Earned Income 101 for Nonprofits
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Earned Income 101 for Nonprofits

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Many nonprofits use earned income as a source of revenue generation. For example, it was estimated in 2008 that nearly 70% of the $1.4 trillion generated by nonprofits came from the sale of goods......

Many nonprofits use earned income as a source of revenue generation. For example, it was estimated in 2008 that nearly 70% of the $1.4 trillion generated by nonprofits came from the sale of goods and services. However, despite its long-standing, common use in the nonprofit sector, the area of earned income for nonprofits is often wrought with misconceptions and misunderstandings which can lead to untapped sources of revenue or unknowingly jeopardizing the organization’s exempt status. Especially in light of current economic challenges facing the nonprofit sector, nonprofits should become familiar with the basic principles related to earned income to best help their organizations more effectively further their missions

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  • 1. Earned Income 101 for Nonprofit Gene Takagi & Emily Chan January 18, 2012A Service Of: Sponsored by:
  • 2. INTEGRATED PLANNING Advising nonprofits in: www.synthesispartnership.com • Strategy • Planning (617) 969-1881 • Organizational Development info@synthesispartnership.comA Service Of: Sponsored by:
  • 3. Affordable collaborative data management in the cloud.A Service Of: Sponsored by:
  • 4. Today’s Speakers Gene Takagi Emily Chan Managing Attorney Associate Attorney NEO Law Group NEO Law GroupAssisting with chat questions: Hosting:April Hunt, Nonprofit Webinars Sam Frank, Synthesis PartnershipA Service Of: Sponsored by:
  • 5. Earned Income 101 forNonprofitsNonprofit WebinarsJanuary 18, 2012Presented by: Gene Takagi and Emily Chan Copyright © 2012 NEO Law Group. All rights reserved.
  • 6. Examples• Let’s start a new business!!!• Let’s buy an existing business!!• Let’s partner with a for-profit!• Let’s start charging for our services. Copyright © 2012 NEO Law Group. All rights reserved.
  • 7. What Have You Got?• Marketable value of ORG’s assets• ORG’s capacity to develop and operate the Venture • Money • Market • Management/Staff Copyright © 2012 NEO Law Group. All rights reserved.
  • 8. First Considerations• Mission-consistency• Board duties• Prudent investment Copyright © 2012 NEO Law Group. All rights reserved.
  • 9. Mission – 501(c)(3) – Charitable Trust• IRC § 501(c)(3) • Operational Test • No private inurement • No private benefit• Articles of incorporation – purpose restriction?• Bases for exempt status – incompatible activities? Copyright © 2012 NEO Law Group. All rights reserved.
  • 10. Board’s Duties Copyright © 2012 NEO Law Group. All rights reserved.
  • 11. Duty of Care • Ordinary prudent person standard • Reasonable inquiry (investigation) • Independent judgment • Issues: • Reliance • Delegation – Limit authority – Reporting Copyright © 2012 NEO Law Group. All rights reserved.
  • 12. Duty of Loyalty • In good faith • In the best interests of the corporation • Issues: • Conflict of interest • Corporate opportunity • Confidentiality Copyright © 2012 NEO Law Group. All rights reserved.
  • 13. Prudent Investment Portfolio Theory Copyright © 2012 NEO Law Group. All rights reserved.
  • 14. Fiduciary Duties and Investments • Lessons from Madoff • Use care • Understand what you invest in • Diversify across asset classes (portfolio theory) • Rely on appropriate advisors with due care • Consider strict conflict of interest provisions • Jeopardizing investment rules for Private Foundations Copyright © 2012 NEO Law Group. All rights reserved.
  • 15. Next Considerations• Employees• Licenses, Permits• Leases• Insurance• Trademarks Copyright © 2012 NEO Law Group. All rights reserved.
  • 16. Tax ConsiderationsTax-exemption relates to income taxBusiness activities okayBUT: Is all business income nontaxable? No. Copyright © 2012 NEO Law Group. All rights reserved.
  • 17. IRS – Tax Perspective Related Unrelated • Generally exempt • May be subject to income corporate taxes Copyright © 2012 NEO Law Group. All rights reserved.
  • 18. Related BusinessAdvances the organization’s charitable purposes irrespective of profits. Copyright © 2012 NEO Law Group. All rights reserved.
  • 19. Unrelated Business 1. A trade or business; 2. Regularly carried on; and 3. Not substantially related to furthering the exempt purpose of the organization. Copyright © 2012 NEO Law Group. All rights reserved.
