Nonprofit Tax Tips
With the 2016 elections on the near horizon, nonprofit tax breaks continue to be a hot-button issue in the House and Congress. Whether it is the charitable tax deduction for donors or tax breaks offered to registered nonprofit organizations, legislation keeps popping up on the table to reduce, eliminate or in some cases enhance charitable tax deductions.
It's an issue that does not seem to be going away anytime soon, even if legislation has not quite changed the landscape in those regards just yet.
Even without the debate, there are many things nonprofits must take into consideration when it comes to filing their taxes … as well as providing donors with the proper documentation to record their own charitable tax deductions.
That's why NonProfit PRO spoke with two expert nonprofit tax attorneys to provide their tips on the tax issue for nonprofit organizations. Here are the insights — from the basics to the changing landscape — shared by Cliff Perlman, partner at the law firm Perlman & Perlman, and attorney Marc J. Lane.
The most obvious yet critical step in nonprofit tax compliance is making sure your organization is a registered nonprofit with the IRS. That means keeping your 990 up to date. It's the only way to ensure your nonprofit meets the tax-exempt qualifications, something that has caused many organizations problems over the years.
Once you know your organization is registered, there are a few more basics Perlman says every nonprofit should take note of to ensure no tax hassles:
- Make sure you pay tax on unrelated income tax.
- Be careful when receiving money from a for-profit company — how the gift is acknowledged by the charity can affect whether it's a donation to the charity or unrelated income, which requires the charity to pay tax on the funds received.
- Acknowledge receipt of money. The law is that any donation of $250 or more must be acknowledged. It's never a bad idea to acknowledge every gift, but it's absolutely necessary for those over $250. Perlman suggests investing in software to track and automatically receipt donors, and make sure your organization is careful and understands both the software and the law.
Another area Perlman says nonprofits must be careful is with cause-marketing campaigns. For instance, if a business makes a statement to the consumer that for each purchase of the company's hamburger that 10 cents will be donated by the business to a charity, the company is a commercial co-venturer required to register in a few states. If the company makes a statement that the purchaser is making a donation by buying a hamburger, the company may be considered to be a professional solicitor, a designation which will trigger additional compliance requirements.
In addition to proposed legislation to limit tax benefits for nonprofits, there are states, politicians and watchdogs out to make a name for themselves by scrutinizing nonprofit organizations. For instance, states such as New York have been more aggressive in investigating and prosecuting charities that they deem may be misleading donors in solicitations.
That was the impetus that led to a fine for the American Red Cross for its fundraising during Hurricane Katrina, Perlman says. The New York Attorney General found that the organization was not using all of the funds for their stated purpose. (And increasingly, these entities are highlighting certain portions of the publicly available 990s. It's up to the organization to make sure that it is compliant and also to explain to the public how it uses and solicits funds.)
Perlman also says that the IRS is focusing on organizations' 1099 forms, which report miscellaneous payments made to non-employee individuals during the calendar year. That means nonprofits must make sure any 1099s are thoroughly filled out and explained.
The changing landscape
These attacks, along with diminishing government grants, inconsistent corporate giving and changing donor preferences, have led to a changing landscape.
"Nonprofits are starting to look more like for-profits because they have to," Perlman says. "The begging model isn't sustainable."
As a result, more nonprofits and foundations are looking toward investor models vs. the traditional individual donors model. Various state laws allow for corporate entities to set up nonprofit ventures and vice versa — often referred to as benefit corporations.
These B corporations are social ventures that are, technically, for-profit entities, but they can be eligible for tax-exempt program investments for foundations, says Lane. They've allowed foundations to invest in income-generating program investments to drive their dollars further than simply handing out the 5 percent in grants they're required to by law. It's attractive to a foundation because it can basically recycle that invested money for socially beneficial purposes, becoming what Lane calls a financial multiplier. This allows the organization to become more self-sustainable.
However, organizations must be careful. If these program investments are not exercised carefully, they could be subject to excise taxes, Lane says. That could result in a 20 percent tax on the foundation, a 5 percent tax on the manager who knew it was taxable, and can even be raised to 100 percent on the foundation and 50 percent on the manager in some instances. So it's urgent to ensure those investments fit social business purposes, not strictly for-profit goods and services. Everything must relate to the mission in a clear way and be documented to fit the laws.
Nonprofits shouldn't be averse to this type of arrangement because the case law reflects very few examples of these taxes actually being levied, Lane says.
"It can open the floodgates of private capital," Lane says. "Nonprofits are heavily dependent on government contracts, and the government is facing challenges. Nonprofits are dependent on philanthropy, but philanthropy is not up to the task of keeping up with the need. Charities can diversify their funding streams by generating earned revenue."
To remain compliant with tax laws, Lane says to get familiar with IRS form 4945, which covers taxes on taxable expenditures. Essentially, the money must be for charitable or similar purposes and include a full and complete report on how the money is spent — and it must demonstrate reasonable belief in social impact. Then, anything that is not used needs to be repaid in full and displayed in the annual report.
"Nonprofits are being squeezed in all directions … Crisis presents opportunity. Nonprofits have to operate more like businesses, employ prudent business practices, and use money more impactfully and efficiently," Lane says. "… It's about reimagining your role and what can be accomplished by opening the door to investments to charities that then become more self-sufficient."
This is the changing landscape in which all nonprofits operate, a place where the lines are blurring between nonprofits and for-profits because, as Perlman says, "nonprofits need to be sustainable, and for-profits need to sustain the world."