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BACKGROUND
BASIC CONCEPTS
1. “Nonprofit”=state law concept
a. Means that org abides by the nondistributional constraint
i. All profits must go toward the exempt charitable purposes of the org, cannot
inure to those in control of the organization
ii. Dividing line between nonprofits and for-profits
b. But nonprofit orgs CAN MAKE A PROFITconstraint is about where this profit goes,
must be reinvested and put toward exempt purposes rather than inuring to insiders or
shareholders.
2. “Tax-exempt”=federal law concept
a. Exempt from federal tax; but not totally, i.e., UBIT
b. §§ 501(a), (c)
c. 501(c) means both tax exempt AND tax deductible.
3. Sources of Funding
a. Fees for services
b. Government grants
c. Donations/private philanthropy
d. Investment income/endowments
e. Membership fees/dues
f. Income from “related” activities

LAWYER ROLES
1. Classic lawyer role
2. Ensure operations within legal compliance
3. Training, teaching, and creating informed client
4. Audits

LAWYERING
1. Board members don't have a how-to manual about board responsibilities.
2. Lawyers can write this. After writing it, there must be a training.
3. Strategic plans should have benchmarks.

ADVISING
1. Business plan
a. Purpose/mission
b. Goals
c. Funding
i. Earned – operations
ii. Unearned – contributions
d. Customers
i. End users
ii. Donors
iii. Public/Atty General
e. Type of structure
i. Corp
ii. Trust;
iii. Association
f. Governance
g. Management
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h. Programming
i. Marketing

  Association (most Corporation (hybrid) Trust (least

flexible) flexible)
Choice of Entity Easy; cheap; flexible Familiarity; flexible Inflexible
Jurisdiction Limited to locality where 1. Must register as corporation; Civil courts
formed. AND
2. Qualify as tax-exempt with a
state's Tax Board.
Law of Internal affairs of state of
incorporation governs.
Tax Can qualify as (c)(3) org. Regulatory  
Liability All members are liable. Limited liability Trustee is
personally liable
Governance Informal; chaotic. Board of Directors (prefer odd numbers  
and staggered terms). Directors can
change mission of corporation.
Funding membership 1. Earned; and/or  
2. Contributed.

2 CATEGORIES
1. Public Serving
a. Exists to further the goals of the public in general.
b. 501c3, c4, political orgs, 527, etc.
c. Can have members, but primary purpose not to benefit those members, i.e., Moma
i. Members have no ownership interest
ii. Members don’t have much of a voice, board manages
d. Upon dissolution, assets must go to another charitable purpose, cannot go to members
2. Mutual benefit/member serving
a. Groups with economic or social nexus
i. Rationale for exemption: pool resources to do together what they would have
done alonewhy tax simply because they got together?
b. Exist to benefit members
c. 501c7, c6
d. Presence of members not dispositive.
e. May have an economic interest upon dissolutionassets may go to members
3. Third category: Religious organizations, including “churches”
a. Generally considered to be public serving, yet operate for the benefit of members

EXEMPT PURPOSES UNDER § 501(C)

1. 501(c)(3)
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a. Purposes: Religious, charitable, scientific, testing for public safety, literary, educational,
foster national or int’l amateur sports competition, prevention of cruelty to children or
animals
i. These are all public charities
b. Benefits of 501(c)(3) status:
i. Donors receive highest deductioneases the burdens of fundraising
ii. Tax benefits
1. Exemption from fed tax
2. Exemption from state and local taxes
iii. Postal rate reduction
iv. Tax-exempt bonds/Low interest rates
v. No shareholder scrutiny and IRS lack of enforcement power
vi. Halo effect to encourage donations
vii. Consumer might trust org moreless incentive to raise price, cut quality
(contract failure)
viii. If public serving, assets cannot go to members upon dissolution
c. Cons of 501(c)(3) status:
i. Absolute prohibition on political campaign intervention
ii. Limits on lobbying expenditures
iii. No private inurement or private benefit
iv. Activities cannot be illegal or against public policy
v. Purposes must fit definition of charitable
vi. Makes it harder to raise capital
1. Contrast to for profits where you can sell equity to investors
vii. Can’t reap personal benefits
viii. Lack of profit motive might mean reduced efficiency
ix. Subject to more regulation
d. Nonprofits can operate very similarly to for profits
i. Compensation to managers/employees can be on par to for profits
1. There just might be more scrutiny re: whether amt is reasonable
ii. NPO can charge fees comparable to for-profits
iii. NPOs not obligated to help the poor in need.
2. 501(c)(4)
a. Social welfare orgs—public service orgs, civic leagues
b. Similar purposes to 501c3
c. Differences
i. No lobbying limit
ii. Donors can’t get 170 deduction
3. 501(c)(5)-labor, agricultural, horticultural
4. 501(c)(6)-business leagues, chambers of commerce, real estate boards, boards of trade,
professional football leagues.
5. 501(c)(7)-social clubs (recreational)
6. Overall U.S. Policy re: exemption
a. Allow broad range to qualify for exemption the use laws to ensure that orgs remain
public

ROLE OF THE TAX SYSTEM

1. Support via tax relief
2. Equity
3. Regulatory
4. Border patrol
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THEORIES OF EXEMPTION
1. Public benefit/traditional subsidy theory
a. Relieves the burdens of government by providing goods or services that indivuals may be
unwilling to pay for, providing a community benefit
b. Financial support in the form of exemption
2. Quid pro quo theory
a. Secondary community benefits of NPOs—pluralism, innovators, efficient
3. Tax favors
a. Encourage inherently meritorious activities
4. Income measurement theory
a. NPOs not the proper target of income taxation
5. Capital subsidy theory
a. Contract failure-NPOs typically arise as the most efficient providers of goods and
services where consumers have difficulty evaluating the quantity and quality of the
product or service
i. NPOs work best where consumer is unable to locate best bargain or unable to
enforce the bargainconsumers trust NPOs more.
ii. NPOs lack incentive to raise price and cut quality
iii. Producer as a fiduciary vis a vis consumers.
b. Exemption=compensation
6. Rewarding altruism
7. Donative theory
a. Exemption helps to overcome lack of funding
8. Pluralism

ORGANIZATION UNDER STATE LAW

THE PURPOSES OF A NONPROFIT ORGANIZATION MUST QUALIFY FOR EXEMPTION UNDER BOTH STATE
AND FEDERAL LAW.
1. Harder to qualify at the federal level than the state level.
2. Draft purposes as BROADLY as possible to allow for maximum flexibility

N.Y. STATE LAW

3. N.Y. Not for Profit Law § 201
a. Type A, B, C, D
b. Try to get as Type Bmost preferred, similar to 501(c)(3)
c. Alternative: RMNCA 17.07
4. N.Y. Not for Profit Law § 404
a. Sometimes of organizations require state approval

STEPS TO ORGANIZE
1. Make sure purposes qualify under state (NY 201) and federal (501c3) law
2. Inform founders of restrictions on 501c3 orgs, i.e., limited lobbying
3. Select state of incorporation
4. Pick name
5. Draft articles of incorporate/charter
6. Obtain consents for certain orgs (NY 404)
7. File articles of incorporation with the state
8. Draft bylaws and appoint directors
9. Apply for tax-exempt status (Form 1023)
10. File with Attorney General for state tax exemptions
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11. Annual filings (i.e., Form 990)

SUMMARY: 7 REQUIREMENTS OF A 501(C)(3)

FORM
1. Charitable trust
2. Unincorporated association
3. Nonprofit corporation

ORGANIZED AND OPERATED EXCLUSIVELY FOR EXEMPT PURPOSES

1. Exempt Purposes
a. Traditional exempt purposes-religious, charitable, scientific, testing for public safety,
literary, educational, fostering national or int’l amateur sports competition, prevention of
cruelty to children or animals
i. Traditional purposesrebuttable presumption of public charity, no altruism
required
b. If not traditional charity, courts examine whether rational persons might reasonably
believe that public advantage might accrue, altruism required.
2. Organizational test – satisfaction depends on properly drafted organizational docs
3. Operational test -- “exclusively”= “primarily”
a. Test is not met only if more than an insubstantial amount of activities is not in
furtherance of charitable purposes
4. *Must pass both organizational and operational tests in order to qualify for exemption

NO PRIVATE INUREMENT
1. No part of the net earnings may inure to the benefit of any private shareholder or individual
a. Private inurement is the substantive dividing line b/t NPs and for-profits
2. Concern to prevent inurement to someone who controls the org; purpose to keep a public-benefit
org benefiting the public

NO SUBSTANTIAL POLITICAL ACTIVITY

1. No substantial part of org can carry on political activity, or try to influence legislation, except as
provided in subsection h
a. Lobbying is okay, as long as it isn’t substantial
i. Substantial part test
1. Penalty=loss of exemption + § 4912 taxes
ii. 501(h) election
1. Penalty=§ 4911 intermediate sanctions/taxes
2. Absolute prohibition on political campaigning
a. Penalty= 4955 excise tax
3. Alternative=501(c)(4) org
a. Unlimited lobbying
b. Less than 50% devoted to political campaign activity

CHARITABLE CLASS (non-statutorysee Regs)

1. Scope of benefited class must be PUBLIC (rather than private).
2. Class must be indeterminable to ensure public benefit vs. private benefit.

