Nonprofit Law & Governance For Dummies

 

by Jill Gilbert Welytok, JD, CPA and Daniel S. Welytok, JD

 

 

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I can’t imagine American society without nonprofit work, and I sure don’t want to. Disaster relief, sheltering the homeless, feeding the poor, mentoring young people, and after-school programs are all in a day’s work for charities and churches in every community.

Helping a neighbor is as ingrained in our culture as freedom of speech and the right to vote. Many spend precious leisure hours driving the elderly to doctor appointments or building houses for deserving families. And many Americans find an extra dollar for the Salvation Army kettle or cancer research. Some people can give more than others. Regardless, all Americans reap incalculable benefit from charities.

Reflecting these values, the federal tax code gives generous tax breaks to non-profit groups. Each year, the federal government foregoes the collection of about $280 billion in taxes from non-profit groups.

For decades, Congress handed out these tax breaks without much thought. But then some headlines grabbed our attention. The foundation executive in Boston who dipped into the charity’s funds to pay for his daughter’s expensive wedding. Organizations that were charities in name only because they were used as tax shelters by self-enriching individuals. The car owner who deducted thousands of dollars for donating to charity his 1976 AMC Pacer that goes only in reverse. The well-traveled safari hunter who wrote off his entire trip to South Africa by donating a dusty stuffed ibex head to a museum that never cared to display its prize.

These abuses of American generosity — as reflected in the federal tax code — were outrageous. They threatened the good reputation of charities. They mocked honest taxpayers. Congress needed to act, and we did. We made clear that favorable tax treatment is a privilege, not a right. With this privilege comes a great responsibility — by both the government and individual nonprofit organizations — to safeguard the public trust. We need to protect donors by ensuring contributions are used appropriately. We need to protect taxpayers by guaranteeing that tax benefits given to public charities correlate with the benefits that public charities provide to society. Government officials fulfill this responsibility to both donors and taxpayers with effective oversight and with laws that minimize the potential for abuse while also providing incentives for charitable giving.

As chairman of the Senate Committee on Finance, I worked to reform the laws that relate to nonprofit organizations. In my current capacity as the senior-most Republican on the Finance Committee, I’ll continue that work. We need to make nonprofit operations more transparent and improve nonprofit governance. Among all charities, of those that have failed their mission, I’ve found that poor board governance unites all of them. A vigilant and committed board is key to making sure charities stay focused on the goals that encourage people to give.

Nonprofit organizations play an important role in safeguarding the public trust. They need to be guided by the best practices in the charitable field. Those put forward by the Independent Sector’s Nonprofit Panel and the Better Business Bureau Wise Giving Alliance are two good examples among many others. This book is another important resource for nonprofit organizations. It’s a road map on how to meet legal obligations and further the good work of the charitable missions that are an essential part of the fabric of American life.

Chuck Grassley United States Senator, Iowa

 

About the Authors

Jill Gilbert Welytok, JD, CPA, LLM, practices in the areas of corporate law, nonprofit law, and intellectual property. She is the founder of Absolute Technology Law Group, LLC (www.abtechlaw.com). She went to law school at DePaul University in Chicago, where she was on the Law Review, and picked up a Masters Degree in Computer Science from Marquette University in Wisconsin where she now lives. Ms. Welytok also has an LLM in Taxation from DePaul. She was formerly a tax consultant with the predecessor firm to Ernst & Young. She frequently speaks on nonprofit, corporate governance–taxation issues and will probably come to speak to your company or organization if you invite her. You may e-mail her with questions you have about Sarbanes-Oxley or anything else in this book at jwelytok@abtechlaw.com. You can find updates to this book and ongoing information about SOX developments at the author’s website located at www.abtechlaw.com.

Daniel S. Welytok, JD, LLM, is a partner in the business practice group of Whyte Hirschboeck Dudek S.C., where he concentrates in the areas of taxation and business law. Dan advises clients on strategic planning, federal and state tax issues, transactional matters, and employee benefits. He represents clients before the IRS and state taxing authorities concerning audits, tax controversies, and offers in compromise. He has served in various leadership roles in the American Bar Association and as Great Lakes Area liaison with the IRS. He can be reached at dsw@whdlaw.com.

