If dealing with the IRS makes you feel overwhelmed, you are not alone. Sometimes it seems like the Internal Revenue Service uses a foreign language that you never took in school. We know this and can help translate for your nonprofit. Compliance with the IRS is crucial to keeping your organization above board and in good standing. By making sure to take care of a few relatively straightforward matters, you can ensure your nonprofit maintains that precious 501(c)(3) status. Follow this guide to help keep the IRS happy with your organization.
The IRS can be rather particular about a nonprofit's mission statement. When establishing your nonprofit, make sure you have a clear corporate purpose statement listed in your Articles of Incorporation. The key is to have a mission that is specific enough to show your uniqueness but general enough so modifications that may naturally take place as the organization grows are still covered. If your mission statement is too specific, it can lead to restricted access to funding or re-evaluation of 501(c)(3) status. Our firm is happy to help your nonprofit craft a corporate purpose statement that is just right.
No Excess Benefits
An excess benefit transaction is a transaction in which an economic benefit is provided by an applicable tax-exempt organization, directly or indirectly, to or for the use of a disqualified person, and the value of the economic benefit provided by the organization exceeds the value of the consideration received by the organization. This simply means that an insider receives something from the organization that is above a reasonable amount (or fair market value).
Examples of Excess Benefit
- Unreasonable Salary: Organization A, located in KCMO, is an arts program that receives $1 million in annual revenue and has 20 full-time employees. The executive director receives $500K in annual salary and other compensation. This is probably an excess benefit transaction and subject to intermediate sanctions.
- Sale of Property: Organization B owns several buildings. The Board approves the sale of one of the buildings to a company that is 40% owned by the CEO. The sale is 30% below market value, but Board never undertook due diligence to realize the sale was below market. This is almost certainly an excess benefit transaction (and likely private inurement) and subject to intermediate sanctions.
Prevention of Excess Benefit
- Rebuttable Presumption of Reasonableness: A procedure for approving transactions with insiders that, if followed by an organization's board, provides the organization with the protection of a “rebuttable presumption” that the transaction approved is reasonable. A rebuttable presumption means that the IRS will essentially view the transaction as reasonable and thus, not an excess benefit transaction. The IRS can overcome the presumption, but it has to develop sufficient evidence to the contrary in order to rebut the presumption.
If an excess benefit transaction has occurred, the IRS can levy taxes, commonly referred to as intermediate sanctions, on both the disqualified person who received the excess benefit and the organizational manager(s) who knowingly approved the excess benefit transaction:
- 25% excise tax of the excess benefit on the disqualified person who received the excess benefit; and an additional 200% excise tax of the excess benefit if the violation is not corrected within the taxable period
- 10% excise tax of the excess benefit on the organizational manager [e.g., a director or board member] who knowingly participated in the transaction (maximum of up to $20,000)
- Plus, additional 100% excise tax if willful and flagrant
Automatic Excess Benefit
When a 501(c)(3) fails to properly substantiate payments that it makes to its insiders as either compensation or reimbursement, those payments may be considered an automatic excess benefit transaction regardless of whether the amount was reasonable. If fringe benefits or reimbursements are paid to insiders but not substantiated and treated as compensation, the IRS automatically considers the transaction to be an excess benefit and thus subject to intermediate sanctions.
Example of Automatic Excess Benefit
- Expense Reimbursement: Organization C pays $5,000 in expense reimbursements to its CEO. Reimbursements are not done according to an “accountable plan” and not included on the CEO's W-2. An accountable plan must require:
- (i) that the expenses have a business connection;
- (ii) adequate accounting for expenses within a reasonable period of time (i.e., providing receipts); and
- (iii) the return of any excess reimbursement within a reasonable period of time
*This is an automatic excess benefit transaction and subject to intermediate sanctions because the reimbursement was neither done according to an accountable plan nor reflected on the W-2, even if the $5,000 is a reasonable reimbursement of a legitimate business expense.
Advocacy and Lobbying
All 501(c)(3) organizations are legally allowed to engage in advocacy activities. Public charities may also engage in an insubstantial amount of lobbying (private foundations are generally prohibited from doing so). Lobbying is defined as activities that attempt to influence, whether in direct support of, or opposition to, specific legislation. Specific legislation can be either legislation that has been introduced in a “legislative body” and a specific legislative proposal a charity supports or opposes. Judicial, executive, and administrative bodies are NOT considered legislative bodies. The Substantial Part Test and Expenditure Test are used in the determination of the threshold.
Quid Pro Quo Contributions
A quid pro quo contribution is a contribution made by a donor in exchange for goods or services. Donors may only take a contribution deduction to the extent that their contributions exceed the fair market value of the goods or services the donors receive in return for the contributions; therefore, donors need to know the value of the goods or services. An organization must provide a written disclosure statement to a donor who makes a payment exceeding $75 partly as a contribution and partly for goods and services provided by the organization.
Example of Quid Pro Quo Contribution
- Auction: A donor places the winning bid at a charitable organization's annual gala for a set of concert tickets. The donor's bid was $150. The fair market value of the tickets was $100. Because the donor's payment (which is a quid pro quo contribution) exceeds $75, the organization must furnish a disclosure statement to the donor, even though the deductible amount does not exceed $75.
Written Disclosure Requirement
Must inform the donor that the amount of the contribution that is deductible for federal income tax purposes is limited to the excess of money contributed by the donor over the value of goods or services provided by the organization and provide the donor with a good-faith estimate of the fair market value of the goods and services.
- Penalty: If an organization fails to provide a written disclosure, the penalty is $10 per contribution, not to exceed $5K per fundraising event or solicitation.
If your nonprofit has 501(c)(3) tax-exempt status, make sure you file for the organization's 990 Annual Information Return every year. Make sure to have the board review it before submission as well. If this document goes unfiled for three consecutive years, then the tax-exempt status will be automatically revoked. Your nonprofit will have to reapply for tax-exempt status, and no one wants to spend the time or money filling out Form 1023 again. So, save yourself the hassle and file it.
While dealing with the IRS can be stressful and if we are honest sometimes scary, it does not have to be that way. Getting advice from professionals who regularly engage with the IRS can alleviate your worries and strengthen confidence that your nonprofit is following all the rules. At Mission Counsel, we know nonprofit leaders have a wide range of skills and great passion for their mission. However, if you feel like interpreting IRS lingo is not your strong suit, let us help by scheduling a Mission Discovery Session.