FUNDAMENTAL PUBLIC POLICY REQUIREMENT

3. No part of purposes may be illegal or violate fundamental public policy (Bob Jones)
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a. Not organized and operated for exempt purposes if purpose of org violates public policy.
4. Stems from common law definition of “charitable” as defined by IRS and courts.
5. Broader concept of charity implies a public benefit
a. No public benefit if illegal purposes or contrary to public policy.

FORMS OF NONPROFITS
“CORPORATIONS, AND ANY COMMUNITY CHEST, FUND, OR FOUNDATION.”

CHARITABLE TRUSTS
1. Trustees have fiduciary relationship with respect to property management for the benefit of the
beneficiaries
a. Higher standard than corporate directors
2. Different from private trusts
a. Beneficiary=community, enforceable by AG
b. Assets must be irrevocably dedicated to the charitable purpose (even upon dissolution)
3. Advantages
a. Ease and swiftness of formation
b. Easier/less expensive to administer
c. Control by grantor
4. Cons
a. High tax rates
b. Liability concernstrustees might be personally liable, best for holding property
5. Trustee can be ONE person, but tradeoff is you give up limited liability.
a. Disadvantage is trustee is personally liable, inflexible, and unfamiliar to the outside
world.

UNINCORPORATED ASS’NS
1. 2 or more persons organized for a common purpose
2. Off the radarno reporting requirements
3. Dissolutioneach member gets pro rata share
4. Pros: informality and flexibility
5. But cons outweigh the benefits
a. Members are personally liable
b. Can’t hold property
c. Prob not good for donations
d. Agency law applies

NONPROFIT CORPORATIONS
1. Predominant form in U.S.
2. Hallmark=nondistributional constraint
3. Creatures of STATE law
4. Formalities, yet flexible internal governance
5. Indefinite existence
6. Limited liability
7. Centralized management
8. Different from a for-profit corporation because AG can sue if there’s diversion of assets from
charitable purpose
9. Advantages include fundraising experience, etc.
10. Corporations can have a single member. It can even be a trust (hybrid structure). Trust can have
right to ratify Board resolutions.
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a. Corporation Boards can have different classes of Board members

NONPROFIT CORPORATION BOARD ROLE

FISCAL AGENT RELATIONSHIPS

1. Unincorporated ass’n can find a larger organization with similar purpose and bootstrap itself on.
Fiscal agent as a conduit for group
2. Fiscal agents collect taxes and contributions for group
3. Donors give money to fiscal agentfiscal agent gives moneys to group
4. Proceeds on the understanding that fiscal agent will give to group
a. Group pays fiscal agent a fee
b. Fiscal agent has dominion and control of money, can’t force them to give to group
5. Advantages
a. Avoids the time and expense of incorporating and seeking exemption
b. Donors more comfortable giving to an established organization, will get deduction for
their contribution
6. Limits: can’t do this if budget greater than 5k/yr

ORGANIZED AND OPERATED EXCLUSIVELY FOR EXEMPT PURPOSES

EXEMPT/CHARITABLE PURPOSES
1. 501c3s must be organized and operated for 1 or more exempt purposes
2. Traditional categories/per se exempt/explicitly listed in 501c3:
a. Religious, charitable, scientific, testing for public safety, literary, educational, fostering
national or int’l amateur sports competition, prevention of cruelty to children or animals
3. If activity falls under a traditional exempt category, the org gets a rebuttable presumption that it’s
valid and altruism is not required.
a. If not a traditional category, courts will examine whether rational persons in general
might reasonable believe that public advantages might accrue. Altruism is required.
4. “Charitable” is the broadest category
a. Not used in its ordinary sense (relief to the poor)
i. There is no redistributive requirement.
b. Legal definition-a function to promote the general welfare that does not violate public
policy
c. Congress has never defined charitable but regs (1.501c3-1d2) construe the term
expansively:
i. Relief to the poor and distressed, social welfare, advancement of religion,
education and science, health, public buildings/monuments/works, lessening
burdens of govt, promotion of social welfare, lessening neighborhood tensions,
eliminating discrimination, civil rights, juvenile delinquency, some advocacy
orgs
d. Evolving conceptmeaning changes over time
5. Who polices purpose?
a. State attorneys general and IRS
b. IRS more likely to look closely at purposes

ORGANIZATIONAL TEST
1. Enumerated purposes in properly drafted articles of incorporation
2. Best practice is to have a dissolution provision
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a. But no dissolution provision is not fatal, can be filled in by state law

OPERATIONAL TEST
1. Focuses on the activities of the organization
2. Org must be operated exclusively for exempt purposes, but this really means PRIMARILY for
exempt purposes (regs)
3. Bob Jones University
a. 501c3 can’t engage in illegal activities or activities that violate fundamental public
policy.
b. In BJ, SCOTUS imbues the IRS with the power to police the policy border.
i. However, IRS doesn’t like to police that line.

DISSOLUTION AND DISTRIBUTION OF ASSETS

DISSOLUTION AND DISTRIBUTION OF ASSETS
1. Best to determine this at the outset, in the organizing documents.
2. Pioneer Rule:
a. Public benefit organizations must transfer their assets upon dissolution to charitable or
similar uses
b. Mutual benefit organizations may distribute their assets to members upon dissolution or
in accordance with such other plan provided for in the articles or bylaws
3. Dissolution of Trusts
a. State purposes broadly or include variance clause
b. Cy presupon dissolution assets must go to purposes as near as possible
4. Dissolution of Unincorporated Associations and Fiscal Agent Relationships
a. UAmembers get pro rata share
b. FAassets will probably go to fiscal agent pursuant to contract
5. Dissolution of Corporations
a. Procedure
i. Board resolution
1. Adopt plan
2. Member approval
3. State approval
ii. Notice to creditors, payment of liabilities, distribution of remaining assets
1. Assets must be distributed in accordance with state law
a. Less strict than for trusts
b. Ex.) NY Assets must go to an org engaged in “substantially
similar” activities (Multiple Sclerosis)
iii. File certificate of dissolution with secretary of state
iv. Wind up activities

CHARITABLE TRUSTS—CY PRES AND DEVIATION (THREAT OF DISSOLUTION)

1. Equitable doctrines that apply when:
a. Compliance with trust terms has become impossible or illegal
b. Circumstances have changed such that purposes will not be accomplished.
2. Rationale: the law favors charitable trusts and will do its best to save from failure.
3. Courts are more likely to approve deviation vs. cy pres
a. When issue is arguable, always ask for deviation.
4. Tension: respecting donor intent vs. deadhand control
5. Cy Pres
a. Modification of trust’s PURPOSES and/or BENEFICIARIES
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b. Charitable purpose becomes—impossible, inexpedient, impracticable of fulfillment,

already accomplished.
c. Standard for dissolution more stringent than for corporations (as nears possible vs.
substantially similar [NY])
d. Courts will generally permit only when frustration is great and change is small
i. Ineffective or inefficient philanthropy doesn’t count.
ii. Purpose must have CEASED.
e. 3 part test:
i. Valid charitable trust
ii. Settlor’s specific charitable obligation frustrated, necessitating cy pres to carry
out settlor’s wishes
iii. Settlor’s general intent not restricted to precise purpose in trust instrument
1. Implicitly consents to change
f. Reasons to apply:
i. Insufficient funds to accomplish purpose
ii. Avoidance of unconstitutional or illegal conditions
iii. Legatee refuses gift subject to restriction/strict impossibility not required (Cerio)
g. Inefficiency or waste is not a reason to apply cy pres (Buck Trust, Hershey Trust)
i. Some legislative responses to this issue, but not widely adopted.
h. Overall, courts will strictly adhere to donor intent
i. Donor should put in provisions that deal with what happens if things change,
variance clause, procedural clause.
6. Deviation
a. Modification of a trust’s administrative, procedural, or distributive provisions
b. Compliance impossible or illegal; change circumstances frustrate purpose
c. Barnes Foundation-successful deviation suit by trustees
i. Art subject to many restrictions, runs out of money
ii. Court authorizes move to Philadelphia to increase public access.
iii. Barnes’ primary mission—education—will be preserved, even with relocation
iv. Good lawyering to frame this as deviation
v. Quincy-trust for education of Quincy girls; insufficient funds; court allows
admission of non-Quincy girls
vi. Cy pres not applicable—purpose not yet impossible and change allows purpose
to remain intact.
d. Ex.)Changing investment vehicle to generate funds for org

PRIVATE INUREMENT, PRIVATE BENEFIT, EXCESS BENEFIT

PRIVATE INUREMENT
1. Private inurement is only about INSIDERS
a. Founders, directors, people in general position to influence financial affairs of org
b. UCC-outsourced fundraisers are not insiders; no PI issue.
2. Operational test: org must be operated primarily for public rather than private interests
3. Dividing line between nonprofits and for-profits
4. Pre-4958: Absolute prohibition against private inurement
a. Subject to hair trigger: $1 is inurement
b. Result: loss of exemption
c. Punished the wrong parties—org, beneficiaries, donors
d. Rarely invoked because of draconian result
e. Result: most private inurement goes unpunished
f. Scientology-court revoked exemption, IRS reinstated
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PRIVATE BENEFIT
1. Different from private inurement.
2. This is about when persons, other than insiders, receive more than an incidental private benefit.
Benefit goes to “outsider.”
3. 1.501c3-1d1ii says it is necessary for organization to establish that it is not organized or operated
for benefit of private interests such as designated individuals, creator or his family, shareholders
of organization, or persons controlled, directly or indirectly, by such private interests.

