Legal Minute: NonProfit 101 and The Important Issues To Consider
This will be the first of two articles discussing the important issues that should be considered by anyone starting a nonprofit organization. If you are planning to start an organization that creates a social impact or has a charitable purpose, you can likely form that organization as a nonprofit. There are a number of benefits to forming your organization as a nonprofit, one of the biggest being tax-exempt status. However, it is important to remember that being tax-exempt comes with certain regulations. This article will be part one of two installments examining the regulations nonprofits must comply with to avoid losing tax-exempt status.
There are a number of both direct and indirect ways a nonprofit’s funds can be deemed to have benefited a private individual. The most common form of prohibited benefit is unreasonable compensation paid to insiders of the nonprofit. Other forms of private benefit could include the sale of assets to an insider, the purchase of assets from an insider, lending money to an insider, gifts, or other unreasonable compensation agreements. An organization is not necessarily prohibited from providing compensation to or engaging in business transactions with insiders. However, there are two very important points of consideration when conducting deals with insiders. First, compensation must be reasonable; second, business transactions must be done at arms length.
An example of when UBIT became an issue is an organization that defined its charitable purpose as an effort to stimulate and foster public interest in the fine arts by promoting art exhibits, sponsoring cultural events, and supplying information about fine arts to the public. This organization also conducted business activities in which they leased studio apartments to artist tenants and ran a dining hall for these tenants. The leasing and dining hall activities were not substantially related to the charitable purpose of fostering public interest in the fine arts, and were thus subject to UBIT.
When forming a nonprofit, a clear charitable purpose should be articulated, and the primary activities of the nonprofit should serve that purpose. If there is any doubt about whether the nonprofit is generating profits from business activities that are “unrelated” to the purpose of the nonprofit, an attorney should be consulted to ensure compliance with any federal tax requirements.
Next month, part two to this article will further discuss the need to create and act within the scope of your nonprofit’s charitable purpose, by exploring the political and lobbying restrictions imposed on nonprofits.
Disclaimer: The information in this article is presented for informational purposes only, and should not be taken as legal advice. Before acting on any information presented in this article, you should consult an attorney regarding the facts of your specific situation. We would love to hear from you, so please feel free to contact Wilkinson Mazzeo for a consultation.
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