The first part of the UBI test is to determine if your activity is a trade or business. If your organization is selling goods or services to generate income, even if it is conducting the activity within a larger group of activities related to its exempt purpose, the activity is a trade or business. So, while your 501(c)(3) is carrying on its daily exempt function, it could also be carrying on activities that are taxable. Example: A tax-exempt organization solicits, sells, and publishes advertisements for commercial vendors in its publication. Even though the publication contains content related to the organization’s exempt purpose, the publishing of advertising is still an unrelated trade or business. Part 2: Is your activity regularly carried on? If you’ve determined that your activity is a trade or business, the next part of the UBI test is to decide if the activity is “regularly carried on.” In most cases, if the activity shows frequency and continuity and is conducted the same way that a non-exempt organization would run a similar business, it is regularly carried on. Example: A hospital auxiliary operates a health food stand for one week at a preventative health education conference. Because the activity is a one-time occurrence and is unlikely to compete with for-profit health food stores that operate year-round, the activity is not “regularly carried on.” However, if the hospital auxiliary operates a health-food stand daily at the hospital, that is likely the regular conduct of a trade or business.
These provisions are from the Model Non Profit Act.
In order to ensure that the foregoing responsibilities are fulfilled, directors and officers have a fiduciary duty of care to the non-profit. There has been recent debate over whether non-profits’ directors and officers should be held to the standard of care applied to directors and officers of for-profit corporations, or whether the more stringent standard applied to “trustees” is appropriate. 16 The trend in the law, however, has been to apply the corporate standard to non-profits’ directors and officers, which requires that a director or officer act with the care that a reasonably prudent person in a similar position would exercise under the same circumstances. 17 Specifically, the Model Non-Profit Act defines the director’s duty of care as follows:
May include rules mandated by accreditation agencies, or required by the organization’s articles of incorporation and bylaws.
Directors and officers, however, are permitted to rely upon information and reports provided by: (1) officers or employees of the non-profit “whom the director reasonably believes to be reliable and competent in the matters presented”; (2) professionals and other persons retained by the organization “as to matters the director reasonably believes are within the person’s professional or expert competence”; and (3) a committee of the board “as to matters within its jurisdiction, if the director reasonably believes the committee merits confidence.” 20 A director, however, is not acting “in good faith” if he or she relies upon information where the director’s own personal knowledge renders such reliance unwarranted. 21 Further, in delegating the responsibilities of the organization’s management to others, the directors must implement appropriate policies and procedures that provide for the oversight of personnel.
A conflict of interest arises when a director or officer has a direct or indirect personal interest in a transaction involving the organization. Conflicts of interest are not, however, per se prohibited. Indeed, many individuals are recruited to serve on the boards of non-profits because of their professional or business affiliations and activities. There may be situations in which, as a result of a director’s or officer’s connection or affiliation with other persons or entities, the non-profit is able to engage in a transaction on terms more favorable than it could have obtained on its own. Liability, therefore, is not imposed on a director or officer for the mere approval of a transaction in which he or she may have a conflict of interest. Instead, the focus is on the process by which the transaction was reviewed and approved by the board. Under the Model Non-Profit Act, and the laws of many states, the existence of a conflict of interest will not be deemed a breach of fiduciary duty if the transaction was approved under certain conditions. First, the director with the conflict should disclose the material facts regarding the conflict to the other board members and refrain from participating in the deliberations and vote on the matter. Second, it must be shown that the disinterested directors approved the transaction in good faith and reasonably believed it was fair to the organization. In some cases, the directors may insulate themselves from liability by obtaining the approval of the state attorney general or a court either before or after consummation of the transaction. 25 Some transactions, however, may be prohibited entirely by state non-profit laws. For example, the Model Non-Profit Act bars a non-profit corporation from lending money to or guaranteeing the obligation of a director or officer of the corporation. The corporate opportunity doctrine involves any situation where a director or officer is presented with a business opportunity, whether or not she learned of it through her position with the organization, which she reasonably should know may be of interest to the non-profit’s present or future activities. In such circumstances, most states require that the director or officer disclose the transaction to the board so that its disinterested members may determine whether the organization should act or decline to act with respect to the opportunity. Only after the board has declined the opportunity on the record should the director or officer take advantage of the opportunity. Directors and officers are under a duty to treat as confidential the organization’s internal activities, unless there has been general public disclosure or the information is a matter of public record or public knowledge.
