Recommendations for Charitable Organizations

Last week the U.S. Senate Finance Committee issued recommendations that the Senate may consider regarding reforming the tax system as it relates to tax-exempt organizations and charitable giving.

While it is clear that we have a long way to go before we achieve fundamental reform of this system, the recent IRS scandal has focused a great deal of attention on this area. As a result, we would not be surprised if Congress soon embarks on a comprehensive overhaul.

Later this year, the Sustainable Law Group will open an office in Washington, DC. Our DC office will provide representation to nonprofit organizations, hybrid entities and small businesses in the DC area. We will also use our DC presence to advocate for laws and regulations that support entities and individuals offering sustainable solutions to societal and environmental issues.

Although we cannot detail the myriad of areas the Senate report touches upon, we highlight here a few areas that may be of particular interest to our clients.

SOCIAL ENTERPRISE

Especially noteworthy for nonprofit social enterprises, the report suggests a number of ways the government can limit the benefits provided to nonprofits engaging in business activities and the donors that support such nonprofits. However, the report also offers a carve-out for nonprofits engaging in business activities that directly further their charitable mission.

CHARITABLE CONTRIBUTION DEDUCTION
1. Outright repeal of the charitable contribution deduction.
2. Converting the deduction to a refundable or Nonrefundable credit
3. Structuring the charitable incentive as a "match" paid directly to the charity (and possibly linking this to the current deduction).
4. Capping the value of the charitable contribution deduction (an option the Obama Administration has repeatedly proffered).
5. Allowing taxpayers that don’t itemize deductions to receive benefits from charitable contributions.
6. Allowing the deduction solely for those charities that serve the "needy."
8. Increase effect of charitable incentives by limiting deduction to taxpayers who give a minimum percentage of their income.
9. And a variety of options to restrict or limit the deduction.

LIMITS ON EXECUTIVE COMPENSATION
The report identifies two ways nonprofits can limit executive compensation, including further defining what constitutes a private benefit when a nonprofit enters into a for profit partnership, increasing officer and director obligations to investigate potential insider benefits](http://www.finance.senate.gov/newsroom/ranking/release/?id=5fa343ed-87eb-49b0-82b9-28a9502910f7), and requiring nonprofit leaders to disclose the compensation surveys they use to justify executive compensation.

The Senate Finance Committee report also includes a number of recommendations regarding lobbying and political activities of nonprofit organizations.

Please contact us if you would like more information on how current tax-exempt organizations’ laws and regulations apply to you, and if you are interested in engaging with policymakers to reform the system Ina way that better serves sustainable organizations.

Think Creatively Before Settling on a Hybrid Entity

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At Sustainable Law Group we are privileged to work with a number of social entrepreneurs who are redefining business as usual in for profit and nonprofit organizations alike. Since we opened our doors in April 2012 we have helped to structure and form all of the new types of hybrid entities, including Low Profit Limited Liability Companies (L3Cs), Benefit Corporations and Flexible Purpose Corporations.

Social entrepreneurs can be – and have been – particularly creative when structuring business enterprises. Although this penchant for thinking outside the box led to the creation of the new hybrid entities, these new forms are not necessarily a panacea that offers the greatest opportunities for success.

Each week we hear from people who are excited to accomplish meaningful work outside the bounds of traditional for profit and nonprofit structures. However, we often find ourselves counseling our clients that forming a hybrid entity may not be the right choice, as it may increase costs and reduce opportunities to receive traditional sources of capital.

For example, several of our clients that intended to form hybrid entities had business ideas that would qualify as charitable programs under Internal Revenue Code section 501(c)(3).  Choosing a for profit structure (and all hybrid entities are taxed as for profits) over a nonprofit charity may mean that these clients would not be able to attract as much revenue and assets to their organizations, and would confront a much higher cost of doing business in the form of federal and state income taxes.

Many social entrepreneurs are attracted to hybrid entities because they can actually own all (or part of) their business.  We agree that equity ownership is a great benefit, but if an organization would qualify as a charity, this benefit must be weighed against the cost of losing out on charitable gifts, grants and contributions.  Also, it’s important to remember that nonprofits – and their founders – are free to form for profit subsidiaries and joint ventures using hybrid and more traditional for profit entities.

