United States non-profit laws
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|Taxation in the
United States of America
United States non-profit laws relate to taxation, the special problems of an organization which does not have profit as its primary motivation, and prevention of charitable fraud. Some non-profit organizations can broadly be described as "charities" — like the American Red Cross. Some are strictly for the private benefit of the members — like country clubs, or condominium associations. Others fall somewhere in between — like labor unions, chambers of commerce, or cooperative electric companies. Each presents unique legal issues.
If an organization is to qualify for tax exempt status, the organization's (a) charter — if a not-for-profit corporation — or (b) trust instrument — if a trust — or (c) articles of association — if an association — must specify that no part of its assets shall benefit any of persons who are members, directors, officers or agents (its principals). As well the organization must have a legal, charitable purpose, i.e. the organization must be created to support educational, religious, or charitable activities. These elements do not mean that the organization cannot pay employees or contractors for work or services they render to the organization. This limitation means that as long as the organization operates within its exempt purposes and it maintains an endowment or uses any excess revenue to further develop its activities it will not be taxed by the Internal Revenue Service.
Such a surplus — that is, whatever part of its income is left after its operating expenses are paid — which might be considered similar to "profit" — must be spent on the charitable or public purpose(s) for which it was organized, not paid as a dividend or benefit to anyone associated with running or organizing it.
Not only must the organization meet the requirements the state where it is organized sets for non-profits, but it must also meet complex IRS regulations. These regulations are used not only to determine if the organization is exempt from tax under the organization's activities as a non-profit organization. If the organization purpose is one of those described in §501(c)(3) of the Internal Revenue Code, it may apply for a ruling that donations to it are tax deductible to the persons or business entities who make them. The organization itself will be exempt from taxation as long as it does not engage in unrelated business activities. Such organizations are then required to file Form 990.
As well the IRS has enacted intermediate sanctions should the members of the organization engage in practices that may excessively benefit any of the organization's members (or officers, directors, etc.) rather than revoking the organization's exempt status (which was the only option available before the adoption of intermediate sanctions) the IRS may now levy a penalty on the organization for engaging in a transaction that resulted in a private inurement or private benefit. See the entry on intermediate sanctions for more detailed information.
Differing requirements at the state and federal levels
Due to differing requirements by the states and the federal government, it is possible to be recognized as a non-profit organization by the state, but not by the federal government. Such an organization would be exempt from state taxes, but not from federal taxes. This may actually be desirable in certain limited circumstances. For example, federally tax-exempt organizations are generally prohibited from influencing elections and legislation, whereas the state may or may not prohibit non-profits from that activity. If you wish to receive grants and donations, it is generally necessary to be a federally recognized non-profit (i.e. 501(c)(3) or similar designation). Contributions made to federally recognized non-profits (such as 501(c)(3) entities) would typically be tax deductible for the person or entity giving the donation. In other words, if the federal court decides that a non-profit organization is acting contrary to the laws, its taxation benefits may be permanently revoked.
Non-profit organizations in the United States are, like for-profit corporations, mostly organized and operated under the law of a state, rather than the federal government. There are some federally chartered charities, though, including the American Red Cross, the Boy Scouts of America, and the United States Olympic Committee.
Generally, non-profits and people operating non-profits must comply with all of the same laws which would apply to for-profit businesses. There are exceptions for taxes (noted above) and some exceptions related to First Amendment concerns, noted below. Directors and officers of non-profits owe a fiduciary duty to the non-profit and its beneficiaries similar to the duties owed by directors and officers of for-profit corporations. Non-profits can have vicarious liability for injuries caused by their employees or volunteers to third parties, such as by traffic accidents. For this reason it is prudent for any non-profit to obtain liability insurance. Non-profits which have paid staff must comply with minimum wage laws, and with the requirement in most states to obtain workers compensation insurance.
Churches and religious non-profits are something of a special case, because the First Amendment to the U.S. Constitution forbids the government making a law "respecting an establishment of religion" and also forbids "prohibiting the free exercise thereof [that is, of religion]." The First Amendment originally bound only the U.S. Federal Government, but by incorporation through the 14th Amendment, also binds state and local governments. Under the Religious Freedom Restoration Act many generally applicable state laws regarding employment, zoning and the like are relaxed for churches.
Similarly, some non-profits, as private organizations, are not subject to the anti-discrimination laws which might apply to similar organizations serving the public for profit. As an example, the Boy Scouts of America do not allow girls as Cub Scouts or Boy Scouts, and the courts have held this does not violate anti-discrimination laws.
Charity non-profits face many of the same challenges of corporate governance which face large, publicly traded corporations. Fundamentally, the challenges arise from the "agency problem" - the fact that the management which controls the charity is necessarily different from the people who the charity is designed to benefit. In a non-profit corporation, the "agency problem" is even more difficult than in the for-profit sector, because the management of a non-profit is not even theoretically subject to removal by the charitable beneficiaries. The board of directors of most charities is self-perpetuating, with new members chosen by vote of the existing members.
Charitable fraud prevention
In the United States, prevention of charitable fraud is mostly a function of state governments, and laws vary widely from state to state. Approximately 45 states have laws regulating charities and require registration before soliciting donations.
- "NON-PROFIT ORGANIZATIONS". Retrieved 15 January 2014.
- "Types of Tax-Exempt Organizations". IRS. Retrieved 15 January 2014.
- "What is a 501(c)(3)?". Retrieved 15 January 2014.
- "Instructions for Form 990 Return of Organization Exempt From Income Tax" (PDF). Internal Revenue Service. 2015. Retrieved February 3, 2016.
- Terry W. Knoepfle, Karen A. Froelich. "Intermediate Sanctions and Exempt Organizations". Retrieved 15 January 2014.
- "Fiduciary Responsibilities of Board Members". Retrieved 15 January 2014.
- "TIPS ON AVOIDING FRAUDULENT CHARITABLE CONTRIBUTION SCHEMES". Retrieved 15 January 2014.