Disclosure If there is any kind of potential financial benefit to a DQ, the insider involved should disclose to the Board the nature of the interest as well as any other relevant facts about the transaction that the board should know in making its decision. Management must make sure that parties to transactions, and board members, disclose all such connections so that a conflicting interest that may give rise to &quot;excess benefit&quot; is detected ahead of time. Regular disclosure requests are a must. 2. Recusal. The insider with a conflict of interest should not be present during the deliberations or the vote. Think of this as the &quot;leave the room&quot; requirement. (Answering questions is permitted.) This also applies to any vote regarding whether there is, or is not, a conflict of interest in the first place. The decision-makers must be composed entirely of (not just controlled by) individuals who do not have a conflict of interest. 3. The Board should be sure to obtain enough documented data as to comparability, including competitive bids or some other thorough price comparison, before it decides to contract with the interested party. Whenever possible, at least three bids should be required (this is the safe harbor for organizations with gross receipts of less than $1 million annually). The IRS is especially skeptical about arrangements that have revenue-sharing, percentage-type compensation. &quot;Reasonableness&quot; isn't determined until the compensation becomes fixed. When entering into a deal with a flexible compensation arrangement, include a cap that the IRS can find reasonable. 4. The transaction must be approved in advance NOT RETROACTIVELY by an &quot;authorized&quot; body, usually the full board or a committee with authority to act. By implication, this means that the Board must be more cautious about delegating decisions on transactions to officers, although &quot;committee&quot; may include a committee of one. The approval should include a finding that the transaction is fair to the organization and if the transaction involves accepting a higher bid from a DQ than offered by an unrelated party, should explain the reasons for the decision. 5. The 10% penalty that can be imposed on management for &quot;knowing&quot; participation in an excess benefit transaction can be defended in part if &quot;after full disclosure of the factual situation to an appropriate professional, the organization manager relies on a reasoned written opinion of that professional with respect to elements of the transaction within the professional's expertise.&quot; Note, however, that a professional opinion is no defense on the question of whether or not the transaction actually is an excess benefit transaction, only a defense against the 10% penalty on management. The minutes should document all of the preceding, and should be circulated no later than the next meeting (or within sixty days, if later), and approved &quot;within a reasonable time,&quot; presumably by the following meeting. Board members concerned about their own liability should be particularly anxious to go on record as having voted against the transaction.
Nonprofits that do not comply with federal, state and local laws may be subject to government enforcement actions .
1. Corporate Governance Issues for Nonprofit Organizations
2. Tax Exempt Status <ul><li>Nonprofit is a tax status; not a business plan. </li></ul><ul><ul><li>Operating any organization at a deficit or without a sufficient "rainy day" fund is not good business. In order to maintain the viability of any organization, it is important to operate with some "net revenue" at the end of a year. What distinguishes nonprofits is not whether they can make a profit, but what happens to profits. Nonprofits are prohibited from distributing profits in the same way for-profit corporations can. All revenue must be earmarked for the organization's mission. </li></ul></ul>
3. Who Regulates Nonprofits? <ul><li>Boards- All nonprofits are governed by a board of directors or trustees (there's no real difference), a group of volunteers that is legally responsible for making sure the organization remains true to its mission, safeguards its assets, and operates in the public interest. </li></ul><ul><li>Private Watchdog Groups - Several private groups (who are themselves nonprofits) monitor the behavior and performance of other nonprofits. </li></ul><ul><li>State Charity Regulators - The attorney general's office maintains a list of registered nonprofits and investigates complaints of fraud and abuse. </li></ul>
