The document provides guidance on forming a non-profit social venture, emphasizing the rules for obtaining tax-exempt status and the legal requirements involved. Key points include the importance of adhering to exempt purposes, avoiding political activities, and maintaining a structure that prevents private benefit. Additionally, it outlines options for collaboration with for-profits and other non-profits, emphasizing careful legal and financial planning.

1. HOW TO FORM YOUR NON-PROFIT SOCIAL VENTURE
Presented by Wayne Lippman
Walnut Creek, CA

2. Today’s Presentation
I. Rules of the Game for Tax Exempt Non-
Profits
II. Getting Into the Game: How to Obtain Tax
Exempt Status
III. Playing Well with Others: Collaborating with
Other Non-Profits and For-Profits

3. Reminder
This workshop is intended to provide you with
general legal information, but it does not
substitute for legal advice from an attorney!

4. HOW TO FORM YOUR NON-PROFIT SOCIAL VENTURE
I. Rules of the Game
for Tax-Exempt Non-Profit

5. ❖ To get the benefit of tax exempt status, you have to apply to the IRS (?)
❖ For organizations that have tax exempt status:
❖ Can’t make a profit (?)
❖ Can’t engage in political activity (?)
❖ Never have to pay taxes (?)
❖ Always possible for donors to get tax deductions (?)
❖ Have to pay small salaries (?)
Myths about Tax Exempt Non-Profits

6. Sum: Why Apply for Tax Exempt Status
for Your Organization?
– investment income, except:
• income from activities
unrelated to tax exempt
purposes
• investment income from assets
acquired with debt
– Tax Deductions for Charitable
Contributions
– Can utilize volunteers
– Exemption from other Taxes:
• Federal Unemployment Tax
• State Property/Franchise Taxes
• Activities must be limited to 501c3
exempt purposes
• No substantial Lobbying
• No political activity on behalf/in
opposition to any candidate
• Upon dissolution, assets must be
donated to another 501c3
• Cannot unduly benefit private
individuals
• Greater scrutiny by IRS and State
Attorney General’s Office
• Limited Resources (typically)
Advantages Disadvantages

7. What’s Different about Being Tax Exempt?
A non-profit is essentially a trust – A custodian of
assets that have been dedicated to the public good.
Guiding Principles (4)
1) Organized and
operated exclusively for
exempt purposes
2) No private benefit
(e.g., no profit sharing)
3) Assets are permanently
dedicated to exempt
purposes
4) No advocacy
for/against a candidate
or legislation

8. 1) Organized and Operated for
Exempt Purposes
❖ IRS will only grant tax exempt status to organizations that are
both organized and operated exclusively for one or more
charitable, educational or other exempt purposes
>> see IRS Code, 26 USC section 501(c)(3)
❖ Organization’s bylaws, articles of incorporation, and Board of Directors
Meetings
• A Non-Profit Organization risks losing its tax exemption if it
engages in activities unrelated to its exempt purpose
-- Unless the activities are insubstantial in amount

9. Exempt Purposes – 26 USC 501(c)(3)
Includes:
❖ Relief of the poor and distressed or the underprivileged;
❖ Advancement of religion;
❖ Advancement of education, arts, culture or science;
❖ Promotion of amateur sports competition;
❖ Prevention of cruelty to children or animals;
❖ Promotion of social welfare by organizations designed to accomplish any of the above
purposes, or
❖ (i) to lessen neighborhood tensions;
❖ (ii) to eliminate prejudice and discrimination;
❖ (iii) to defend human and civil rights secured by law; or
❖ (iv) to combat community deterioration and juvenile delinquency.
See 26 CFR sec 1.501(c)(3)-1(d)(iv)(2)

10. Is the Activity Related or Substantial?
What is unrelated ?
 Activity that is not exempt (not 501(c)(3) purpose)
 Activity that does not further the exempt purposes
stated in the non-profit’s articles of incorporation or
its tax exempt application
What is insubstantial?
 No set test
 IRS Rulings: figure <15% of organization resources

11. What if the Activity is Unrelated ?
❖ Again, the organization may engage in the activity, without
jeopardizing its tax exemption, as long as the activity is not
more than an insubstantial part of the organization’s overall
activities
❖ The organization may have to pay unrelated business
income tax (UBIT) on profits from the activities
❖ The organization may want to consider establishing a
subsidiary corporation for the unrelated activities (see later)

12. 2) No Private Benefit
>> Basic Rules
❖ No profit sharing
❖ No special perks for Board Members or Staff
❖ Private benefit can only be INCIDENTAL to accomplishing the exempt purpose -- e.g., non profit
hospitals, Oregon Public House
>> Can Tax Exempt Orgs Do Commercial Activities?
❖ Primary purpose needs to be exempt
❖ IRS Inquiry:
❖ Does it operate like and compete with commercial businesses ?
❖ Does it have a “donative element” ?
❖ Fees/prices charged -- Below cost for members of “charitable class”?
❖ Is it a reasonable scale ? -- no larger than necessary for charitable purpose

