United States of America non-profit laws
Encyclopedia
United States of America non-profit laws relate to taxation, the special problems of an organization which does not have profit as its primary motivation, and prevention of charitable fraud. Some non-profit organizations can broadly be described as "charities" — like the American Red Cross
. Some are strictly for the private benefit of the members — like country clubs, or condominium associations. Others fall somewhere in between — like labor unions, chambers of commerce, or cooperative electric companies. Each presents unique legal issues.
— if a not-for-profit corporation — or (b) trust instrument
— if a trust — or (c) articles of association — if an association
— must specify that no part of its assets shall benefit any of persons who are members, directors, officers or agents (its principals). As well the organization must have a legal, charitable purpose, i.e. the organization must be created to support educational, religious, or charitable activities. These elements do not mean that the organization cannot pay employees or contractors for work or services they render to the organization. This limitation means that as long as the organization operates within its exempt purposes and it maintains an endowment or uses any excess revenue to further develop its activities it will not be taxed by the Internal Revenue Service.
Such a surplus — that is, whatever part of its income is left after its operating expenses are paid — which might be considered similar to "profit" — must be spent on the charitable or public purpose(s) for which it was organized, not paid as a dividend or benefit to anyone associated with running or organizing it.
Not only must the organization meet the requirements the state where it is organized sets for non-profits, but it must also meet complex I.R.S. regulations. These regulations are used not only to determine if the organization is exempt from tax under the organization's activities as a non-profit organization. If the organization purpose is one of those described in §501(c)(3) of the Internal Revenue Code, it may apply for a ruling that donations to it are tax deductible to the persons or business entities who make them. The organization itself will be exempt from taxation as long as it does not engage in unrelated business activities
. As well the IRS has enacted intermediate sanctions
should the members of the organization engage in practices that may excessively benefit any of the organizations members (or officers, directors, etc.) rather than revoking the organization's exempt status (which was the only option available before the adoption of intermediate sanctions) the I.R.S. may now levy a penalty on the organization for engaging in a transaction that resulted in a private inurement or private benefit. See the entry on intermediate sanctions for more detailed information.
Due to differing requirements by the states and the federal government, it is possible to be recognized as a non-profit organization by the state, but not by the federal government. Such an organization would be exempt from state taxes, but not from federal taxes. This may actually be desirable in certain limited circumstances. For example, federally tax-exempt organizations are generally prohibited from influencing elections and legislation, whereas the state may or may not prohibit non-profits from that activity. If you wish to receive grants and donations, it is generally necessary to be a federally recognized non-profit (i.e. 501(c)3 or similar designation). Contributions made to federally recognized non-profits (such as 501(c)3 entities) would typically be tax deductible for the person or entity giving the donation.
In other words, if the federal court decides that a non-profit organization is acting contrary to the laws, its taxation benefits may be permanently revoked.
, the Boy Scouts of America
, and the United States Olympic Committee
.
Generally, non-profits and people operating non-profits must comply with all of the same laws which would apply to for-profit businesses. There are exceptions for taxes (noted above) and some exceptions related to First Amendment
concerns, noted below. Directors and officers of non-profits owe a fiduciary duty to the non-profit and its beneficiaries similar to the duties owed by directors and officers of for-profit corporations. Non-profits can have vicarious liability
for injuries caused by their employees or volunteers to third parties, such as by traffic accidents. For this reason it is prudent for any non-profit to obtain liability insurance
. Non-profits which have paid staff must comply with minimum wage
laws, and with the requirement in most states to obtain workers compensation insurance.
Churches and religious non-profits are something of a special case, because the First Amendment
to the U.S. Constitution forbids the government making a law "respecting an establishment of religion" and also forbids "prohibiting the free exercise thereof [that is, of religion]." The First Amendment originally bound only the U.S. Federal Government, but by incorporation through the 14th Amendment, also binds state and local governments. Under the Religious Freedom Restoration Act
many generally applicable state laws regarding employment, zoning and the like are relaxed for churches.
Similarly, some non-profits, as private organizations, are not subject to the anti-discrimination laws which might apply to similar organizations serving the public for profit. As an example, the Boy Scouts of America do not allow girls as Cub Scouts or Boy Scouts, and the courts have held this does not violate anti-discrimination laws.
