No Good Deed Goes Unpunished

Why Didn’t Toms Shoes Set Up As A Not For Profit Entity?

kent — Wed, 18 Apr 2012 16:44:34 +0000

Whether the general public knows it or not, Toms Shoes, yes, the famous Toms Shoes, is a not a nonprofit organization. In fact, it is a for profit enterprise that makes millions of dollars for its shareholders. Some of you who are interested in “cause marketing” and “social enterprise” may be interested to learn the legal reasons why Toms Shoes did not set up originally as a nonprofit organization.

One could say there was clearly a compelling economic reason which is the shareholder’s can profit this way, but there are also some very good legal reasons. Despite what appears to be a charitable purpose of “giving away shoes”, the IRS analyzes the activity as “selling shoes” and if an organization is selling shoes then this is a commercial activity and not a charitable activity.

Specifically, under Section 512 and 512 of the IRC, the IRS has set forward certain parameters relating to income that a charity receives which constitutes “unrelated business income” (“UBIT”) and, if such income is “unrelated” then, the income is taxable pursuant to Section 11 of the IRC. The IRS has created a “test” (“Test”) to determine if such income is taxable. In addition, if there is too much UBIT, then this may in fact jeapordize the tax exempt status of nonprofit set up to sell a product, like selling shoes, to the general public raising monies for those who are in need (“Business Opportunity”). The Test is as follows:

The activity must be a trade or business
The trade or business must be continuous and regular
The activity must be “unrelated” to the exempt purpose of the organization.

In order for the Test to be met, each and every prong of the Test must be met. In other words, if one is missing, then, the income is not taxable under Section 512 of the IRC.

Unrelated Business Income

First, we will apply the Test to the Business Opportunity.

Is the activity of operating the Business Opportunity a trade or business? The answer is, yes. A trade or business is an enterprise which has the intention of generating a profit and is entered into for the purposes of gain. In this case, running a Business Opportunity, the goal is to sell a product and compete with other business, to sell products to the general public. It could be no clearer of a case of a business enterprise even though the proceeds will go for the benefit of helping those in need.
Is the Business Opprotunity regularly and continuously carried on? The term “regularly and continuously” carried refers to nature of the activity. The IRS has determined that frequency typically involves a continuity of time of operation and operates like other businesses of its kind. For example, The operation of a sandwich stand by a hospital auxiliary for only 2 weeks at a state fair would not be the regular conduct of trade or business. The sandwich stand would not compete with the operation of similar facilities by a taxpaying organization which would ordinarily operate on a year-round basis. The sale of advertising by volunteers of an exempt organization, which raises funds for an exempt symphony orchestra and publishes an annual concert book distributed at the orchestra’s annual charity ball, is not a business regularly carried on in determining unrelated income under section 512 of the Code. Rev. Rul. 75–201. On the other hand, the sale of advertising during a four month period by the paid employees of an exempt organization, which raises funds for an exempt symphony orchestra and publishes a weekly concert program distributed free at the symphony performances over an eight month period, is a business regularly carried on in determining unrelated income under section 512 of the Code. Rev. Rul. 75–200. In the instance case, it seems inarguable that the Business Opportunity is regularly and continuously carried on as that is the purpose of owning and operating it on a daily basis.
Is the activity related to an exempt purpose which is charitable, educational, etc? To determine whether a business activity is or is not substantially related requires an examination of the relationship between the business activities which generate the particular income in question—that is, the activities of producing or distributing the goods or performing the services involved—and the accomplishment of the organization’s exempt purpose. To be related, in the statutory sense, the relationship must be causal. In addition, the causal relationship must be a substantial one. Thus, the activities which generate the income must contribute importantly to the accomplishment of the organization’s exempt purposes to be substantially related. Regs. 1.513–1(d). An exempt organization’s operation of a retail grocery store as part of its therapeutic program for emotionally disturbed adolescents, almost fully staffed by the adolescents, and on a scale that is no larger than is reasonably necessary for the performance of the organization’s exempt functions, is not unrelated trade or business. Rev. Rul. 76–94 Unrelated trade or business does not include any trade or business in which substantially all the work is performed for the organization without compensation. For example, an orphanage operating a retail store where substantially all the work in carrying on the business is performed for the organization by unpaid volunteers would not be carrying on unrelated trade or business. In Rev Ruling, 76-94, the key terms are that the store was not operated on a “a scale that is no larger than is reasonably necessary” for the performance of the organization’s exempt functions. In this case, Arc Mission is to assist with education, job training and providing job opportunities to Recipients, this is the very purpose of the organization which the IRS recognized as “charitable”. Juxtapose this with Revenue Ruling 73-127, in which the IRS held that a grocery store providing low cost items to poor areas, which had as one of its element a “training program” for the unemployed, who received a temporary training, then, sent out to the work force, was not a charitable organization and the activity was “larger” than the scale to further its exempt purposes and therefore the operation of the store was “Unrelated” to an exempt purpose. Again, it is very hard to argue that activity of “selling a product” is related to a 501c3 purpose such as charitable, scientific, etc. Yes, the monies will go to this purpose but not the “selling of the product”. Very likely all income earned would be taxable and an organization set up to engage in such activity would NOT be eligible for 501c3 status.