 

Dedication

To Tara, Julia, and Daniel Welytok

 

Authors’ Acknowledgments

We would like to thank the following people:

Judith Steininger, nonprofit consultant. Judy is a professor emeritus at the Milwaukee School of Engineering and a former Peace Corps volunteer. She has served on numerous nonprofit boards, including Hoan Foundation, Patrick & Beatrice Haggerty Art Museum, Dominican High School, Girls Scouts, Milwaukee County Council, and Milwaukee Chamber Theater. Judy is a great philanthropist and a Milwaukee treasure, and her perspective on this book has been invaluable.

Amy Seibel, technical editor, attorney, CPA. Amy is an AV-rated attorney with more than two decades of experience in the nonprofit and corporate governance realm. We have been very fortunate to have her as a technical editor on this book.

Donna Mortara, school board member, community volunteer. Donna is one of those influential community members who quietly seems to be everywhere getting things done and balancing community interests. She is approachable with concerns and creative in addressing them. We are fortunate that she has shared here perspective with us as a responsive community volunteer over the years.

We would also like to thank Ron Jones and Dan Steininger for their kind words about the book. And we’re especially grateful to Senator Chuck Grassley for taking time out of his busy schedule to write the foreword.

 

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Contents

Title

Introduction

About This Book

Conventions Used in This Book

What You’re Not to Read

What We Assume About You

How This Book Is Organized

Icons Used in This Book

Where to Go from Here

Feedback, Please

Part I : Nonprofits in the 21st Century

Chapter 1: Defining and Scrutinizing the Nonprofit Sector

Characteristics That Nonprofits Share

Comparing Small Nonprofits to Small For-Profit Businesses

Surveying the Latest Legal Landscape

Focusing on Good Governance

Chapter 2: Regulating Nonprofits: Who’s in Charge?

The IRS: The Primary Federal Regulator

U.S. Postal Regulations

Federal Election Laws

State Regulations

Regulations in Counties and Municipalities

Chapter 3: The State of the Nation’s Nonprofits

Unprecedented Scrutiny

Lessons from Nonprofits in the News

New Federal Legislation: The Pension Protection Act of 2006

Part II : The Nuts and Bolts of Nonprofits

Chapter 4: Starting Up and Staying True to the Mission

Making the Mission Matter

Getting Tax-Exempt Status

Choosing an Entity Type

Incorporating as a Nonprofit

Getting Leaders on the Board

Chapter 5: Getting Tax-Exempt Status

Checking Out the “Eligible” List for Tax-Exempt Status

Applying for Tax-Exempt Status

Appealing an Adverse Determination with the IRS

Chapter 6: Paying Nonprofit Directors, Officers, Staff, and Volunteers

Convening a Compensation Committee

Following IRS Guidelines

Cooking Up a Compensation Package

Governance Issues and Compensation

Avoiding Tax for Volunteers

Part III : Structuring a Nonprofit to Meet Its Mission

Chapter 7: Filing the Dreaded Form 990

Introducing Form 990: What It Is and Who Has to File It

Figuring Out Which Form to File

Satisfying the States with Form 990

Avoiding Common 990 Nightmares

Researching Form 990s Online

Sampling Some Form 990s

Chapter 8: The Responsibilities of the Board

Introducing the Basics of the Board of Directors

Understanding a Director’s Responsibilities

Your Rights as a Director

SOX Policies and Nonprofit Boards

Chapter 9: Creating the Right Committee Structure

Basic Committee Structures

Forming a Committee

Types of Committees

Chapter 10: All About Audit Committees

The Role of the Audit Committee

Audit Committee Membership Guidelines

Serving on an Audit Committee

Part IV : Some Special Types of Nonprofits

Chapter 11: Forming a Solid Foundation

Why Form a Foundation?

Comparing Private Foundations to Public Charities

The Types of Private Foundations

Establishing a Foundation: Time to Jump Through Some Legal Hoops

Running Your Foundation

Terminating a Private Foundation

Chapter 12: Capitalizing on Cooperatives

Cashing In on Collaboration: How Cooperatives Work

Categorizing Cooperatives

Members Only: Who Can Be Part of a Cooperative?