EXCESS BENEFIT TRANSACTIONS (§ 4958)

1. Intermediate sanction on perpetrators and knowing managers.
a. Ultimate sanction reserved for most egregious cases (not even applied in Caracci),
determined by facts and circumstances (Reg. 1.501c3-1f2ii):
i. Size and scope of regular and ongoing activities that further exempt purposes
before and after the EBT occurred.
ii. Size and scope of EBT in relation to the size and scope of the org’s regular and
ongoing activities that further exempt purposes
iii. Repeated EBTs?
iv. Safeguards?
v. Correction?
2. Excessive Benefit Transaction (§4958(c)(1)(A))
a. Economic benefit to DQP from org>value of consideration received for providing such
benefit
i. Excessive Compensation
ii. Transaction between DQP and NPO that unduly benefits DQP, i.e., lease, loan,
sale
3. Order of Operations:
a. Do we have an applicable tax-exempt organization?
i. 4958 applies only to public charities—501c3, 501c4
ii. Doesn’t apply to:
1. Private foundations
2. State universities that are government instrumentalitiesstates can
decide what to do with their money
iii. Is the org required to file? Churches not required to report, so may slip past the
radar
b. Are there DQPs?
i. Types of DQPs
1. Statutory DQP
a. Substantial influence
b. Family members
c. 35% controlled entity
2. Deemed DQP (exercises substantial influence)
a. Board members
b. Officers
c. Any other capacity to exercise substantial control
3. Deemed Non-DQP
a. Other 501c3 orgs
b. Employees that are not highly compensated—no subs influence
4. Factors indicating DQP
a. Founder
b. Substantial contributor
c. Revenue-based compensation
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d. Authority to control or determinate a significant portion

e. Manages a discrete and significant segment of org
5. Factors indicating non-DQP
a. Bona fide vow of poverty for org
b. Independent contractor (attny, accountant, investment advisor)
c. Direct supervisor not a DQP
d. No substantial influence
ii. Does initial contract exception apply?
1. Only applies if compensation is fixed
2. Automatically not a DQP with respect to initial contract, but possible
problem for renewal.
iii. Even if no DQPs, there still might be a private benefit issue
c. Is there an EBT?
i. Is it a compensation issue? Question of fact.
1. Reimbursement of travel expenses to attend a board meeting is
disregarded as an economic benefit for purposes of 4958.
a. But payment of spouse expenses might be compensation to DQP,
not the best idea to do this.
2. Include money from controlled entities
a. Ex.)University employee + alumni ass’n
3. Did org pre-designate as compensation?
a. If yes, proceed
b. If no, automatic EBT
4. Is payment fixed or discretionary?
a. If discretionary, no rebuttable presumption available
b. If fixed, org may have gotten rebuttable presumption of
reasonableness.
5. Is payment revenue-based?
a. If yes, 4958c4 says that revenue-based comp is an EBT under
regs prescribed by the Secretary
i. But there are no regs!
ii. Result: treated same as non-revenue based compensation
b. If no, proceed.
6. Does org have a rebuttable presumption of reasonableness?
a. Terms approved in advance by disinterested board or committee?
b. Did board use comparability data?
i. Look at similar orgs
ii. Look at qualifications
iii. Look at job description
iv. *What’s required is unclear, so best to cover your basis
1. Might be best to get a compensation consultant,
although expensive so hard for smaller orgs
c. Did board document basis for determination?
ii. Is it non-compensation excess benefit transaction?
1. Did board get a reasoned opinion of counsel saying this was not an EBT
before engaging in the transaction?
d. If there are DQPs/EBT, assess applicable penalty
i. Only the excessive part of the transaction is subject to penalties.
ii. Initial Penalties
1. DQP must pay 25% of EBT (only excess part)
2. Knowing manager must pay 10%
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a. Unless can show participation not willful and due to reasonable

cause
iii. Correction
iv. If no correction, second tier penalties200% on DQP
v. IRS may also abate the penalty
vi. Ultimate sanction is always looming in the background, but probably won’t be
applied (Caracci)

PRIVATE BENEFIT
1. Can apply to ANYBODY, not limited to insiders
2. De minimis exceptions—not subject to hair trigger
3. Penalty=loss of exemption
a. No intermediate sanctions
b. May be imposed if org no longer operating primarily for exempt public purposes
4. UCC-Posner suggests possibility of private benefit issue due to outside fundraiser’s K with
nonprofit that contained excessive favorable terms.

JOINT VENTURES
Nonprofit’s participation in a joint venture does not necessarily mean loss of exemption. Two-part test to
determine if joint venture should result in loss of exemption of nonprofit:
1. Does charity’s participation in joint venture further its exempt purpose?
2. Does legal structure of joint venture permit charity to operate exclusively for exempt purpose and
not for an impermissible private benefit?
If either answer is “no,” then exemption is denied.

Some types could be:

1. Parent-subsidiary
a. Parent is a c3 exempt organization. Parent receives passive dividends.
i. Dividends are nontaxable.
b. Subsidiary is taxable. Subsidiary would pay tax.
c. But subsidiary can pay to parent through:
i. Rent;
ii. Management fees.
d. But if the subsidiary shifts a deductible amount to a parent, IRS will investigate.
2. Subsidiary-parent
a. Parent is a for-profit corporation.
i. Parents feeds money to non-profit, but parent can only deduct 10%.
ii. Parent can try to pay sub's rent and try to deduct it.
b. Subsidiary is non-profit.
i. Every corporation's foundations is a private foundation.
1. Recall, a private foundation is any 501c3 unless 509(a)(1), (2), or (3)
apply. In this case, (1)-(3) don't apply to a corporation's foundation.
ii. This relationship is free of "insider" inurement. It is considered self-dealing.
c. A transaction between for-profit and its nonprofit foundation cannot occur if there is a
disqualified person, except for fair/reasonable compensation.
3. Brother-sister
a. One is a corporation, the other is a c3. both controlled by same people.
b. Say, c3 engages in research, with 5 board members. Say, corp has 5 on board. 4
members serve on both boards.
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TYPES OF EXEMPT ORGANIZATIONS

EDUCATIONAL ORGANIZATIONS
1. Definition
a. For the advancement of education
b. For the instruction or training of the individual for the purpose of improving/developing
capabilities
c. Instruction of the public on subjects useful to individuals and beneficial to the community
2. Types of educational institutionsBROAD
a. Regular/traditional schools (170b1Aii)
i. Regular faculty, regular student body
b. Public discussion groups
c. Cultural institutions
d. Limits:
i. Animal training schools are NOT educational
ii. Orgs that engage in activities contrary to public policy or illegal are not
educational
1. Ex.)Passivism org that engages in civil disobedience not exempt because
encourages violation of local ordinances (Rev. Rul. 75-384)
e. Advocacy groups
i. FFE
ii. Methodology
f. Hate groups

RELIGIOUS ORGANIZATIONS
1. Churches vs. regular religious organizations
a. Both tests fuzzy
b. IRS doesn’t like to police this area
c. Church at least has factor test (Rev. Rul. 59-129)
d. Church as preferred category
i. Presumption of PC
ii. Exempt from filing reqs
iii. Higher level of deductions
iv. Harder to audit
v. Less state regulation
2. Exemption from state property tax (Walz)
3. Test of religiosity (Holy Spirit Ass’n)
a. Courts will not inquire into the content of the doctrine, etc.
b. Beliefs must be sincere—in good faith and not a sham

HEALTHCARE ORGANIZATIONS
1. Promotion of health included in def’n of “charitable”
2. Redistributive requirement: healthcare orgs must also provide a community benefi
3. Facts and circumstances test—doesn’t really require comm’ty benefit
a. Governing board
b. Separation
c. Open staff policy
d. Full time emergency room open to all
e. Non-emergency care to all who can pay
4. Resurgence of redistributive req?
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5. Non-traditional health orgs subject to more stringent community benefit test

a. IHC v. Commissioner-HMO not exempt
i. Services must be available to the community
ii. PLUS community benefitsmust be primary purpose
6. Pharmacies-need to have a community benefit
a. Selling goods at a discount is NOT a community benefit

