography
TERRY MILLER brings years of training and consulting experience in
the nonprofit sector across a broad range of organizations. His
passion is making information accessible to nonprofit managers,
boards and advisors. He received his B.A. from Antioch College in
Yellow Springs, Ohio in 1977, and his M.B.A. from the University of
Portland in 1984. Terry balances consulting with his work as Finance
Manager for River Network, a Portland, Oregon based environmental
organization working to strengthen local watershed group nationally.
TERRY MILLER
www.TerryMiller.biz Terry@TerryMiller.biz
62 Rudden Ave San Francisco California 94112-2540
voice: 415-333-6320
fax: 415-333-6309
American Institute of CPAs
Preview
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Public Charity Status
• Planning options if the public support test(s) won’t work out
Policy Advocacy
• Tips on stretching lobbying dollars
• When to create a 501(c)(4) lobbying affiliate?
Commerciality
• UBTI exclusions: remember, analyze, utilize
• When to start a for-profit subsidiary?
Other Concerns: understanding, evaluating and creating
positive documentation
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Private benefit vs. public benefit
The “public policy doctrine”
The commensurate test, a/k/a “efficiency & effectiveness”
Anti-terrorism concerns
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Public Charity (“PC”) Status
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…planning options if the support tests will not work out
Plan ahead! These only work if you see failure coming
before it arrives …
IF will not pass the 509(a)(1)/170(b)(1)(A)(vi)
“10%+facts & circumstances” nor the 509(a)(2) test
for two consecutive years, then:
• will no longer qualify as a publicly supported PC, so consider
- 501(c)(4)
- Private Operating Foundation
- 509(a)(3) Type I
- Sponsored project
- Private Foundation
- Private Foundation, then termination, new 5 year period
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Public Charity Status
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501(c)(4) status
• sometimes works in cases where (a)(2) fails because of too few
fee-payers; can always set up a fiscal sponsorship for some
grant-funded charitable work done by (c)(4)
Private Operating Foundation
• offers same favorable deductibility (% AGI, FMV v. basis) as PC
status; otherwise all the constraints of a PF
• complex rules & compliance; expensive tax prep
• slightly better grant opportunities PFPOF requires expenditure
responsibility but is then a qualifying distribution for the PF
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Public Charity Status
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509(a)(3) Type I
• in cases where there are multiple “allies,” a broad charitable set
of activities, but too few donors, possible to:
- 1. support a “class of public charities” (e.g. environmental
preservation charities) and
- 2. be controlled by delegates, one each from a handful of
representative charities (say, 5 charities + 2 donors = 7
person board)
- must get legal counsel to understand parameters of
permissible activities, but it waives the public support
test and provides the other benefits of PC status
Become a “Fiscally Sponsored Project” of a larger
charity
• loss of control, but now the public support is a larger pool
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Public Charity Status
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Private Foundation
• can work, unless you:
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depend on grants from other private foundations
lobby explicitly
must have self-dealing other than fair pay for services
must make lots of foreign grants or make grants to non-charities
• still tax-deductible to donors (lower % AGI, and less favorable
for non-cash gifts; for most individual and business donors no
difference at all); still a “501(c)(3)” for the halo
Private Foundation then Termination
• once in a while, can fail, exist as a PF for a part-year, then
terminate as a PF and elect a new five year advance period
• requires fancy footwork: must show why facts will be different;
but sometimes when startup was just too slow, it works
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Public Charity Status
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PC vs. Alternatives: abbreviated attributes *
(a)(1or2)
PC
PF
POF
(a)(3)
Type I
(c)(4)
Spons
Proj
Max
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Less
Max
Max
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NONE
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Max
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?
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?
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Deductions
Lobbying
Reasonable
Self-Dealing OK?
Get PF Grants?
Make grants to non(c)(3)s?
Investment income
tax-exempt?
Control?
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* MANY caveats & much fine print: summary only
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Policy Advocacy
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…tips on stretching lobbying dollars
Context: Lobbying, within limits, is bona fide
charitable activity.
Quick History:
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1930:
1934:
1954:
1976:
1990:
Slee v. Commissioner of Internal Revenue
“no substantial part” added to IRC 501(c)(3)
prohibition on candidate “intervention” added to 501(c)(3)
IRC 501(h) and 4911 added to provide more certainty
defining regulations adopted
Unless over $21M exempt purpose expenditures,
definitely elect 501(h) (will assume we mean 501(h)
electing publicly supported charities)
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Policy Advocacy
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Context: Lobbying, within limits, is bona fide
charitable activity.
Quick History:
•
•
•
•
•
1930:
1934:
1954:
1976:
1990:
Slee v. Commissioner of Internal Revenue
“no substantial part” added to IRC 501(c)(3)
prohibition on candidate “intervention” added to 501(c)(3)
IRC 501(h) and 4911 added to provide more certainty
defining regulations adopted
Unless over $21M exempt purpose expenditures,
definitely should elect 501(h) (next slides assume we
mean 501(h) electing publicly supported charities)
Biggest message: someone must MASTER 501(h)
Next slides: What is NOT lobbying?