13. 3) Assets are Permanently
Dedicated to Exempt Purposes
❖ Who owns the non-profit?
❖ Sales of assets or services = at fair market value
❖ unless providing to a charitable class, e.g., low-
income folks
❖ If close down, have to donate to another tax
exempt organization
❖ Need to get approval from Attorney General

14. 4) No Advocacy for/against a
Candidate or Legislation
❖ Any level of political activity will increase likelihood of 1023 rejection or IRS audit
❖ Section 501(c)(3) organizations are prohibited from directly or indirectly participating
in, or intervening in, any political campaign on behalf of (or in opposition to) any
candidate running for public office. The prohibition applies to all campaigns (federal,
state and local level)
❖ Examples
❖ inviting a political candidate to make a campaign speech at an event hosted by the
organization
❖ using the organization's funds to publish materials that support (or oppose) a candidate
❖ donating money from the organization to a political candidate
❖ any statements by the organization's executive director, in his or her official capacity, that
support a candidate
❖ Lobbying is separate from political activity
❖ Not-mention to limit free speech
❖ Section 501(c)(3) organizations may engage in some activities to promote voter
registration, encourage voter participation, and provide voter education

15. HOW TO FORM YOUR NON-PROFIT SOCIAL VENTURE
II. Getting Into the Game:
How to Obtain Tax Exempt
Status

16. Options for Obtaining Tax-Exempt Status
1 - Set up a Fiscal Sponsorship Arrangement with
an Existing Tax Exempt Non-Profit
2 - Form a Non-Profit Corporation and Apply to the
IRS for Recognition

17. Option 1: Fiscal Sponsorship
❖ Many non-profit organizations are not themselves tax exempt:
instead, they affiliate with an existing tax-exempt organization
❖ The non-profit organization doesn’t have to be incorporated
❖ The non-profit DOES have to further the sponsor’s exempt purposes
❖ Requires a written fiscal sponsorship agreement
❖ Fees normally based on revenues
How it works:
1. Non-exempt non-profit
arranges a grant or
donation
2. Grantor Donor pays the
$$ to the Sponsor on non-
exempt’s behalf
3. If giving the $$ to the non-
exempt would further the
Sponsor’s purposes, then the
Sponsor grants the $$ to the
non-exempt organization.
4. Sponsor has discretion
NOT to grant the $$ (can’t
just be a conduit)
5. Sponsor reports the $$
on its tax return (non-
exempt doesn’t file a
return).
6. Sponsor may provide
other supportive services
to non-exempt (e.g.,
accounting)

18. Option 2: Forming a Tax Exempt
Non-Profit Organization in CA
1. Form the Legal Entity – Usually a Corporation
- File Articles of Incorporation with Sec. of State -$30
- Must contain “magic” language for 501(c)(3) exemption
- see: http://www.sos.ca.gov/business/corp/pdf/articles/arts-pb.pdf
- Convene the first meeting of the Board
- Board approves Bylaws to govern the Corporation
- Additional filings: Secretary of State, Attorney General
Charities Bureau, State tax exemption form
2. Apply for Federal Tax Exempt Status…

19. Guidelines for Non-Profit Articles
Government Required:
❖ Name
❖ Boilerplate language
❖ Specific description of Purposes
❖ Contact for service of process
❖ IRS Boilerplate
❖ “No activities not permitted”
❖ “No private inurement”
❖ “No campaigning”
❖ Dissolution language
❖ Signed by Incorporator
Other Provisions:
 Limitation on Damages
 Decision regarding membership
 Limiting Corporate Existence
 Creating Special Board
Quorum/Voting Requirements
Optimal/Optional:
 Initial Directors
 Indemnification Language

20. IRS Application and Process
❖For Finding Forms and Doing Research:
IRS website: www.irs.gov
Publication 557
Form 1023 and Form 1023 EZ Instructions
❖Timing:
If filed Within 27 months of incorporation:
- Tax Exempt Status will go back to date of
incorporation
If filed Late
- Tax Exempt Status starts as of Application Filing
Date
❖Fees:
$850 usually, 400 if low-income Organization

21. IRS Forms: 1023 or 1023 EZ
❖Any organization may use IRS Form 1023 to apply for exemption from
federal income tax under section 501(c)(3)
❖Some organizations can use a streamlined version, IRS Form 1023
EZ
- Eligibility to use 1023 EZ depends on certain criteria:
❖The organization projects that annual gross receipts over the next three
years will not exceed $50,000
❖Annual gross receipts have not exceeded $50,000 in any of the past three
years
❖Total assets of the organization do not exceed $250,000
❖The organization is not formed under the laws of a foreign country
❖The organization is not organized as an LLC
❖The organization is not a successor of a for-profit entity
❖… and other critieria found in the Form 1023 EZ-Eligibility Worksheet

22. IRS Form 1023 EZ
Components
❖ Identification information
❖ Check the box regarding:
❖ Organizational Structure
❖ Corporation, Unincorporated Association, Trust
❖ Date of formation
❖ Organizing Document with “magic” language
❖ Specific activities
❖ Charity v. Foundation
❖ Attachments:
❖ Organizing Document

