By: Shobha Lizaso
You have a cause that you are passionate about. You have the drive and motivation to put your time and effort behind that cause. You have the dedication to use all of the aforementioned to create a 501(c)3 nonprofit organization. However, once you create the organization, you must also be diligent in protecting your organization’s tax-exempt status.
Like most people who start a non-profit organization, your focus and energy is probably directed towards serving the community rather than performing internal compliance checkups. However, you cannot serve your target community well if your nonprofit is not run in a manner that is compliant with the law.
What happens when the IRS revokes your organization’s nonprofit status? Here are some examples:
- The nonprofit is no longer exempt from federal income tax and will have to pay corporate income tax on annual revenue.
- The nonprofit may be subject to back taxes and penalties.
- Any state tax exemptions that the nonprofit received that are dependent on federal tax –exempt status may be revoked.
- The nonprofit will be removed from the IRS publication that lists organizations eligible to receive tax-deductible contributions.
- Donors will not be able to receive a tax deduction for gifts to the nonprofit after the revocation date.
A 501(c)(3) organization can maintain its tax-exempt status if it follows the rules affecting the following areas: private benefit/conflicts of interest, lobbying, political campaign activity, unrelated business income, annual reporting obligation, and operation in accordance with stated exempt purpose. Of these six areas, it seems that complying with the rules regarding private benefit/conflicts of interest is the most difficult to follow without a concrete compliance plan and is difficult to assess without a compliance audit. A 501(c)(3) organization’s activities should be directed toward some exempt purpose. Its activities should not serve the private interests, or private benefit, of any individual or organization.
For board members of nonprofit organizations, conflicts of interest occur whenever a director acts in a position of authority on an issue in which they have financial or other interests. In cases of potential conflict of interest, directors must act to preserve and enhance public trust in the organization by putting the interests of the organization ahead of all other business and personal interests. In addition to the public’s sensitivity to self-dealing, activities which appear to have a conflict of interest can be the basis for lawsuits against the directors and officers.
When Board Members are confronted with an actual or apparent conflict of interest, there are reasonable steps that the organization can take to preserve its integrity and its tax-exempt status.
- Make sure that the nonprofit has a Conflict of Interest Policy in place. The Conflict of Interest policy serves as the rules for the Board to follow when a perceived conflict arises. This policy should be reviewed and/or updated by the Board annually and the organizations should have meeting minutes and corporate resolutions to prove that. The IRS requests information regarding the nonprofit’s Conflict of Interest policy on Form 990, so this should not be taken lightly.
- Hire an experienced attorney to review your corporate books, contracts, and Board member relationships to evaluate the nonprofit’s compliance with relevant laws.
- Each member of the Board should annually complete a conflicts questionnaire on which each member discloses his or her other financial interests.
- Review transactions that involve the members of the Board (or their families) and the nonprofit for possible conflicts of interest.
- Review the outside business dealings of the members of the Board to identify conflicts of interest.
- Board Members must always disclose potential conflicts of interest to the rest of the Board through a written conflict of interest disclosure form.
- A Board Member with a potential conflict of interest regarding a particular transaction must recuse from the vote regarding the transaction. The value of a transaction should be based on fair market value and/or comparables and should not private benefit, of any individual or organization. The board must adequately document the basis for approving the transaction.
If the IRS determines that a conflict of interest resulting in an excess benefit transaction has occurred, it can impose penalties on the person receiving the benefit in the form of an excise tax equal to 25% of the excess benefit. That person must also pay back the excess benefit to the nonprofit within a certain period of time or the IRS may impose additional sanctions on that person equal to 200% of the excess benefit. In addition, the IRS may impose monetary sanctions of 10% of the excess benefit on any individual director, manager or officer of the nonprofit organization who knowingly participated in the excess benefit transaction, including the person who benefited.
Although working with nonprofit organizations is highly rewarding and is a perfect vehicle to carry your passions through to effective community action, you must always be very alert as to the new laws and regulations that come about in the nonprofit industry, and you must thoroughly document all important actions taken by the organization. It is very easy for you get so involved with your nonprofit’s cause that the procedures and compliance falls to the wayside, but you must perform this intricate balancing act to keep the organization functional and useful to the community.