MISCELLANEOUS ORGS
1. Redistribution element required
a. Public interest law firms
b. Community development orgs
c. Low income housing
2. Amateur sports orgs
a. For the advancement of education
3. Promotion of arts and culture
4. Testing for public safety
5. Scientific purposes
6. Prevention of cruelty to animals or children

LIMITS ON LOBBYING AND POLITICAL CAMPAIGN ACTIVITIES

NO SUBSTANTIAL PART OF ITS ACTIVITIES CONSISTS OF CARRYING ON PROPAGANDA OR OTHERWISE
ATTEMPTING TO INFLUENCE LEGISLATION
IRS 501(h) says charities can spend some on lobbying without penalty, with sanctions imposed after a
certain amount.
1. Private foundations are subject to punitive excise taxes for any lobbying.
2. But noncharitable exempt organizations can lobby, as long as germane to their purposes.
What is influencing legislation?
1. Action organizations are NOT ok because they influence legislation. See 1.501c3-1c3
2. Legislation includes actions by lawmaking bodies, not Executive branch or
administrative agencies.
3. If organization's primary objective is obtainable only by changing legislation, it will NOT
get exempt status (it will be an action org)
What is NOT lobbying?
1. Just communicating with members on issues. BUT if exhort members to contact
legislators, that is influencing legislation.
2. Mere research is NOT influencing legislation.
3. Giving expert testimony is NOT lobbying, but an unsolicited appearance before
congressional committee may be lobbying.

1. Substantial Part Test (Default)

a. No one knows the meaning of “substantial”
b. Subjective factor balancing test
i. Expenditures—what % devoted to influencing legislation?
ii. Time, efforts, spent lobbying vs. doing other stuff
iii. Nature of the org
iv. Message—are there calls to action?
v. Intermittent vs. continuous
vi. Controversial
vii. Did org have substantial influence?
 15

viii. 1.501(c)(3)-1(d)(2) says it's OK to advocate social change or take positions on

BROAD public issues.
ix.
c. Failure
i. Action organization
ii. Loss of exemption (no intermediate sanctions)
iii. IRS can impose § 4912 excise tax on top of exemption
1. 4912(a) excise tax:
a. 5% of lobbying expenses and applies to all 501c3 organizations
(but not private foundations).
iv. Cannot convert to 501(c)(4) status, but may reapply as 501(c)(3)
2. 501(h) Expenditure Test (Election)
a. Requires election (Form 5768)
i. Who can elect? Private foundations and churches cannot elect
ii. Valid starting the first day of the calendar yr in which election made
iii. Only 2% of charities have made the election
iv. Elect if:
1. Lobbying controversial or visible
2. Lots of volunteers
3. Member organization
v. Don’t elect if:
1. Small start-up org that can’t afford a lawyer
2. Large org
a. Ceiling amounts phase out at $17 million EPE
b. A substantial part of a large org is big
b. Objective test, detailed and daunting rules, but extremely permissive
c. Enacted in response to the inadequacies of the substantial part test
d. Spending limits:
i. Lobbying nontaxable amount (LNTA) is limited to:
1. 20% of first 500k of exempt purpose expenditures
2. 12% of next 500k
3. 10% of next 500k
4. 5% of excess of 1.5mm
ii. LNTA is capped at 1mm.
iii. Grassroots nontaxable amount (GNTA) is 25% of LNTA. Violating this results
in 25% excise tax. See p. 499 for example.
e. Penalties: § 4911
i. Manny views these penalties as a cost of lobbying rather than a punishment
ii. 4912(a) excise tax:
1. 5% of lobbying expenses and applies to all 501c3 organizations (but not
private foundations).
f. Effect on ability to receive grants? Not really
i. So long as the amount of each single grant can go to general, non-lobbying
purposes, and so long as the grant is not earmarked for lobbying, permissible
ii. This is true even if multiple grants, some of which will necessarily be used for
lobbying.
3. Direct vs. Grassroots Lobbying
a. Direct
i. Communication with any member or employee of a legislative body, or any other
government official/employee who may participate in the formation of the
legislation
 16

ii. Principal purpose of the communication must be to influence legislation

iii. Must refer to specific legislation
iv. Must reflect a view on legislation
v. Note: if referendum (public vote), public can become a legislative body
vi. Attempting to influence legislators or gov't official, with principal purpose of
changing legislation. See 4911(d)(1)(B).
vii. Must refer to specific legislation.

b. Grassroots
i. Refer to specific legislation
ii. Reflects a view on legislation
iii. Call to action
1. Strong call to action-communications that directly encourage action
2. Weak call to actionmerely encourages actionspecifically identifies
one or more legislators who will vote on the legislation
3. Distinction matters for purposes of:
a. Member communications
b. Distribution of research analysis
c. Otherwise, a call to action is a call to action and better to use a
strong call to action to get more bang for your buck.
c. Mass Media Rule-GRL, even if no call to action
i. Within 2 weeks of vote by a legislative body
ii. Highly publicized piece of legislation
iii. Communication reflects a view
iv. Refers to legislation or encourages members of the public to communicate with
their legislators on the general subject matter of the legislation.
v. Rebuttable if org can demonstrate communication is a type regularly made by the
org in the mass media without regard to timing of the legislation.
4. Excepted communications
a. The following are not influencing legislation:
i. Making available results of nonpartisan analysis;
ii. Discussion of broad social problems;
iii. Technical advice (on request of gov't body);
iv. Self-defense
v. Member communications
1. Must be a bona fide member with
2. More than a nominal connection with org (helpful to have paying
member).
5. § 4911
a. Exceptions (4911(d)(2))
i. Nonpartisan analysis, study, research
ii. Providing advice where invited to do so
iii. Appearances or communications re: matter that might affect the existence of the
organization (self-defense exception)
iv. Communications between org and its bona fide members with respect to
legislation or proposed legislation of direct interest to the org and members, other
than as provided in 4911d3
1. D3A-directly encourages members to directly lobby
2. D3B-direcly encourages members to engage in GRL
v. Communications with non-legislative branch government
b. Order of operations
 17

i. Eligible organization?
1. 501h4-public charities are eligible
2. 501h5-disqualified orgschurches, PFs
ii. Determine exempt purpose expenditures (EPE) (§ 4911(e)(1))
iii. Calculate maximum nontaxable amounts
1. LNTA
2. GNTA
iv. Calculate excise taxesdo overall grassroots lobbying exceed the LNTA or
GNTA?
1. Affiliated org expenditures are pooled
v. Ultimate sanction? Imposed if LCA or GCA exceeded “normally” (4 yr period)

POLITICAL CAMPAIGN LIMITATIONS

Rev. Rul. 2007-41
A. 501c3 says you can't participate in political campaign
B. 1.501c3 says an action org (an org that can't get nonexempt status) if it participates in
political campaign on behalf of a candidate for public office.
C. Whether an org is participating in political campaign depends on facts and circumstances
a. Providing a forum for debates/educations is OK;
i. But if showed bias, it is not OK (biased questions, etc.
D. Situations
a. Booth at a state fair; no mention of candidates. NOT engaged.
b. Org sets up phone bank for candidate C. If voter appears to agree with C, org
will remind voter about election. ENGAGED.
c. Candidates pays for ad, naming CEO of Hospital. Candidate pays for ad and
CEO's endorsement is in his personal capacity. NOT engaged.
d. President of University says in alumni newsletter his personal opinion candidate
be reelected. ENGAGED, even if President pays for newsletter (it is official
publication).
e. Minister of church says candidate should be reelected at an off-church, unrelated
site. NOT engaged.
f. Chairman of org said candidate should be elected. Statements made during
official org meeting. ENGAGED.
 