Although the field of impact investing is growing rapidly, many traditional investors are not ready to invest in hybrid businesses.  Equity investors are often more comfortable with risk, but within certain bounds.  Because the hybrid entities are so new, some traditional investors view them as riskier investments because the distinctive aspects of their corporate governance haven’t yet been tested in court.  Therefore, choosing to form hybrid entities may cut out a large swath of capital.

We are always thrilled to form hybrid entities.  But we really enjoy employing all available tools to maximize our clients’ potential to do well by doing good.  These new structures offer social entrepreneurs greater flexibility to use business practices to make the world a better place.  However, it’s important to remember that traditional entities have their benefits too, and may still be the best option.

If you are thinking about starting a new social enterprise please contact us to learn more about what’s right for you and your business.

Photo credit: Dave Dugdale / Foter.com / CC BY-SA

Why The IRS 501(c)(4) Scandal Happened

the-u-s-capitol-building_lAs nonprofit attorneys, we frequently work with clients to obtain tax-exempt status for them under Internal Revenue Code (IRC) sections 501(c)(3) and 501(c)(4).  We received questions from our clients about why the IRS 501(c)(4) scandal happened and what can be done about it.  While the Congress is still investigating the IRS misconduct and the facts are not all out, we see several clear factors that led to the IRS’s decision to single out “Tea Party” applications for special scrutiny.

The regulations that distinguish between 501(c)(4) social welfare organizations and IRC § 527 political organizations are not clear and require interpretation by the agent reviewing each exemption application.  A social welfare organization qualifies for tax exempt status under IRC § 501(c)(4) if : “(i) It is not organized or operated for profit; and (ii) It is operated exclusively for the promotion of social welfare.” The second criteria, “exclusively” has been interpreted by the IRS to mean: “primarily engaged in promoting in some way the common good and general welfare of the people of the community.” Further, a 501(c)(4) can participate in elections except that “promotion of social welfare does not include direct or indirect participation or intervention in political campaigns on behalf of or in opposition to any candidate for public office.” As attorneys we know all too well that words like “primarily” and “direct or indirect participation or intervention” are open to interpretation.

By contrast, a political organization formed under IRC § 527 is “a party, committee, association, fund, or other organization (whether or not incorporated) organized and operated primarily for the purpose of directly or indirectly accepting contributions or making expenditures, or both, for an exempt function.”   These organizations are largely tax-exempt.  The key difference is that § 527 political organizations must publicly disclose their donors’ identities, while 501(c)(4) organizations do not.

In the recent scandal, the IRS blames being overworked and understaffed for its short-cut tactic in singling out “Tea Party” affiliated organizations that might not qualify under 501(c)(4).  Considering that the IRS receives 70,000 applications and has fewer than 200 agents working through them each year, the practice of using key words as a method of singling out potential political organizations is not too far-fetched, although only using terms commonly associated with one political party is wrong.

Additionally, the IRS is under heightened pressure to watch out for 501(c)(4) applicants that should be treated as political organizations under IRC § 527 after the Supreme Court decision Citizens United v. Federal Elections Commission changed how money can be used in elections.  Citizens United opened the flood gates to allow corporations, including 501(c)(4) nonprofits, to make unlimited contributions to influence elections.  Since the Supreme Court issued that decision, money supporting both Republicans and Democrats (and the Tea Party) have been funneled through 501(c)(4) nonprofit organizations as a way to keep the names of their donors private.  During the 2012 elections, Americans for Responsible Leadership, an Arizona-based 501(c)(4) organization, used its status as a 501(c)(4) to anonymously launder $11 million for a Super PAC in California to defeat a contested tax hike and to limit political spending for unions.  Just recently Americans for Responsible Leadership was again in the news for failing to disclose that it spent (in addition to the $11 million on California ballot initiatives) an additional $9.8 million on Federal  electoral campaigns during the 2012 election cycle, which is $4.1 million more than they initially disclosed.  Americans for Responsible Leadership’s use of its 501(c)(4) status to give its donors the ability to anonymously donate over $20 million in 2012 state and Federal elections has raised serious questions about the consequences of Citizen’s United for our democratic process.