Legal Pitfalls of Internet Fundraising; The Charleston Principle Discussed

kent — Sun, 08 Apr 2012 18:07:06 +0000

Charities who raise funds online may be wondering what legal obligations they have, amongst all the other concerns that they have in terms of raising funds. Why this might make matters more challenging; understanding the legal do’s and dont’s might make a life a little easier. In 1999, a delegation of all state charity officials convened in South Carolina to discuss principles related to internet fundraising. The National Association of State Charity Officials (NASCO) came up with some suggested guidelines known as the Charleston Principle (the “Guidelines”).

The Guidelines are simply such guide posts for states to adopt in connect with the rules and regulations of charities. Each state may adopt its own rules and regulations.

Here some of this is discussed.

Use of Internet Sites to Raise Funds

First, if you have a website, whether directly or through another platform, and you allow the “interactive” nature of the website such that one may be able to donate online funds or engage in a transaction of purchasing a product or service which will benefit a charitable purpose, then, under the Guidelines:

a. The charity must register in each state in which the activity is,

1. Substantial or repeated or on ongoing basis [These terms are not strictly defined, but, if more than 100 transactions and the result is $25,000 or greater in proceeds, then, it meets this test]

2. The website specifically targets individuals in that state.

Use of email aka electronic email

The use of charity email to solicit funds is a practice sometimes used to great success. In this case, the use of email under the Guidelines should be treated in exactly the same way in which regular mail or fax is treated by each state. If the state requires registration for such activities, then, the charity should do the same for email activity.

Cause Marketing Via The Internet

For those individuals and organizations who have certain companies that sell products or services online and donate a portion of the proceeds to your charity, you are also required to register in those states requiring registration provided that the activity is a) substantial and b.) repeated and ongoing.

Exclusions

If you are utilizing a web platform that does not help market your website in anyway except from a technical or administrative standpoint, this would not be considered to be “professional fundraising”.

10 Common Mistakes Celebrities Make When They Engage In Philanthropy

kent — Tue, 03 Apr 2012 23:45:14 +0000

1. In leiu of receiving direct payment for services in making appearances, they will ask the payor to pay the “compensation” to their charity. This triggers a concept known as the “assignment of income” doctrine, resulting in tax the celebrity and ultimately less money to the celebrity charity.
2. Celebrities that are not entirely funding their own 501c3 organization but are generating funds from the general public make the mistake of calling it a “foundation’” which it is not; a private foundation is for high net worth folks who solely fund the 501c3. This is a misnomer and leads the public to believe that the foundation is full funded thereby creating the false impression of a rich organization and spurning fundraising efforts which further frustrates the celebrity.
3. The celebrities will form their own 501c3 nonprofit corporation and many times this is simply an administrative burden which becomes costly, frustrating and fruitless and leads to more problems and less solutions. Each celebrity should carefully about how to engage in philanthropy including “donating time, likeness, image, name” etc or to utilize a donor advised fund or a fiscal sponsor or to create their own entity or to just utilize a for profit.
4. Hiring family members to help run the charity or to sit on the board of directors.
5. Not being more careful about the campaigns they are endorsing. Do research. One slip up can be very costly in terms of sponsorship and goodwill for the celebrity.
6. They don’t donate time, thereby a less purposeful connection is made which means not as much fulfillment and happiness from the connection.
7. Not teaming up more with existing charities and other celebrities to create awareness for their passion on philanthropy.
8. Not utilizing the strategies of social media in such a way that create the type of “mark” and ability to be an influencer
9. Not leveraging their existing relationships to donate their time, money and energy
10. Not engaging in philanthropy at all. It is a shame individually and for the benefit of goodwill, and, their celebrity’s own happiness to engage in any philanthropy; almost a crying shame.

Don’t Get Caught Holding The Bag Doing A National Cause Marketing Campaign

kent — Wed, 14 Mar 2012 15:40:24 +0000

Charities more than ever are finding ways to do business with the for profit world. In doing so, both the charities and the for profit organizations must make sure they each are comply with each Jurisdiction’s requirements in engaging in these campaigns. We recently were engaged by one of our charity clients to help them register in the 39 jurisdictions to comply with these obligations. Be mindful that you want to plan your compliance with significant lead time prior to the commencement of your campaign.

California Enacts New Statute Creating For Social Enterprise

kent — Tue, 28 Feb 2012 15:46:45 +0000

In a historic development, the State of California enacted two statutes that now give rise to two different types of social enterprise type of corporations, the “Flexible Purpose” corporation and the “Benefit” corporation. These are interesting statutes and while they do not enjoy the same tax benefits of being a charity, they attempt to legislate and protect, directors and officers, from lawsuits for managing corporations in such a way that may advance a social benefit rather than simply a bottom line. If you are very serious and interested in social enterprise and structures, you may want to check the website www.bcorporation.net, a website dedicated exclusively to “certifying” corporations that meet comprehensive and transparent social and environmental performance standards, meet higher legal accountability standards and build business constituency for public policies that support sustainable business. This is not an official governmental agency however it creates a branding mechanism for those who are doing business with it to know it is approved as a “B Corporation”.