Candidate appearances
Factors to consider when candidate appears at org event:
1. Does org provide equal opporunity to other candidates
2. Does org indicate support or opposition;
3. Does political fundraising occur.
Factors to considers when many candidates speak at a forum:
1. Are questions prepared/presented by independent nonpartisan panel;
2. Will candidates talk about broad public topics;
3. Is each candidate given equal chance to speak;
4. Are candidates asked to agree/disagree on platform of org;
5. Does moderator imply approval/disapproval of candidates
6. President of org invites candidates to speak. His announcement doesn't
mention qualification or preferences. NOT engaged.
7. Same as above, except one candidate declines invitation. President says
candidate declined. NOT engaged.
8. Minister invites only one candidate and the candidate asks voters to
come out to vote. This was at official church event. ENGAGED.
 18

 
Candidates appearing as non-candidates.
Factors to consider:
1. Why he is speaking;
2. Does he speak in noncandidate capacity;
3. Does he make mention of his candidacy;
4. Does campaign activity occur in connection with candidate's attendance;
5. Does organization maintain nonpartisan atmosphere;
6. Does org indicate he is appearing in his individual capacity;

DOES NOT PARTICIPATE OR INTERVENE IN ANY POLITICAL CAMPAIGN ON BEHALF OF OR IN

OPPOSITION TO ANY CANDIDATE FOR PUBLIC OFFICE.
1. Absolute prohibition
a. Penalty=revocation of exemption
b. IRS tends to ignore de minimis violations
2. Candidate
a. Individuals offering themselves or proposed by others for national, state, or local elective
public office.
i. Intention to run is key
3. Attributable to a 501(c)(3) org
a. Not expressing himself in individual capacity; IRS doesn’t intend to limit free expression
4. Participation in a political campaign activityFactor Test (Rev. Rul. 2007-41)
a. Voter education, voter registration, get out the vote drives
b. Activity by organization leaders
i. Individual capacity
ii. Organizational capacity
c. Candidate appearances
d. Candidate appearances where speaking or participating as a non-candidate
e. Issue advocacy vs. political campaign intervention
f. Business activities
g. Websites
h. Providing use of assets, i.e., mailing list
i. Must be done on an equal basis to all candidates for regular price, must usually
rent out mailing list.
5. Penalty: § 4955 Excise Tax
a. Initial tax, opportunity for correction, secondary tax
b. Tax on knowing managers
c. Can be imposed in lieu of or in addition to revocation
6. § 501(c)(4) affiliate alternative (Regan)
a. Unlimited lobbying, significant political campaign activities
b. 501c3 will create and control
i. 501c3 can’t have a political action committee
c. 501c3 can make grant to 501c4 for lobbying (hiring c4 to lobby)
i. Will count as c3’s lobbying expenditures
d. Can work together, share all resources
e. Separate bank accountants
f. Contributions made to c4 not deductible
g. Upon dissolution, c3 assets may not go to c4
h. Can also add 527 org
i. Can’t provide mailing list for free—must charge market rate
 19

j. Strategy: do as much lobbying as possible with c3, continue excess with c4

i. Allows org to take maximum advantage of tax deductible contributions
k. If a c3 org can't meet its objective or if fails substantial part test or 501(h) expenditure
test, it can form a related 501(c)(4) entity. It gives tax-exempt status for orgs promoted
for social welfare. But contributions are NOT tax deductible.
l. Social welfare is defined as (rev. rul. 71-530):
i. Can qualify if primarily engaged in social welfare, even if the org is an action
org.
ii. Action org has 2 characteristics:
1. Main purpose attained only through legislation (or defeat of legislation);
and
2. It advocates, campaigns for attainment of such objective.
m. Assisting legislators by presenting expert witnesses, though advocating changing of law,
still promotes social welfare.

PRIVATE FOUNDATIONS
BACKGROUND
1. A fund of private wealth established for charitable purposes, often in perpetuity
2. Most foundations are principally grantmaking in nature (non-operating)
3. Pros
a. Greater individual control over spending, investment
b. Ability to provide for your family—endowment/perpetuity
c. Naming conventions
4. Cons
a. Don’t get best 170 deduction
b. 2% excise tax on net investment income, including capital gains
c. Tougher restrictions/penalties on self-dealing, etc.
d. No intermediate sanctions for private inurement—just loss of exemption
e. Tougher reporting and disclosure requirements
f. Administration costs
5. Donation options
a. Donate money to a public charity, ask them to use your money to this end
b. Set up your own private foundation
c. Create a supporting organization
d. Donor advised fund.
6. Types of Foundations
a. Independent
i. Usually established by contributions from individual or family
b. Corporate
i. Established by corporation but legally separate entity.
ii. Receive portion of profits annually
c. Community
i. Mutliple donors
ii. Technically classified as public charity, so must meet public support test
d. Operating
i. Runs its own programs and funds them
7. The 3 exceptions:
a. Public charity
i. Mechanical test; or
ii. Facts and circumstances test
 20

b. Publicly supported organization

i. Test:
1. Public support test; and
2. Investment income test
a. Total investment income < 1/3 of total support
c. Supporting organization
i. Purpose test; and
1. Must benefit or carry purpose of supported organization
ii. Control test
1. Supported organization must control supporting organization.

GRANT-MAKING CRITERION
A. Core Grant Criteria
a. Must be adopted by Board
b. Can later change but must follow the procedures laid out therein.
B. Founding Statements (comes from Mission statement)
a. Usually comes from Founder's wishes
b. Reflects Founder's core values
C. Grant criteria
a. Must list minimum size
b. Must list requirements of the receiving organization
c. Must list how funds are to be used
d. Must list grant agreement and conditions
D. Grant allocation
a. How much and when will foundation give money?
E. Following-up
a. Org must report on how money is spent in order to receive future grants

PRIVATE OPERATING FOUNDATION

1. Conduct own charitable programs. Definition in sec 4929(j)(3)
2. Advantages:
a. More favored tax treatment for donations
b. 50% limit of AGI
3. Tests:
a. Income test: must use substantially income for charitable purpose (at least 85%)
AND
i. Assets test: 65% of assets used for active conduct of foundation exempt
function; or
ii. Endowment test: must expend funds for exempt purposes in amount of
at least 3.5% of FMV; or
iii. Support test: at least 85% from public
4. Support test: at least 85% public support AND 5 or more exempt organizations
5. Excise taxes on:
a. Investment income - 2% on investment income
b. Self dealing -- 10% penalty (on amt of transaction)
c. Minimum distribution requirements -- must make 5% of FMV distributions, or
30% penalty of undistributed income.
d. Excess business holding –
e. Jeopardy investments -- 10% penalty if investment that jeopardizes exempt
purposes
 21

f. Taxable expenditures

DONOR ADVISED FUNDS

A. Donor advised funds (4966(d)(2)(A))
a. Definition: fund separately identified by reference to contributions of donor(s).
b. Two types of funds excluded:
i. Fund benefitting designated org or gov't entity;
ii. Where donor offers advice on grants for travel or study
B. Excise taxes
a. 4966(a)(2)
i. 20% on SPORG and 5% on manager for any taxable distributions.
1. Fund managers are officers, directors, trustees, or similar responsibility
ii. Taxable distribution is grant from DAF to (see 4966(c)(1)):
1. Individual
2. Entity other than public charity or gov't mentioned in 170(b)(1)(A) if not
for charitable purpose;
3. Disqualified SO's, unless SPORG has expenditure responsibility.
b. Prohibited benefits:
i. Sec 4967 impose 125% tax on advice leading to more than incidental benefit
from grantee.
ii. Ex: paying college tuition of a donor
C. Other sanctions/penalties
a. Intermediate sanctions
i. Sec 4958 is expanded
1. Any grant, loan, payment of compensation by DAF to donor is subject to
25% excise tax. See 4958(c)(2), (f)(7)
b. Excess business holdings
i. Sec 4943 holds
ii. DAFs have 5 years to divest and another 5 years if DAF can demonstrate
hardship
c. Reporting and disclosure
i. DAFs must require SPORG to state its contemporaneous written gift
acknowledgment. See 170(f)(18)(B).
1. SPORGs must disclose the number of DAFs they administer

SUPPORTING ORG (509(A)(3))

1. See 1.509(a)-4(f)(2) for relationship requirements.
2. Unlike private foundation, most SO's are not required to disposed of excess business holdings,
but donor will give up some control.
3. Relationships
a. SO's may be operated or controlled by, supervised in connection with, or operated in
connection with publicly supported charities. Must be responsive to needs of public
charity.
4. Types
a. Type I - operated supervised or controlled by. Majority of officers, directors, or trustees
must be appointed or elected by governing body or officers of supported org.
b. Type II -- "in connection with." Analogous to brother-sister relationship. Must have
common supervision or control. Control must be vested in same person that controls
public charity.
 22

c. Type III -- "operated in connection with." Most flexible. Must comply with a stated
notification requirement and responsiveness test and integral part test.
5. Organizational test
a. Must look at articles and bylaws. Purpose limited to exempt purposes. Must designated
supported org by name.
b. Operational test
i. Requires supporting orgs engage "solely in activities which support or benefit
publicly supported orgs". 1.509(a)-4(e)(1)
c. Control test
i. See 1.509(a)-4(j)

TYPES OF PUBLIC CHARITIESNOT PRIVATE FOUNDATIONS

1. 509a4-testing for public safety
2. 509a3-supporting organization
a. Purpose test-Organized and operated exclusively for the benefit of, to perform the
functions of, or to carry out the purposes of a PUBLIC CHARITY
b. Control test-Operated, supervised, or controlled by or in connection with one or more
public charities
c. Is not controlled directly or indirectly by one or more DQPs (4946) other than foundation
managers and other than PUBLIC CHARITIES.
3. 509a2-publicly supported org (see below)
a. Normally receives more than 1/3 support from:
i. Gifts grants, contributions, or membership fees, and
ii. Gross receipts from admissions, sales of merchandise, performance of services,
or furnishing of facilities
1. In an activity which is not an unrelated trade or business
2. Not including such receipts from any person, bureau or similar agency of
a governmental unit in any taxable yr to the extent such receipts exceed
the GREATER of $5000 or 1% of the org’s support in such taxable year.
3. From persons other than dQPs
4. From govt units
5. From PUBLIC CHARITIES.
b. Meets the gross receipts/membership test
4. 509a1-org described in 170b1A(i)-(vi)
a. Church
i. Or convention or ass’n of churches
b. A regular school
i. Regular faculty, curriculum, student body, educational activities
c. Providing medical or hospital care or medical education or medical research
i. Medical research must be in conjunction with a hospital
d. Supporting state colleges and universities
e. Govt units
f. Grant reliant publicly supported orgs (see below)
i. Mechanical test
ii. Or facts and circumstances test.

