No Good Deed Goes Unpunished

The IRS 2011 Revocation of 501c3 Status of 275,000 charities: The AFTERMATH

Kent Seton - Wednesday, December 12, 2012

In May 2011, the IRS may good on its promise to "wipe out" the 501c3 charity status of approximately 275,000 charities for failing to file three consecutive years of returns. Many suspected and thought this was good as it would wipe out "small" charities. As it turns out, this is not the case. There have been many substantial charities who have their 501c3 status revoked. With this revocation, these revocations are not appealable. You must apply for reinstatement.

But, where does this leave charities who have had their 501c3 status revoked under this IRS Action? 

1. You have a limited period of time to seek reinstatement. As part of this, you must submit the Form 1023 and pay a User Fee.

2. From the period of revocation to when you are reinstated, you may have to file a Corporate Tax Return since you are not exempt from taxes. Further, you will have to account, report and pay taxes pursuant to Section 11 of the Internal Revenue Code.

3. The donors who have given during this "revoked" period must be informed of this "lack of 501c3 status".

Furthermore, it is important to note that the IRS is not being lenient on granting "retroactive reinstatement". 

Some procedural policies of the IRS to note as follows:

The organization must reapply and pay the appropriate user fee ($850 if gross revenue is over $10,000 per year and $400 if under) to have the tax-exempt status reinstated since it was revoked due to failure to file for 3 years.  The status is automatically revoked by operation of law and not by a determination by the IRS. There is no appeal for the revocation. Reinstatement of tax-exempt status may be retroactive to the date of revocation if the organization shows that it had reasonable cause for not filing for 3 consecutive years. 

To establish reasonable cause the organization must provide evidence that it exercised ordinary business care and prudence in determining and attempting to comply with its reporting requirements for each of the 3 years and over the entire 3 year period but was nevertheless unable to file the required returns. In making its determination, the IRS will take into account all pertinent facts and circumstances including the following factors:

  1. Failure was due to its reasonable good faith reliance on erroneous written info from the IRS, stating the organization was not required to file a return;
  2. Failure arose from events beyond the organization's control that made it impossible to file for each of the 3 years;
  3. Organization acted in a responsible manner by undertaking significant steps to avoid or mitigate the failure to file the required returns and to prevent similar failures in the future, including:
    1. Attempting to prevent an impediment or failure, if it was foreseeable;
    2. Acting as promptly as possible to remove an impediment or the cause the the reporting failure, once it was discovered;
    3. After failure was discovered, implementing sufficient safeguards to ensure future compliance with the reporting requirements.
  4. Aside from the 3 consecutive years in which it failed to file returns, the organization has established history of complying with its reporting requirements (if any).

The IRS will only consider a factor on the above list or any other factor (such as the fact that substantially all of an organization's activities are performed by volunteers) if the organization shows to the satisfaction of the IRS evidence to substantiate the factor. 

Application for reinstatement must be done within 15 months of the later of the date of the IRS revocation letter or the date on which the IRS posts the name of the organization on the list on the IRS website. 

Social Enterprise Takes A Step Forward

Kent Seton - Wednesday, December 12, 2012

As many practitioners know, beginning January 1, 2012, the State of California now recognizes the "benefit" and "flexible" corporation. While there are distinctions between the two and "general" corporation, they have a capital structure just like a corporation. They have shareholders, boards, etc.

The key distinction is that the leadership of profit making enterprise if they are formed under the laws of a "flexible" or "benefit" corporation, don't need to worry about shareholder lawsuits against them for failing to maximize profits if they also have a goal of advancing social benefit.

An articles in Huffington Post on this very matter, See this link,

Why is it not business as usual for charities

Kent Seton - Wednesday, December 12, 2012

The legal rules regarding UBIT are relatively important as the trend for "social enterprise" becomes more and more prevalent in both nonprofits and for profits. Due to the shrinking of governmental budgets, local, state and federal, funds are being depleted .There are approximately 1,000,000 charities in the US, thus, many charities fighting over depleted funds means one thing, sustainability and "doing good" must entice enterprises that "generate revenue" through their programs, whether they are operating in the "nonprofit" or for profit business model. Remember, a charity is NOT required to feed homeless, or, to prevent abuse to the elderly or, to provide relief to the distressed, one can form a for profit enterprise, like a corporation to operate a homeless shelter, However, charities are ideal vehicles for these types of activities because contributions are tax deductible to the donor and the income is exempt from taxation. However, the minute a charity generates revenue "unrelated" to its exempt purpose and that revenue is "regular and continuous" and from a "trade or business", the revenue is taxable subject to Section 512 and 513 of the Internal Revenue Code.