Collaborating for Tax Benefits

Forming a Cooperative in Five Easy Steps

Running a Cooperative: Is It Any Different Than a Corporation?

The Typical Operations of a Cooperative

Dealing with Some Cooperative Conundrums

Part V : Legal Landmines

Chapter 13: Existing in a World of Sarbanes-Oxley

A Quick and Clean Overview of Sarbanes-Oxley

Applying SOX to the Nonprofit Arena

Implementing Standards Logically: A Balanced Approach

How SOX-Savvy Is Your Nonprofit?

Chapter 14: Some Sticky Accounting Issues That All Nonprofits Face

“Tax Exempt” Doesn’t Mean “Tax Free”

Valuing Donations Realistically

Dealing with Donations, Deductions, and Donors Who Overvalue Their Items

The Requirements of the Pension Protection Act

Chapter 15: Communicating Comfortably with the IRS

The Tax Exempt and Government Entities Division of the IRS

Soft Contacts: Friendly Notes from the IRS

Sending a Determination Letter

Surviving an IRS Audit

Part VI : The Part of Tens

Chapter 16: More Than Ten Web Sites Every Nonprofit Should Visit

Guidestar

The Internet Nonprofit Center

USA.gov

CompassPoint

NASCOnet.org

Other Worthwhile Sites

Chapter 17: Ten Questions to Ask Before Agreeing to Join a Nonprofit Board

Who’s on the Current Board and How Did They Get There?

How Long Are the Director’s Terms?

How Many Board Members Does It Take to Get Anything Done?

What Committees Does the Board Control?

Can I See the Books and Records of the Organization?

What’s the Organization’s Financial Situation?

Is the Organization Current on Its Payroll Taxes?

What Are the Responsibilities of the Directors?

When, Where, and How Often Does the Board Meet?

Is the Board Being Sued or Has It Ever Been Sued?

Chapter 18: Ten Ways to Lose Tax-Exempt Status

Engage in Plenty of Nonexempt Activities

Get Involved in Prohibited Political Activities

Become a Partnership

Divert Some of Your Organization’s Earnings to Private Individuals

Farm Out Control of Your Operations

Fail to Limit Your Commercial Activities

Require Donations in Exchange for Your Organization’s Services

Skip Filing IRS Form 990 for Three Years in a Row

Support Terrorist Activities

Pay Your Executives Exorbitant Salaries

Chapter 19: Ten Tips for Dealing with the Media

Acquaint Yourself with Your Local Media

Create Your Message

Be Prepared When Being Interviewed

Keep Control of the Story

Don’t Avoid the Press

Hire Professional PR Help When Necessary

Remember That Nothing Is Ever “Off the Record”

Gather the Forces When Appropriate

Know the Difference between News and Advertising

Surf the ’Net

Part VII : Appendixes

Appendix A: Sample Nonprofit Bylaws

Appendix B: Sample Audit Committee Report

Appendix C: State Regulatory Authorities for Nonprofits

Appendix D: Selections from the Revised Model Nonprofit Corporation Act (1987)

Chapter 2: Organization

Chapter 7: Members’ Meetings and Voting

Chapter 8: Directors and Officers

Chapter 10: Amendment of Articles of Incorporation and Bylaws

Chapter 11: Merger

Chapter 12: Sale Of Assets

Chapter 13: Distributions

Chapter 14: Dissolution

Chapter 15: Foreign Corporations

: Further Reading

Introduction

Welcome to Nonprofit Law & Governance For Dummies. This book takes you on a tour of the nation’s nonprofits in the world of Sarbanes-Oxley and enhanced financial oversight. Whether you’re a board member, officer, volunteer, employee, or donor, this book is for you. It’s designed to tell you where you fit into the gears of the nonprofit sector (which incidentally employs one out of seven Americans).

Having the big picture straight in your mind helps ensure that you won’t lose track of the mission of your organization in the details of daily administration or the pressure of public scrutiny.

About This Book

In the wake of the Sarbanes-Oxley Act, or SOX, questions have been raised about the overall health of the nation’s nonprofit sector. In addition, in the wake of the September 11, 2001, terrorist attacks and Hurricane Katrina in 2005, questions have been raised as to the financial fitness and oversight of this important sector of our economy. The sector itself has taken an approach of proactively governing itself and working with legislators to bring about reasoned reforms.

