Nonprofit compliance laws are put in place by federal and state authorities to protect the public and ensure nonprofit organizations do not abuse their financial advantages. Because 501(c)(3) organizations are exempt from federal taxes and have access to public funding, they are held to a high standard by the public and by our government. Therefore, following federal and state compliance rules are vital to your organization’s success and sustainability.
Once your organization has obtained tax exempt status, you’ll need to know how to manage the things properly. If you hold a leadership position within your organization, such as board member, principal officer, executive director, etc., you will need to know what responsibilities you have and what activities can jeopardize your organization’s 501(c)(3) tax exempt status.
Where to Begin?
Start by understanding relevant terms, your legal obligations (i.e. mandatory registration and filing dates, regular board communication), and keeping good records.
Become Familiar with Relevant Terms
- Principal Officer – The president, vice president, treasurer, assistant treasurer, chief accounting officer, or other corporate officers in your organization.
- Disqualified Person – Any person who was in a position to exercise substantial influence over the affairs of the tax-exempt organization at any time during the look-back period (the five-year period before the excess benefit transaction occurred). Family members of the disqualified person and entities controlled by the disqualified person are also disqualified persons.
- Bylaws – This refers to the operating manual that consists of the internal set of rules established by the organization’s Board of Directors to regulate and govern itself.
- Conflict of Interest Policy – A Document that protects the organization’s interest when it is contemplating entering into a business transaction or arrangement that might benefit the private interest of one of its officers or directors or might result in a possible excess benefit transaction for a disqualified person. This document is created, adopted, and signed by all directors.
- IRS 990 •The annual information return required to be filed with the IRS by most tax-exempt organizations.
- Private Benefit •Private benefit occurs when an individual or organization receives a benefit—monetary or non-monetary—from a 501(c)(3) organization. •It is allowable when it is insubstantial or incidental to the main service being provided.
- Inurement •When an individual who has significant influence over the organization enters an arrangement with the nonprofit and receives benefits greater than she or he provides in return. •Section 501(c)(3) contains the specific requirement that “no part of the net earnings of [the organization] inures to the benefit of any private shareholder or individual . ” This is never allowable.
- Lobbying •Contacting or urging the public to contact members of legislative bodies for the purpose of proposing, supporting, or opposing legislation. Substantial lobbying, not allowed.
- Political Campaigning •Taking a stand in any political campaign; supporting or opposing a political candidate. Political Campaigning is Never allowed.
- Unrelated Business Income Tax (UBIT)– This refers to business income from a trade or business that is regularly carried on; yet, the activity from which the income is originated is not substantially related to your organization’s charitable purpose or the basis of the organization’s tax exemption. Excessive UBIT may even jeopardize your IRS Tax Exemption status.
While it’s beyond the scope of this training to cover every possible legal situation and obligation that your specific organization may face, we can offer a general list of legal obligations that most 501(c)(3) public charities will face.
Legally Mandated Activities Include:
- Creating Bylaws and acting in accordance with them. Bylaws govern how your nonprofit will manage itself.
- Creating A Conflict of Interest Policy and disclosing conflicts as they arise. The Conflict of interest Policy protects the organization’s interest.
- Holding regular board meetings. Nonprofits are required by law to hold at least one annual board meeting. Four annual board meetings have been recommended by nonprofit councils as a best practice.
- Monitoring Unrelated Business Activities and paying taxes as required. Nonprofits must pay taxes on income from unrelated activities exceeding $1,000.
- Filing IRS 990/990EZ/990N returns on time. Nonprofit IRS Information Returns are due on the 15th day of the 5th month following the end of your accounting period.
- Applying for State income tax exemption (if Applicable). Obtaining a 501(c)(3) Tax Determination exempts your organization from federal income taxes. The process for state tax exemptions vary depending on the state.
- Complying with State Charitable Registration requirements (if applicable). There are currently, 41 states plus Washington, DC that require charities to register with the state division of charities prior to soliciting the public for donations.
- Keeping good Records. As a rule, public charities must maintain books and records to show that it is in compliance with tax rules.
The Importance of Keeping Good Records
Record-keeping is essential for accountability and tracking nonprofits activities. Good records are also essential if your nonprofit must defend itself, a member, an officer, a director, staff, or volunteers against accusations of nonprofit impropriety.
In addition, accurate records will be needed in order to properly file IRS annual returns. As a tax-exempt public charity, you must be able to document sources of income and expenses reported on Form 990 or Form 990-EZ and Form 990-T. The IRS reviews sources of income to determine whether an organization should be classified as a public charity.
If your organization is not able to show that it qualifies for tax-exempt status, or that you should be classified as a public charity,
the organization can risk losing its tax-exemption or be classified as a private foundation, rather than a public charity.
In short, good record-keeping habits will help the organization in many areas, including:
- Preparing Annual Returns and Tax Returns.
- Avoiding unnecessary filing penalties and possible revocation of tax-exempt status.
- Evaluating Charitable Programs.
- Monitoring Budget & Prepare Financial Statements.
- Quickly identifying Sources of Receipts.
- Substantiating Revenues and Expenses for Unrelated Business Income Tax (UBIT) Purposes.
- Complying with Grant-Making Procedures.
Records management refers to a set of activities that involve the creation, receipt, maintenance, use and disposal of paper or digital records. Nonprofit tax-exempt organizations must be prepared to show evidence of its business activities and transactions throughout its life cycle, from the time of creation or inscription to its eventual disposition. This information may be requested of you from the IRS, funders, stakeholders, an other relevant officials.
Commonly managed records include:
- Gross Receipts – amounts of money received from all sources.
- Purchases – items bought (even if the item becomes inoperable or resold).
- Expenses – money spent on products or services to carry out the program.
- Employment Taxes – if the organization has employees, you must keep records of compensation and taxes paid.
- Assets and Liabilities – this includes property (in any form) owned by the organization, as well as obligations of the organization.
At a minimum, your records should indicate the amount received or paid, the payee’s name, and transaction date.
Other Best Practices
- Ensuring paid officers are not directors. This is recommended to prevent any possible conflicts of interest. If for any reason a paid officer MUST also be a director, that officer should recuse him or herself from any vote involving him or her.
- Obtain all licenses needed to perform your programs and services (i.e. business license or other licenses required for your activities).
- Maintain risk management policies, such as a policy outlining document destruction and retention.
- If required, maintain organization facilities that are ADA compliant.
- Maintain organization employee policies that cover all legally required elements.
- Ensure that your board of directors is aware of and maintains a regular schedule of internal compliance reviews.