  • 20. UBIT: Trade or Business• Any activity carried on for the production of income from selling goods or performing services.• Even if carried on within a larger framework of other activities that may, or may not, be related to the organizations exempt purposes. Copyright © 2012 NEO Law Group. All rights reserved.
  • 21. UBIT: Regularly Carried On• Activities that show a frequency and continuity, and are pursued in a manner similar to, comparable commercial activities of nonexempt organizations. Copyright © 2012 NEO Law Group. All rights reserved.
  • 22. UBIT: Not Substantially Related• Substantially related when the conduct of the business activities has a substantial causal relationship to achieving exempt purposes (other than through the production of income).• The activities that generate the income must contribute importantly to accomplishing the organizations exempt purposes to be substantially related. Copyright © 2012 NEO Law Group. All rights reserved.
  • 23. Substantially related?IRS considers factors such as: • Nature and size of business • Fees • Who is served • Business operationsFor each activity! Copyright © 2012 NEO Law Group. All rights reserved.
  • 24. “Charitable”• Relief of the poor, distressed or underprivileged (low income, minority, elderly, disabled, other 501(c)(3) organizations, or similarly situated persons)• Promotion of social welfare by lessening neighborhood tensions, eliminating prejudice and discrimination, defending human and civil rights, and combating community deterioration and juvenile delinquency• Lessening the burdens of government• Promotion of health• Advancement of education Copyright © 2012 NEO Law Group. All rights reserved.
  • 25. Earned Income Examples• One-time: Woodland Park Zoo Doo• Business activity: Girl Scouts• Social Enterprise: Goodwill Industries Copyright © 2012 NEO Law Group. All rights reserved.
  • 26. Exclusions & ModificationsIncluding: • Volunteer workforce • Convenience of members • Selling donated merchandise • Passive income* * debt-financed property exception not addressed here Copyright © 2012 NEO Law Group. All rights reserved.
  • 27. Application of the Rule Unrelated Business? Exclusion? Modification? (facts & circumstances) Copyright © 2012 NEO Law Group. All rights reserved.
  • 28. Example: Museum Cafe Café Open to Public Rooftop Coffee Bar - Street entrance - Accessible through museum - Open to the public - Must have museum admission ticket - UBIT? - UBIT? Copyright © 2012 NEO Law Group. All rights reserved.
  • 29. Fragmentation Rules Examples• Dual-use facility• Sale of various merchandise Copyright © 2012 NEO Law Group. All rights reserved.
  • 30. Example: Museum Theater Auditorium • Museum has a program of public education in arts and sciences • Theater designed for showing educational films • Operation while museum is open to the public – UBIT? • Operation as a motion picture theater for public when museum is closed – UBIT? Copyright © 2012 NEO Law Group. All rights reserved.
  • 31. Example: Museum Gift Shop Copyright © 2012 NEO Law Group. All rights reserved.
  • 32. Unrelated Business Activities & Commerciality • Unrelated business income tax? • Jeopardize 501(c)(3) status? Copyright © 2012 NEO Law Group. All rights reserved.
  • 33. Substantiality Test• How much unrelated business activity is too much?• Factors: • Relationship of the business activity to the overall activities of ORG in terms of time, effort and dollar income • Relationship between business activity and the exempt function of ORG (commensurate test) • Reason that ORG conducts the particular business activity • Methods of operation and the control exercised by the board over the business operations Copyright © 2012 NEO Law Group. All rights reserved.
  • 34. Business Considerations/Risks• Loss of money• Overburdened staff• Mission creep• Private benefit (actual or perceived)• Adverse PR/marketing• Culture compatibility Copyright © 2012 NEO Law Group. All rights reserved.
  • 35. Legal Form Considerations• In-house• Subsidiary• Other social enterprises Copyright © 2012 NEO Law Group. All rights reserved.
  • 36. In-house• IRC § 501(c)(3) Rules• Articles of incorporation – restriction?• Basis for exempt status – incompatible?• Capacity? Copyright © 2012 NEO Law Group. All rights reserved.
  • 37. SubsidiariesTax-exempt or taxable subsidiaryConsiderations • Business • Legal • Tax Copyright © 2012 NEO Law Group. All rights reserved.
  • 38. Subsidiaries Nonprofit For-profit c3 c3 Affiliation Ownership c3 FPBusiness w/ different risk profile Investment laws Copyright © 2012 NEO Law Group. All rights reserved.
  • 39. Taxable SubsidiariesNonprofit subsidiary • ORG is sole memberFor-profit subsidiary • ORG is sole shareholderThe key is separateness Copyright © 2012 NEO Law Group. All rights reserved.