4. Who Regulates Nonprofits? <ul><li>Internal Revenue Service - A division of the IRS (the Tax Exempt/Government Entities division) is charged with ensuring that nonprofits are complying with the requirements for eligibility for tax-exempt status. As a result of the thousands of audit investigations, a handful have their tax-exempt status revoked; others pay fines and taxes. </li></ul><ul><li>Donors & Members - Some of the most powerful safeguards of nonprofit integrity are individual donors and members. By withholding their financial support, donors can strongly encourage nonprofits to reappraise their operations. </li></ul><ul><li>Media - Many nonprofit leaders may feel misunderstood or even maligned by negative media coverage, however, this media watchdog role has resulted in increased awareness and accountability throughout the sector. </li></ul>
5. 501(c)(3) <ul><li>Most significant group of organizations exempt from federal income taxation. </li></ul><ul><li>Contributions to a 501(c)(3) is generally tax deductible. </li></ul><ul><li>Also generally exempt from state income and sales taxes, property taxes and franchise and use taxes. </li></ul>
6. Purposes <ul><li>Must be operated exclusively for one or more of the following purposes: </li></ul><ul><ul><li>Religious </li></ul></ul><ul><ul><li>Charitable </li></ul></ul><ul><ul><li>Scientific </li></ul></ul><ul><ul><li>Testing for public safety </li></ul></ul><ul><ul><li>Literary </li></ul></ul><ul><ul><li>Educational </li></ul></ul><ul><ul><li>Fostering amateur sports </li></ul></ul><ul><ul><li>The prevention of cruelty to children or animals </li></ul></ul>
7. Restrictions <ul><li>The net earnings may not inure to the benefit of any private shareholder or individual; </li></ul><ul><li>Carrying on propaganda, influencing legislation and participating in political campaigns are strictly prohibited. </li></ul>
8. Public Charities/Private Foundations <ul><li>More stringent tax rules and operating restrictions for private foundations. </li></ul><ul><li>Public charities are those with a broad base of public support. </li></ul>
9. Tax Exempt Does Not Mean Tax Free <ul><li>Tax-exempt status means that an organization does not pay corporate federal income tax on income from activities that are substantially related to the purposes for which the organization was given exempt status. The organization does pay that tax on other types of income called “unrelated business income.” </li></ul>
10. Unrelated Business Income <ul><li>Only income from commercial activities “substantially related” to the organization’s purpose and which “contribute importantly” to the organization’s purpose is tax exempt. </li></ul>
11. UBI – Three Part Test <ul><li>The first part of the UBI test is to determine if your activity is a trade or business. </li></ul><ul><li>If you’ve determined that your activity is a trade or business, the next part of the UBI test is to decide if the activity is “regularly carried on.” </li></ul><ul><li>The last part of the UBI test is to decide whether the activity is substantially related to furthering your 501(c)(3)’s exempt purpose. </li></ul>
12. UBI Exemptions <ul><li>Volunteer workforce </li></ul><ul><li>Convenience of members </li></ul><ul><li>Sale of donated merchandise </li></ul><ul><li>Distribution of low-cost articles </li></ul><ul><li>Convention or trade show activity </li></ul><ul><li>Sponsorship </li></ul><ul><li>Traditional bingo </li></ul>
13. UBI- Exclusions <ul><li>Interests and dividends </li></ul><ul><li>Rents from real property </li></ul><ul><li>Royalty income </li></ul><ul><li>Gains or losses from the sale of property </li></ul>
14. Fundraising Compliance <ul><li>The Division of Charitable Solicitations and Gaming administers the Tennessee Charitable Solicitations Act and the Charitable Gaming Implementation Law , and regulates accounts established pursuant to the Catastrophic Illness Trust Act . </li></ul>
15. Charitable Solicitations Act <ul><li>Requires that charitable organizations that solicit contributions register with the division. </li></ul><ul><li>Exemptions: </li></ul><ul><ul><li>bona fide religious institutions; </li></ul></ul><ul><ul><li>educational institutions and supporting organizations (PTAs) </li></ul></ul><ul><ul><li>volunteer fire departments, rescue squads and local civil defense organizations; </li></ul></ul><ul><ul><li>political parties, candidates, and PACs; hospitals; and </li></ul></ul><ul><ul><li>organizations receiving less than $30,000 per annum (must file an “Exemption Request”) </li></ul></ul>
16. Charitable Solicitations Act <ul><li>Prohibits false and misleading solicitation practices, and empowers the division to investigate violations of the Act, and impose a civil penalty of up to $5,000 for each and any violation of the Act. </li></ul><ul><li>Prohibits false and misleading solicitation practices, and empowers the division to investigate violations of the Act, and impose a civil penalty of up to $5,000 for each and any violation of the Act. </li></ul>
17. The Charitable Gaming Implementation Law <ul><li>Raffles </li></ul><ul><li>Lotteries </li></ul><ul><li>Sweepstakes </li></ul><ul><li>Duck Races </li></ul><ul><li>Cakewalks </li></ul>