Charity non-profits face many of the same challenges of corporate governance
which face large, publicly traded corporations. Fundamentally, the challenges arise from the "agency problem" - the fact that the management which controls the charity is necessarily different from the people who the charity is designed to benefit. In a non-profit corporation, the "agency problem" is even more difficult than in the for-profit sector, because the management of a non-profit is not even theoretically subject to removal by the charitable beneficiaries. The board of directors of most charities is self-perpetuating, with new members chosen by vote of the existing members.
American Red Cross
The American Red Cross , also known as the American National Red Cross, is a volunteer-led, humanitarian organization that provides emergency assistance, disaster relief and education inside the United States. It is the designated U.S...
. Some are strictly for the private benefit of the members — like country clubs, or condominium associations. Others fall somewhere in between — like labor unions, chambers of commerce, or cooperative electric companies. Each presents unique legal issues.
Taxation
If an organization is to qualify for tax exempt status, the organization's (a) charterCharter
A charter is the grant of authority or rights, stating that the granter formally recognizes the prerogative of the recipient to exercise the rights specified...
— if a not-for-profit corporation — or (b) trust instrument
Legal instrument
Legal instrument is a legal term of art that is used for any formally executed written document that can be formally attributed to its author, records and formally expresses a legally enforceable act, process, or contractual duty, obligation, or right, and therefore evidences that act, process, or...
— if a trust — or (c) articles of association — if an association
Voluntary association
A voluntary association or union is a group of individuals who enter into an agreement as volunteers to form a body to accomplish a purpose.Strictly speaking, in many jurisdictions no formalities are necessary to start an association...
— must specify that no part of its assets shall benefit any of persons who are members, directors, officers or agents (its principals). As well the organization must have a legal, charitable purpose, i.e. the organization must be created to support educational, religious, or charitable activities. These elements do not mean that the organization cannot pay employees or contractors for work or services they render to the organization. This limitation means that as long as the organization operates within its exempt purposes and it maintains an endowment or uses any excess revenue to further develop its activities it will not be taxed by the Internal Revenue Service.
Such a surplus — that is, whatever part of its income is left after its operating expenses are paid — which might be considered similar to "profit" — must be spent on the charitable or public purpose(s) for which it was organized, not paid as a dividend or benefit to anyone associated with running or organizing it.
Not only must the organization meet the requirements the state where it is organized sets for non-profits, but it must also meet complex I.R.S. regulations. These regulations are used not only to determine if the organization is exempt from tax under the organization's activities as a non-profit organization. If the organization purpose is one of those described in §501(c)(3) of the Internal Revenue Code, it may apply for a ruling that donations to it are tax deductible to the persons or business entities who make them. The organization itself will be exempt from taxation as long as it does not engage in unrelated business activities
Ultra vires
Ultra vires is a Latin phrase meaning literally "beyond the powers", although its standard legal translation and substitute is "beyond power". If an act requires legal authority and it is done with such authority, it is...
. As well the IRS has enacted intermediate sanctions
Intermediate sanctions
Intermediate sanctions is a term used in regulations enacted by the United States Internal Revenue Service that is applied to non-profit organizations who engage in transactions that inure to the benefit of a disqualified person within the organization. These regulations allow the IRS to penalize...
should the members of the organization engage in practices that may excessively benefit any of the organizations members (or officers, directors, etc.) rather than revoking the organization's exempt status (which was the only option available before the adoption of intermediate sanctions) the I.R.S. may now levy a penalty on the organization for engaging in a transaction that resulted in a private inurement or private benefit. See the entry on intermediate sanctions for more detailed information.
Due to differing requirements by the states and the federal government, it is possible to be recognized as a non-profit organization by the state, but not by the federal government. Such an organization would be exempt from state taxes, but not from federal taxes. This may actually be desirable in certain limited circumstances. For example, federally tax-exempt organizations are generally prohibited from influencing elections and legislation, whereas the state may or may not prohibit non-profits from that activity. If you wish to receive grants and donations, it is generally necessary to be a federally recognized non-profit (i.e. 501(c)3 or similar designation). Contributions made to federally recognized non-profits (such as 501(c)3 entities) would typically be tax deductible for the person or entity giving the donation.
In other words, if the federal court decides that a non-profit organization is acting contrary to the laws, its taxation benefits may be permanently revoked.
Organization
Non-profit organizations in the United States are, like for-profit corporations, mostly organized and operated under the law of a state, rather than the federal government. There are some federally chartered charities, though, including the American Red CrossAmerican Red Cross
The American Red Cross , also known as the American National Red Cross, is a volunteer-led, humanitarian organization that provides emergency assistance, disaster relief and education inside the United States. It is the designated U.S...