DQP FOR PFS (4946(A)(1))

1. Substantial contributor
2. Foundation managers
 23

3. Owners of substantial contributors

4. Family members
5. Related entities

TESTS TO DETERMINE PUBLIC CHARITY STATUS/AVOID PF STATUS

1. Traditional Public Charities, 509a1/170b1Avi test
a. Mechanical test – 1.170A-9T(f)(2)
i. Public support
1. Includes:
a. Gifts, bequests, grants from general public
i. But only to the extent they don’t exceed 2% of total
support
1. Limit not for govt or public charity grants
ii. Quid pro quo excluded from calculus—only portion that
represents a charitable contribution counts
iii. Includes from DQPs
b. Govt support
c. Membership fees
2. Excluded: investment income, exempt purpose income, unusual grants
ii. Total Support
1. Includes
a. Gifts, grants, bequests from inds or NP orgs
b. Govt support
c. Membership fees
d. Net income from unrelated business activity
e. Gross investment income
2. Excluded: exempt function income, value of donated services, unusual
grants
iii. Testing Period-4 yrs
b. Facts and Circumstances Test
i. Orgs that fail the mechanical test can try to pass this test
ii. Public support must be at least 10%
1. The closer to 1/3, the better
iii. Must be organized and operated so as to attract new and additional support or
govt support on a continuous basis
1. Factors
a. % of financial support
b. Sources of support
c. Representative governing body
d. Availability of public facilities or services and public
participation
e. Additional factors for members orgs
2. Gross Receipts and Membership Test, 509a2
a. Public support test
i. Similar to 509a1 test, but different
1. Includes exempt function income
2. Excludes amounts from DQPs (2% cap in other test)
3. Gross receipts from each person for exempt functions are capped at the
greater of 5k or 1% of org total support
4. Excludes unusual grants
b. Investment income test
 24

i. Investment income and unrelated business cannot normally exceed 1/3 of total
support
3. Analysis
a. Exempt function income included in a2 test, but not a1
b. Orgs that sell things do better under 509a2
c. Orgs that are dependent on board contributions will do better under 509a1
d. Org will never pass 2nd prong of 509a2 if dependent on investment income

TAX ON NET INVESTMENT INCOME - § 4940

1. Imposes 2% on foundation’s net income.
A. Net investment income = (gross investment income + cap gain net income) – related
expenses (sec 4940(c)(1)).
I. Gross investment income includes dividends, interest, rents, royalties, etc. (see
4940(c)(2), (5))
II. Cap gain net income = cap gain – loss from disposition of property used for
production of gross investment income.
III. Can deduct ordinary and necessary expenses for production of gross investment
income (see 53.4940-1(e)).
2. Rate reduction
A. 4940(e) reduces tax rate to 1% if foundation increases qualifying distributions
B. Qual. distributions must equal or exceed sum of:
I. Value of foundation’s assets for year multiplied by average percentage charitable
payout for base period of 5 years; and
II. 1% net investment income.
3. Other rules
A. 4940(e)(3)(C) provides that for any year in base period that tax rate was reduced, the
amount of qualifiying distributions is also reduced by amount of rate reduction
B. Reduction not available if foundation has penalty under 4942 for meeting minimum
payout requirements

FIDUCIARY DUTIES OF PRIVATE FOUNDATIONS

I. INVESTMENT MANAGEMENT
A. Delegation of investment responsibilities
i. Allowed under UPMIFA and R3 Trusts
ii. Delegation is a matter of discretion, and R3 Trusts says to delegate as a prudent
investor would delegate.
iii. Prior to delegation, must define investment objectives
b. Prudent person
i. Applies to trustees for private trusts
ii. Defined by process through which investment strategies and tactics developed,
adopted, implemented, and monitored (ie. defined by how risk is managed)
iii. Factors to consider:
1. Role investment product is to play in entire portfolio;
2. Whether role is designed to serve purposes for which portfolio is being
held, taking into account risk of loss and profit;
3. Competence of fiduciary or delegates to employ product or technique;
4. Reasonableness of terms and conditions of such delegation
c. UPMIFA
i. Applies to charitable institutions
ii. Standard of care is that foundation exercise ordinary business care and prudence
under facts and circumstances. Can consider
 25

1. long and short term needs

2. present and future financial requirements
3. expected total return
4. general economic conditions
iii. Foundation must follow donor’s written intent. See sec 4(c) for construction
rules.
iv. 7% rule:
1. If foundation spends more than 7% of endowment in one year, then
presumed not prudent.
II. RISK MANAGEMENT
a. Leave enough in endowment to preserve purchasing power and keep up with inflation.
b. Pay no more than 35% of operating budget from endowment.
III. ENFORCEMENT OF FIDUCIARY OBLIGATIONS
a. Self-regulation
b. Record keeping and filing requirements
i. Model Act requires keeping corporate records
ii. State filing requirements
iii. Federal requirements
c. Attorney General
i. Power to investigate
ii. Power gather information
iii. Responsible for charitable oversight
d. Trustees/Directors have standing to sue
e. Donors cannot sue
f. Members can sue

SELF DEALING EXCISE TAXES - § 4941

1. More stringent than private inurement restraints on public charities
a. Even if favorable to the PF and made at an arm’s length, transaction may be considered
self dealing
2. 2 types of self-dealing
a. Inurement self dealingshould result in loss of exemption
b. Non-inurement self dealing4941 excise taxes
3. Acts of Self Dealing (4941d1)
a. Sales, exchanges, leases of property
b. Loans
c. Furnishing goods, services, facilities
d. Payment of excessive compensation
e. Transfer of assets
4. Knowledge requirement
a. See 53.4941(a)-1(b)(3)
b. Person participated knowing it was self dealing only if:
i. Actual knowledge;
ii. Aware such act violates tax law; and
iii. Negligently fails to ascertain if it is indeed self dealing
5. Exceptions (4941d2):
a. Provided without charge
b. Compensation is:
i. Reasonable and necessary
 26

ii. Not excessive

iii. No rebuttable presumption available though
iv. Reimbursement to DQP may okay, so long as counted toward compensation
1. Reimbursement for fam members probably not okay—stay away from
this, even though there are ways to do itattribute it as compensation to
DQP
6. Amount involved—determined at date of self-dealing
7. Penalties
a. Initial
i. 10% of transaction on DQP
ii. 5% on knowing managers
b. Second level (if not corrected within specified period)
i. 200% tax on dqp
ii. 50% on manager

CHARITABLE DISTRIBUTION REQUIREMENT - § 4942

1. First level tax is 30% of undistributed income. Second-level is 100% of UI (4942(a),(b))
2. Undistributed income defined in 4942(c) = distributable amount – qualifying distributions
a. Distributable amount = minimum investment return + UBIT (4942(d))
i. minimum investment return = 5% of (FMV of all assets – acquisition
indebtedness). 4942(e)(1).
b. Qualifying distribution (4942(g)(1),(3)) – amount paid to accomplish charitable purpose.
Payments to Type III SO’s do not count (4942(g)(4))
EXCESS BUSINESS HOLDINGS - § 4943
1. Excess business holdings are amount of stock that must be distributed in order to have “permitted
holdings.” 4943(c)(1).
a. Permitted holdings are 20% of corp’s voting stock minus percentage held by DQP.
b. But if effective control resides elsewhere, then it is 35%.
2. Foundation has 90 days to dispose of excess holdings from date of discovery. 53.4943-2(a)(1)(ii)
JEOPARDY INVESTMENTS - §4944
1. First level of tax is 20% (4945(a)(1)). If manager knows, then he pays 5%, up to $10k limit.
Additional sanctions include 100% tax and 50% tax on manager, up to $20k.
2. Types of taxable expenditures
a. Propaganda and lobbying
i. Exceptions:
1. Not actions by executive, judicial, or administrative bodies
2. Nonpartisan analysis, study, or research
3. Providing technical assistance to governmental body
b. Elections and voter reg’n drives
i. Exception
1. Nonpartisan and broadly supported voter registration drives, if carried on
in 5 or more states
c. Grants to individuals
i. Exception
1. Unless grant is a scholarship or fellowship
a. Number of scholarship should not exceed 25% of eligible
applicants (10% of employee’s children in company foundation)
b. Must monitor academic performance
2. Prize or award
3. Achieve specific objective
d. Grants to other orgs
 27