18. The Charitable Gaming Implementation Law <ul><li>Authorizes qualified 501(c)(3)’s to hold an annual gaming event for the benefit of the organization; </li></ul><ul><li>The division reviews applications and sends the list of qualifying applicants to the general assembly for approval; </li></ul><ul><li>Organizations must submit financial reports following the event for review; </li></ul><ul><li>the division may investigate violations of the Act and assess a civil penalty of up to $50,000 for each and any violation. </li></ul>
19. Other Fundraising Methods <ul><li>Prize </li></ul><ul><li>Chance </li></ul><ul><li>Consideration </li></ul>
20. Corporate Governance
21. Recordkeeping <ul><li>Charter </li></ul><ul><li>Bylaws </li></ul><ul><li>Minutes of Board meetings </li></ul><ul><li>Minutes of Members meetings </li></ul><ul><li>Membership lists and communications </li></ul><ul><li>Accounting and financial records </li></ul><ul><li>Compliance with Form 1023 application and IRS Determination Letter. </li></ul>
23. Duties of Directors, Officers and Managers <ul><ul><li>A director shall discharge his or her duties as a director, including his or her duties as a member of a committee: </li></ul></ul><ul><ul><li>(1) in good faith; </li></ul></ul><ul><ul><li>(2) with the care an ordinarily prudent person in a like position would exercise under similar circumstances; and </li></ul></ul><ul><ul><li>(3) in a manner the director reasonably believes to be in the best interests of the corporation. </li></ul></ul>
24. The Duty of Care <ul><li>The responsibilities of nonprofit boards include: </li></ul><ul><ul><li>Setting policies and ensuring that policies are carried out; </li></ul></ul><ul><ul><li>Overseeing management, especially the CEO; </li></ul></ul><ul><ul><li>Monitoring finances, including approving and monitoring the budget; </li></ul></ul><ul><ul><li>Establishing and promoting the mission of the nonprofit; </li></ul></ul>
25. The Duty of Care (cont’d) <ul><li>Raising the funds necessary for the nonprofit to fulfill its mission; </li></ul><ul><li>Ensuring compliance laws, rules and regulations; and </li></ul><ul><li>Ensuring that the board functions effectively. </li></ul>
26. Fulfilling the Duty of Care <ul><li>Directors are expected to attend board and committee meetings. </li></ul><ul><li>Directors are expected to be prepared and to participate in board and committee meetings. </li></ul><ul><li>Generally, a director may not vote by proxy at meetings. </li></ul><ul><li>Directors and officers are expected to exercise independent judgment. </li></ul><ul><li>Directors and officers must not willfully ignore problems. </li></ul>
27. The Business Judgment Rule <ul><li>If directors and officers act in good faith, and in a prudent, diligent and informed manner, they will be protected from liability under the “business judgment rule” for any decisions or actions that may later prove to be a mistake. </li></ul>
28. The Duty of Loyalty <ul><li>Directors and officers are not allowed to further their own interests at the expense of the nonprofit. </li></ul><ul><li>Directors and officers are expected to act in a manner consistent with the best interests of the nonprofit as a whole, rather than representing a particular constituency. </li></ul>
29. Duty of Loyalty – the 3 “C’s” <ul><li>C onflicts of interest between directors and officers and the interests of the nonprofit </li></ul><ul><li>C orporate opportunities that become available to the nonprofit; and </li></ul><ul><li>C onfidentiality of non-public information. </li></ul>
30. Protect Yourself <ul><li>DISCLOSURE </li></ul><ul><li>RECUSAL </li></ul><ul><li>DOCUMENTATION </li></ul><ul><li>ADVANCE APPROVAL </li></ul><ul><li>SEEK PROFESSIONAL HELP </li></ul><ul><li>KEEP GOOD MINUTES. </li></ul>
31. The Duty of Obedience <ul><li>Obedience to the nonprofit’s mission , and </li></ul><ul><li>Obedience to all applicable laws . </li></ul>
32. Conflict of Interest Related to Employment Contracts <ul><li>A committee of the board of directors should conduct research to determine comparable salaries for executives, who make over $100,000 in similar positions. This should be well documented. </li></ul><ul><li>There should be competitive bids related to independent contractors who are paid over $100,000. </li></ul>
33. Conflict of Interest Related to Loans to Directors and Executives <ul><li>Do not make loans to officers or directors. </li></ul><ul><li>Existing loans may be “grandfathered”, but should be paid off as soon as possible. </li></ul><ul><li>The following are not considered loans: </li></ul><ul><ul><li>Travel advances in performances of executive responsibilities </li></ul></ul><ul><ul><li>Relocation payments subject to reimbursement. </li></ul></ul>
34. Contact Information <ul><li>Mary Neil Price – Miller & Martin PLLC </li></ul><ul><ul><li>[email_address] </li></ul></ul><ul><ul><li>(615) 744-8480 </li></ul></ul>