, the Boy Scouts of America
Boy Scouts of America
The Boy Scouts of America is one of the largest youth organizations in the United States, with over 4.5 million youth members in its age-related divisions...
, and the United States Olympic Committee
United States Olympic Committee
The United States Olympic Committee is a non-profit organization that serves as the National Olympic Committee and National Paralympic Committee for the United States and coordinates the relationship between the United States Anti-Doping Agency and the World Anti-Doping Agency and various...
.
Generally, non-profits and people operating non-profits must comply with all of the same laws which would apply to for-profit businesses. There are exceptions for taxes (noted above) and some exceptions related to First Amendment
First Amendment to the United States Constitution
The First Amendment to the United States Constitution is part of the Bill of Rights. The amendment prohibits the making of any law respecting an establishment of religion, impeding the free exercise of religion, abridging the freedom of speech, infringing on the freedom of the press, interfering...
concerns, noted below. Directors and officers of non-profits owe a fiduciary duty to the non-profit and its beneficiaries similar to the duties owed by directors and officers of for-profit corporations. Non-profits can have vicarious liability
Vicarious liability
Vicarious liability is a form of strict, secondary liability that arises under the common law doctrine of agency – respondeat superior – the responsibility of the superior for the acts of their subordinate, or, in a broader sense, the responsibility of any third party that had the "right, ability...
for injuries caused by their employees or volunteers to third parties, such as by traffic accidents. For this reason it is prudent for any non-profit to obtain liability insurance
Liability insurance
Liability insurance is a part of the general insurance system of risk financing to protect the purchaser from the risks of liabilities imposed by lawsuits and similar claims. It protects the insured in the event he or she is sued for claims that come within the coverage of the insurance policy...
. Non-profits which have paid staff must comply with minimum wage
Minimum wage
A minimum wage is the lowest hourly, daily or monthly remuneration that employers may legally pay to workers. Equivalently, it is the lowest wage at which workers may sell their labour. Although minimum wage laws are in effect in a great many jurisdictions, there are differences of opinion about...
laws, and with the requirement in most states to obtain workers compensation insurance.
Churches and religious non-profits are something of a special case, because the First Amendment
First Amendment to the United States Constitution
The First Amendment to the United States Constitution is part of the Bill of Rights. The amendment prohibits the making of any law respecting an establishment of religion, impeding the free exercise of religion, abridging the freedom of speech, infringing on the freedom of the press, interfering...
to the U.S. Constitution forbids the government making a law "respecting an establishment of religion" and also forbids "prohibiting the free exercise thereof [that is, of religion]." The First Amendment originally bound only the U.S. Federal Government, but by incorporation through the 14th Amendment, also binds state and local governments. Under the Religious Freedom Restoration Act
Religious Freedom Restoration Act
The Religious Freedom Restoration Act of 1993, Pub. L. No. 103-141, 107 Stat. 1488 , codified at through , is a 1993 United States federal law aimed at preventing laws that substantially burden a person's free exercise of their religion. The bill was introduced by Howard McKeon of California and...
many generally applicable state laws regarding employment, zoning and the like are relaxed for churches.
Similarly, some non-profits, as private organizations, are not subject to the anti-discrimination laws which might apply to similar organizations serving the public for profit. As an example, the Boy Scouts of America do not allow girls as Cub Scouts or Boy Scouts, and the courts have held this does not violate anti-discrimination laws.
Charity non-profits face many of the same challenges of corporate governance
Corporate governance
Corporate governance is a number of processes, customs, policies, laws, and institutions which have impact on the way a company is controlled...
which face large, publicly traded corporations. Fundamentally, the challenges arise from the "agency problem" - the fact that the management which controls the charity is necessarily different from the people who the charity is designed to benefit. In a non-profit corporation, the "agency problem" is even more difficult than in the for-profit sector, because the management of a non-profit is not even theoretically subject to removal by the charitable beneficiaries. The board of directors of most charities is self-perpetuating, with new members chosen by vote of the existing members.
Charitable fraud prevention
In the United States, prevention of charitable fraud is mostly a function of state governments, and laws vary widely from state to state.External links
- Free Questions and Answers About Nonprofits in the United States provided by Allexperts.com
- GuideStar searchable directory of nonprofit organizations and governance information