Should Nonprofits Utilize Pro Bono Legal Counsel

kent — Sat, 25 Feb 2012 18:38:29 +0000

I am often asked the question by those who are either starting charities or run existing charities whether I believe it is a good idea to have solely pro bon legal counsel act as their legal counsel. Now, I am may be a little bit biased but, would you ask a person who would work for free to do the plumbing for your whole house? Would you hire an electrician to deal with carpentry? The answer is probably no, even it was for free. Why because even though money is important, you want the right person for the job. Now, just because someone is a great real estate lawyer and he or she sits on your board, does not mean the understand the laws of charities nor do they understand the true workings of charities like a real lawyer that specializes in this area. So the real question people need to ask themselves is not whether to use pro bono counsel, but, more importantly, do they want mediocrity out of their organization? Do they just want to be average? Do they care if they are the best at what they do? Now, if you answer you do, then, you want a lawyer who understands and is by far better to pay for expert legal advice rather than to get free advice even if coming from a good place. This is another installment in the series of blogs about “No Good Deed Goes Unpunished”

Revenue Bill May Ignite M&A Activity in Nonprofit Sector

david — Mon, 16 Aug 2010 18:08:07 +0000

David A. Paterson, N.Y. Governor signed a bill that may significantly reduce the amount on charitable contributions made by high income earners, people with an AGI (adjusted gross income) of $10-million annually. The new law reduces charitable write off on their state income taxes from 50 percent to only 25 percent. While the act will provide up to $100-million in revenue during the current fiscal year for the state, it could lead to devastating consequences for the nonprofit sector. Funding could decrease significantly as the wealthy have less incentive to make contributions.

In the recent economic downturn, issue of funding has lead to many nonprofits reducing operations and sometimes even as far as dissipating. Other charities have looked towards alternative means to survival, which M&A activity has been a very viable option. M&A has become increasingly more popular as a solution for financial difficulties that some charities are facing. Edward Charles Institute (ECI) anticipates that the bill will only amplify the effects of the recession and potentially leading to greater M&A activity in the nonprofit sector.

Revoking of Tax-Exempt Status!

david — Tue, 10 Aug 2010 18:06:12 +0000

If your nonprofit currently holds tax-exempt status, you are required to file annual information return (Form 990, 990-EZ, or 990-PF) with the IRS; failing to do so for three consecutive will result in the automatic revocation of your tax-exempt status! While the IRS hasn’t fully detailed the exact process, it will be publishing a list of organizations that have lost exemptions on its website in 2011.

Revocation of your tax-exempt status will lead to severe consequences. GuideStar recently published a study explaining that, “Revocation has a drastic and expensive impact on a nonprofit. If it’s a charitable organization, it will no longer be able to accept tax-deductible contributions. Whatever type of exempt organization it is, it will need to pay federal income taxes. it may also incur penalties for failure to pay income taxes, to say nothing of the loss of the trust of its donors, members, and clients.”

For more information on the GuideStar report, “Automatic Revocation of Nonprofits’ Tax-Exempt Status,” click here

The Board of Charities Can Help or Hinder Mergers

david — Wed, 04 Aug 2010 00:07:42 +0000

No matter how fast that you think you can move in business….in the charity world, the boards and their busy schedules can ultimately provide obstacles in the progress of a merger/ acquisition taking place…..unless you have a Committee dedicated to handling the process, it can be the sole obstacle to a merger/ acquisition taking place…..

Bridgespan Report on Mergers and Acquisitions (M&A) in Nonprofit Sector

david — Thu, 29 Jul 2010 19:41:14 +0000

A recent research report conducted by Bridgespan, a subsidiary of Bain Consulting, “Nonprofit M&A: More Than a Tool for Tough Times,” concluded that “There are far more potential for M&A to create value in the nonprofit sector than most people realize…Now is the time for the strongest, most effective organizations to use it as a strategic tool to further their impact.” Once a $4.5 million organization in Tuscan, the Arizona’s Children Association (AzCA) emerged from a ten year strategic expansion campaign as a 40-million state-wide nonprofit; which CEO Fred Chaffee attributes to “using M&A to gain footholds in new services, geographies and beneficiary populations.”

While typically M&A opportunities and transactions are the headlines of today’s for profit world, it’s equally important to investigate its potential within the nonprofit sector. Typical strategic benefits that can arise from M&A activity include:

Improvements in the quality and efficiency of existing programs
Increased funding opportunities
Development of new skills and cooperation of a diverse backgrounds
Breaking barriers of entry into new geographies

M&A may not be an universal solution to the financial setbacks of every organization, but it can and should be seen as a viable alternative that can create synergy and opportunities to affect a greater number of communities.

Bridgespan Article Link