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Policy Advocacy
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What is NOT lobbying?
• Volunteer effort (501(h) is an expenditure test)
- Reg 56.4911-2(b)(4)(ii)
• Attempts to influence executive branch matters
- Reg 56.4911-2(b)(1)(i)
• Communications with the public expressing a view on specific
legislation, with NO call to action (except mass media immed
prior to a vote)
- Reg 56.4911-2(b)(2)(ii)
• Communications with members [donors] expressing a view on
specific legislation, with NO DIRECT call to action
- Reg 56.4911-5(b)
• Communications about a Broad Social Problem are not a
specific legislative proposal, by definition
- Reg 56.4911-2(c)(2)
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Policy Advocacy
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What is NOT lobbying? (continued)
• Nonpartisan Analysis Study & Research (unless exact piece used
subsequently within 6 months to lobby) - Reg 56.4911-2(c)(1)
- substantial non-lobbying distribution, not just to one side of a
proposal
- Reg 56.4911-2(b)(2)(v)(E)
- full exposition of the facts
- Reg 1.501(c)(3)-1(d)(3)
- may express a view, but only contain an indirect call to action
- Reg 56.4911-2(c)(1)(vi),(vii)
• Requests for opinions, recommendations and Technical Advice by
a legislative body, committee or sub-committee
- Reg 56.4911-2(c)(3)
• Self-defense lobbying (affects existence, powers & duties, taxexempt status, or deductibility of contributions)
- Reg 56.4911-2(c)(4), 2(d)(3)
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Policy Advocacy
5/5
…when to start a 501(c)(4) lobbying affiliate?
After mastering 501(h), total lobbying is more than 501(h)
allowance, and
enough more to make the extra hassle worth it, and
funding is available.
OR
The (c)(4) might hit hard enough in messaging to
approach candidate electioneering (forbidden to (c)(3)).
OR
Voter registration / education that will not be purely
nonpartisan in the (c)(3) way.
Can use (c)(4) affiliate to bank annual lobbying amounts
via lobbying grants; if yes, try to build lists in the (c)(4)
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Commerciality
1/4
…remember, understand, analyze & utilize UBTI exclusions
Context, History, Definitions
• The Mueller Macaroni Company: “destination test” becomes the
“operated exclusively for” test, circa 1950
• NET Unrelated Business Income is taxable: Unrelated Business
Taxable Income
Definition of Unrelated Business Income
• Trade or business, and
• Regularly carried on, and
• Unrelated to the tax-exempt purpose of the 501(c)(3)
Definition leads to certain exclusions
First, ask if a broadened mission might work?
• If yes: [get counsel] amend Articles of Incorporation purposes,
disclose new activity to IRS on Form 990: now Related
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Commerciality
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Common UBTI Exclusions
(TIP! best abbreviated list of all exclusions was in the 2007 and earlier
Form 990 instructions…included with session materials)
• Passive income (i.e. not “carried on”) – Interest, Dividends,
Gains & Losses, Rents & Royalties
• Not Regularly Carried On (annual event, short duration)
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Substantially Conducted by Volunteers
Sale of Donated Merchandise
Activity for the Convenience of Members or Patrons
Qualified Sponsorship Payments
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Commerciality
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Some cautions
• Rent from debt-financed property is not passive
• Rent where extra services are included is not passive
• Calculation of net advertising income may require complex
calculations of membership dues as if subscription income
• Sale of “logo-wear” merchandise is commercial unless
emblazoned with educational messaging
• IRS applies the “fragmentation” rule: evaluates the relatedness
of each item in a gift shop, museum shop, or college bookstore
Effect on the Public Support Test
• Income excluded because of 1) passive, or 2) not regularly
carried on, is still in the denominator of the public support test,
so
• the other exclusions are more attractive if both are available
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Commerciality
4/4
…when to start a for-profit subsidiary?
“operated exclusively for” exempt purposes erodes if a UBTI
generating activity becomes substantial
(roughly: >= 20% of activity & attention)
• If a venture will be this big, put it in a subsidiary; note 20% of activity
not of income (common misconception)
• Separate entity may offer more clear expense accounting to calculate
net income
• Separate business venture may help shield liability in separate
corporate entity
• Separate business entity may allow a separate corporate culture
around money and management skill
• Better to do it sooner than later if it is likely to be that large (if there are
other investors in the subsidiary, valuation can be difficult if you wait to
spin off)
• Profits flowing in to the parent public charity will be subject to the 2%
limitation for the public support test
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Other Concerns
1/5
…understanding, evaluating & creating positive documentation
(First, note that there are one or more other sessions on
Compensation, a big topic in recent tax-exempt law!)