We are hopeful that the IRS snafu and the controversy over organizations like Americans for Responsible Leadership will result in some significant clarification of the 501(c)(4) regulations and that the nation will find a way to reform campaign finance regulations in the post Citizens United landscape.  Just last month the Los Angeles City Council and 77% of the Los Angeles electorate voted to instruct local and state officials to promote the overturning of Citizens United.  Last week the Los Angeles Times published an editorial called The right way to investigate the IRS.  The LA Times suggests that “[t]he best way to restore confidence in the IRS is to impanel a commission with no stake in the 2014 election and no political ax to grind, and have it recommend whatever changes may be necessary to fix the problems it uncovers.”  Dean Alan B. Morrison, in his Huffington Post blog article Focusing on the Wrong IRS 501(c)(4) Scandal, suggests two solutions: either apply the same no-election campaigning rules that govern 501(c)(3) organizations to 501(c)(4) organizations (i.e., prohibiting intervening in political campaigns, but allowing for a limited amount of lobbying), or require disclosure of the names of donors giving $200 or more to the 501(c)(4).

However this issue gets resolved, we hope that it leads to a stronger, more transparent democratic process.  To keep up to date on this and many other issues affecting nonprofit organizations follow us on Twitter: @sustainable_law.

If you have specific questions about nonprofit organizations or the tax exemption process please contact us at info@sustainable-lawyer.com or call us at 310-883-7923.

Photo credit: Glyn Lowe Photoworks / Foter.com / CC BY

Social Enterprise Alliance – Building an Economy on Purpose

Last week Social Enterprise Alliance held its Annual Summit in Minneapolis. The Summit showcased how the social enterprise industry is experiencing dramatic change and growth, and SEA’s national and regional leaders are initiating an ambitious plan to "Build an Economy on Purpose."

SEA sees that social enterprise and social businesses already comprise a substantial (and growing) portion of our GDP. The organization’s leadership is rolling out strategies to help social mission enterprises continue to grow, and to educate policymakers, investors, philanthropy, educational institutions and other stakeholders about the role these enterprises play in building a sustainable economic recovery.

Since 2010, I have served on the Board of Directors of Social Enterprise Alliance – Los Angeles Chapter. During the Summit I joined three other regional chapter leaders to share my insights on building local leadership through collaborating with SEA members and partner organizations to establish a healthy local social enterprise ecosystem.

While at the Summit, I learned that SEA and its members are building an economy on purpose by directing renewed efforts to pursue policy initiatives that help these entities succeed. SEA’s specific policy objectives include:

  • Supporting the passage of the Social Enterprise Ecosystem and Economic Development Commission Act (re-introduced by RI Rep. David Cicilline last Monday) to establish criteria for defining and identifying social enterprises, identify opportunities for the federal government to leverage social enterprise, and develop a report to further support social enterprise.

  • Expanding a variety of US Small Business Administration and Department of Commerce loan, loan guaranty and technical assistance programs to include nonprofit social enterprises.

  • State and local proclamations recognizing Social Enterprise Day/Week to increase policymakers’ awareness of social enterprise.

  • Formation of state and local task forces, which serve as vehicles to build support for, and the growth of, social enterprise.

  • Adding social enterprise to public procurement policies and practices.

  • Increasing the use of Social Impact Bonds (SIBs)/Pay for Success programs.

  • Adopting new hybrid social business legal entities, including L3Cs, Benefit Corporations, Flexible Purpose Corporations and other entities.

Sustainable Law Group is excited to collaborate with SEA and its partners to further support social enterprises and the policies that contribute to Building an Economy on Purpose. If you support SEA’s goals, please consider becoming a member of your local chapter and reaching out to your legislators to ask them to support these policy positions. To learn more, please contact Cecily Jackson-Zapata at (213) 223-6262 or cecily@sustainable-lawyer.com.

SBCLA Industry Achievement Awards: A Night of Collaboration

SBC - pic© SBCLA

Last Wednesday was a very special night – hundreds of entrepreneurs, activists and thought leaders came together to celebrate the best sustainable businesses of southern California at the Sustainable Business Council of Los Angeles  2nd Annual Industry Achievement Awards.  We would like to congratulate this year’s winners in each of the seven categories:

Lifetime Achievement in Sustainability Award: Cisco Pinedo, Founder, Cisco Home

Lifetime Business Achievement Award: Ralph Grogan, President and CEO, Bentley Prince Street

B Corp. Award: Erbaviva 

Sustainable Small Business Award: EcoSet Consulting, LLC

Sustainable Business Award: Solar City

Best Public Advocate for Sustainability Award: Jessica Aldridge, Executive Director, Burbank Green Alliance

People’s Choice Award: Sustainable Restaurant: Café Gratitude

MH - picOur Attorney Becki Ueno had the honor of presenting the keynote speakers and MC’s of the evening: Mariel Hemingway and Bobby Williams.  Mariel and Bobby spoke about how important it is to live a sustainable life from the inside – out; that each of us has an innate knowledge about how to create a healthy life, one imbued with love and adventure.  We particularly love this message, because it is something that we can use in our daily lives and in the business world.  (We wrote in an earlier post about gaining confidence in your business ventures through tapping into the knowledge you already have.   If you missed it, you can read it here.)