You might say but wait a second Kent, why does it matter if it meets this three prong test, the money generated is going to be going to charitable activities. The answer is the Government does not believe that it is fair to businesses who are in the same or similar businesses to have to compete with charities and are subject to taxes, thus, charities operating non-charitable business activities must be taxed like businesses even if the monies will benefit charitable causes.

Why Didn’t Toms Shoes Set Up As A Not For Profit Entity?

Kent Seton - Wednesday, April 18, 2012

Whether the general public knows it or not, Toms Shoes, yes, the famous Toms Shoes, is a not a nonprofit organization. In fact, it is a for profit enterprise that makes millions of dollars for its shareholders. Some of you who are interested in “cause marketing” and “social enterprise” may be interested to learn the legal reasons why Toms Shoes did not set up originally as a nonprofit organization.

One could say there was clearly a compelling economic reason which is the shareholder’s can profit this way, but there are also some very good legal reasons.  Despite what appears to be a charitable purpose of “giving away shoes”, the IRS analyzes the activity as “selling shoes” and if an organization is selling shoes then this is a commercial activity and not a charitable activity.

Specifically, under Section 512 and 512 of the IRC, the IRS has set forward certain parameters relating to income that a charity receives which constitutes “unrelated business income” (“UBIT”) and, if such income is “unrelated” then, the income is taxable pursuant to Section 11 of the IRC. The IRS has created a “test” (“Test”) to determine if such income is taxable. In addition, if there is too much UBIT, then this may in fact jeapordize the tax exempt status of nonprofit set up to sell a product, like selling shoes, to the general public raising monies for those who are in need (“Business Opportunity”).  The Test is as follows:

  1. The activity must be a trade or business
  2. The trade or business must be continuous and regular
  3. The activity must be “unrelated” to the exempt purpose of the organization.

In order for the Test to be met, each and every prong of the Test must be met. In other words, if one is missing, then, the income is not taxable under Section 512 of the IRC.

Unrelated Business Income

First, we will apply the Test to the Business Opportunity.

  1. Is the activity of operating the Business Opportunity a trade or business? The answer is, yes. A trade or business is an enterprise which has the intention of generating a profit and is entered into for the purposes of gain. In this case, running a Business Opportunity, the goal is to sell a product and compete with other business, to sell products to the general public. It could be no clearer of a case of a business enterprise even though the proceeds will go for the benefit of helping those in need.
  2. Is the Business Opprotunity regularly and continuously carried on? The term “regularly and continuously” carried refers to nature of the activity. The IRS has determined that frequency typically involves a continuity of time of operation and operates like other businesses of its kind. For example, The operation of a sandwich stand by a hospital auxiliary for only 2 weeks at a state fair would not be the regular conduct of trade or business. The sandwich stand would not compete with the operation of similar facilities by a taxpaying organization which would ordinarily operate on a year-round basis. The sale of advertising by volunteers of an exempt organization, which raises funds for an exempt symphony orchestra and publishes an annual concert book distributed at the orchestra’s annual charity ball, is not a business regularly carried on in determining unrelated income under section 512 of the Code. Rev. Rul. 75–201. On the other hand, the sale of advertising during a four month period by the paid employees of an exempt organization, which raises funds for an exempt symphony orchestra and publishes a weekly concert program distributed free at the symphony performances over an eight month period, is a business regularly carried on in determining unrelated income under section 512 of the Code. Rev. Rul. 75–200. In the instance case, it seems inarguable that the Business Opportunity is regularly and continuously carried on as that is the purpose of owning and operating it on a daily basis.
  3. Is the activity related to an exempt purpose which is charitable, educational, etc? To determine whether a business activity is or is not substantially related requires an examination of the relationship between the business activities which generate the particular income in question—that is, the activities of producing or distributing the goods or performing the services involved—and the accomplishment of the organization’s exempt purpose. To be related, in the statutory sense, the relationship must be causal. In addition, the causal relationship must be a substantial one. Thus, the activities which generate the income must contribute importantly to the accomplishment of the organization’s exempt purposes to be substantially related. Regs. 1.513–1(d). An exempt organization’s operation of a retail grocery store as part of its therapeutic program for emotionally disturbed adolescents, almost fully staffed by the adolescents, and on a scale that is no larger than is reasonably necessary for the performance of the organization’s exempt functions, is not unrelated trade or business. Rev. Rul. 76–94 Unrelated trade or business does not include any trade or business in which substantially all the work is performed for the organization without compensation. For example, an orphanage operating a retail store where substantially all the work in carrying on the business is performed for the organization by unpaid volunteers would not be carrying on unrelated trade or business. In Rev Ruling, 76-94, the key terms are that the store was not operated on a “a scale that is no larger than is reasonably necessary” for the performance of the organization’s exempt functions. In this case, Arc Mission is to assist with education, job training and providing job opportunities to Recipients, this is the very purpose of the organization which the IRS recognized as “charitable”. Juxtapose this with Revenue Ruling 73-127, in which the IRS held that a grocery store providing low cost items to poor areas, which had as one of its element a “training program” for the unemployed, who received a temporary training, then, sent out to the work force, was not a charitable organization and the activity was “larger” than the scale to further its exempt purposes and therefore the operation of the store was “Unrelated” to an exempt purpose. Again, it is very hard to argue that activity of “selling a product” is related to a 501c3 purpose such as charitable, scientific, etc. Yes, the monies will go to this purpose but not the “selling of the product”. Very likely all income earned would be taxable and an organization set up to engage in such activity would NOT be eligible for 501c3 status.