Good board minutes: “Whereas” statements can be
very important for framing intention: shows
conscious intent
Use the “new activities” section of the 990 if any
doubt: again, shows conscious intent, not mere
“drift”
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Other Concerns
2/5
Private benefit vs. public benefit
• Private benefit is a larger concept than “private inurement” which is
limited to insiders, a subset of private benefit; ask “who benefits”?
• “the presence of private benefit, if substantial in nature, will destroy taxexempt status regardless of an organization’s other charitable purposes
or activities” – Owens on Better Business Bureau of DC v. US
• “non-incidental benefits conferred on disinterested persons that serve
private interests” – Owens on American Campaign Academy
• notion of incidental private benefit as a “byproduct” conferred by public
benefit – e.g. universities primarily benefit the public, and incidentally
individual students
• recent examples: credit counseling, downpayment assistance
• best defense: clear thinking, good governance practices
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Other Concerns
3/5
The “[contravention of] public policy doctrine”
• most famous case was Bob Jones University which lost tax exemption
because it refused to admit members of mixed race married couples,
thereby discriminating
• other outright racially discriminatory schools – no tax exemption if
discriminate – in fact, exempt schools must affirmatively NOT
discriminate
• “…the purpose of a charitable trust may not be illegal or violate
established public policy…” Supreme Court in Bob Jones case
• what happens as public policy changes?
• boycotts, demonstrations & similar “confrontational” tactics will be
evaluated to see if bona fide parts of exempt purpose (e.g.
Greenpeace)
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Other Concerns
4/5
The commensurate test, a/k/a “efficiency &
effectiveness”
• IRS has been making speeches on this topic co-incident with the rollout
of the “new” 990
• similar to question of Functional % (Program-Admin-FR): are you
getting enough work done to justify the money being spent?
• public sunshine has proved the best disinfectant so far, because courts
have limited the reach of specific rules – only most egregious cases
seem to attract regulatory scrutiny
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Other Concerns
5/5
Anti-terrorism concerns
• key elements of this policy area are the P.A.T.R.I.O.T. Act and the
Treasury Department Voluntary Guidelines / best practices (2002/2006)
• Voluntary Guidelines were revised at least once to soften them
• notion of “listed persons” – illegal to provide support to, to provide
support to a person who provides support to, and even to a person who
associates with
• some funders may require use of specialized software to clear all staff
& contractors: problem is English language translation of names in
other alphabets (i.e. Arab)
• key element is to use rigor and direct involvement, and document that
in any foreign grantmaking; the scale of due diligence should fit the
amounts spent (e.g. one friend photographing a footbridge vs. hiring a
firm to “audit” foreign)
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Resources / Readings
1/2
…links to all are also at: www.TerryMiller.biz/AICPA-NFP11
(For all topics, Bruce Hopkins’ texts provide invaluable background and context.)
Public Charity Status
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“Public Support Tests: Context & Calculation” my AICPA NFP 08 Session 51
Policy Advocacy / Lobbying
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IRS CPE 1997 “P. Lobbying Issues” Judith Kindell & Jack Reilly
http://www.irs.gov/pub/irs-tege/eotopicp97.pdf
IRS CPE 2000 “S. Affiliations Among Political, Lobbying and Educational
Organizations” Ward Thomas & Judith Kindell http://www.irs.gov/pub/irstege/eotopics00.pdf
“Public Charity Lobbying” – overview + advanced strategies (my material)
“Public Policy Advocacy Bibliography & Resources: A Selection” Ver 7.0 2011
(my material & updates, based on early initial help from John Pomeranz)
UBTI / Commerciality
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Form 990-T Instructions, Form 990 Core Form Instructions
Many IRS CPE articles (30-page topical index): http://www.irs.gov/pub/irstege/cpeindexbytopic.pdf
“The Tax Implications of Earned Income” (my article, 2002)
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Resources / Readings
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Private Benefit
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IRS CPE 2001 “H. Private Benefit Under IRC 501(c)(3)” Megosh, Scollick, Salins
& Chasin http://www.irs.gov/pub/irs-tege/eotopich01.pdf
Mark Owens’ AICPA NFP 2007 session “Private vs. Public Benefit”
Public Policy Doctrine
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IRS CPE 1994: “L. Illegality and Public Policy Considerations,” Wright & Rotz
http://www.irs.gov/pub/irs-tege/eotopicl94.pdf
IRS CPE Text 1985 “J. Activities That Are Illegal Or Contrary To Public Policy,”
http://www.irs.gov/pub/irs-tege/eotopicj85.pdf
Commensurate Test
•
Search on “speeches by IRS” on “nonprofits” “efficiency & effectiveness” (mix &
match search terms)
Anti-terrorism
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Search on “PATRIOT Act and nonprofits”
Treasury Department [revised] “Anti-Terrorist Financing Guidelines: Voluntary
Best Practices for U.S.-Based Charities” 2006, + Treasury’s response to
comments on 2005 draft
Search on “Treasury Department Voluntary Guidelines” for editorial comment
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