The goal of Nonprofit Law & Governance For Dummies is to give you a helicopter view of the regulatory terrain, while giving you enough detail to spot the legal landmines within your own organization. This book is also intended to give you the level of insight you need for practical, cost-effective decision making.

For example, this book can help you do the following:

bullet Understand what types of organizations make up the United States nonprofit sector: The nonprofit sector of the U.S. economy is larger than the economies of many small countries. It consists of organizations ranging from informal community groups to private foundations and complex corporate structures with multiple divisions and subsidiaries.

bullet Understand the role of the Internal Revenue Service: The Internal Revenue Service, or IRS, is the primary federal organization that regulates nonprofit organizations. It wields the power to grant, deny, or revoke organizations’ tax-exempt status.

bullet Comply with state laws and regulations: Even though the federal government is the primary arbiter of tax-exempt status, states take an avid interest in what types of entities are formed, how funds are solicited, and other activities that are conducted within their borders.

bullet Avoid lawsuits and adverse regulatory actions: This book, although not intended as a substitute for a good securities lawyer or certified public accountant, takes a hard look at the types of liability that board members, officers, employees, and other volunteers can incur when they’re involved in carrying out the mission of a nonprofit organization. It also gives you an idea of who incurs liability under SOX and how you can avoid having your company (or yourself) added to the list of litigants.

bullet Anticipate future rules and trends: Regulation of the nonprofit sector is constantly evolving, and it has gained momentum following the highly publicized scandals involving such organizations as the Red Cross and the United Way. This book takes a look at how new regulations and scrutiny may affect nonprofits at all levels.

Conventions Used in This Book

It’s unfortunate, but true: Understanding the nonprofit sector and the laws that apply to these organizations means that you’re going to run into lots of legal jargon and accounting minutiae. To give you a jump-start, we define some legal and accounting terms in this book and use italics to make such terms stand out a bit.

Also, so that they’re easy to spot and easy to read, we have placed all Web sites (and there are plenty!) in monofont.

What You’re Not to Read

We occasionally wander off-topic to discuss something historical, technical, or interesting (or, at least, interesting to us!). In these instances, we set the discussions apart by placing them in sidebars, which are the gray boxes that you’ll see from time to time throughout the book. Because the text in sidebars is nonessential, feel free to skip it if it doesn’t interest you.

What We Assume About You

In writing this book, we had to make a few assumptions about who our readers would be and what kind of information they’d be looking for. First of all, we assume that you want to understand the legal and regulatory issues facing nonprofits in a way that you can’t achieve by suffering through the thousands of pages of statutes and regulations, including the Internal Revenue Code. We also assume that you want to keep up with the most important legislation and standards regarding nonprofits and that you want to figure out exactly how they affect your organization.

Whether you’re a board member, executive director, staff person, volunteer, donor, or you head up a private foundation, this book is for you. Nearly everyone in the United States has some sort of stake in the vitality of our nation’s nonprofit sector. This book helps you understand some of the following issues, which are universal concerns to nonprofit stakeholders:

bullet How an effective nonprofit should operate

bullet The complex overlay of federal and state laws that apply to nonprofits, including IRS regulations

bullet What standards should be voluntarily adopted by your organization

bullet How to maintain an effective and smoothly functioning nonprofit board

bullet The best ways to stay true to the mission of your organization

How This Book Is Organized

Nonprofit organizations vary widely in size, mission, organizational structure, and practices. The index and table of contents can help you find your way to the parts of the book that are most relevant to your organization. The chapters in this book treat each topic independently without assuming you’ve read previous chapters (as a textbook might), so you can use them as references and jump around to find what you need. Nonprofit Law & Governance is divided into six parts, which we explain in the following sections.

Part I: Nonprofits in the 21st Century

This part of the book looks at the historical mission of nonprofits and the role that they have played in the United States economy over the last 200 years. It explains why the government gives these organizations a “free ride” by exempting them from federal and state taxes. It explains how the Internal Revenue Service and the states work in tandem to weave a regulatory framework that protects donors, stakeholders, and intended beneficiaries of nonprofit organizations.