i. Exception
1. Unless “expenditure responsibility” is established (4945(d)(4) and (h))
a. Pregrant inquiry
b. Written agreement
c. Regular reports
d. Report to IRS by grantor
e. Expenditures for noncharitable purposes (catchall, 4945(d)(5))
TAXABLE EXPENDITURES RESTRICTION ON PFS - § 4945
1. Prohibits inappropriate expenditures, even if consistent with PF’s charitable purpose
a. There are ways to get out of tax—follow certain guidelines
2. Types of Taxable Expenditures (4945d)
a. Propaganda or lobbying (influencing legislation)
i. Exceptions: nonpartisan analysis, technical assistance in response to written
request, self defense
b. Elections and voter registration drives
i. 4945(f)-okay if nonpartisan, not one specific election period broadly supported,
more than 5 states
c. Grants to individuals
i. Okay if PF follows 4945g
1. Awarded on objective and non-discriminatory basis, approved in
advance by Secretary
2. Scholarship at a regular school
3. Prize or award if selected from general public
4. Made to achieve specific objective, produce report, improve/enhance
skill
d. Grants to orgs that are not public charities
i. Okay if PF exercises expenditure responsibility under 4945h
1. Pre grant investigation
2. Written agreement
3. Follow up procedures to determine that grant appropriate spent
4. Grantor report to IRS
e. Expenditures for non-charitable purpose (Catchall)
3. Penalties
a. Initial tax-20% on foundation, 5% on knowing manager
b. Secondary tax if no correction-100% on PF, 50% on managers (10k cap)

PF ALTERNATIVES
1. Community foundations
2. Donor advised funds

ENDOWMENTS
A. Endowment
1. It's the reserve that a Foundation has.
2. Types:
a. Unrestricted
i. Controlled by Board
b. Restricted
i. Donor limited
c. Temporarily restricted
i. Conditions under which endowment can (or cannot) be used.
ii.  
 28

3. Another way to look at this would be:

a. Permanent, based on percent of value or fixed dollar earnings amount.
 Can't invade endowment
b. Temporary, based on percent of value or fixed dollar earnings amount.
 Can invade principal only when conditions removed.
c. "Quasi" is board-controlled and decided.

TERMINATION OF PF STATUS
a. Sec 507
i. Can give up PF status
1. Voluntarily; or
2. Through willful repeated acts (507(a)(2)).
ii. Involuntary (507(c),(d))
1. Termination tax is equal to lower of:
a. Aggregate historical tax benefits of exemption to foundation and
substantial contributors, plus interest; OR
b. Value of net assets for foundation.
2. IRS can abate a portion of termination tax if PF gives its assets to public charity
in existence for at least 5 years or corrective action taken (507(g)).
iii. Voluntary
1. PF should transfer assets to one or public charity and operate itself as an org
described in 509(a)(1), (2), or (3).
2. Or can transfer all PF assets to public charity in existence for at least 5 years
(507(b)(1)(1)). Best to give prior notice to IRS.
3. Conversion to public charity or SPORG
a. Give notice to IRS and embark on 5 year qualification period (507(b)(1)
(B)).
4. Abdication
a. Termination of activities. Notify IRS of intention. Assets do not transfer,
so PF must pay termination tax.
b. Notice to IRS must compute the tax penalty and pay it when statement
is filed with IRS.
iv. Why PF would want to terminate activities:
1. Family strife;
2. Change legal form;
3. Simplicity;
4. Change to DAF or SPORG
a. Sunsetting
i. Some foundations are voluntarily sunsetting by a clause in the Articles. To prevent the
Articles from being amended, you can make a membership organization with a
perpetual member that can never die and will always be interested in perpetuating
the founder's wishes.
ii. The member could be another 501c3, specifically a trust. The purpose of the trust is
only to vote on the articles of the corporation. In short, the member should have the
following characteristics:
1. Can't die
2. Vested interest
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3. Inflexible
iii. Reasons for foundation dissolution:
1. Family discord
2. No one left
3. Apathy
4. Different visions
5. Gets too small
b. Voluntary
i. Disperse all the money
ii. Reorganize into public charity, SPORG
iii. Merge into another not-for-profit.
c. Involuntary
d. Non-Taxable terminations
i. See 507(b)
e. Termination tax
i. All the benefits you enjoyed must now be paid to IRS + value of net assets
ii. Includes penalties and interest
iii. Penalties on substantial contributors (507(d)(2)).
f. Construct a foundation knowing that family dysfunction is nearly inevitable:
i. Create clear dissolution procedures
1. If foundation ceases, then money goes to another org. But if the org ever
changes in the slightest, there is always the question of whether it is the same
organization. What is it that really matters? Better to define the organization
by what it does rather than its name (if you take the name, go to Guidestar or
Foundation Center to find the actual name). These are questions to ask the
donor.
ii. Designate orgs to receive money.
iii. Trigger reorganization instead of dissolution.
1. Be careful not to create incentive to split up the foundation. Rather than getting
along, the family might want to split up and go their separate ways.
g. For drafting advice, see book by Jodi Blazek
i. Drafting CLEs.
ii.

COMMERCIAL ACTIVITES AND UBIT

COMMERCIAL ACTIVITIES
1. The Framework

Related Unrelated
Insubstantial OK OK (UBIT)
Substantial OK NO

a. Non profits may engage in business activities so long as

i. Insubstantial and related
ii. Substantial and related
b. Taxed if activity is insubstantial and unrelated
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c. Loss of exemption if activity is substantial and unrelated

i. Org fails the operational testbeing operated primarily for private gain.
2. Based on source of income test
3. 2 issues:
a. Should commercial activity jeopardize the exempt status of the org?
b. If org able to retain exemption, will profits from business be taxed as UBIT
4. Order of operations
a. Identify primary purpose of org, determine if it’s an exempt purpose
b. Are there commercial activities? Substantial?
c. Are the commercial activities related?
i. Primary purpose of org
ii. Subjective balancing facts and circumstances test to determine relatedness (Reg.
1.501c3-1e)
1. Size and extent of trade or business
2. Size and extent of activities in furtherance of exempt purposes
d. Ensure that org still passes the operational test
5. Example: NYU pizza restaurant
a. Primary purposed is education
b. Pizza restaurant wont jeopardize exempt status
c. Pizza profits will be taxed—insubstantial, but unrelated
6. 2 approaches
a. Conventional wisdom/Commerciality doctrine/source of income test/Manny/Majority
(see above)
b. Unconventional wisdom/commensurate in scope doctrine/destination/minority
i. Comes from GCMs in 60s and 70s
ii. Suggests that 502 feeder orgs are exempt because destination of their income is
for exempt purposes
1. Limit: beneficiaries cannot be predetermined
iii. Exemption so long as charitable contribution is commensurate in scope with the
size of the org and its income.
7. 502 Feeder Organizations
a. No exempt, exists for primary purpose of profiting, even if funds ultimately go to exempt
purpose
b. Classification based on source of income test
c. Ex.)Shoe store that turns over all profits to NYU, Sagrada Orden, Mueller

CALCULATING UBI
1. UBI defined as all unrelated business minus deductions for expenses to produce that income
(512)
a. If exploitation of exempt activities, expenses are not deductible. (1.512(a)-1(d)(1)).
2. To calculate UBI, take % of actual use, not available use.
3. Income from debt-financed property is included in UBI.
a. See 512(c)(2)(B) for exceptions:
i. If property received by bequest or devise, no acquisition indebtedness for period
of 10 years following date of acquisition.
b. Debt/Basis * UBI = UBIT
4. Do not aggregate UBI. Take it on item-by-item basis.

CALCULATING UBIT
1. Ensure that org is still operating primarily for exempt purposes (passes operational test)
2. UBIT as an intermediate sanction
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3. Stated purpose: to prevent unfair competition

a. But this doesn’t really hold up
4. Definition (512a)-gross income derived from any unrelated trade or business, regularly carried on
by the org, minus certain enumerated deductions.
5. IRS takes FRAGEMENTATION approach in assessing tax.
6. Framework: NYU Pizza Restaurant
a. Will it jeopardize exempt status?
i. Probably not, NYU still operated primarily for education.
b. Will NYU be taxed on pizza profits?
i. Yes, trade or business, regularly carried on, and selling pizza does not relate or
further the exempt purpose of education.
c. But note: lots of escape hatches
7. 1950s-Congress moved from destination of income test (Sagrada Orden , Mueller) to source of
income test
8. 511a1-imposes tax on unrelated business at corporate tax rates; trusts taxed higher
9. Applies to all 501a exempt orgsBROAD APPLICATION
10. 3 Conditions Must be Met to Impose UBIT (512a)
a. Trade or business
i. For production of income from sale of goods or services
b. Regularly carried on
i. Frequency, continuity
ii. "Safe harbor" is if you have MORE than a third of income with regularly carried
on activities, then you will PROBABLY LOSE exempt status.
c. Not substantially related to org’s exempt purposes
i. There must be a causal relationship btwn commercial activity and achievement
of exempt purposes of the org
ii. Activity must directly contribute to purpose
iii. Facts and circumstances test: size and scope
11. Exceptions to UBIT (513a)
a. Volunteers
b. Convenience exception
c. Donated merchandise
12. Exemptions from UBIT (512b)
a. Passive income
i. Dividends, rents, royalties, capital gains, derivatives, lease agreements
b. Rents
i. Real property-fully excludable
ii. Personal property
c. Royalties
i. Payments for right to use intangible property
d. Research income
e. Payments from controlled orgs
13. Examples
a. Advertising
b. Hospital pharmacy
c. Sporting events/facilities
d. Travel tours
e. Museum cafeteria
f. Museum gift shop
14. Excluded from UBIT
a. Bingo (513(f))
 32

b. Trade shows, State fairs (513(d))

c. Certain hospital services (513(e))
d. Pole rentals (513(g))
e. Distributing low cost articles with no obligation to buy (513(h))
f. Sponsorship payments (513(i))