Legal Pitfalls of Internet Fundraising; The Charleston Principle Discussed

Kent Seton - Sunday, April 08, 2012

Charities who raise funds online may be wondering what legal obligations they have, amongst all the other concerns that they have in terms of raising funds. Why this might make matters more challenging; understanding the legal do’s and dont’s might make a life a little easier. In 1999, a delegation of all state charity officials convened in South Carolina to discuss principles related to internet fundraising. The National Association of State Charity Officials (NASCO) came up with some suggested guidelines known as the Charleston Principle (the “Guidelines”).

The Guidelines are simply such guide posts for states to adopt in connect with the rules and regulations of charities. Each state may adopt its own rules and regulations.

Here some of this is discussed.

Use of Internet Sites to Raise Funds

First, if you have a website, whether directly or through another platform, and you allow the “interactive” nature of the website such that one may be able to donate online funds or engage in a transaction of purchasing a product or service which will benefit a charitable purpose, then, under the Guidelines:

a. The charity must register in each state in which the activity is,

1. Substantial or repeated or on ongoing basis [These terms are not strictly defined, but, if more than 100 transactions and the result is $25,000 or greater in proceeds, then, it meets this test]

2. The website specifically targets individuals in that state.

Use of email aka electronic email

The use of charity email to solicit funds is a practice sometimes used to great success. In this case, the use of email under the Guidelines should be treated in exactly the same way in which regular mail or fax is treated by each state. If the state requires registration for such activities, then, the charity should do the same for email activity.

Cause Marketing Via The Internet

For those individuals and organizations who have certain companies that sell products or services online and donate a portion of the proceeds to your charity, you are also required to register in those states requiring registration provided that the activity is a) substantial and  b.) repeated and ongoing.


If you are utilizing a web platform that does not help market your website in anyway except from a technical or administrative standpoint, this would not be considered to be “professional fundraising”.

10 Common Mistakes Celebrities Make When They Engage In Philanthropy

Kent Seton - Tuesday, April 03, 2012
1. In lieu of receiving direct payment for services in making appearances, they will ask the payor to pay the “compensation” to their charity. This triggers a concept known as the “assignment of income” doctrine, resulting in tax the celebrity and ultimately less money to the celebrity charity.
2. Celebrities that are not entirely funding their own 501c3 organization but are generating funds from the general public make the mistake of calling it a “foundation’” which it is not; a private foundation is for high net worth folks who solely fund the 501c3. This is a misnomer and leads the public to believe that the foundation is full funded thereby creating the false impression of a rich organization and spurning fundraising efforts which further frustrates the celebrity.
3. The celebrities will form their own 501c3 nonprofit corporation and many times this is simply an administrative burden which becomes costly, frustrating and fruitless and leads to more problems and less solutions. Each celebrity should carefully about how to engage in philanthropy including “donating time, likeness, image, name” etc or to utilize a donor advised fund or a fiscal sponsor or to create their own entity or to just utilize a for profit.
4. Hiring family members to help run the charity or to sit on the board of directors.
5. Not being more careful about the campaigns they are endorsing. Do research. One slip up can be very costly in terms of sponsorship and goodwill for the celebrity.
6. They don’t donate time, thereby a less purposeful connection is made which means not as much fulfillment and happiness from the connection.
7. Not teaming up more with existing charities and other celebrities to create awareness for their passion on philanthropy.
8. Not utilizing the strategies of social media in such a way that create the type of “mark” and ability to be an influencer
9. Not leveraging their existing relationships to donate their time, money and energy
10. Not engaging in philanthropy at all. It is a shame individually and for the benefit of goodwill, and, their celebrity’s own happiness to engage in any philanthropy; almost a crying shame.