Part II: The Nuts and Bolts of Nonprofits

This part of the book delves into the basics of how nonprofits are organized and the critical characteristics they all share. It also explains the legal and regulatory environments in which all nonprofits operate, and the administrative and organizational structures they must have in place to carry out their missions. This part ends with a chapter that can guide you through the sticky subject of compensating officers and directors.

Part III: Structuring a Nonprofit to Meet Its Mission

This part explores some of the different types of legal entities (such as trusts and corporations) that can be formed to operate nonprofits. It also explains the duties that you’ll assume if you agree to become part of a nonprofit board of directors, and it explores the difficulties in recruiting, compensating, and keeping good board members. Finally, it delves into the area of creating effective committees and delegating board functions to them (with an entire chapter devoted to audit committees).

Part IV: Some Special Types of Nonprofits

This part of the book takes you on a tour of the types of organizations that make up the nonprofit sector. They range from small, unincorporated associations and community groups to large private foundations, cooperatives, and multimillion-dollar corporations that rival their private sector counterparts in terms of their impact and influence on the American economy.

Part V: Legal Landmines

It’s a sad fact that a few nonprofits run astray of their missions and encounter lawsuits, regulatory actions, and negative publicity. This part looks at the common mistakes that even some of the nation’s largest nonprofits have made. This peek at the common mistakes can help you identify strategies so that your organization can avoid suffering the same fate.

For example, this part explains how to avoid common tax traps (such as failing to pay tax on unrelated business income) and activities that may cause your organization to lose its tax-exempt status. It also offers information on communicating effectively with the IRS in case questions arise, and gives you some tips for the sticky situations that even the most conscientious nonprofit organizations might encounter.

Part VI: The Part of Tens

The short chapters in this part offer checklists on important topics that can help board members and organizations avoid difficult situations. It suggests questions to ask before agreeing to serve on a nonprofit board, summarizes common ways that organizations lose their tax-exempt status, and provides a list of good Web site resources that can help you and your organization on a daily basis. We round out this part with a chapter on the ten ways you can use the media to your advantage.

Part VII: Appendixes

The appendixes in this book contain useful reference materials that you can actually put to use in your organization. You’ll find sample nonprofit bylaws and a sample audit committee report. You’ll also find a directory of contact information for state and regulatory authorities and select articles from the Model Nonprofit Corporation Act of 1987.

Icons Used in This Book

For Dummies books use little pictures, called icons, to flag parts of the text that stand out from the rest for one reason or another. Here’s what the icons in this book mean:

Tip

Time is money. When you see this icon, your attention’s being directed to a compliance shortcut or timesaving tip.

LawyersNote

This icon signals the type of advice you may get in a lawyer’s office if your organization were paying the exorbitant going rates. Of course, the information highlighted by this icon is no substitute for sound legal advice from your organization’s attorney, who actually knows the facts of your individual situation.

AccountantsNote

This icon indicates that you’re getting the kind of tip your audit or CPA firm might dispense. But remember, you should actually consult a real accounting professional before acting on anything that follows this icon.

Warning(bomb)

This is a heads-up warning to help you avoid compliance mistakes, legal traps, and audit imbroglios.

Remember

This icon flags particularly noteworthy information — stuff you shouldn’t forget.

Where to Go from Here

Because we wrote each chapter of this book as a stand-alone treatment of the topic covered, you can start with Chapter 1 and read the whole book, or you can skip around and brush up on only the topics that interest you at the moment. If you’re new to the nonprofit sector, we recommend that you start with Part I. If you’re hip to nonprofit governance issues, skip ahead to the parts in the book that address your particular needs or concerns.

Feedback, Please

We’re always interested in your comments, suggestions, or questions, so we’d love to hear from you. Send Jill an e-mail message at jwelytok@abtechlaw.com, or send Dan one at dsw@whdlaw.com. You can also visit abtechlaw.com. On this site, you’ll find contact information for all the great legal and accounting professionals who helped with this book (I’ve included their credentials and accomplishments on the acknowledgments page).

Part I

Nonprofits in the 21st Century

In this part . . .

This part provides the basics on nonprofits, including what they are, what legislation has recently changed their governance, and who regulates them. We round out the part with a chapter that explains the state of today’s nonprofits.