CORPORATE SPONSORSHIP
1. 513i: qualified sponsorship payments
a. There cannot be a substantial return benefit
b. De minimis exceptions (less than 2%)
2. SRBs
a. Advertising (comparative, SRB) vs. value neutral (display of logo)
b. Contingent payments
i. Amount of attendance-SRB
ii. Occurrence-not SRB
c. Exclusive provider agreements
i. But exclusive sponsor agreements are QSPs
d. Goods, facilities, services in excess of 2% of payment
e. Exclusive or nonexclusive rights to use an intangible asset of an exempt org
3.
Stated purpose

NONPROFIT GOVERNANCE
BY FORM
1. Corporation
a. Managed at the discretion of board of directors who may delegate to officers
b. General standard of care: gross negligence
c. Committed to org’s mission (vs. for-profit boards who are committed to profit
maximization)
d. Duties include:
i. Select and evaluate CEO;
ii. Review and adopt long-term strategic directions;
iii. Ensure necessary resources are available;
iv. Monitor performance of management;
v. Nominate suitable candidates for election.
vi. Mergers, acquisitions, terminations
vii. Elect directors
viii. Fundraising (for operations and endowment)
ix. Budget
x. Managing endowment
1. Hiring and appointment money managers ("stewarding the money")
2. Raising money
xi. Branding/marketing
xii. Both for the cause and the organization's validity. Try to tie the cause to the
organization.
xiii. Compliance
1. Form 990 must be submitted to Board before filing (part of SarbOx)
2. Charities with revenues of $2mm or more must have audited financial
statement.
 33

a. Must have an audit committee.

2. Trust
a. Managed by trustees who owe a fiduciary duty to the beneficiaries, must do all that is
necessary to administer the trust
b. Higher standard of care required than corporation; trustees liable for negligence
i. Can’t abrogate trust duties by moving to corporate form.
3. Unincorporated association
a. Governing structure determined by articles of association, bylaws
b. Members usually play a large role in governance

CORPORATE FIDUCIARY DUTIES (STATE LAW)

1. Duty of Care
a. Includes duty of attention
i. Directors have a duty to attend board mtgs, listen, investigate, actively participate
in org’s operations, review financial statements, review mtg minutes
b. Director decisions are protected by the business judgment rule (process)
c. Issue: unique nature of nonprofit board members
i. Typical management function
ii. Unique fundraising function
d. What to do with board members who are there solely because of their fundraising
abilities?
i. Since board is bound by duty of care, best to have a bifurcated board, with an
advisory committee who is not bound by law to exercise management functions.
ii. Also make sure to inform board members of their duties before they join
e. Can fail duty of care by:
i. Failing to manage or supervise properly;
ii. Failing to make informed decision about fundamental corporate decision.
2. Duty of Loyalty
a. Director must act in a manner not harmful to the corporation, can’t use board position to
obtain personal benefits or advantages that more properly belong to the organization.
b. How to deal with conflicts of interest/“sanitize” the transaction
i. State law approaches (best to do BOTH):
1. Procedural approach-DISCLOSURE
2. Substantive approach-FAIRNESS
a. Recognition that conflicts of interest can be helpful to public
charities (prohibited for PFs, regardless)
ii. Federal law approach: prophylacticPROHIBITION of all conflict of interest
transactions.
c. New Form 990 asks whether org has a conflict of interest policy
d. Context in which employee learns of opportunity is important in determining whether
there is a breach of the duty of loyalty.
3. Duty of Obedience
a. Duty to further the mission of the organization
b. Unique to nonprofit sector

ENFORCEMENT OPTIONS
1. Government
a. State Attorney General
b. Federal IRS
c. Issue: not enough money to actually do a good job at this.
 34

2. Director with sufficient special interest

3. Relators
4. Donors can sue only if they’ve entered into a K
5. Note: beneficiaries can almost never sue.
6. Should standing to sue be expanded?

PENALTIES FOR BREACH OF FIDUCIARY DUTY

1. Typically:
a. Bad publicity
b. Removal of director
2. State remedy is rarely injunction, restitution, personal liability of directors (Apollo)
3. Possibility of federal penalties:
a. 4958/EBT excise taxes for public charities
b. 4941 (self dealing)/4945 (taxable expenditures) excise taxes for PFs
4. Requires state attorney general or IRS to step inrare
a. Contrast to for profit corporation which is accountable to shareholders

CHARITABLE IMMUNITY
1. Limitation on director liability if:
a. Acting in scope of authority; and
b. Ordinary negligence.
c. NOTE: gross negligence not covered.
2. Federal Volunteer Protection Act. Elements:
a. Volunteer within scope of duty;
b. Volunteer properly licensed;
c. Harm not caused willfully;
d. Harm not caused by volunteer operating motor vehicle
3. Indemnification

AVOID CONFLICTS OF INTEREST

1. You should disclose any potential conflicts of interests (ex: you own a company that you
sell services to the Board you sit on).
2. Disclosures don't eliminate the conflict, but you discharge your duty. Failure to disclose
is a violation.
3. You should disclose and have the remainder of the Board vote.
4. You should disclose financial or family conflicts.
5. Every organization should have a conflict of interest statement.
6. Board members should disclose either:
A. Annually; and
B. Orally.

EXPENDITURE REPONSIBILITY (SEE HANDOUTS)

If foundation gives money to non-US charity, it must meet the criteria that the NGO could have been a
charity in the US (this is called "equivalency.")
1. Lawyers make the equivalency determination, following IRS guidelines. IRS either
approves or rejects.
2. IRS will require that you track the money you distribute and report it back to the IRS on
990PF.

Grants to NGO from private fdn are not qualifying unless either:
 35

1. Foreign org gets IRS determination letter; or

2. US org either:
a. Exercises reasonable judgment to ensure equivalency (use affidavit); or
b. Exercises expenditure responsibility (show to IRS that NGO is charitable)

Expenditure responsibility
1. Fnd determines that NGO is able to fulfill purpose of grant;
2. Written agreement signed by director or officer of NGO that NGO will
a. Submit annual reports;
b. Maintain books and records regarding grants;
c. Repay grants if not used in furtherance of charitable purposes; and
d. Refrain from using funds for purposes prohibited under US law
3. NGO required to keep detailed records regarding use of grants.
4. Fnd must supplement annual tax returns by including specific information

SCHOLARSHIPS (SEE HANDOUT)

With regard to scholarship, two main issues:
1. Is the expenditure a “grant” pursuant to 4945(d)(3); and
2. Does it satisfy 4945(g)?

Can give money to individuals by way of (see 4945(d)(3)):

1. Scholarships
2. Individual awards
3. Prizes/awards
4. Emergency/crisis money

4945(d)(3) says taxable expenditures are not allowed, but 4945(g) gives criterion for exception.
1. See "Summary of IRS Scholarship Program Requirements" handout.
a. See page 2 for specific requirements.
i. Objective, nondiscriminatory basis
ii. Procedure must be approved by IRS
iii. Used for scholarship
iv. A prize or award not included in gross income to recipient;
v. Purpose of achieving a specific objective, producing a report or other similar
product or improving a skill
2. Two ways to get approval:
a. The time the foundation is first formed. The IRS has 45 days to respond or it's
automatically approved.

PLANNED GIVING

Closely held stock 170(b)(1)(A) 170c

Issues: Bad idea, but might make Bad idea

sense if charity had an
interested party to buy
the stock (but be careful
 36

that charity doesn't file

form 8282).

Valuation FMV - get appraisal Cost basis - what you paid for it.
Most closely held stock has nearly 0
basis because they borrow money
to start the business.

Control of company If org sells company, there Same as 170(b)(1)(A). Greatly

is a control premium impacts distribution requirements.
Also, PFs can't hold S corp stock.
Illiquid stock.

Minority holding If org sells, there is a  

discount.

Not marketable If org sells, there is In addition, there is excess biz

discount holding tax

I. Charitable Remainder Trust

A. Definition (664(d)
a. Trust that pay outs between 5 and 50% to one or more persons (at least one is not
an org described in 170c
b.
c.

II. Charitable Lead Trust