23. The Full Application: IRS Form 1023
Components
❖ Identifying information
❖ Narrative Description of Purposes and Activities
❖ Description and Assurances (Checkboxes & Extra Info. Needed)
❖ Financials
❖ Attachments for certain programs: churches, child care, grant
providers
❖ Appendices – Attach Organization’s Articles and Bylaws

24. When Applying, Good to Know the IRS’
Preferences & “Sensitive” Areas
❖ 26 USC 501c3: The CATEGORIES of Exempt
Activities
❖ Regulations: 26 CFR.. (Says More about the
Categories)
❖ Publication 557 (Categories, and IRS Expectations for
Exempt Organizations)
> Do EXTRA research with any of the “Sensitive” Areas;
possibly wise to have an attorney draft the application

25. IRS “Sensitive Areas”:
Need to Research & Describe
Activities CAREFULLY
❖ Private Benefit
❖ E.g., Economic Development
❖ Leadership Conflicts of Interest
❖ Self Dealing
❖ 3rd Party Influence on Decisionmaking
❖ Commercial Activity
❖ Primary Purpose Must be Non Profit
❖ Unrelated Business Activity
❖ Activities in Foreign Countries
❖ Fiscal oversight required
= Application Could Go on “THIRD” Pile (12 mo+
Review)

26. Planning Tips
❖ IRS is backlogged with 1023 applications
❖ Consideration of a full Form 1023 application can take
several months to a year
❖ In the meantime, you can seek a fiscal sponsor, or seek
donations based on your application status (can be
tricky)
❖ May cause difficulty obtaining donations prior to an
IRS response, especially in the latter part of the year

27. HOW TO FORM YOUR NON-PROFIT SOCIAL VENTURE
III. Playing Well with Others:
Collaborating with Other Non-
Profits and For-Profits

28. Options for Non-Profit/For-Profit Affiliations
1. Contracting
2.Forming a subsidiary
3. Forming a Joint Venture

29. Contracting
❖ Tax Exempt Organizations can enter into written
agreements with for-profits for the sale of services or
assets
- e.g., a contract for custodial services
❖ Agreements have to be “arms-length”
- Tax Exempt Org. must get reasonable value for
its services/assets

30. The Mozilla case

31. Subsidiary
Non-Profit
Entity
For-Profit
Subsidiary

32. Benefits from Forming a Subsidiary
Allows tax exempt organization to:
❖ Protect its tax-exempt status by parking
unrelated/commercial activities in Sub
❖ Insulate itself from liability associated with these
activities
❖ Obtain financing from conventional sources
❖ Attract staff and board members with business
experience (with competitive wages)
❖ Earn dividends (profits) tax-free from the subsidiary

33. Process: Establishing a Subsidiary
File Articles
First
Meeting
BOD
Adoption of
By Law
Issue of
Shares
File Limited
Share
Offering
File articles of
incorporation
for for-profit
corporation with
Secretary of
State
In CA,
See:
www.sos.ca.gov/b
usiness/corp/pdf/ar
ticles/arts-gs.pdf
Convene first
meeting of
Board of
Directors
Board of
Directors
adopts
bylaws
Issue shares
in exchange
for value
(Non-p pays
assets)
File limited share
offering form with
Dept. of
Corporations

34. Both Tax Exempt Org and Sub Must
Observe Corporate Formalities
❖ The Tax Exempt Org and the Subsidiary each must have their own
Boards of Directors, with separate meetings, minutes, accounts, books
and records
❖ There can be overlap but the Boards shouldn’t be the same
❖ The Tax Exempt Org is not involved in the day to day management of
the Subsidiary
❖ As majority shareholder, it appoints and removes directors
❖ Transactions between the Tax Exempt Org and Subsidiary should be
documented and on market terms
❖ Agreements for space and services are common
Critical

35. Private Benefit/Inurement Issues
❖ The Tax Exempt Org cannot provide anything to the
subsidiary at less than market value.
-- Need to avoid private benefit
❖ Directors, officers, managers and other persons with
substantial influence over the Tax Exempt Org cannot
engage in ‘excess benefit transactions’ with the
Subsidiary.
❖ Need to avoid private inurement

36. Joint Ventures
The IRS applies a two-part test to joint ventures with for-profits:
The second part requires a showing that the tax exempt org. has sufficient
control over the overall operations of the venture. The exempt org must play
an active role in the venture’s management and generally have majority voting
power as to the use of the JV’s assets
- The IRS will want to review a written JV agreement.
1) Does the overall
purpose of the
venture further the
tax exempt org’s
purposes?
2) Do the terms of the JV
agreement allow the
exempt organization to act
exclusively in furtherance of
its exempt purposes, and
provide no more than
incidental private benefit to
its for profit partner?(See
Rev. Rul. 98-15)

37. About Wayne Lippman
https://www.facebook.com/lippman.
associates.CPAs
https://www.youtube.com/waynelipp
man
http://lippmancpas.com
https://twitter.com/waynelippman
Wayne Lippman has forty years of
experience in public accounting including
twenty years with Price Waterhouse,
where he served as a tax partner in the
San Francisco and Oakland offices. He
was previously Managing Tax Partner of
the Walnut Creek office of Price
Waterhouse. http://Waynelippman.wordpress.co
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