 We were also brilliantly inspired by each of the award recipients – each of them has an incredible story to tell about their work.  Each of them also, humbled in their moment, gave thanks to all of the community members, co-workers, and heroes who helped them make their goals a reality.  To us, this is the most important part of any awards ceremony: to recognize that we all conspire, collaborate and inspire each other to make the positive change that we seek in this world.  And, at the end of that night, we were grateful for our ever-growing community of social entrepreneurs, green businesses, activists, thought leaders, and dreamers, all of you who have joined us in the sustainable business world.

Do you have a sustainable business?  Share with us who you are grateful for helping you to achieve your mission on our Facebook Page.

Earth Day 2013

Happy Earth Day!

Sustainable Law Group and our clients and partners are committed to protecting and preserving our natural resources.  We are sharing the below opinion piece with you because we agree with the author’s sentiment and many of the policy proposals outlined.

http://www.politico.com/story/2013/04/reboot-earth-day-90392.html

If you would like more information, you can see the full summary report here: http://www.ase.org/sites/default/files/report_summary.pdf

What a Balance Sheet Can Reveal About the Health of a Nonprofit Organization

f990The IRS requires most 501(c)(3) nonprofit organizations with annual incomes in excess of $50,000 to file either a 990EZ or 990 (Those with less income file a 990N).  The 990EZ and 990 are detailed reporting forms that require an organization to generate a “Balance Sheet,” which is a financial report that describes an organization’s assets, liabilities, and net assets and fund balances at the beginning and end of its fiscal year.  The Balance Sheet, however, is also an important tool that nonprofit boards of directors can use to determine the overall financial health of the organization throughout the year.

Recently we attended a Los Angeles Social Venture Partners (LASVP) workshop on how to read and interpret financial statements for nonprofits.  The training was designed for grant-makers, donors and nonprofit directors.  We found the high-level presentation very informative, and we identified two points we feel are particularly important to share with our readers: first – the cash liquidity of an organization reveals the health of the organization, and second – the total assets of an organization must be broken down into different parts to understand whether the organization has the capital to manage its program work.

The Balance Sheet’s “cash” column shows an organization’s “monthly liquidity,” or how many months an organization can survive on the cash it currently has in the bank.  This figure is crucial.  The presenter, David Grecco of Nonprofit Finance Fund, gave a shocking statistic: about 57% of nonprofits in California have less than 3 months’ liquidity.  This means that most nonprofits are struggling to make ends meet, they cannot innovate new programs, and they are constantly fundraising.  Mr. Grecco noted that 3-6 months of liquidity is the benchmark for a nonprofit to have the freedom to engage in longer term planning.  Nonprofits with 6 or more months of liquidity are considered to be sustainable and healthy organizations that can plan, grow, and handle risks and crises.  Knowing your monthly liquidity is reason enough to generate a Balance Sheet on a frequent basis, not just when it’s time to complete your 990 tax filing.

Mr. Grecco also pointed out that the numbers reported in the Form 990 Balance Sheet can give an organization and its donors a misleading picture of its health.  For example the “total assets” on the Form 990 Balance Sheet will not explain what assets are actually liquid or available for immediate use.  It is crucial to dive deeper to see how much of those assets are receivables (funds promised but not received), temporarily restricted (restricted for specific uses and/or for specific purposes), permanently restricted (such as an endowment which can only be used to generate investment income), and land/equipment (brick and mortar investment).   By parsing out these numbers, a nonprofit board and its funders can determine the organization’s ability to actually fund its programs.  Importantly, the nonprofit and its funders need to consider the impacts of locking up a large percentage of assets in land/equipment or restricted income.  The higher the percentage of assets that are unrestricted and available for the organization to use, the more stability it has.

Would you like to learn more?  As nonprofit attorneys we are happy to advise you on the best strategies to keep your nonprofit healthy and sustainable.  Contact us at: www.sustainable-lawyer.com