  • 40. Separateness• Boards, directors, officers• Meetings• Books, accounts• Filings• Stationary, marketing materials• Phone numbers• Parent does not participate in day-to-day management of Sub• Helpful facts: • Majority of Sub’s Board independent of Parent • CEO of Sub is neither an Officer nor Director of Parent Copyright © 2012 NEO Law Group. All rights reserved.
  • 41. Considerations regarding a Subsidiary• If unrelated business, and substantial activity: • Form subsidiary• Liability • Subsidiary may provide limited liability protection, but there are limitations: • ORG guarantees Sub’s obligations • Veil piercing (failure to observe formalities, inadequate capitalization)• Financing Copyright © 2012 NEO Law Group. All rights reserved.
  • 42. Taxation• Dividend from a taxable subsidiary - Not taxable income to ORG• Payment of interest, annuity, royalty or rent from a subsidiary (controlled entity) - ORG may exclude such payments if they do not exceed FMV (excess is subject to UBIT plus 20% penalty) Copyright © 2012 NEO Law Group. All rights reserved.
  • 43. Collaborations with For-Profits• Contractual Relationships / Sponsorships• Joint Ventures Copyright © 2012 NEO Law Group. All rights reserved.
  • 44. Sponsorships• Sponsorship payments to ORG not UBTI if sponsor does not receive any substantial return benefit (Qualified Sponsorship Payment or QSP) • The use or acknowledgment of sponsor • Insubstantial benefits - FMV does not exceed 2% of sponsorship payment Copyright © 2012 NEO Law Group. All rights reserved.
  • 45. Use or Acknowledgement of Sponsor• Grant of exclusive sponsorship in an activity to a for- profit• Use of logos and slogans that do not contain qualitative or comparative descriptions of sponsor’s products, services, facilities or company• Use of a list of sponsor’s locations, telephone numbers or internet addresses• Use of value-neutral descriptions, including displays or visual depictions of sponsor’s product line or services• Use of sponsor’s brand or trade names and product or service listing Copyright © 2012 NEO Law Group. All rights reserved.
  • 46. Qualified Sponsorship Payment – Yes or No?• “Ride for Life” sponsored by ABC Company• “Buy ABC Widgets”• “ABC Company – for the finest widgets” Copyright © 2012 NEO Law Group. All rights reserved.
  • 47. Nonprofit – For-profit Joint Ventures• NP Hospitals + Physicians - Ambulatory surgical center• Developer + Nonprofit - Low-income housing• University + Health System - Distance learning Copyright © 2012 NEO Law Group. All rights reserved.
  • 48. Joint Ventures – Motivating Factors(Nonprofit) • Additional opportunities to further its charitable purposes • Greater access to capital and expertise • Possibility of capital appreciation • Flexibility in operation • Protection from liability Copyright © 2012 NEO Law Group. All rights reserved.
  • 49. Joint Ventures – Motivating Factors(For-profit) • Enhanced good will • Increased marketing opportunities • Access to expertise and political capital • Availability of financial opportunities - Low-Income Housing Tax Credits Copyright © 2012 NEO Law Group. All rights reserved.
  • 50. Two-Prong Test1. Whether participation in JV furthers a charitable purpose2. Whether JV permits the nonprofit to act exclusively in furtherance of its exempt purpose and only incidentally for the benefit of its limited partners Copyright © 2012 NEO Law Group. All rights reserved.
  • 51. Vehicles for JVs: Social Enterprise Entities• Certified “B” Corporation• L3C• Benefit corporation• Flexible purpose corporation• Nonprofit – for-profit joint ventures Copyright © 2012 NEO Law Group. All rights reserved.
  • 52. DisclaimerThe information contained in this presentation has been prepared by NEO LawGroup and is not intended to constitute legal advice. NEO Law Group has usedreasonable efforts in collecting, preparing, and providing this information, butdoes not guarantee its accuracy, completeness, adequacy, or currency. Thepublication and distribution of this presentation are not intended to create, andreceipt does not constitute, an attorney-client relationship. 201 Spear St., Suite 1100 San Francisco, CA 94105 415.977.0558 www.NEOLawGroup.com www.NonprofitLawBlog.com gene@neolawgroup.com twitter.com/gtak emily@neolawgroup.com twitter.com/emilychan Copyright © 2012 NEO Law Group. All rights reserved.
  • 53. Find listings for our current season of webinars and register at: NonprofitWebinars.comA Service Of: Sponsored by: