How to Form a Nonprofit Corporation in California

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How to Form a Nonproﬁt Corporation in California

Attorney Anthony Mancuso

LAW for ALL SIXTEENTH EDITION APRIL 2015 Editor DIANA FITZPATRICK Cover Design SUSAN PUTNEY Production COLLEEN CAIN Proofreading IRENE BARNARD Index UNGER INDEXING Printing BANG PRINTING

ISSN: 2327-218X (print) ISSN: 2327-2171 (online)

ISBN: 978-1-4133-2138-8 (pbk) ISBN: 978-1-4133-2139-5 (epub ebook)

Tis book covers only United States law, unless it specifcally states otherwise.

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Please note We believe accurate, plain-English legal information should help you solve many of your own legal problems. But this text is not a substitute for personalized advice from a knowledgeable lawyer. If you want the help of a trained professional—and we’ll always point out situations in which we think that’s a good idea—consult an attorney licensed to practice in your state. Acknowledgments Te author extends a special thanks to my editor, Diana Fitzpatrick, and Stan Jacobsen for invaluable and thorough research assistance, and to all the hardworking people at Nolo. About the Author Anthony Mancuso is a California attorney and a corporations and limited liability company expert. He graduated from Hastings College of Law in San Francisco, is a member of the California State Bar, writes books and software in the felds of corporate and LLC law, and has studied advanced business taxation at Golden Gate University in San Francisco. He is currently employed by Google in Mountain View, CA. He is the author of many Nolo books on forming and operating corporations (both proft and nonproft) and limited liability companies. His titles include Incorporate Your Business, How to Form a Nonproft Corporation (national and California editions), Form Your Own Limited Liability Company, Te Corporate Records Handbook, LLC or Corporation?, and Your Limited Liability Company: An Operating Manual. His books have shown over a quarter of a million businesses and organizations how to form a corporation or LLC. He also is a licensed helicopter pilot and has performed for years as a guitarist. Table of Contents

Your Legal Companion for Forming a Nonproﬁt Corporation in California ...... 1

1 Is Nonprofit Incorporation Right for You? ...... 3 Is Your Group a Nonprofit Tat Can Use Tis Book? ...... 5 Benefits of the Nonprofit Corporation ...... 9 Te Disadvantages of Going Nonprofit ...... 13 How Nonprofits Raise, Spend, and Make Money ...... 16 Your Path to Nonprofit Status ...... 18 Incorporating in Another State—Don’t Fall for It ...... 18 2 Legal Rights and Duties of Incorporators, Directors, Officers, Employees, and Members ...... 21 Incorporators and Teir Role as Promoters ...... 24 Directors ...... 25 Officers ...... 39 Employees ...... 41 Membership Nonprofits ...... 42

3 Requirements for Section 501(c)(3) Tax Exemption ...... 47 Section 501(c)(3) Organizational Test ...... 48 Valid Purposes Under Section 501(c)(3) ...... 49 Other Requirements for 501(c)(3) Groups ...... 56 Information for Speciﬁc Questions About Your Group’s Activities ...... 62

4 Public Charities and Private Foundations ...... 65 Te Importance of Public Charity Status ...... 66 How to Qualify for Public Charity Status ...... 67 Private Foundations ...... 81 5 Other Tax Beneﬁts and Requirements ...... 85 Federal and State Tax Deductions for Contributions ...... 86 Federal Estate and Gift Tax Exemptions ...... 87 Federal Unrelated Business Income Tax ...... 88 California Unrelated Business Income Tax ...... 90 California Nonproﬁt Tax Exemption ...... 90 California Attorney General Reporting Requirements ...... 91 California Welfare Exemption ...... 92 Other California Tax Exemptions ...... 99 State Solicitation Laws and Requirements ...... 100

6 Choose a Name and File Your Articles of Incorporation ...... 103 Choose a Corporate Name ...... 105 Practical Suggestions for Selecting a Name ...... 107 Check Name Availability ...... 110 Reserve Your Corporate Name ...... 112 Perform Your Own Name Search ...... 113 Prepare Articles of Incorporation ...... 116 File Your Articles ...... 124 Appoint Initial Corporate Directors ...... 129

7 Bylaws ...... 131 Choose a Membership or Nonmembership Structure ...... 133 Bylaws for a Public Beneﬁt Corporation ...... 134 Membership Bylaw Provisions for a Public Beneﬁt Corporation ...... 144 Bylaws for a Religious Corporation ...... 150 Membership Bylaw Provisions for a Religious Corporation ...... 161

8 Apply for Your Federal 501(c)(3) Tax Exemption ...... 169 Getting Started ...... 170 Do You Need to File Form 1023? ...... 176 Prepare Your Tax Exemption Application ...... 177 Filling Out the Schedules ...... 218 Assemble and Mail Your Application to the IRS ...... 225 What to Expect From the IRS ...... 227 Te Federal Determination Letter ...... 227 9 Final Steps in Organizing Your Nonprofit ...... 229 Obtain Your State Tax Exemption ...... 230 Set Up a Corporate Records Book ...... 230 Prepare Offer to Transfer Assets From an Existing Business or Organization to Your Nonprofit ...... 231 Prepare Minutes of Your First Board of Directors’ Meeting ...... 237 Complying With the Bulk Sales Law ...... 246 Prepare a Bill of Sale for Assets ...... 247 Prepare Assignments of Leases and Deeds ...... 249 File Final Papers for the Prior Organization ...... 250 Notify Others of Your Incorporation ...... 250 Apply for a Mailing Permit ...... 250 Apply for Your Property Tax Exemption ...... 251 File a Domestic Corporation Statement ...... 253 File an Initial Report With the Attorney General ...... 253 Issue Membership Certificates ...... 254 File Your Articles With the County Recorder ...... 254 Register With the Fair Political Practices Commission ...... 255

10 After Your Corporation Is Organized ...... 257 Piercing the Corporate Veil—If You Want to Be Treated Like a Corporation, It’s Best to Act Like One ...... 258 Federal Corporate Tax Returns ...... 259 California Corporate Tax Returns and Reports ...... 261 Federal and State Corporate Employment Taxes ...... 263 Sales Tax Forms and Exemption From Sales Tax ...... 266 Licenses and Permits ...... 268 Workers’ Compensation ...... 269 Private Insurance Coverage ...... 269 Dissolving a Nonproﬁt Corporation ...... 269

11 Lawyers, Legal Research, and Accountants ...... 273 Lawyers ...... 274 Legal Research ...... 275 Accountants and Tax Advice ...... 276 A Using the Interactive Forms and Other Online Material ...... 279 Editing RTFs ...... 280 List of Corporate, IRS, and other Forms and Publications on the Nolo website ...... 281

B Forms ...... 283 Incorporation Checklist Special Nonproﬁt Tax-Exempt Organizations Name Availability Inquiry Letter Name Reservation Request Form California Form 3500A, Submission of Exemption Request IRS Form 1023-EZ: Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code IRS Package 1023: Application for Recognition of Exemption (With Notice 1382) Member Register Membership Certiﬁcate

Index ...... 359 Your Legal Companion for Forming a Nonproﬁt Corporation in California

orming a nonproft corporation may tQSFQBSFBOEëMFOPOQSPëUDPSQPSBUJPO sound like a daunting task that you should articles and bylaws F hand over to a lawyer as quickly as you tBQQMZGPSBOEPCUBJO D UBYFYFNQU can—after all, aren’t there a lot of paper work status from the IRS and flings, and complicated IRS nonproft tTBUJTGZ*34DPOìJDUPGJOUFSFTUBOEFYDFTT tax laws to learn? Tere is paperwork, and you beneft guidelines will need to deal with the IRS, but the truth tRVBMJGZBTB D QVCMJDDIBSJUZ is, you can do it yourself. Forming a nonproft tQSFQBSFNJOVUFTGPSZPVSëSTUCPBSE corporation in California is actually a fairly meeting, and straightforward process. And, with the help tUBLFDBSFPGQPTUJODPSQPSBUJPOëMJOHTBOE of our line-by-line instructions, you can also tasks. obtain tax exempt status from the IRS for your Tere are legal and tax technicalities that newly formed nonproft corporation. Tousands nonprofts must deal with in exchange for the of people have gone through the entire process substantial benefts they receive as nonprofts. of incorporating a nonproft and obtaining We give you the information and tools you 501(c)(3) tax exempt status with this book to need both to form your tax exempt nonproft guide them. and understand the practical and ongoing issues Along the way, there may be decisions you related to running a nonproft. need to make where you should seek profes sional We know that any legal process can be advice. We’ll let you know when you need outside challenging. We hope this book, with its step- help. And even if you do decide to hire a lawyer to by-step approach to incorporation and obtaining handle some of the work for you, the information tax exempt status from the IRS, will help you in this book will help you be an informed client— through the legal hoops and over the hurdles and get the most for your money. of incorporating your nonproft in California Tis book explains, in plain English, how to and obtaining tax exempt status from the IRS. incorporate your nonproft in California and Congratulations on taking your frst steps toward obtain 501(c)(3) tax exempt status from the success in your new nonproft endeavor! IRS. We show you how to:

Get Forms, Updates and More Online You can download forms in this book at: www.nolo.com/back-of-book/NON.html If there are important changes to the information in this book, we will post updates there.

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CHAPTER

Is Nonproﬁt Incorporation Right for You? 1

Is Your Group a Nonprofit Tat Can Use Tis Book? ...... 5 Public Benefit Corporations ...... 6 Religious Corporations ...... 7 Mutual Benefit Corporations ...... 8 Benefits of the Nonprofit Corporation ...... 9 Tax Exemptions ...... 9 Receiving Public and Private Donations ...... 10 Protection From Personal Liability ...... 10 Separate and Perpetual Legal Existence ...... 12 Employee Benefits ...... 12 Formality and Structure ...... 12 Miscellaneous Benefits ...... 12 Te Disadvantages of Going Nonprofit ...... 13 Official Paperwork ...... 13 Incorporation Costs and Fees ...... 14 Time and Energy Needed to Run the Nonprofit ...... 14 Restrictions on Paying Directors and Officers ...... 15 Restrictions Upon Dissolution ...... 15 Restrictions on Your Political Activities ...... 15 Oversight by the Attorney General ...... 16 How Nonprofits Raise, Spend, and Make Money ...... 16 Initial Fundraising ...... 16 Making Money From Related Activities ...... 17 Making Money From Unrelated Activities (Unrelated Income) ...... 17 Making Money From Passive Sources ...... 18 Your Path to Nonprofit Status ...... 18 State Law Requirements for Nonprofits ...... 18 Tax-Exempt Status Under Federal and State Tax Law ...... 18 4 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Incorporating in Another State—Don’t Fall for It ...... 18 Qualifying as a Foreign Corporation in California Will Cost You More ...... 19 Multiple Tax Exemptions ...... 19 Multiple State Laws ...... 19 Out-of-State Activities Below the Radar ...... 19 When Out-of-State Incorporation Makes Sense ...... 20 CHAPTER 1 | IS NONPROFIT INCORPORATION RIGHT FOR YOU? | 5

eciding to form a nonproft corpo- the members of the nonproft (a mutual beneft ration will be a big step for you and the corporation). It’s easy to form a nonproft Dmembers of your group. It will involve corporation in California: Just prepare articles more paperwork and government forms, on of incorporation that say you are formed for both the state and federal level, than anyone one of these three broad nonproft purposes will like; and you’ll have to conduct your and then fle your articles with the California business within the legal framework of various Secretary of State. Tis creates your legal state and federal laws. Fortunately, there are corporate entity. However, having a nonproft big payofs to all this work and attention, corporation recognized by the California including the ability to attract donors and grant Secretary of State is only your frst hurdle. Te funds, obtain real and personal property tax next important step is to obtain the neces- exemptions and special nonproft mailing rates, sary state and federal corporate income tax avoid corporate income taxes, and shield ofcers exemptions for your nonproft corporation. To and directors from legal liability. Before starting obtain these exemptions, your nonproft must down the path of nonproft incorporation, be formed for one or more specifc purposes however, you’ll want to learn a little more about described in the income tax statutes. who can form a nonproft and the consequences Tis book has been written specifcally for of doing so. In this chapter, we’ll explain: non proft corporations that want to qualify for tUIFLJOETPGHSPVQTUIBUDBOBOEDBOU a federal income tax exemption under Section form a nonproft using this book 501(c)(3) of the Internal Revenue Code. Tis tUIFCFOFëUTZPVMMFOKPZBTBOPOQSPëUBOE means your nonproft corporation must be some of the disadvantages to choosing this formed for religious, chari table, scientifc, route literary, and/or educational purposes. If you tIPXOPOQSPëUTDBOSBJTFTUBSUVQGVOETBOE want to organize as a religious purpose group, earn money, should they wish to do so we will show you how to form a California tUIFQSPDFTTZPVMMHPUISPVHI GPMMPXJOHUIF religious nonproft corporation. If you want instructions in this book) to incorporate to organize as a nonproft to engage in any of and obtain your tax-exempt status, and the other 501(c)(3) tax-exempt pur poses, we tGPSUIPTFDPOTJEFSJOHJODPSQPSBUJOHJO will show you how to form a Cali fornia public another state, considerations to bear in beneft corporation. Tis book is not for groups mind before doing so. that want to form a mutual beneft corporation, because mutual beneft nonprofts usually obtain their tax exemption under a subsection Is Your Group a Nonproﬁt of Section 501(c) other than 501(c)(3). It is Tat Can Use Tis Book? also not for certain special types of nonprofts (including some public beneft corporations) A for-proft corporation can be formed for any that do not fall under Section 501(c)(3). See lawful purpose. Nonproft corporations, how- discussion below, “Special Types of California ever, must be established under California law Public Beneft Corporations,” and “Mutual for one of three broad purposes: (1) for the Beneft Corporations.” beneft of the public (a public beneft corpo- When thinking about incorporating your ration), (2) for religious purposes (a religious non proft, consider which purpose you fall corporation), or (3) for the mutual beneft of 6 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Corporation Basics

You don’t have to understand all there is to know corporate assets remain to be divided among about corporations in order to follow this book the shareholders after payment of all creditors. or form your nonprofit. But there are a few basic Nonprofits, on the other hand, generally concepts you’ll want to have under your belt as cannot issue shares of stock or pay dividends you go through the process. Here they are, with under state law (unless they are some type of special emphasis on any differences between for- hybrid such as consumer or producer co-ops). profit corporations and nonprofits: Te federal tax code also prohibits 501(c)(3) t A corporation is a separate legal entity. A tax-exempt nonprofit corporations from corporation is a legal entity that allows a group paying dividends or profits to their members of people to pool energy, time, and money or other individuals. When a 501(c)(3) tax- for profit or nonprofit activities. It acquires exempt nonprofit corporation dissolves, it legal existence after its founders comply with must distribute its remaining assets to another their state’s incorporation procedures and tax-exempt nonprofit group. formalities. Te law treats a corporation as a t In-state and out-of-state corporations. separate “person,” distinct from the people who Corporations formed in California are known own, manage, or operate it. Te corporation in California as “domestic” corporations. can enter into contracts, incur debts, and Corporations formed in other states, even if pay taxes. Corporations are either for-profit physically present and engaging in activities (business corporations) or nonprofits. in California, are called “foreign” corporations. t For-profit, or business, corporations versus For example, a corporation formed in nonprofits. Business corporations can be California is a domestic corporation as far formed for any legal purpose. Tey can issue as California is concerned, but a foreign shares of stock to investors in return for money cor por ation when considered by other or property, or services performed for the states. At the end of this chapter, we give corporation. Shareholders receive a return you more information on doing business on their investment if dividends are paid or if, outside California and deciding whether to upon dissolution of the corporation, any incorporate in another state.

under for Section 501(c)(3). Once you know Public Beneﬁt Corporations you fall within one of the 501(c)(3) purposes, Under state law, public beneft corporations you can rest assured that this book can help are corporations formed for a “public purpose” you through the process. First we’ll help you or “charitable purpose.” Most groups forming create your corporate entity in California by public beneft corporations also want to qualify showing you how to prepare and fle articles of for Section 501(c)(3) status. Tese groups usually incorporation for a public beneft or religious organize for one of the specifed purposes corporation. Ten we’ll show you how to obtain under Section 501(c)(3)—charitable, scientifc, your state and federal nonproft income tax literary, or educational. All of these 501(c)(3) exemptions for 501(c)(3) status. purposes are considered “charitable” purposes CHAPTER 1 | IS NONPROFIT INCORPORATION RIGHT FOR YOU? | 7 under California law. For example, a school Religious Corporations or educational facility would organize as a Just as the name indicates, religious corpo- California public beneft corporation formed rations are formed primarily or exclusively for under state law for “charitable” purposes but religious purposes. Tese groups can qualify its 501(c)(3) purposes would be “educational.” as religious organizations under both state Te public purpose classifcation under state incorporation law and Section 501(c)(3). law is for groups that want to form civic league You need not set up a formal church to form or social welfare public beneft corporations a religious nonproft corporation; these groups (see discussion below on civic league and social can have a general religious purpose. For welfare groups). Don’t worry—we show you example, a group organized to promote the how to fll in your articles so you put in the right study and practice of a particular religion purposes under California law and also satisfy could incorporate as a religious nonproft the federal and state tax exemption requirements.

Special Types of California Public Beneﬁt Corporations

Tis book covers the incorporation of California to use this book to incorporate these types public benefit and religious nonprofits that want of public benefit corporations. (See “Special to obtain their tax exemption under Section Nonprofit Tax-Exempt Organizations,” in 501(c)(3) of the Internal Revenue Code. Tere are Appendix B, for a list of organizations that several other types of California public benefit qualify for tax-exempt status under a sub- corporations that obtain tax exemption under section of 501(c) other than Subsection 3.) other sections of the Internal Revenue Code or t Medical or legal service corporations. Tese that must meet special state law requirements. are nonprofit corporations operated to Below, we list several of the most common types assume or defray the cost of medical or legal of these special California nonprofit corporations. services. Tese corporations may be organized If you plan to form one of these special non- as California public benefit corporations profits, you’ll need to do your own research or get or mutual benefit corporations. Special legal help to form your corporation—this book provisions of the California Corporations does not cover the incorporation of these special Code apply (see California Corporations Code groups. See “Where to Go for Help for Non-501(c) §§ 10810–10841). (3) Nonprofits,” below. t Humane societies. A humane society, formed t Civic leagues and social welfare groups. Civic to prevent cruelty to children or animals, leagues and social welfare groups are formed as can be formed as a California public benefit California public benefit corporations and seek corporation. Te Department of Justice their exemption from federal corporate income must perform a criminal history check on taxation under Section 501(c)(4) of the Internal all incorporators and issue a certificate Revenue Code. Because this book covers only before the secretary of state will accept the nonprofits exempt under Section 501(c)(3) of articles of incorporation for filing (California the Internal Revenue Code, you won’t be able Corporations Code §§ 10400–10406). 8 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

corporation. It is unlikely that the California corporation can own part of the corporation. Secretary of State’s ofce, where you’ll fle your When the corporation dissolves and all its debts articles of incorporation, will question whether and liabilities are paid, the remaining assets, your religious activities are genuine. Tis type gains, and profts can be distributed to its of debate is more likely to occur (if it occurs members. at all) when you apply for your state or federal tax exemptions. Do-Good LLCs and Corporations— Te Latest in Limited Liability Entities Mutual Benefit Corporations Tis book is not intended for mutual beneft A number of states enable the formation of corporations. Unlike public beneft corpo rations hybrid entities (LLCs and/or corporations) that and religious corporations, these groups usually can make a profit yet also do good. For example, qualify for tax-exempt status under a subsection some states (although not California at present) of 501(c) other than 501(c)(3). authorize the formation of a low-profit LLC Examples of mutual beneft corporations (also called an L3C) that can be formed for an include trade associations, automobile clubs, educational or charitable purpose but also can and social groups, such as tennis clubs. make a profit. States initially created this special Chambers of commerce, boards of trade, and type of hybrid entity to allow foundations mechanics’ institutes, which are generally to more easily distribute funds to a qualified formed to promote trade and commerce, can social-purpose organization, but the IRS has not organize as mutual beneft corporations or as yet formally approved L3Cs for this purpose. regular, for-proft corporations. Cooperatives, Closer to home, California allows the formation comprising producers or consumers organized of flexible purpose corporations and benefit for their mutual beneft, can also qualify as corporations, which can be formed to do good mutual beneft nonprofts with special added works as well as to make money. Te advantage restrictions applicable to them. of these new California entities is that they can Because these groups do not qualify for tax- allow the principals to spend time and money exempt status under Section 501(c)(3), they are trying to do good without having to worry OPUFOUJUMFEUPNBOZPGUIFCFOFëUTFOKPZFE about stakeholders being upset (and suing them) by public beneft and religious corporations. for not spending all their time trying to turn For example, contributions to mutual beneft a profit. Because these entities are formed to corporations are normally not tax deductible, make money, they do not qualify for a 501(c)(3) and other benefts (such as special nonproft corporate income tax exemption. mailing rates and real and personal property tax All of the above hybrid entities are sometimes exemptions) are not available to mutual beneft loosely referred to as B corporations. However, corporations. Mutual beneft corporations also this term really refers to a certification that a cannot distribute gains, profts, or dividends socially-responsive corporation, LLC, or other to those designated in their articles or bylaws entity can seek, as opposed to a separate type as members, but may provide them with other of corporation or other distinct legal entity (see benefts such as services and facilities. On www.bcorporation.net for more information). the other hand, members of a mutual beneft CHAPTER 1 | IS NONPROFIT INCORPORATION RIGHT FOR YOU? | 9

Benefits of the Nonprofit Where to Go for Help for Corporation Non-501(c)(3) Nonprofits Now that you understand that this book is If you want to form a nonprofit for any purpose intended for nonprofts organized for religious, other than one recognized under Section charitable, scientifc, literary, and/or educa- 501(c)(3) of the Internal Revenue Code, this tional purposes that want to qualify for a book is not for you. For example, if you are a tax exemption under Section 501(c)(3) of the civic league or social welfare group that wants Internal Revenue Code (and hopefully your nonprofit status, you will want to organize as nonproft is among them), let’s look at the a public benefit corporation under Section CFOFëUTZPVMMFOKPZBTB D UBYFYFNQU 501(c)(4) of the Internal Revenue Code. Or, nonproft corporation. Te relative importance if your group is a California mutual benefit of each of the following benefts will vary from corporation, you will seek tax-exempt status group to group, but at least one of them should under a subsection of 501(c) other than be very signifcant for your organization. 501(c)(3). Tis book is not intended for these If you fnish this section and conclude that special types of nonprofits. nothing here is very important for your group, If you are a special nonprofit that is not covered you’ll want to consider whether it makes sense by this book, you can find legal forms and tax to incorporate at all. Many groups accomplish exemption help online. For sample articles of UIFJSOPOQSPëUQVSQPTFTKVTUëOFBTVOJODPSQP incorporation for mutual benefit corporations rated nonproft associations, without formal and public benefit civic leagues and social welfare organizational paperwork or written operational groups, go to the California Secretary of State rules. If you can continue to accomplish your website (the Business Entities section). If you are nonproft purposes and goals informally, you seeking tax exemption for a nonprofit under a may be happier staying small. subsection of 501(c) other than 501(c)(3), go to the IRS website at www.irs.gov and obtain Tax Exemptions IRS Package 1024. Te IRS 1024 package contains Nonproft corporations are eligible for state and forms and instructions to use to apply for a federal exemptions from payment of cor po- nonprofit tax exemption under Internal Revenue rate income taxes, as well as other tax exemp- Code Sections 501(c)(2), (4), (5), (6), (7), (8), tions and benefts. At federal corporate tax (9), (10), (12), (13), (15), (17), (19), and (25). rates of 15% on the frst $50,000 of taxable Te California Franchise Tax Board website income, 25% on the next $25,000, and 34% at www.ftb.ca.gov has state tax exemption and higher on income over $75,000, it goes application forms to download and use to apply without saying—at least if you expect to earn for your state corporate income tax exemption a substantial amount of money (from services, for these special non-501(c)(3) groups. IRS exhibits, or performances, for example)—that Publication 557 and IRS Form 1024 also contain you’ll want to apply for an exemption. Te information and instructions on forming some California corporate income tax exemption of these special purpose nonprofits. is equally attractive, as are county real and personal property tax exemptions. Chapters 3, 4, and 5 cover tax exemptions in detail. 10 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

SEE AN EXPERT Protection From Personal Liability Get the help of a competent tax adviser Protecting the members of your group from as soon as you decide to incorporate. Make sure personal liability is one of the main reasons you choose someone experienced in the special field for forming a corporation (either proft or of nonprofit bookkeeping. Ask the adviser to help you (especially your treasurer) set up a good record- nonproft). Once you’re incorporated, in keeping system. Have the tax helper periodically most situations directors or trustees, ofcers, review the system to be sure that you have met employees, and members of a corporation accepted bookkeeping standards and have filed your won’t be personally liable for corporate debts tax forms on time. or liabilities, including unpaid organizational EFCUTBOEVOTBUJTëFEMBXTVJUKVEHNFOUTBHBJOTU the organization, as they normally would Receiving Public and be if they conducted their afairs without Private Donations incorporating. Creditors can go after only corporate assets to satisfy liabilities incurred One of the primary reasons for becoming by the corporation—not the personal assets a 501(c)(3) nonproft corporation is that it (car, home, or bank accounts) of the people increases your ability to attract and receive who manage, work for, or volunteer to help the public and private grant funds and donations. nonproft corporation. tPublic sources. Tax-exempt government foundations (like the National Endowment EXAMPLE: A member of the audience sued for the Arts or Humanities, the Corporation a nonproft symphony orchestra when the for Public Broadcasting, or the National patron fell during a concert, claiming that Satellite Program Development Fund) as the symphony (which also owned the concert well as private foundations and charities hall) provided an unsafe ramp. Te patron (such as the Ford Foundation, the United XPOBKVEHNFOUUIBUFYDFFEFEUIFPSDIFTUSBT Way, or the American Cancer Society) are insurance policy limits. Te amount of the usually required by their own operating KVEHNFOUJOFYDFTTPGJOTVSBODFJTBEFCU rules and federal tax regulations to donate of the corporation, but not of its individual their funds only to 501(c)(3) tax-exempt directors, members, managers, or ofcers. organizations. By contrast, had the orchestra been an tPrivate sources. Individual private donors can unincorporated association of musicians, claim personal federal income tax deductions the principals of the unincorporated group for contributions made to 501(c)(3) tax- could be held personally liable for the excess exempt groups. At death, a complete federal KVEHNFOUBNPVOU estate tax exemption is available for bequests made to 501(c)(3) groups. In a few situations, however, people involved In short, if you plan to ask people to give you with a nonproft corporation may be personally signifcant amounts of money in furtherance liable for the corporation’s liabilities. Here are of your nonproft purpose, you need to TPNFNBKPSBSFBTPGQPUFOUJBMQFSTPOBMMJBCJMJUZ demonstrate to your donors that you have tTaxes. State and federal governments can hold 501(c)(3) tax- exempt status. the corporate employee who is respon sible for CHAPTER 1 | IS NONPROFIT INCORPORATION RIGHT FOR YOU? | 11

reporting and paying corporate taxes (usually risks fnancial liability without sufcient the treasurer) personally liable for any unpaid backup in cash or other assets, a court may taxes, penalties, and interest due for failure disregard the corporate entity and hold the to pay taxes or fle necessary returns. With principals responsible for debts and other proper planning, your non proft corporation liabilities of the corporation. In legalese, should be tax exempt, but you may still have this is known as “piercing the corporate to fle informational returns and annual veil.” Piercing the veil is the exception, not reports with the secre tary of state, as well the rule, and only happens when a court as pay employee with holding and other decides that it is necessary to prevent a payroll taxes and taxes on income unrelated HSPTTJOKVTUJDFPSGSBVEQFSQFUVBUFECZUIF to your nonproft purposes. IRS penalties founders or principals of a corporation. for delinquent tax payments and returns are tPrivate foundation managers. If the nonproft substantial, so keep this exception to limited corporation is classifed as a private foun- liability in mind—particularly if you will be dation, foundation managers can be held the treasurer. personally liable for federal excise taxes tDues. Members of a nonproft corporation associated with certain prohibited trans- are personally liable for any membership actions. Tey may also be held personally fees and dues they owe the corporation. In liable for penalties and interest charged most cases, this is a minor obligation since for failing to fle certain tax returns or dues are normally set at modest amounts. pay required excise taxes. (As explained in tViolations of statutory duties. Corporate Chapter 4, a private foundation is a 501(c)(3) directors are legally required to act respon- corporation that does not qualify as a public sibly (not recklessly) when managing the charity—you’ll see that most 501(c)(3) corporation. Tey may be held personally nonprofts can qualify as public charities fnancially liable if they fail to act respon- BOEBSFOPUTVCKFDUUPUIFQSJWBUFGPVOEBUJPO sibly. Personal liability of this sort is the requirements.) exception, not the rule. Generally, as long tLoans. When a nonproft corporation takes as directors attend meetings and carry out a loan to cover its operating costs or buys corporate responsibilities conscientiously, QSPQFSUZTVCKFDUUPBNPSUHBHF CBOLTBOE they should have little to worry about—the commercial lending institutions sometimes corporate limited liability shield insulates insist on the personal guarantee of its direc- directors from all but the most reckless and tors or ofcers. If the directors or ofcers irresponsible decisions. agree to personally guarantee the loan or tIntermingling funds or other business dealings. mortgage, the protection that they would A nonproft corporation must act so that OPSNBMMZFOKPZBTBSFTVMUPGUIFJSPSHB its separate existence is clear and respected. ni zation’s corporate status goes away. It is If it mixes up corporate funds with the somewhat unusual for nonproft directors or personal funds of those in charge, fails to ofcers to sign a personal guarantee. Obvi- follow legal formalities (such as failing to ously, if they do, they will be liable to repay operate according to bylaws, hold director the loan if the corporation cannot do so. meetings, or keep minutes of meetings), or 12 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Separate and Perpetual procedures for decision making and dispute Legal Existence resolution. Tis is important for any collective activity, but for nonproft groups it is vital, A corporation is a legal entity that is separate especially if the board includes members of from the people who work in it. Again, one the community with diverse interests and beneft of this separate existence is that corpo- viewpoints. Without the clear-cut delegation rate liabilities are not the liabilities of the of authority and specifc operating rules in the managers, ofcers, or members of the corpora- articles and bylaws, running the organization tion (known as the corporate characteristic of might be a divisive, if not futile, afair. limited liability). Another beneft is that this corporate legal person is, in a sense, immortal; Miscellaneous Beneﬁts the nonproft corporation continues to exist as a legal entity despite changes in management Additional advantages are available to non- or other corporate personnel caused by the profts that engage in particular types of resig nation, removal, or death of the people activities or operations. Tese benefts can be associated with it. It may, of course, be dissolved helpful, and in some cases are critical, to the or drastically afected by the loss of key people, success of a nonproft organization. Here are but its inherent perpetual existence makes examples of some of the benefts available to it more likely that the group’s activities will certain types of tax- exempt nonprofts: continue, an attractive feature to the private or t:PVSOPOQSPëUNBZRVBMJGZGPSFYFNQUJPOT public donor who prefers funding activities that from county real and personal property are organized to operate over the long term. taxes. t D PSHBOJ[BUJPOTSFDFJWFMPXFSQPTUBM Employee Beneﬁts rates on third-class bulk mailings. t.BOZQVCMJDBUJPOTPêFSDIFBQFSDMBTTJëFE Another beneft of the nonproft corporation advertising rates to nonproft organizations. is that its principals can also be employees t/POQSPëUTBSFUIFFYDMVTJWFCFOFëDJBSJFT and, therefore, eligible for employee fringe of free radio and television public service benefts not generally available to the workers announcements (PSAs) provided by local in unincorporated organizations. Tese media outlets. benefts include group term life insurance, t.BOZTUPSFTPêFSMPXFSNFNCFSTIJQSBUFTUP reimbursement of medical expenses, and nonproft employees. coverage by a qualifed corporate employee t/POQSPëUFNQMPZFFTBSFPGUFOFMJHJCMFUP pension or retirement income plan. QBSUJDJQBUFJOKPCUSBJOJOH TUVEFOUJOUFSO work-study, and other federal, state, and Formality and Structure local employment incentive programs Te formal corporate documents—the articles, (where salaries are paid substantially out of bylaws, minutes of meetings, and board federal and state funds). resolutions—that you’ll prepare as a nonproft t D QFSGPSNJOHBSUTHSPVQTBSFRVBMJëFE will actually be quite useful to your organization. to participate in the performance programs Tey’ll outline the group’s purposes, embody sponsored by federally supported colleges its operating rules, and provide structure and and universities. CHAPTER 1 | IS NONPROFIT INCORPORATION RIGHT FOR YOU? | 13

t$FSUBJO D FEVDBUJPOBMPSHBOJ[BUJPOT be able to do that! ” then chances are you’ve are eligible for a tax refund for gasoline decided to tackle the rules and forms necessary expenses (for example, in running school to establish your status as a legal nonproft. buses). #FGPSFKVNQJOHJO IPXFWFS UBLFBNJOVUF to read the following descriptions of some of EXAMPLE: A senior citizens’ botany club the hurdles and work you’ll encounter along began as an informal organization. Initially, the way, especially if you have been operating six members took a monthly nature walk informally (and successfully) without fnancial UPTUVEZBOEQIPUPHSBQISFHJPOBMìPSB or employee record keeping or controls. If any Everyone chipped in to buy gas for whoever of the following appear insurmountable to you, drove to the hike’s starting point. Recently, think again about incorporating. however, membership increased to 15 and the group decided to collect dues from Oﬃcial Paperwork members to pay the increased expenses— One disadvantage in forming any corporation gas money, guidebooks, maps, and club is the red tape and paperwork. You’ll begin T-shirts—associated with more frequent by preparing initial incorporation documents feld trips. To avoid mixing club monies with (articles of incorporation, bylaws, and minutes personal funds, a treasurer was designated of frst meeting of the board of directors), and to open a bank account on behalf of the an IRS income tax exemption application. organization. Several people suggest that it is Although this book will show you how to time to incorporate the club. prepare your own incorporation forms and Does incorporation make sense at this income tax exemption application with a time? Probably not. Tere is no new minimum of time and trouble, the process will pressing need to adopt the corporate form still take you a few hours at the very least. You or to obtain formal recognition as a tax- and your compatriots must be prepared for exempt nonproft. Most banks will allow some old-fashioned hard work. an unincorporated group without a federal After you’ve set up your corporation, you’ll Employer Identifcation Number or IRS tax need to fle annual information returns with the exemption to open up a non–interest-bearing state (the Franchise Tax Board and the attorney account. However, should the club decide to general) as well as the Internal Revenue Service. seek funding and contributions to spearhead Also, you will need to regularly prepare minutes a drive to save open space in the community, of ongoing corporate meetings, and, occasion- it might be a good idea to incorporate. ally, forms for amending articles and bylaws. Te annual tax reporting forms will require the implementation of an organized bookkeeping Te Disadvantages of system plus the help of an experienced non proft Going Nonproﬁt tax adviser, as explained below. Fortunately, keeping minutes of these meetings is not all If your group has come together for 501(c)(3) that difcult to do once someone volunteers tax-exempt purposes, and if reading about for the task (typically the person you appoint the benefts of becoming a nonproft above as corporate secretary). Sample forms for prompted a “Wow! We would really like to amending nonproft articles are available from 14 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

the California Secretary of State’s website. Go With a larger, more accountable organization to the Business Entities section and click on come a number of new tasks: setting up and “Forms, Samples, and Fees.” balancing books and bank accounts, depositing Annual nonproft informational tax returns do and reporting payroll taxes, and meeting with present a challenge to a new group unfamiliar an accountant to extract and report year-end with state tax reporting forms and require- fgures for annual informational returns. ments. Other record-keeping and reporting Although these fnancial, payroll, and tax chores, such as double-entry accounting concerns are not exclusively corporate chores, procedures and payroll tax withholding and you’ll fnd that most unincorporated nonprofts reporting, can be equally daunting. At least at keep a low employment, tax, and fnancial the start, most nonprofts rely on the experience profle and get by with minimum attention to of a tax adviser, bookkeeper, or other legal or legal and tax formalities. tax specialist on the board or in the community to help them set up their books and establish EXAMPLE: A women’s health collective a system for preparing tax forms on time. See operates as an unincorporated nonproft Chapter 11 for recommendations on fnding organization. It keeps an ofce open a few legal and tax professionals for your nonproft. days a week where people stop by to read and exchange information on community Incorporation Costs and Fees and women’s health issues. Te two founders donate their time and the ofce space and For nonproft incorporators unwilling to pay operating costs (such as phone, utilities, EPUIFKPCUIFNTFMWFT BNBJOEJTBEWBOUBHF and photo copying) that aren’t covered by of incorporating a nonproft organization contributions from visitors. Te organization is the cost of paying an attorney to prepare has never made a proft, there is no payroll, the incorporation forms and tax exemption and tax returns have never been fled. Tere applications. Putting some time and efort is a mini mum of paperwork and record into understanding the material in this book keeping. can help you eliminate this disadvantage, Te founders could decide to continue this leaving you with only the actual cost of incor- way indefnitely. However, the founders want poration. Including the typical $400 federal to expand the activities and revenues of the tax exemption application fee, total fees to collective. Tey decide to form a 501(c)(3) incorporate are approximately $450 to $500. nonproft corporation in order to be eligible (Costs are $450 higher for nonprofts that for tax- deductible contributions and grant anticipate gross receipts of more than $10,000. funds from the city, and to qualify the Tese groups pay an $850, rather than a $400, group to employ student interns and work- federal tax exemption application fee.) study students. Tis will require them to prepare and fle articles of incorporation and Time and Energy Needed a federal corporate income tax exemption to Run the Nonproﬁt application. Tey must select an initial board When a group decides to incorporate, the legal of directors and prepare organizational decision is often part of a broader decision to bylaws and formal written minutes of the JODSFBTFOPUKVTUUIFTUSVDUVSF CVUUIFPWFSBMM frst board of directors’ meeting. scope, scale, and visibility of the nonproft. CHAPTER 1 | IS NONPROFIT INCORPORATION RIGHT FOR YOU? | 15

After incorporation, the group holds of directors cannot be paid (other than as a regu lar board meetings documented with director), or related to other persons who are written minutes, sets up and uses a double- paid, by the corporation. Tis can represent entry bookkeeping system, implements a signifcant restriction because it eliminates regular federal and state payroll and tax the close-knit organization many picture when pro ce dures and controls, fles exempt organi- they think of a small, grassroots nonproft zation tax returns each year, and expands corporation. its operations. A full-time staf person is assigned to handle the increased paperwork Restrictions Upon Dissolution and bookkeeping chores brought about One of the requirements for the 501(c)(3) by the change in structure and increased tax exemption is that upon dissolution of the operations of the organization. corporation, any assets remaining after the corporation’s debts and liabilities are paid must Tis example highlights what should be one of go to another tax-exempt nonproft, not to the frst things you consider before you decide members of the former corporation. to incor porate: Make sure that you and your coworkers can put in the extra time and efort that an incorporated nonproft organization will Restrictions on Your require. If the extra work would overwhelm or Political Activities overtax your current resources, we suggest you Section 501(c)(3) of the Internal Revenue hold of on your incorporation until you get Code establishes a number of restrictions and the extra help you need to accomplish this task limitations that apply to nonprofts. Here, we smoothly (or at least more easily). discuss a limitation that may be very signi fcant to some groups—the limitation on your politi- Restrictions on Paying cal activities. Specifcally, your organization Directors and Oﬃcers may not participate in political campaigns for or against candidates for public ofce, and As a matter of state corporation law and the cannot substantially engage in legislative or tax exemption requirements, nonprofts are grassroots political activities except as permitted restricted in how they deal with their directors, under federal tax regulations. ofcers, and members. None of the gains, profts, or dividends of the corporation can go EXAMPLE: Society for a Saner World, Inc., to individuals associated with the corporation, IBTBTPOFPGJUTQSJNBSZPCKFDUJWFTMPCCZJOH including directors, ofcers, and those defned hard to pass federal and local legislation as members in the corporation’s articles or that seeks to lessen societal dependency on bylaws. State self-dealing rules apply as well, fossil fuels. Since a substantial portion of regulating action by the board of directors if a the group’s eforts will consist of legislative director has a fnancial interest in a transaction. lobbying, the group’s 501(c)(3) tax exemption Finally, with respect to California public beneft probably will be denied by the IRS. Instead, corporations (if you form a 501(c)(3) tax- the group should seek a tax-exemption exempt nonproft corporation for nonreligious under IRC § 501(c)(4) as a social welfare purposes, you will form a California public group, which is not limited in the amount CFOFëUDPSQPSBUJPO BNBKPSJUZPGUIFCPBSE of lobbying the group can undertake. 16 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Of course, the benefts of 501(c)(4) tax A nonproft may use its tax-free profts for exemption are fewer too—contributions its operating expenses (including salaries for to the group are not tax-deductible and ofcers, directors, and employees) or for the grant funds will be more difcult to beneft of its organization (to carry out its obtain—see “Special Nonproft Tax-Exempt exempt purposes). It cannot, however, distribute Organizations,” in Appendix B. any of the profts for the benefts of its ofcers, directors, or employees (as dividends, for example). Oversight by the Attorney General Tis section explains how nonprofts raise Te California Attorney General has broad initial funds and how they make money on an power to oversee the operations of California ongoing basis. public beneft corporations, more so than it does with other California nonprofts. (Remem- Initial Fundraising ber: If you form a nonreligious 501(c)(3) tax- A California nonproft corporation is not exempt corporation, you will be forming a legally required to have a specifed amount of California public beneft corporation.) Te state money in the corporate bank account before can even take the corporation to court to make commencing operations. Tis is fortunate, of sure it complies with the law. course, because many beginning nonprofts By contrast, California religious purpose start out on a shoestring of meager public and OPOQSPëUDPSQPSBUJPOTIBWFXJEFSìFYJCJMJUZJO private support. managing their internal afairs. If a religious So, where will your seed money come from? corporation does not set up its own operating As you know, nonproft corporations cannot rules, provisions of the nonproft law will issue shares, nor can they provide investment apply to its operations by default. Tese are incentives, such as a return on capital through less stringent than those that would apply to the payment of dividends to investors, bene- a public beneft corporation under similar factors, or participants in the corporation (see circumstances. “Corporation Basics,” at the beginning of this chapter). Nonprofts have their own means and meth- How Nonproﬁts Raise, ods of obtaining start-up funds. Obviously, Spend, and Make Money the most common method is to obtain revenue in the form of contributions, grants, Most nonprofts need to deal with money— and dues from the people, organizations, indeed, being able to attract donations is a and governmental agencies that support the prime reason for choosing nonproft status. nonproft’s purpose and goals. Also, if you Nonprofts can also make money. Nonproft are incorporating an existing organization, does not literally mean that a nonproft its assets are usually transferred to the new corporation cannot make a proft. Under federal corporation—these assets may include the cash tax law and state law, as long as your nonproft reserves of an unincorporated group, which can is organized and operating for a recognized help your corporation begin operations. You nonproft purpose, it can take in more money can also borrow start-up funds from a bank, than it spends in conducting its activities. although for newly formed corporations a bank CHAPTER 1 | IS NONPROFIT INCORPORATION RIGHT FOR YOU? | 17 will usually require that incorporators secure Making Money From Unrelated the loan with their personal assets—a pledge Activities (Unrelated Income) most nonproft directors are understandably Nonprofts can also make money in ways reluctant to make. unrelated to their nonproft purpose. Often Often, of course, nonprofts receive initial and this income is essential to the survival of ongoing revenues from services or activities pro- the nonproft group. Tis unrelated income, vided in the pursuit of their exempt purposes however, is usually taxed as unrelated business (ticket sales, payments for art lessons or dance income under state and federal corporate courses, school tuition, or clinic charges). income tax rules. While earning money this For information on meeting California’s way is permissible, it’s best not to let unrelated special fundraising rules, see “State Solicitation business activities reach the point where you Laws and Requirements,” in Chapter 5. start to look more like a for-proft business Making Money From than a nonproft one. Tis can happen if the unrelated income-generating activities are Related Activities absorbing a substantial amount of staf time, Many nonprofts make money while they requiring additional paid staf, or producing further the goals of the organization. Te non- more income than your exempt-purpose proft can use this tax-exempt revenue to pay activities. If the unrelated revenue or activities for operating expenses (including reasonable of your tax-exempt nonproft reach a substantial salaries) and to further its nonproft purposes. level, the IRS can decide to revoke the group’s For example, an organization dedicated to the 501(c)(3) tax exemption—a result your identifcation and preservation of shore birds nonproft will no doubt wish to avoid. might advertise a bird-watching and -counting hike for which they charge a fee; the group EXAMPLE: Many thousands of books are could then use the proceeds to fund their bird donated to Friends of the Library for its rescue operations. What it cannot do with BOOVBMCPPLTBMF POFPGJUTNBKPSGVOE the money, however, is distribute it for the raising events. Although the sale is always beneft of ofcers, directors, or employees of highly successful, thousands of books are the corporation (as the payment of a patronage left over. Friends decides to sell the more dividend, for example). valuable books by advertising in the rare and out-of-print books classifed sections EXAMPLE: Friends of the Library, Inc., is a in various magazines. Te response is 501(c)(3) nonproft organized to encourage overwhelming; soon, there are six employees literary appreciation in the community and to cataloging books. In addition, Friends begins raise money for the support and improvement a business purchasing books from other of the public library. It makes a proft from dealers and reselling them to the public. its sold-out lecture series featuring famous Such a situation could attract attention from authors and from its annual sale of donated the IRS and prompt it to reconsider Friends’ books. Friends can use this tax-exempt proft 501(c)(3) tax-exempt status. for its own operating expenses, including salaries for ofcers and employees, or to beneft the library. 18 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Making Money From rations Code §§ 5000–9927) governs the Passive Sources organi zation and operations of California nonproft corporations. Although it’s not typical for the average non- We focus on public beneft corporations in proft, a nonproft corporation can make money this book (those formed for public or charitable from passive sources such as rents, royalties, purposes) because these corporations make up interest, and investments. Tis income is UIFNBKPSJUZPGOPOQSPëUDPSQPSBUJPOTFMJHJCMF nontaxable in some cases. for exemption under Section 501(c)(3) of the Internal Revenue Code. Requirements for Your Path to religious corporations are noted only if they are diferent from the requirements for public Nonproﬁt Status beneft corporations. Nonproft organizations frst obtain nonproft corporate status with the California Secretary Tax-Exempt Status Under of State—a simple formality accomplished by Federal and State Tax Law fling articles of incorporation. Ten they go Both state and federal tax laws apply to Cali- on to obtain a corporate income tax exemption fornia nonproft corporations. To obtain tax- with the Internal Revenue Service. California exempt status, nonprofts must comply with recognizes your federal tax exemption, so initial and ongoing requirements under the you don’t have to prepare a separate state federal Internal Revenue Code. California tax tax exemption application. In sum, your law parallels the federal law. In most ways, path to nonproft status is a basic two-step understanding and complying with state process—frst you incorporate with the and federal tax rules is more important (and California Secretary of State, then you apply more challenging) than fulflling the state for tax-exempt recognition from the Internal corporate law requirements. Tis book focuses Revenue Service (you’ll notify the California on nonproft corporations seeking tax-exempt Franchise Tax Board of your federal income tax status under Section 501(c)(3) of the Internal exemption). When you’re done with this book, Revenue Code, which are nonprofts organized you’ll have completed each of these steps. for religious, charitable, educational, scientifc, or literary purposes. State Law Requirements for Nonproﬁts Incorporating in Another Te California Secretary of State must ofcially recognize all California nonproft corporations. State—Don’t Fall for It To obtain state recognition, you’ll fle articles Corporations formed in a particular state are of incorporation with the secretary of state’s known in that state as domestic corporations. ofce stating that your organization is entitled When viewed from outside that state, these to receive nonproft corporate status. Tis book corporations are considered foreign. A foreign covers the basic requirements for obtaining corporation that plans to engage in a regular recognition by California’s Secretary of State as or repeated pattern of activity in another state a nonproft corporation. Te California Non- must qualify to do business there by obtaining proft Corporation Law (California Corpo- CHAPTER 1 | IS NONPROFIT INCORPORATION RIGHT FOR YOU? | 19 a certifcate of authority from the secretary of Multiple State Laws state. For example, a corporation formed in :PVSPVUPGTUBUFDPSQPSBUJPOXJMMTUJMMCFTVCKFDU Nevada that intends to do regular business in to many of the laws that afect corpo ra tions California is a foreign corporation here, and in California. Many of California’s corpo rate must qualify the corporation with our secretary statutes that apply to domestic corporations of state. also apply to foreign corporations. Incorporators who plan to operate in another state besides California have naturally considered Out-of-State Activities whether it makes sense to incorporate in that other state. Maybe the incorporation fees Below the Radar or corporate taxes are lower than those in 'PSUIFBCPWFSFBTPOT NPTUSFBEFSTXIPìJSU California or the nonproft statutes are more with the idea of incorporating in a state other ìFYJCMFɨFO UIFSFBTPOJOHHPFT POFDPVME than California would be well advised to skip qualify the corporation in California as a foreign it. Tis doesn’t mean, however, that you’ll have corporation. As tempting as this end run may to trim all of your activities to stay within appear, it’s not usually worth it. Tis section California. Fortunately, there are many things explains why, and also advises you of out-of- nonprofts can do as a foreign corporation in state activities that you can engage in without another state without obtaining a certifcate of worrying about qualifying in another state. authority from the secretary of that state. Here are some that are recognized in many (but not Qualifying as a Foreign Corporation all) states: in California Will Cost You More tNBJOUBJOJOH EFGFOEJOH PSTFUUMJOHBOZ legal action or administrative proceeding, Te process of qualifying a foreign corporation including securing or collecting debts, and to operate in California takes about as much enforcing property rights time and expense as incorporating a domestic tIPMEJOHNFFUJOHTPGDPSQPSBUFEJSFDUPST corporation. Tis means that you will pay more or of the membership and distributing to incorporate out-of-state since you must pay information to members the regular California qualifcation fees plus tNBJOUBJOJOHCBOLBDDPVOUTBOENBLJOH out-of-state incorporation fees. grants of funds tNBLJOHTBMFTUISPVHIJOEFQFOEFOU Multiple Tax Exemptions contractors and engaging in interstate or :PVSDPSQPSBUJPOXJMMTUJMMCFTVCKFDUUPUBYB foreign commerce tion in each state in which it earns or derives tDPOEVDUJOHBTPDBMMFEJTPMBUFEUSBOTBDUJPO income or funds. If the state of incorporation that is completed within 30 days and is not imposes a corporate income tax, then the one of a series of similar transactions, and nonproft corporation will need to qualify for tFYFSDJTJOHQPXFSTBTBOFYFDVUPS BENJOJTUSBUPS two state corporate tax exemptions—one in or trustee, so long as none of the activities California, the state where the corporation will required of the position amounts to be active, and one for the state of incor poration. transacting business. Similarly, double sales, property, and other state tax exemptions may often be necessary or appropriate. 20 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

When Out-of-State to incorporate, you can refer to the secretary Incorporation Makes Sense of state’s website for each state where you operate. Type “nonproft resource libraries” Tere may be a few of you for whom incorpo- into your browser’s search box—you’ll fnd a ration in another state makes sense. If you plan host of online resources at your disposal. An to set up a multistate nonproft with corporate experienced nonproft lawyer or consultant can ofces and activities in more than one state also help you determine which state is the most (a tristate environmental fund for example), convenient and least costly to use as the legal you may want to consider incorporating in home for your new nonproft corporation. the state that ofers the greatest legal, tax, and practical advantages. To help you decide where

References to IRS Articles and Materials

Troughout the book, there are references to In other words, use this material to learn about IRS articles and materials that you can download IRS tax issues, but don’t expect to be able to from Nolo’s website (see Appendix A for the rely on it if you end up in a dispute with the IRS. link). Some of this material includes articles Nolo includes this material as a convenience to and information made available by the IRS on the reader and as an alternative to directing you its website as part of its Exempt Organizations to the IRS website. Tis material is taken directly Continuing Professional Education Technical from the IRS website at www.irs.gov (enter “EO Instruction Program, which regularly publishes Tax Law Training Articles” in the search box at articles for tax-exempt organizations. Te IRS has the top of the main website page, then follow the following statement on its website regarding the links to “Exempt Organizations Continuing this material: “Tese materials were designed Professional Education Technical Instruction specifically for training purposes only. Under Program” main page, where you’ll find a link to no circumstances should the contents be used an alphabetical index of the articles, “Exempt or cited as authority for setting or sustaining a Organizations CPE Topical Index”). If you are technical position.” interested in one of the issues, you should check the IRS website for any updated articles or information on your topic. ● CHAPTER Legal Rights and Duties of Incorporators, Directors, Officers, Employees, and Members 2

Incorporators and Teir Role as Promoters ...... 24 A Promoter Must Act With the Corporation’s Best Interests in Mind ...... 24 Directors Must Ratify a Promoter’s Actions ...... 24 Promoters Can Avoid Personal Liability ...... 24 Convincing Tird Parties to Do Business With a Promoter ...... 25 Directors ...... 25 Selecting Directors ...... 25 Paying Your Directors ...... 27 Public Benefit Corporations and the “51% Rule” ...... 28 Term of Office ...... 29 Quorum Rules ...... 30 Voting Rules ...... 30 Executive Committees ...... 31 Directors Must Act Carefully ...... 32 Directors Must Be Loyal ...... 33 How to Avoid Self-Dealing ...... 34 Loans and Guarantees ...... 36 Special Protections for Volunteer Directors and Officers ...... 37 Officers ...... 39 Duties and Responsibilities ...... 39 Officers May Bind the Corporation ...... 40 Compensation of Officers ...... 40 Loans, Guarantees, and Immunity Laws ...... 41 Employees ...... 41 Employee Immunity ...... 41 Employee Compensation ...... 42 Employee Benefits ...... 42 22 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Membership Nonproﬁts ...... 42 Nonmembership Corporations ...... 42 Who Is a Member Under Law? ...... 43 Classes of Membership ...... 44 Membership Quorum and Voting Rules ...... 45 Membership Action to Dissolve the Nonproﬁt ...... 45 Expelling Members ...... 45 Complying With Securities Laws ...... 45 CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 23

ven though a corporation is a legal person Tis chapter explains the rights and responsi- capable of making contracts, incurring bilities of those in your group who will organize E liabilities, and engaging in other activities, and operate your nonproft corporation. Tese it still needs real people to act on its behalf to incorporators, directors, ofcers, members, carry out its activities. Tese people decide to and employees have separate legal rights and incorporate, select those who will be responsible responsibilities. Later, after your nonproft is for running the organization, and actually up and running, you may want to refer back to manage and carry out the nonproft’s goals and this chapter if you have questions regarding the activities. powers and duties of these important people.

Te Importance of Protecting Your Corporate Status

Before you start looking for people to help run reach of newly formed small non profits. Also, your nonprofit, take a moment for a reality check: D&O coverage often excludes the sorts of Many potential helpers will hesitate to become potential liabilities that your directors and involved because they’ve read in the press about officers may be worried about (personal injury a few notorious, high-visibility lawsuits where and other types of legal tort actions, claims of nonprofit directors have been held personally illegality, or intentional misconduct and the like). liable for misconduct by executives of the If you decide to investigate the cost of D&O nonprofit (for example, the executive of a large, insurance, you will want to make sure to go over public membership nonprofit misappropriates the areas of coverage and exclusion in the policy program funds to buy a yacht or high-priced very carefully before you buy in. apartment for personal use). On a more down- California nonprofit law recognizes that non- to-earth level, a potential treasurer for your profits often can’t afford D&O liability insurance nonprofit may hesitate to serve if that person with adequate claim coverage and it contains thinks he or she will be personally responsible provisions that help limit volunteer directors’ for the organization’s tax reporting penalties, and officers’ exposure to liability. Corporations or a potential director may be worried about must also indemnify (advance or pay back) being personally sued by a fired employee of the a director for legal expenses incurred in a nonprofit. Fortunately, these types of personal lawsuit under certain conditions. Tese special liability are extremely rare. Most nonprofits California statutes are discussed in more detail should be able to assure potential director and in “Directors,” below, and they can provide officer candidates that the nonprofit will be run added comfort to people considering serving accountably and sensibly with out undue risk of as a California nonprofit corporation director tax or legal liability for the directors. or officer. Again, we believe the best and most One obvious way to reassure candidates is to practical way to reassure directors and officers purchase directors’ and officers’ liability insurance to hitch their wagon to your nonprofit organi- from an insurance broker who handles nonprofit zation’s star is to be able to show them you corporate insurance (called D&O errors and will operate your nonprofit fairly, responsibly, omissions insurance). Tis type of insurance, and safely without undue risk of lawsuits by however, is expensive and usually beyond the employees or complaints by the public. 24 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Incorporators and Teir ëEVDJBSZɨJTMFHBMKBSHPOTJNQMZNFBOT the incorporator has a duty to act in the Role as Promoters best interests of the corporation, and must An incorporator is the person (or persons) who make full disclosure of any personal interest signs and delivers the articles of incorporation and potential benefts derived from business to the secretary of state for fling. In practice, transacted for the nonproft. the incorporator is often selected from among EXAMPLE: When the incorporator/promoter the people who serve as the initial directors arranges to sell property he or she owns to of the corporation. Once the corporation is the nonproft corporation, the incorporator formed, the incorporator’s legal role is fnished. must disclose to the non proft’s board of During the organizational phase, it’s not directors both any ownership interest in the unusual for an incorporator to become a property and any gain she or he stands to “promoter” of the corporation. An incorpo- make on the sale. rator’s promotional activities can quickly go beyond enthusiastic talk about the organi zation. Promotional activities may involve obtaining Directors Must Ratify a money, property, personnel, and whatever else Promoter’s Actions it takes to get the nonproft corporation started. Arranging for a loan or renting ofce space will Most of the time, a nonproft corporation won’t require signatures and promises—to repay the be bound by an incorporator’s preincorporation loan and pay the rent. But will the newly formed contract with a third party unless the board of corporation automatically become responsible? directors ratifes the contract or the corporation 'VUVSFEJSFDUPSTNBZIFTJUBUFUPKPJOBOFX accepts the benefts of the contract. For example, organization that is saddled already by contracts if a nonproft board votes to ratify the lease negotiated by an eager (but perhaps unsavvy) signed by an incorporator before the date of promoter. Te promoters themselves will incor poration, the corporation will be bound to naturally be nervous that they’ll be personally honor the lease. Similarly, if the nonproft moves responsible if the incorporation plans go awry. into its new ofces and conducts business there, And what about the third parties? Tey may not their actions will constitute a ratifcation and the be inclined to do business with promoters unless nonproft will be bound. they are assured that there will be a respon sible party at the other end. After explain ing how a Promoters Can Avoid promoter must approach every trans action—with Personal Liability the corporation’s best interests in mind—we’ll Fortunately, if promoters carefully draft show you how to address the concerns of the documents—such as any loan papers and eventual directors, the promoters themselves, and leases—they can avoid the risk of personal the third parties with whom they do business. liability in the event that the corporation doesn’t ratify the deal (or if the corporation A Promoter Must Act With the never comes into being). Incorporators will not Corporation’s Best Interests in Mind be personally liable for these contracts if they When an incorporator acts as a promoter, sign in the name of a proposed corporation, he or she is considered by law to be its not in their individual name, clearly inform the CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 25

third party that the corporation does not yet the corporation (the incorporators) also exist and may never come into existence, and become the corporation’s frst directors and tell the third party that even if it does come they are also the ones who prepare and fle the into existence, it may not ratify the contract. articles of incorporation. Although there are no residency requirements (you can have out- Convincing Tird Parties to Do of-state directors) or age requirements, your Business With a Promoter directors should be over the age of 18 to avoid contractual problems. As you might imagine, a cautious third party may balk at doing business with an individual whose yet-to-be-formed nonproft may repudiate Selecting Directors the deal. One way to provide some assurance to Choosing directors is one of the most important a third party is for an incorporator to personally decisions you will make when organizing your bind to the contract—in essence, become a nonproft. Here are some important things guarantor for the loan, lease, or other contract. to consider that will help you make the best Understandably, few incorporators will be able possible choice for your organization. or willing to put their personal fnances on the line, unless they are absolutely sure that Commitment to Your Nonproﬁt’s Purpose the corporation will in fact be formed and Your directors are a crucial link between will ratify the deal. Te other solution is to your organization and its supporters and incorporate quickly—which you can do with benefactors. Make sure that the members of the help of this book! the community that you plan to serve will see your directors as credible and competent EXAMPLE: An incorporator/promoter enters representatives of your group and its nonproft into an agreement to lease ofce space goals. Teir status and integrity will be crucial for its organi zation. Six months later, the to encouraging and protecting public trust organization obtains nonproft corporate in your organization, and their connections status. Te newly formed nonproft is not will be vital to attracting recognition, clients, bound by the lease agree ment unless its donations, and other support. board of directors ratifes the agreement or t$POTJEFSNFNCFSTPGUIFDPNNVOJUJFTZPV the organi zation used the ofce space during will serve who have a proven commitment the preincor poration period. to the goals of your organization. Tere may be more than one community you’ll want to consider. For example, your draw may Directors be local (city, county, or state), regional, or national. If you are an environmental group Directors meet collectively as the board concerned with issues in the southern part of directors, and are responsible—legally, of the state, you have both a geographic fnancially, and morally—for the management community (people in the area) and a and operation of your nonproft corporation. community of interest (environmentalists A nonproft in California must have at least HFOFSBMMZ :PVSCPBSETIPVMESFìFDUBDSPTT one director, although many nonprofts have section of interested and competent people three or more. Often, the people who formed from both these communities. 26 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

t-PPLGPSQFPQMFXJUIDPOUBDUTBOESFBM taxes or accounting properly for public or world knowledge and experience in the private grant monies. specifc area of your nonproft’s interest. tUseful practical skills. Do you need the If you are starting a new private school professional expertise of a doctor, lawyer, or health clinic, someone familiar with or architect; or operational assistance in your state’s educational or public health areas such as public relations, marketing, or bureaucracy would be a big help. publishing? If so, make fnding one of these t*GZPVSPSHBOJ[BUJPOJTTFUVQUPEPHPPE professionals a high priority during your works that will beneft a particular group, board search. don’t overlook the value of including a member of that recipient group. You may learn important things about your Public Officials Are a Good Choice mission and get valuable buy-in from the Te IRS likes to see that you have a representa- benefciaries of your hard work. tive (and financially disinterested) governing body that reflects a range of public interests, Business Knowledge and Expertise not simply the personal interests of a small Directors’ responsibilities include developing number of donors. While it’s by no means and overseeing organizational policies and required, the presence of a sympathetic public goals, budgeting, fundraising, and disbursing official on your board can enhance its credibility a group’s funds. Te board of directors may with both the IRS and the community. hire an administrator or executive director to supervise staf and daily operations, or it may supervise them directly. Either way, your board of directors should be a practical-minded group Avoid Conflicts of Interest with strong managerial, technical, and fnancial When selecting board members, you may skills. In making your selection, try to fnd need to inquire about, or at least consider, a people with the following skills and experience: prospective member’s agenda or motives for t Fundraising experience. While many large KPJOJOHUIFCPBSE0CWJPVTMZ QFPQMFXIPXBOU nonprofts have a staf fundraiser, smaller UPKPJOGPSQFSTPOBMCFOFëUSBUIFSUIBOGPSUIF groups often can beneft from the advice of beneft of the organization or the public should an experienced board member. not be asked to serve. Tis doesn’t mean that tExperience managing money. A profes sional FWFSZPOFXJUIBSFNPUFPSQPUFOUJBMDPOìJDUPG accountant or someone with expertise interest should be automatically disqualifed. It in record keeping and budgeting can EPFTNFBOUIBUBOZTMJHIUPSQPTTJCMFDPOìJDU be a godsend. Many nonprofts get into of interest should be fully recognized and difculty because their record-keeping EJTDVTTFE*GUIFDPOìJDUJTMJNJUFE EJSFDUPST and reporting techniques aren’t adequate may be able to serve constructively if they to produce the information required refrain from voting on certain issues. by the federal and state governments. Te bylaws included in this book have Many are simply inattentive to fnancial DPOìJDUPGJOUFSFTUQSPWJTJPOTUIBUDPOUBJO responsibilities, such as paying withholding rules and pro cedures for avoiding or approving CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 27

transactions, including compensation arrange- should get regular updates on changes made to ments, that beneft the nonproft’s directors, these rules and regulations. ofcers, employees, or contractors. See Article 9 of the bylaws and “Limitation on Profts and TIP Benefts,” in Chapter 3, for more information Choose the right number of directors. on this topic. You’ll want enough to ensure a wide basis of support (particularly with respect to fundraising), Develop a Realistic Job Description but not so many as to impede eﬃciency in the Your board of directors should be prepared board’s operation. Boards with between nine and 15 to put time and energy into the organization. directors often work well. Make sure every prospective director has a realistic and clear understanding of what the KPCFOUBJMT#FGPSFZPVDPOUBDUQSPTQFDUJWF Paying Your Directors DBOEJEBUFT XFTVHHFTUUIBUZPVQSFQBSFBKPC Nonproft directors usually serve without description that specifes at least the following: compensation. We believe this is generally wise. tUIFTDPQFPGUIFOPOQSPëUTQSPQPTFE Having nonproft directors serve without pay activities and programs reinforces one of the important legal and ethical tCPBSENFNCFSSFTQPOTJCJMJUJFTBOEUJNF distinctions of the nonproft corporation: commitments (expected frequency and Unlike its for-proft counterpart, its assets are length of board meetings, extra duties that used to promote its goals, not for the private may be assigned to directors), and enrichment of its incorporators, directors, tUIFSFXBSETPGTFSWJOHPOZPVSCPBSE TVDI agents, members, or employees. as the satisfaction of working on behalf of If you compensate directors, do so at a reason- a cause you care about or the experience of able rate, related to the actual performance of community service). services and established in advance by a board "DMFBSBOEDPNQSFIFOTJWFKPCEFTDSJQUJPO resolution. (See Article 9 of the bylaws included will help with decision making and will also in this book for specifc procedures to follow help avoid future misunderstandings with when approving compensation arrangements.) board members over what is expected of them. Most nonprofts reimburse directors only for necessary expenses incurred in performing Train Your New Directors director duties, such as travel expenses— Te organizers of a nonproft corporation typically a gas or mileage allowance—to attend often need to give initial directors orientation board meetings. Sometimes directors are paid a and training about the nonproft’s operations set fee for attending meetings. and activities. Tis training should continue Te bylaws included with this book contain so that board members can handle ongoing DPOìJDUPGJOUFSFTUBOEDPNQFOTBUJPO operational issues as well. For example, if your approval policies that help a nonproft nonproft corporation is organized to provide obtain its 501(c)(3) tax exemption. Tese health care services, board members may policies require disinterested members of the need to learn city, state, and federal program board or a committee of the board (such as requirements that impact your operations, and a compensation committee) to approve all 28 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

compensation paid to directors, ofcers, and amount for attending board meetings. All others who exert control over a nonproft three directors can be paid for attending (substan tial contributors, higher-paid meetings without violating the 51% rule. employees, or contractors). Before approving One of the board members is also paid a the compen sation, the board or committee salary as the organization’s chief operating must determine that the pay is comparable ofcer and another director is also paid to the amounts paid to others who serve in as a legal consultant to the nonproft. Te similar roles for similar organi zations. For nonproft is in violation of the 51% rule more information on these bylaw provisions, because only one-third of the board is see Chapter 7, the sample bylaws for a public “disinterested,” not the required 51% or beneft corporation, special instruction 12. greater. If the board member who is the legal consultant agrees to render legal advice Public Beneﬁt Corporations and services for free, the nonproft will be and the “51% Rule” in compliance with the 51% rule because then two-thirds of the board would be If you form a California public beneft corpo- disinterested (only one board member, the ration and choose to compensate your directors chief operating ofcer, would be interested). for performing nondirector services for your corporation, you’ll need to understand the 51% Te California Attorney General enforces rule, a state law provision applicable to public the 51% disinterested director rule. How will beneft corporations (California Corpo rations the attorney general know if you’re in violation $PEFf ɨJTSVMFTQFDJëFTUIBUBNBKPSJUZ of the rule? Every year, you’ll fle a Periodic of directors of a public beneft corporation Report form (Form RRF-1) with the attorney cannot be interested persons. A director is general’s ofce, in which you’ll be asked about interested if he or she is receiving payment your directors’ interested or disinterested status. from the corporation for services rendered in If you are a public beneft corporation and the the past 12 months to the corporation in any BUUPSOFZHFOFSBMMFBSOTUIBUBNBKPSJUZPGZPVS capacity other than as a director, or is related to board (including relatives of board members) is such a person (for example, a director also serves not disinterested, it will, at the very least, send and is paid as an ofcer or consultant to the your corporation a letter requiring compliance. corporation). Under the statute, related means Larger nonproft corporations and those that a brother, sister, ancestor, descendant, spouse, SFMZPOHSBOUGVOET XIFSFFWFOTUSJDUFSDPOìJDU brother-in-law, sister-in-law, son-in-law, daughter- of-interest rules often apply) will already be in-law, father-in-law, or mother-in-law of any familiar with director compensation limita- TVDIQBJEQFSTPOɨJTNFBOTUIBUBNBKPSJUZPG tions and are less likely than their smaller the board, including relatives of board members, counterparts to run into problems with the cannot be paid as ofcers, employees, or 51% rule. Smaller groups, however, tend to rely independent contractors of the corporation. more heavily on the same group of people (and their family members) to act as directors and EXAMPLE: A 501(c)(3) education nonproft also as ofcers, employees, and independent corpora tion, organized as a California public contractors of their organization. Tese smaller beneft corporation, has three directors on public beneft corporations may need to look its board, each of whom is paid a modest for extra, unrelated people to fll some of the CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 29

directors’ positions so that the more active on the board, the board is now in violation directors (or their family members) can also be of the 51% rule. paid salaries as ofcers or employees. Te following examples highlight some of the problems that small nonprofts run into with Term of Oﬃce the 51% disinterested directors rule. You can set the term of ofce for your directors in your bylaws (if you don’t, the law provides EXAMPLE 1: Your public beneft corporation that directors of public beneft and religious has four directors: you, your sister Blanche, corporations can serve for only one year). and two unrelated persons, Bob and Ray. Should you decide to set the term, you’ll need Bob’s brother-in-law, Alfredo, is one of the to abide by the rules for public beneft corpo- paid ofcers of the corporation. If you get rations and religious corporations. paid for doing occasional work during the year as an independent contractor, your Public Beneﬁt Corporations corporation has violated the 51% rule. Why? Te maximum term for directors of a public Because you are an interested person (you beneft corporation depends on whether the are getting paid during the current year for corporation has members. (For a discussion services other than acting as a director) and of members, see “Membership Nonprofts,” your sister Blanche is an interested person below). If the public beneft corporation has (she is related to you). Even if you replace members, the maximum term is four years; Blanche with an unrelated unpaid board without members, the maximum term is six member, your public beneft corporation years. A director whose term has expired, board will still be in violation of the 51% however, can be reelected immediately and rule because Bob is an interested person as can serve an unlimited number of additional well (his brother-in-law is a paid employee consecutive terms. PGUIFDPSQPSBUJPO 3FNFNCFS BNBKPSJUZ Public beneft corporations can get around of the board cannot be paid for nondirector the four-year (or six-year) term limitation by work or be related to anyone who is paid by including a special provision in their bylaws the corporation. authorizing the designation, instead of election, of directors. Te bylaws can provide that one or EXAMPLE 2: A two-person board consists more persons, usually the more active directors, of two unrelated, unpaid people who run a are authorized to designate the other directors small, non proft public beneft corpo ration. for any prescribed term. Generally, public From time to time, they consult the spouse beneft corporations with members can use this of one of the directors, who is an accountant procedure for only one-third of their authorized and does not charge the corporation. After number of directors. BCJHQSPKFDU UIFZEFDJEFUPNBLFBUPLFO payment to the accountant for all the tax Religious Corporations XPSLEPOFPOUIFQSPKFDU8IPPQTɨF Religious corporations can set up their EJSFDUPSXIPJTUIFBDDPVOUBOUTTQPVTFKVTU own rules for the term, election, selection, became an interested person for this calendar designation, removal, and resignation of year and because there are only two people 30 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

directors. Tese rules can be specifed in the whichever is larger. A public beneft corporation corporation’s articles or by-laws. with only one director, however, may of course have a one-person quorum. Religious corporations TIP can choose any quorum requirement they wish. We suggest a three-year term for directors. EXAMPLE: A public beneft corporation You’ll get the most out of what a director has to contribute and will ensure continuity in operations. with fve direc tors must have at least a In return, the director will get the satisfaction of two-director quorum. A 15-director public long-term service and hopefully will see some goals beneft corpo ration must have at least a fulﬁlled. three-person quorum.

Staggered Elections for Board Members Voting Rules

In the interest of continuity, staggered elections Once a quorum is present at a meeting, a of board members may be a good idea. For specifed number of votes is needed to pass a example, rather than replacing the entire board board resolution. Unless otherwise stated in the at each annual election, you may wish to reelect articles or bylaws, a resolution must be passed one-third of the board members each year to CZBNBKPSJUZWPUFPGUIFEJSFDUPSTQSFTFOUBU serve a three-year term. To start this staggered a meeting where there is a quorum. In some system out with a 15-member board—five of cases, the votes of interested directors cannot the initial directors would serve for one year, be counted. Tis is discussed more in “How to five for two years, and the remaining five for the Avoid Self-Dealing,” below. full three-year term. At each annual reelection, EXAMPLE: Te bylaws of a corporation with one-third of the board would be elected to ten board members specify that a quorum serve three-year terms. DPOTJTUTPGBNBKPSJUZPGUIFCPBSEBOE that action by the board can be taken by BNBKPSJUZPGUIFEJSFDUPSTQSFTFOUɨJT Quorum Rules means that a quorum of at least six people For the board of directors to take action at a BNBKPSJUZPGUIFUFOQFSTPOCPBSE NVTUCF meeting, a specifed number of directors of present to hold a board meeting and, at the the corporation—called a quorum—must WFSZMFBTU GPVSWPUFT BNBKPSJUZPGUIFTJY be present. Unless otherwise provided in the members present at a meeting) are required to CZMBXT BNBKPSJUZPGUIFOVNCFSPGEJSFDUPST pass a resolution. If eight of the ten directors in ofce represents a quorum. Most small attend the meeting, action must be approved OPOQSPëUTSFTUBUFUIJTNBKPSJUZRVPSVNSVMFJO CZBUMFBTUëWFWPUFTBNBKPSJUZPGUIPTF their bylaws. present at the meeting. If you want a lower quorum requirement, you If a quorum is present initially at a meeting DBOQSPWJEFGPSJUJOZPVSCZMBXT TVCKFDUUP and one or more board members leave, action certain restrictions. A public beneft corporation can sometimes still be taken even if you lose must have a quorum of at least two directors, your quorum. As long you can still obtain the or one-ffth of the total number of directors, OVNCFSPGWPUFTUIBUSFQSFTFOUTBNBKPSJUZPG CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 31

the required quorum stated in the bylaws, the Fortunately, keeping the full board abreast of board can take action even though a quorum executive committee actions isn’t very difcult. is no longer present at the meeting (this is Te full board should receive regular, timely known as the initial quorum rule). Going back minutes of executive committee meetings and to the example above, in a ten-director board, should review and, if necessary, reconsider the required quorum for board action is six important executive committee decisions EJSFDUPST BNBKPSJUZPGUIFUFO BOEBUMFBTUGPVS at each regularly scheduled meeting of the WPUFT BNBKPSJUZPGUIPTFQSFTFOU BSFOFFEFE full board. Te full board should retain the to take board action. Under the initial-quorum power to override decisions of the executive rule, two directors can leave the meeting and committee. the four remaining votes will still be sufcient Tere are certain actions that can’t be dele- to pass a resolution. Why? Because a quorum gated to an executive committee. Specifcally, was initially present and four board members, an executive committee cannot be given SFQSFTFOUJOHBNBKPSJUZPGUIFSFRVJSFERVPSVN authority to: of six, can vote to pass a resolution. tBQQSPWFBDUJPOUIBUSFRVJSFTBQQSPWBMCZUIF membership TIP tëMMWBDBODJFTPOUIFCPBSEPSPUIFS Get a quorum by teleconferencing. committees Your board of directors doesn’t necessarily have to tëYEJSFDUPSTDPNQFOTBUJPO meet in person to take action. Directors can take tBMUFSCZMBXT action (following their regular voting rules) using tBQQPJOUDPNNJUUFFT PS a conference telephone call or other means of tVTFDPSQPSBUFGVOETUPTVQQPSUBOPNJOFF electronic transmissions. See Article 3 of the bylaws to the board after more people have been (on the Nolo website; see appendix A for the link). nominated than can be elected. Don’t confuse this special executive committee of directors with other corporate Executive Committees committees. Te board typically appoints Te board of directors can delegate some or several specialized committees to keep track even a signifcant part of the board’s duties of and report on corporate operations and to an executive committee of two or more programs. Tese committees act as working directors. Tis arrangement is often used groups that are more manageable in size and when some directors are more involved in help make better use of the board’s time running and managing the nonproft’s afairs and its members’ talents. Tey may include and business than others. Even the passive fnance, personnel, buildings and grounds, new directors, however, should still keep an eye on QSPKFDUT GVOESBJTJOH PSPUIFSDPNNJUUFFT what their more active colleagues are up to and Tese committees, often consisting of a mix actively participate in regular meetings of the of directors, ofcers, and paid staf, do not full board. To encourage passive directors to normally have the power to take legal action on stay involved, courts have held the full board behalf of the corporation; their purpose is to responsible for the actions of the executive report and make recommendations to the full committee. board or the executive committee. 32 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

EXAMPLE: Te board of directors appoints a the court orders directors to repay the losses fnance committee charged with overseeing their actions caused. the organization’s fundraising, budgeting, 0SEJOBSZOFHMJHFODFPSQPPSKVEHNFOUJT expen ditures, and bookkeeping. Te corpo- usually not enough to show a director breached ration’s treasurer chairs the committee. his or her duty of care. Instead, there generally Periodically, this committee makes must be some type of fraudulent or grossly fnan cial recom mendations to the full negli gent behavior. Volunteer directors and board. Te board could also appoint a FYFDVUJWFPïDFSTPGOPOQSPëUTFOKPZFYUSB personnel committee to establish hiring protection from personal liability. Tese and employment policies and to interview personal immunity laws are discussed in detail candidates for important positions. A plans in “Special Protections for Volunteer Directors and programs committee might be selected and Ofcers,” below. to put together the overall action plan for accomplishing the goals of the organization. EXAMPLE: A committee of the nonproft Any action taken based on a committee’s advises the board of an unsafe condition on SFQPSUPSSFDPNNFOEBUJPOXPVMECFTVCKFDU the corporation’s property. Te committee to approval by the board. recommends certain remedial actions to get rid of the problem. If the board fails to implement any remedial measures or Directors Must Act Carefully otherwise take steps to deal with the problem, Corporate directors and ofcers have a legal a court could hold the directors personally duty to act responsibly and in the best interests MJBCMFGPSBOZFOTVJOHEBNBHFPSJOKVSJFT of the corporation—this is called their statutory Although the risk of being held personally “duty of care.” Te statutes defning this phrase liable is small, there are some things a director use general, imprecise legal terms that are not can and should do to minimize the risk very helpful in understanding what exactly it of personal liability. Most importantly, all means. As a result, the meaning of the term directors, whether active participants or casual IBTEFWFMPQFEPWFSUJNFBTKVEHFTBOEKVSJFT com munity observers, should attend board faced with lawsuits, decide whether a director’s meetings and stay informed of, and participate acts did (or did not) live up to the duty of care. JO BMMNBKPSCPBSEEFDJTJPOT*GUIFCPBSE Fortunately, most of it boils down to common makes a woefully wrongheaded or ill-advised sense, as the following discussions show. decision that leads to monetary damages, the best defense for any board member is a “No” Personal Liability for Directors’ Acts vote recorded in the corporate minutes. In general, you shouldn’t be overly concerned Also, all boards should try to get an expe- about the prospect of personal liability for your rienced fnancial manager on their board or directors. Broadly speaking, courts are reluctant use the services of a prudent accountant who to hold nonproft directors personally liable, demands regular audited fnancial statements except in the clearest cases of dereliction of duty of the group’s books. Legalities aside, what is or misuse of corporate funds or property. In the most likely to put nonproft directors at risk of rare cases when liability is found, the penalties personal liability is bad fnancial management, are usually not onerous or punitive—typically, such as failing to pay taxes, not keeping proper CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 33

records of how much money is collected and how ness matters. Tat’s because when they make it is disbursed, and commingling funds, either invest ment decisions involving corporate funds, directors’ personal funds with corporate funds or directors have an added duty of care under mixing restricted with nonrestricted funds. California nonproft law to avoid specu lation and protect those funds—a stricter standard Reliance on Regular Business Reports: of care than the normal standard discussed A Safe Haven above. According to this stricter standard of To help directors accomplish their managerial care, directors must “avoid specu lation, look- duties, directors can rely on information ing instead to the permanent dispo sition of from reliable, competent sources within the the funds, considering the pro bable income, as corporation (ofcers, committees, and super- well as the probable safety of the corporation’s visory staf), or on outside professional sources capital.” (California Corpo rations Code (lawyers, accountants, and investment advisers). § 5240(b)(1).) If this information later turns out to be faulty Tis stricter investment standard does not or incorrect, the directors will not be held apply to religious corporations. Directors of personally liable for any decision made in religious corporations are held to the lighter duty reliance on the information, unless the directors of care for the investments of nonproft funds. had good reason to question and look beyond EXAMPLE: Te treasurer of a performing the information presented to the board and arts group tells the group’s directors that failed to do so. the group has a hefty surplus of funds For example, if a nonproft’s treasurer tells the because of its recent road tour. Te board board that the organization has sufcient cash decides to invest this money in a stable to meet ongoing payroll tax requirements, and asset mutual fund rather than one of several the report seems reasonable (perhaps because high-risk equity funds that reported double- the nonproft has a budget surplus), the IRS digit declines in the last several quarters. will probably fnd that the individual board If challenged by the attorney general or members were entitled to rely on the treasurer’s a complaining member, the directors report, even if there is not enough money to should be able to show that they’ve met pay the taxes. However, if the board knows or the statutory investment standard—they should have known that the nonproft is having attempted to preserve the capital of the a difcult time paying its bills despite reports corporation by investing in a stable fund to the contrary by the treasurer, and the board with a predictable positive return track does not direct the treasurer to make sure to set record rather than a riskier fund that was money aside to pay payroll taxes, the IRS may more likely to lose money. try to hold board members personally liable for unpaid taxes. Directors Must Be Loyal Investment Decisions Involving Corporate Assets A director has a duty of loyalty to the corporation. Tis means that the director must Directors of a public beneft corporation must give the corporation a “right of frst refusal” use more caution when making investment on business opportunities he or she becomes decisions than when they decide routine busi- aware of as a director. If the corporation fails 34 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

to take advantage of the opportunity after Te self-dealing rules and proper approval full disclosure, or if the corporation clearly requirements can arise in many diferent types would not be interested in the opportunity, the of transactions, including the purchase or director can then take personal advantage of sale of corporate property, the investment of the opportunity. corporate funds, or the payment of corporate fees or compensation. EXAMPLE: Bob is a volunteer director on the board of Help Hospices, a nonproft hospice EXAMPLE: A board votes to authorize the and shelter orga ni zation. He agrees to shop corporation to lease or buy property owned around for a low-rent location in a reason- by a director, or to purchase services or ably safe neighborhood for the next non proft goods from another corporation in which hospice site. He learns of three low-rent a director owns a substantial amount of loca tions, one of which would also be ideal stock. Either of these could be considered as a low-cost rental studio for his son who a prohibited self-dealing transaction if not wants to move out of his parents’ house properly disclosed and approved, because a as soon as possible. Bob reports all three director has a material fnancial interest in locations to the board, and tells them that each transaction and neither falls within one he plans to apply for a lease in his son’s of the specifc statutory exceptions. name on one of the rental units only if the board decides that it is not interested in A corporation must follow one of several leasing the space for nonproft purposes. distinct procedures to approve a transaction Tis type of specifc disclosure is exactly involving the corporation and one or more what is required for Bob to meet his duty of directors with a material fnancial interest in loyalty to the nonproft. Bob can apply for the transaction. Some of these procedures are the lease for his son if the board gives him similar to the duty of disclosure rules discussed the go-ahead after deciding the nonproft is above for directors who want to take advantage not interested in leasing the space for itself. of an opportunity that could beneft the corporation. Self-dealing transactions, however, are ones where the corporation has decided to How to Avoid Self-Dealing pursue the opportunity and the transaction will Directors must guard against unauthorized beneft the director. self-dealing—that is, involving the corporation If proper self-dealing procedures are not in any transaction in which the director has followed, the corporation, any of its directors a material, or signifcant, fnancial interest or ofcers, or the California Attorney General without proper approval. Any transaction that can, on the attorney general’s motion or upon has a material fnancial impact on a director complaint to the attorney general by a nonproft can trigger the self-dealing rules. Once the insider or member of the public, sue the directors self-dealing rules are triggered, the transaction for the return of assets or repayment of money must be properly approved before it can be obtained through the self-dealing transaction. consummated (see the California Corporations See Article 9 of the bylaws included in this Code § 5233 for public beneft corporations; book for specifc procedures to follow when § 9243 for religious corporations). approving transactions that beneft directors, CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 35

ofcers, employees, or contractors associated Or, you can download a copy from the Nolo website with the nonproft. (see Appendix A for the link). Te Guide contains excellent summaries of the Get Attorney General Approval legal responsibilities and liabilities of nonprofit Te safest and most efective way to handle a directors under California law, as well as practical information on fundraising, fiscal management, and situation where there is potential for self-dealing other important nonprofit issues. We recommend all is to obtain the attorney general’s approval of California nonprofits obtain a copy of this valuable the transaction. You can do this before or after sourcebook. the deal is consummated (before is better). If you don’t want to seek the attorney general’s Obtain Approval From approval, you can simply notify the attorney Disinterested Board Members general of the transaction (and get approval of the transaction from the board, as explained If you don’t have the time to get the attorney in the next section). Tis is not as good a general’s approval for a self-dealing transaction, safeguard for your deal as getting attorney the transaction can be approved by a disinter- general approval, but it does limit the time in ested board, or committee of the board, upon a which a lawsuit can be fled to two years from showing of certain facts. Tis approach is a lot the date of the written notice. Without attorney less safe than getting attorney general approval, general approval or notice, the attorney general but it may be appropriate if you are absolutely has up to ten years after the transaction is certain a self-dealing transaction is completely consummated to fle a lawsuit, and anyone else fair to your nonproft, even though a director has up to three years. is incidentally benefted by the transaction. For California religious nonprofts have extra lee- the board approval to be valid, it must occur way in self-dealing situations. See the California before the transaction is entered into and the Attorney General’s Guide for Charities, available director who has a fnancial interest in the on the Nolo website (see Appendix A for the transaction cannot vote, although the director link), that contains a statement regarding the can be counted for purposes of determining attorney general’s overall hands-of policy whether a quorum is present. In addition, the with respect to the oversight of religious board must: corporations. tIBWFGVMMLOPXMFEHFPGUIFFDPOPNJDCFOFëU to the interested director RESOURCE tEFUFSNJOFUIBUUIFUSBOTBDUJPOJTGBJSBOE benefts the corporation, and Go over the California Attorney General’s tEFUFSNJOFUIBUJUJTUIFCFTUCVTJOFTTEFBM Guide for Charities. It has information on seeking attorney general approval and sending a notice of that the corporation can make. transaction to the attorney general, and provides A properly authorized committee of the board detailed information on how to comply with other can make these fndings, as long as the board nonprofit reporting and filing requirements. You ratifes the committee’s fndings as soon as can browse or download the California Attorney possible. General’s Guide for Charities (plus occasional For religious corporations, the board or separate supplements), at the California Attorney committee must simply determine that the General’s website at www.oag.ca.gov (go to the transaction is fair or in furtherance of the charities section and you will find a link to it there). religious purposes of the corporation. 36 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Exceptions to Self-Dealing Rules tBUSBOTBDUJPOJOWPMWJOHMFTTUIBOPGUIF Exceptions to the self-dealing rules allow corporation’s previous year’s gross receipts corpo rations to make certain decisions without or $100,000, whichever is less, provided having to follow the strict procedures that the interested director has no knowledge of might other wise apply. Here are some actions the transaction. that might fnancially beneft a director but can be approved by normal board action: Loans and Guarantees tBCPBSESFTPMVUJPOëYJOHUIFDPNQFOTBUJPO Any loan or guarantee to a director of a of a director or ofcer of the corporation public beneft corporation must be approved tBUSBOTBDUJPOUIBUJTQBSUPGUIFQVCMJD by the attorney general. Excluded from this char itable, or religious program of the requirement is a director’s repayment obligation corpora tion, as long as it is approved to a corporation for premiums paid on a life XJUIPVUVOKVTUJëFEGBWPSJUJTNBOECFOFëUT insurance policy, provided the obligation is directors or their families only because secured by the proceeds of the policy and its cash they are in the class of persons intended surrender value. Loans made to an ofcer for to be benefted by the particular corporate the purchase of a principal residence are also not program, and

Is Your Nonproﬁt a Socially Responsible Organization?

Do you need to certify your nonprofit as a socially However, if your nonprofit interfaces with one sustainable organization (such as the B corporation of these sustainability-certified companies, certification, as discussed in ”Do-Good LLCs and it may be asked to obtain a certification too. Corporations—Te Latest in Limited Liability More specifically, if you are deemed to be in Entities,” in Chapter 1). Many larger profit- the “supply chain” of a certified company as making corporations are instituting socially a vendor of services, a creditor, or simply an responsible practices and processes and acquiring organization to which it donates money, goods, certifications in an attempt to satisfy a broader or services, the certified company may be range of stakeholders—not only shareholders, required, as part of its certification, to make sure but also employees, suppliers, creditors, and you too are certified. members of the community served or impacted On the accounting front, sustainability by the organization. Tey commit to maintaining standards similar to FASB (Financial Accounting a low carbon footprint, implementing fair Standards Board) rules are being developed by labor practices, socially-responsible investment the SASB (Sustainability Accounting Standards practices, and long-range corporate planning Board) so that publicly-traded and other strategies (as opposed to seeking short-term entities can report their sustainability metrics profits regardless of the long-term financial, to agencies such as the SEC (Securities and social, and environmental impact of doing so). Exchange Commission) and to the public. If Strangely, perhaps, these socially responsible you interface with an SASB reporting company, initiatives typically are being undertaken by large, you may be asked to prepare and report SASB publicly-traded profit-making corporations, and metrics to it and to the public as well. Look up not by mid-sized or smaller nonprofits. “SASB” online for more information. CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 37

TVCKFDUUPUIJTSFRVJSFNFOU BTMPOHBTUIFMPBOJT Of course you should do everything possible necessary, in the board’s opinion, to secure the to minimize potential risks involving your services or continued services of the ofcer and is group’s activities at the outset. For example, secured by real property in California. make sure that employees perform their work Loans and guarantees to directors of religious in a safe manner and that anyone required to corporations do not require the approval of the perform a skilled task is properly trained and attorney general. Instead, they must be made licensed. In addition, the corporation should under the general duty of care guidelines discussed obtain insurance coverage whenever possible above, in “Directors Must Act Carefully.” for any specifc known risks: motor vehicle insurance to cover drivers of corporate vehicles, SEE AN EXPERT and general commercial liability insurance Consult a lawyer before approving any to cover the group’s premises. Tis will help loans or providing any guarantees to directors. reduce the risk of any personal liability for Because a nonprofit’s activities cannot in any way directors. And make sure your nonproft benefit individuals involved in its operations, it’s meets all payroll and corporate tax return easy to see why a loan to a director from tax-exempt requirements imposed by the state and the funds might appear questionable, even if it falls IRS. Failure to withhold and pay payroll taxes outside the attorney general’s approval rules. If or fle timely corporate information returns you plan to make a loan or guarantee to a director, can lead to hefty penalties and fnes against the check with a lawyer to make sure you comply with organization and the individuals responsible the applicable attorney general approval rules, and for the nonproft’s tax flings. make sure the loans and guarantees are fair and in furtherance of the nonprofit’s goals and activities. Public Benefit Corporations California’s nonproft law protects a volunteer Special Protections for Volunteer director or executive ofcer (such as the presi- Directors and Officers dent, vice president, secretary, or treasurer) of a public beneft corporation from personal liability Special laws protect volunteer directors for negligent acts or omissions com mitted from personal liability for actions taken in in the performance of his duties (Cali fornia connection with their duties as directors. Tese Corporations Code § 5239). Tis protec tion laws were passed to provide incentive and pro- applies only to certain third-party laws uits for tection to people willing to serve on boards NPOFUBSZEBNBHFT TVDIBTBQFSTPOBMJOKVSZ and work on behalf of nonproft organizations. claim against a director by a participant in a Te protections ofered by these laws have fundraising event. To get this protection, the OPUQSPWFEUPCFPGNBKPSTJHOJëDBODFɨFZ following conditions must be met: can be helpful, however, particularly for small tUIFBDUPSPNJTTJPONVTUCFXJUIJOUIF nonprofts during the early years when they scope of the director’s or executive ofcer’s often can’t aford director and ofcer liability duties insurance yet need to attract outside people to tUIFBDUPSPNJTTJPONVTUCFQFSGPSNFEJO help with their organizations. good faith tUIFBDUPSPNJTTJPONVTUOPUCFSFDLMFTT wanton, intentional, or grossly negligent, and 38 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tEBNBHFTDBVTFECZUIFBDUPSPNJTTJPONVTU t7PMVOUFFSEJSFDUPSTBOEFYFDVUJWFPïDFST be covered by a liability insurance policy must also make reasonable eforts on their (either in the form of a general liability own to obtain insurance and these eforts policy, a directors’ and ofcers’ (D&O) should be carefully documented. liability policy, or a policy issued personally to the director or executive ofcer), or, if EXAMPLE: Te Better Books Network has there is no such policy, good faith eforts an annual budget of $20,000. Te Treasurer must have been made to obtain liability contacts a nonproft insurance broker and insurance. gets a quote for $500,000 worth of general It is important to remember that these laws liability coverage at a cost of more than protect only volunteer directors and executive $1,000 (more than 5% of the nonproft’s ofcers of public beneft corporations. You can previous annual budget). Under the statute, be reimbursed for expenses such as gas mileage they qualify as having made a reasonable or receive a per diem payment and still be efort to obtain insurance. Tey don’t have to considered a volunteer. You cannot, however, UBLFUIFQPMJDZUIFZKVTUIBWFUPCFBCMFUP receive a salary, fee, or other consideration show that they asked for and obtained this for services to the corporation. Te law isn’t quote (by making a note in the corporate intended to cover day-to-day ministerial actions records and, if possible, attaching a faxed of corporate employees. or written copy of the quote obtained from If the nonproft does not have the insurance their insurance broker). Tey must obtain as mentioned in the fnal point above, the similar quotes for all years in which they organization must be able to show that it made hope to take advantage of this statutory good faith eforts to obtain it. Fortunately, the escape hatch. law gives some meaning to the term, good faith A volunteer director or ofcer may still be eforts. Here are the rules: personally liable to the corporation for negli- t*GZPVBSFB D QVCMJDCFOFëUOPOQSPëU gence in actions brought by other directors in and your annual budget is less than $25,000, the name of the corporation or by the attorney you can show this good faith efort if your general. And the corporation itself remains liable corporate records prove that you made at for damages to third parties, even if its directors least one inquiry each year for $500,000 in and ofcers fall under the protection of these general liability coverage, and that the quotes rules. Also, if a plaintif sues for some thing other received equaled or exceeded 5% of your than monetary damages (such as a court order annual budget for the prior year. for restitution), these rules do not apply. t-BSHFSOPOQSPëUTTIPVMEHFUPOFPSNPSF Tere is a separate provision of California’s quotes for coverage per year and keep a nonproft law (California Corporations Code record of the dates of their contacts with § 5047.5) that protects volunteer directors insurance brokers, agents, and companies, and ofcers of public beneft corporations in the types and amounts of coverage sought, a manner similar to the protections ofered by and quotes or responses received from each Section 5239. To qualify under this section, contact. Documentation of this sort should the public beneft corporation must be tax- also be kept if a larger nonproft gets less exempt under Section 501(c)(3) of the Internal insurance than it originally sought. Revenue Code, have an annual budget of less CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 39

than $50,000, and take out a general liability against the director for either a breach of duty insurance policy of at least $500,000. Larger to the corporation, or simply because of that 501(c)(3) tax-exempt corporations must be person’s status as a director of the corporation. insured for at least $1 million. Tis section Of course, D&O liability insurance can be specifcally requires that the nonproft obtain costly and beyond the reach of many small a general liability policy, whereas Section 5239 nonprofts. Insurance cannot, as a matter of requires only that you be able to show the California law, be purchased to cover any nonproft made attempts to obtain insurance. liability that arises from breaking the self- dealing rules discussed above. Religious Corporations Section 9247 of the California Corporations Code protects volunteer directors and ofcers Oﬃcers of California nonproft religious corporations A California nonproft corporation must have at in a manner similar to Section 5239, discussed least three ofcers: a president (or chairperson above. Section 5047.5, discussed above, also of the board), secretary, and treasurer (as the applies to religious nonprofts that are tax- chief fnancial ofcer). Typically, ofcers are exempt under Section 501(c)(3) of the Internal selected from the board of directors. One Revenue Code. person may fll one or more of the ofcer positions, except that the person who holds Indemniﬁcation for Lawsuits the ofce of secretary or treasurer cannot also Generally, a California corporation must be the president. Tere are no residency or age indemnify (reimburse) a director for legal requirements for ofcers. expenses incurred in a lawsuit related to the performance of his duties as director, if the Duties and Responsibilities director wins the lawsuit. If the director loses Te powers, duties, and responsibilities of the lawsuit, he can still be reimbursed for ofcers are specifed in the corporation’s articles legal expenses if the board, membership, or or bylaws, or by resolution of the board of the court approves the payment and fnds that directors. Generally, ofcers are in charge of the director was acting in good faith and in supervising and implementing the day-to-day a manner he or she believed to be in the best business of the corporation. Tis authority interests of the corporation. does not usually include the authority to enter Indemnifcation is more difcult to obtain JOUPNBKPSCVTJOFTTUSBOTBDUJPOT TVDIBTUIF if the lawsuit involves self-dealing or if the mortgage or sale of corporate property. Tese JOEFNOJëDBUJPOJTGPSKVEHNFOUT ëOFT PS LJOETPGNBKPSUSBOTBDUJPOTBSFMFGUUPUIFCPBSE settlements in actions brought by the corporation of directors. If the board wants the ofcers to itself or by the California Attorney General. IBWFUIFQPXFSUPNBLFPOFPSNPSFNBKPS business decisions, special authority should be Insurance delegated by board resolution. A nonproft corporation can purchase insurance Ofcers have a duty to act honestly and in UPDPWFSBEJSFDUPSTMFHBMFYQFOTFT KVEHNFOUT the best interests of the corporation. Ofcers fnes, and settlements incurred in connection are considered agents of the corporation and with a lawsuit or other proceeding brought DBOTVCKFDUUIFDPSQPSBUJPOUPMJBCJMJUZGPSUIFJS 40 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

negligent or intentional acts if their acts cause EXAMPLE: In a larger nonproft organization, damage and are performed in the scope of their a paid executive director or medical employment. director (these are staf positions, not board of director posts) might oversee routine Oﬃcers May Bind the Corporation operations of a medical clinic, and the Generally, the actions and transactions of an paid principal or administrator (also staf ofcer are legally binding on the corporation. positions) will do the same for a private A third party is entitled to rely on the apparent school. However, in a smaller nonproft, authority of an ofcer and can require the the corporate president or other ofcer may corporation to honor a deal, regardless of assume these salaried tasks. whether the ofcer was actually empowered Te bylaws included with this book contain by the board to enter into the transaction. To DPOìJDUPGJOUFSFTUBOEDPNQFOTBUJPOBQ avoid confusion, if you delegate a special task proval policies that help a nonproft obtain to an ofcer outside the realm of the ofcer’s its 501(c)(3) tax exemption. Tese policies normal duties, it’s best to have your board require disinterested members of the board pass a resolution granting the ofcer special or a committee of the board (such as a authority to enter into the transaction on behalf compen sation committee) to approve all of the corporation. compensation paid to directors, ofcers, and And, of course, any action taken by an ofcer others who exert control over a nonproft on behalf of a corporation will be binding (substantial contributors, higher-paid if the corporation accepts the benefts of the employees, or contractors). Before approving transaction or if the board ratifes the action, the compensation, the board or committee regardless of whether or not the ofcer had the must determine that the pay is comparable legal authority to act on the corporation’s behalf. to the amounts paid to others who serve in similar roles for similar organizations. For Compensation of Oﬃcers more information on these bylaw provisions, Ofcers can receive reasonable compensation see, in Chapter 7, “Bylaws for a Public Beneft for services they perform for a nonproft Corporation,” special instruction 12, in corporation. It is appropriate to pay ofcers “Instructions for Completing Your Bylaws.” who have day-to-day operational authority, and Te California Nonproft Integrity Act of not to pay the ofcers who limit themselves to 2004 contains special California rules for the presiding over the board of directors or making approval of executive compensation. Under overall nonproft policy decisions. In smaller the law, the board or a committee of the nonprofts, it is more common for ofcers board of all “charitable” nonprofts (generally, and directors to also assume staf positions public beneft nonprofts except schools and and be paid for performing these operational IPTQJUBMT NVTUSFWJFXBOEBQQSPWFBTiKVTU tasks. Remember, though, that under the 51% and reasonable” any compensation paid to disinterested directors rule, only 49% of the the nonproft’s president (or chief executive directors of a public beneft corporation can ofcer) and treasurer (or chief fnancial ofcer). receive compensation as ofcers or for another Compensation includes salary, benefts, and any nondirectorial position of the same corporation. other amounts paid. You must obtain board or committee approval initially upon hiring CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 41

the ofcer, when the term of employment is laws for volunteer directors of nonprofts also renewed or extended, and whenever the ofcer’s apply to volunteer executive ofcers of nonproft compensation is modifed. However, separate corporations. Tese laws are discussed in approval of the CEO and CFO’s compensation detail above, in “Loans and Guarantees.” Te is not required if compensation is modifed for executive ofcers who fall under the protection substantially all employees. of the personal immunity laws are the president, If you already have a nonproft CEO or CFO vice president, secretary, treasurer, and anyone who is an at-will employee with no employment who assists in establishing the policy of the contract, your board should review and approve corpo ration, at least with respect to their policy- the ofcer’s compensation. If you are organizing making decisions. A corporation can also insure your nonproft and are appointing your initial or indemnify its ofcers against personal liability ofcers, you should add your fnding as to the for their actions on behalf of the corporation. reasonableness of CEO, CFO, and other ofcer compensation in the Compensation of Ofcers resolution in your Minutes of First Meeting of Employees the Board of Directors, prepared as explained Employees of nonproft corporations work for in “Prepare Minutes of Your First Board of and under the supervision of the corporation Directors’ Meeting,” in Chapter 9. and are paid a salary in return for their services. Here are some Internet resources you can Paid directors and ofcers are considered use to learn more about the rules under the employees for purposes of individual income California Nonproft Integrity Act of 2004: tax withholding, Social Security, state unem- t(PUPUIF$BMJGPSOJB"UUPSOFZ(FOFSBMT ployment, and other payroll taxes the employer website at http://oag.ca.gov. Go to the must pay. Employees have the usual duties Charities section and then the Publications to report and pay their taxes, and the usual section and search for the “Summary of New personal liability for failing to do so. Law: Nonproft Integrity Act of 2004.” t5PSFBEUIFTFDUJPOTPG$BMJGPSOJBMBX Employee Immunity amended or added by the Act, go to the ofcial California Legislative Information Employees are generally not personally liable website at http://leginfo.legislature.ca.gov. for any fnancial loss their acts or omissions Select “California Law” and go to may cause to the corporation or to outsiders, Government Code Sections 12581, 12582, as long as they are acting within the course 12583, 12584, 12585, 12586, 12599, 12599.1, and scope of their employment. If the harm 12599.3, 12599.6, and 12599.7, and Business is done to outsiders, it is the corporation, not and Professions Code Section 17510.5. the employees, that must assume the burden of paying for the loss. Loans, Guarantees, and Immunity Laws CAUTION Employees may be personally liable Loans and guarantees to ofcers are governed for taxes. An important exception to the rule of by the same rules that apply to loans and guar- employee nonliability concerns the employee whose antees to directors (see “Loans and Guaran- duty it is to report or pay federal or state corporate tees,” above). Te special personal immunity or employment taxes. Te responsible employee 42 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

(or officer or director) can be held personally liable tant collateral reason for forming a nonproft for failure to report or pay such taxes. Te IRS may corporation. Tey are often more favorable than take a broad view as to who is “responsible” for those allowed noncorporate employees. such duties—see “Federal and State Corporate ɨFOPOQSPëUJUTFMGFOKPZTBUBYCSFBLXIFO Employment Taxes” in Chapter 10. ofering benefts in certain situations. Benefts are deductible by a nonproft corporation if taxes are owed by the corporation in connection with an Employee Compensation activity that uses the services of these employees. Salaries paid to ofcers or regular employees For example, if a nonproft generates $20,000 in should be reasonable and given in return for gross revenue unrelated to its exempt purposes, services actually performed. A reasonable but pays wages of $10,000 plus benefts of salary is one roughly equal to that received by $5,000 to generate this income, its net unrelated employees rendering similar services elsewhere. business income is reduced to $5,000. If salaries are unreasonably high, they are Nonprofts may establish some of the employee apt to be treated as a simple distribution of benefts plans available to employees of busi ness OFUDPSQPSBUFFBSOJOHTBOEDPVMEKFPQBSEJ[F corporations. Te rules are compli cated, how- the nonproft’s tax-exempt status. Nonprofts ever. For information on setting up qualifed should avoid paying discretionary bonuses at employee plans and other benefts, consult your the end of a good year—this may look like a tax adviser or a benefts plan specialist. payment from the earnings and profts of the corporation, a no-no for nonprofts. In reality, since the pay scale for nonproft personnel Membership Nonprofits is usually lower than that of their for-proft California nonproft law assigns a very specifc counterparts, most of this cautionary advice meaning to the terms member and membership shouldn’t be needed. nonproft. At the time you incorporate, you must decide whether to establish a formal Employee Benefits membership structure for your nonproft. If "NPOHUIFNBKPSBEWBOUBHFTBTTPDJBUFEXJUI you choose to have a membership structure, being an employee of a corporation are the your members will be the ones who approve employ ment benefts it can provide, such as PSEJTBQQSPWFNBKPSDPSQPSBUFEFDJTJPOT*O corpo rate pension plans, corporate medical a nonmembership structure, the board of expense reimbursement plans, and corporate EJSFDUPSTNBLFTUIFNBKPSDPSQPSBUFEFDJTJPOT group accident, health, life, and disability insur- Most smaller groups choose not to form a ance. Generally, amounts the corporation pays membership corporation because it is simpler to to provide these benefts (such as the payment operate without members. of insurance premiums by the corporation) are not included in the employee’s individual Nonmembership Corporations gross income and therefore are not taxed to the 'JSTU UIFO MFUTSFWJFXIPXUIFNBKPSJUZPG employee. Also, the benefts themselves (such as nonprofts run—without a formal membership. insurance proceeds) are often not taxed when In a nonmembership corporation, only the the employee receives them. Tese corporate directors participate in the legal afairs of the employee benefts can sometimes be an impor- corporation. Tis structure avoids the extra CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 43

time, work, and expense involved in having If you already know that your nonproft will NBKPSDPSQPSBUFEFDJTJPOTTVCKFDUUPGPSNBM not have members, you may skip the rest of member approval. this section. If you’re not sure about whether to California nonproft law gives members the have members, this section should guide you in right to approve various corporate decisions. your decision. And should you decide to form a However, if the nonproft’s articles and bylaws membership nonproft, you’ll need to refer back do not provide for members, the law specifcally to this discussion as you go about the normal says that directors act in the place of members steps of setting up and running your nonproft. whenever membership approval of an action is required. So if you read the California Who Is a Member Under Law? nonproft law and see references to approval by Under California nonproft law, a member is members, this means approval by directors in someone who is given the right in the corpo - a nonmembership nonproft. In addition, in a ration’s articles or bylaws to vote for the nonmembership corporation, any membership election of directors, the sale of substantially action can be approved by regular board all of the assets of the corporation, a merger of BQQSPWBM OPSNBMMZNBKPSJUZWPUF FWFOJGUIFSF the corporation, or its dissolution (California is a greater membership vote requirement for Corporations Code § 5056). A member also the action specifed in the nonproft law. means any person who is designated a member Tere may be many interested people asso- in the corporation’s articles or bylaws and ciated with a nonmembership organi zation— has the right to vote on amendments to the folks who pay annual dues or fees to support corporation’s articles or bylaws. Sometimes a the organization or to receive attendance nonproft will refer informally to its members privileges, mailings, or discounts to events— or charge admission fees, dues, or assessments but they’re not members as the term is legally to enroll and maintain an informal nonproft defned. Tese people are often called supporters, membership. Tese people, even if referred to patrons, contributors, advisors, or even members, informally as members, are not members under but they don’t participate in the legal afairs law unless you set up a membership structure in of the nonproft because they have not been your articles and bylaws and give them specifc specifcally granted legal membership rights by voting rights. the corporation. Members Elect and Remove Directors EXAMPLE: Susan, a patron of the Art Museum, has a museum membership that Members elect the directors in a membership entitles her to free admissions, participation corporation. Te election must take place at a in educational programs and events, use of SFHVMBSNFNCFSTIJQNFFUJOHPS TVCKFDUUPTPNF a special facility, or attendance at exhibition exceptions, can be by written ballot. Regular previews. Te membership does not give meetings of members should coincide with Susan any say in the museum’s operation the time for reelection of directors. Tere are and management, which she would have if specifc rules that govern director nomination she were a legal, formal member. and election procedures. 44 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Special meetings of members for the purpose Members Approve Mergers of removing directors can be called by 5% or and Consolidations more of the members. If the corporation has Te principal terms of an agreement to merge fewer than 50 members, removal of directors or consolidate the nonproft corporation with NVTUCFBQQSPWFECZBNBKPSJUZPGBMMNFNCFST another corporation usually must be approved Normal voting requirements apply to the by the members. removal of directors if the corporation has 50 or more members. Members Approve the Sale of Corporate Assets Members Amend Bylaws and Articles Members of a nonproft corporation must Te voting members may, on their own, adopt, approve a board resolution to sell substantially amend, or repeal provisions of the bylaws. Tis all of the corporation’s assets, unless the sale is can be done by unanimous written consent, by made for the purpose of securing the payment written ballots received from at least a quorum or performance of any corporate contract, note, PGNFNCFST PSCZBNBKPSJUZPGBRVPSVN bond, or obligation, or is in the regular course vote at a meeting. Because a quorum for a of business (this latter exception won’t normally member ship meeting can be greater or less apply—few nonproft corporations are organized UIBOBNBKPSJUZPGUIFUPUBMNFNCFSTIJQWPUJOH for the purpose of selling corporate assets). power (see quorum rules, below), a relatively small percentage of membership votes may be Classes of Membership sufcient to change the bylaws. If you decide to set up a membership structure EXAMPLE: If a nonproft corporation has 20 in your bylaws, you can establish diferent voting members, each with one vote, and classes of membership, such as voting and UIFCZMBXTSFRVJSFUIBUMFTTUIBOBNBKPSJUZ nonvoting membership classes. For example, (eight) be present at a meeting to represent a a large botanical society might have one quorum, then fve members can change the class of voting members who elect the board bylaws at a meeting. of directors, and an informal nonvoting membership consisting of persons who receive We think it is wise for the bylaws to contain the society’s magazine and newsletters. higher quorum and voting requirements when If you have diferent memberships, the it comes to changing the bylaws—amending rights, privileges, restrictions, and obligations UIFCZMBXTJTBNBKPSEFDJTJPOBOETIPVMECF associated with each class of membership decided by a substantial number of members of must be stated in the articles of incorporation the corporation. or bylaws. In addition, the corporation must Once formal members have been admitted, a maintain a membership book containing the bylaw or bylaw amendment fxing or changing name, address, and the class of membership, if the authorized number of directors can only be applicable, of each member. passed by the members and not by the board. With few exceptions, members must also approve a board resolution to amend the articles of incorporation, following normal membership voting rules. CHAPTER 2 | LEGAL RIGHTS AND DUTIES | 45

Membership Quorum Lower membership vote requirements are and Voting Rules imposed for an involuntary dissolution. An involuntary dissolution, discussed in more Unless the articles or bylaws state otherwise, detail in Chapter 10, is a dissolution for a each member is entitled to one vote on any specifc reason, usually indicating a failure on matter submitted for approval to the members. the part of the corporation to efectively carry Again, it’s possible to have several classes out its corporate purposes. For an involuntary of membership with diferent voting rights dissolution, one-third of the votes of all the attached to each membership. A quorum members of the corporation is required. Te GPSBNFNCFSTIJQDPSQPSBUJPOJTBNBKPSJUZ votes of members who have participated in any of all members, unless the bylaws provide of the acts which form the basis for requesting for a diferent number (which can be greater involuntary dissolution cannot be counted. PSMFTTUIBOBNBKPSJUZ *GZPVQSPWJEFGPSB membership quorum of less than one-third of Expelling Members all members, then special notice of members’ meetings will be required if less than one-third A member cannot be expelled unless it is done of the members actually attend the meeting. “in good faith and in a fair and reasonable Larger membership nonprofts rarely call manner.” Tere is a specifc procedure that and hold meetings with the expectation that public beneft corporations can use to be sure mem bers will attend and vote at the meeting that their procedure for expulsion of a member in person. Rather, membership proxies is fair and reasonable. We’ve included this (written votes) are usually solicited by mail procedure in the bylaw provisions for public well in advance of the meeting. Te corporate beneft membership corporations contained secretary tallies and reports these votes at the in this book. Te law doesn’t address what membership meeting. Te main business of the constitutes a good faith reason for expulsion— membership—the reelection of the board—is it only deals with the procedure for expulsion. usually accomplished through this proxy-by- Tere have been a number of court cases that mail procedure in large membership nonprofts. have ruled on the fairness of specifc reasons for expelling members, but there’s no general Membership Action to rule. If a question involving the expulsion of Dissolve the Nonproﬁt members arises, see a lawyer. A member can resign from the corporation at "NBKPSJUZPGBMMPGBNFNCFSTIJQDPSQPSBUJPOT any time. Te rights of a member cease upon his NFNCFST OPUKVTUBNBKPSJUZPGNFNCFST expulsion, death, termination from membership, present at a meeting at which a quorum is or upon dissolution of the corporation. present) can elect to voluntarily dissolve the corporation for any reason. Te board of Complying With Securities Laws directors with normal membership approval Memberships in a nonproft corporation are UIFWPUFTPGBNBKPSJUZPGBRVPSVN DBOBMTP considered securities and, as such, are regulated elect to voluntarily dissolve the corporation. by laws governing the ofer and sale of securities. In a few special cases, the board can, on its Generally, the ofer to sell or the sale of own, elect to dissolve the corporation without securities requires the approval of the California obtaining membership approval. Commissioner of Corporations, often involving 46 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

the preparation and fling of complicated and tUIFQSPNPUFSTPGUIFOPOQSPëUDPSQPSBUJPO costly documents. Obtaining this approval is must not expect, intend to, or actually called qualifying the sale of securities and, as you make a proft directly or indirectly from might guess, most small corporations wish to any business or activity associated with the avoid having to obtain this approval. organization or operation of the nonproft Fortunately, nonproft corporations exempt organization, or from remuneration received under Section 501(c)(3) of the Internal Revenue from such nonproft corporation. Code will, in most cases, be eligible for an Tese requirements are basically the same automatic exemption from qualifying the as the requirements for obtaining 501(c)(3) issuance of their memberships. To qualify for status, so you shouldn’t have any trouble this automatic exemption: meeting them. In fact, these requirements tUIFJTTVFSNVTUCFPSHBOJ[FEFYDMVTJWFMZGPS are a little looser than the Section 501(c)(3) educational, benevolent, fraternal, religious, requirements because they include additional charitable, social, or reformatory purposes, purposes. Except for memberships issued by and not for proft a group organized and operated for social tOPQBSUPGUIFOFUFBSOJOHTPGUIFJTTVFSDBO purposes, memberships that meet the frst inure to the beneft of any member or other two requirements above are also exempt from individual, and registration with the Securities and Exchange Commission under Section 3(a)(4) of the federal Securities Act. ● CHAPTER

Requirements for Section 501(c)(3) Tax Exemption 3

Section 501(c)(3) Organizational Test ...... 48 Valid Purposes Under Section 501(c)(3) ...... 49 Charitable Purposes ...... 49 Religious Purposes ...... 51 Scientific Purposes ...... 53 Literary Purposes ...... 54 Educational Purposes ...... 54 Other Requirements for 501(c)(3) Groups ...... 56 Unrelated Business Activities ...... 56 Limitation on Profits and Benefits ...... 57 Limitation on Political Activities ...... 59 Information for Specific Questions About Your Group’s Activities ...... 62 48 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

orporations, like individuals, are nor- you distinguish your organization from similar NBMMZTVCKFDUUPGFEFSBMBOETUBUF commercial endeavors. C income taxation. One reason to establish a nonproft corporation is to obtain an exemp tion from corporate income taxes. Section 501(c)(3) Exemption is not automatic—a corporation Organizational Test must apply and show that it is in compliance with nonproft exemp tion requirements to Under Section 501(c)(3) of the Internal Reve- receive it. Tis chapter focuses on the federal nue Code, groups organized and operated tax exemption available to nonprofts under exclusively for charitable, religious, scientifc, Section 501(c)(3) of the Internal Revenue literary, and educational purposes can obtain an Code and what is required to obtain tax- exemp tion from the payment of federal income exempt status under this provision. Once you taxes. Te articles of incorporation of a 501(c) obtain your federal 501(c)(3) exemption, you (3) corpo ration must limit the group’s corporate can qualify for a state income tax exemption. purposes to one or more of the allowable In Chapter 8, we will take you line by line 501(c)(3) purposes and must not empower it through the federal tax exemption application. to engage (other than as an insubstantial part You’ll notice in going through the material of its activities) in activities that don’t further in this chapter that many IRS tax exemption one or more of these tax-exempt purposes. Tis require ments are broad and seemingly appli cable formal requirement is known as the 501(c)(3) to a wide range of activities, both com mer- organizational test. cial and noncommercial. In fact, many com- A group can engage in more than one mercial organizations are engaged in activities 501(c)(3) tax-exempt activity. For example, that could qualify for 501(c)(3) tax-exempt a group’s activities can be characterized as status. For example, there are for-proft scien tifc charitable and educational, such as a school for organi zations that perform research that could blind or physically handicapped children. qualify as 501(c)(3) scientifc research. Similarly, A nonproft cannot, however, engage simul- many commercial publish ing houses publish taneously in a 501(c)(3) exempt purpose educational materials that could qualify the activity and in an activity that is exempt under organization for 501(c)(3) status. a diferent subsection of Section 501(c). Tus, So why do only some organizations obtain a group cannot be formed for educational and tax-exempt status? Because a corporation must social or recreational purposes because social choose to apply for tax-exempt status from and recreational groups are exempt under the IRS. Many organizations that might be Section 501(c)(7) of the Internal Revenue Code eligible for 501(c)(3) status prefer to operate as (see “Is Your Group a Nonproft Tat Can commercial enterprises because they do not Use Tis Book?” in Chapter 1 for a discus- XBOUUPCFTVCKFDUUPUIFNPOFZNBLJOH QSPëU sion of non-501(c)(3) tax-exempt groups). As distribution, and other restrictions applicable a practical matter, this problem rarely occurs, to nonprofts. (See Chapter 1 for a discussion of because the non-501(c)(3) subsections are these restrictions.) By defning and organizing custom-tailored to specifc types of organi- your activities as eligible for 501(c)(3) status and zations, such as war veterans’ organi zations and then seeking tax-exempt status from the IRS, cemetery companies. CHAPTER 3 | REQUIREMENTS FOR SECTION 501C3 TAX EXEMPTION | 49

Valid Purposes Under Benefit to the Public Section 501(c)(3) Te word charitable as used in Section 501(c)(3) is broadly defned to mean “provid ing services Now let’s take a closer look at the most common benefcial to the public interest.” In fact, other 501(c)(3) purposes—charitable, religious, 501(c)(3) purpose groups—educational, religious, scientifc, literary, and educational—and the and scientifc groups—are often also considered requirements for each of these purposes. In charitable in nature because their activities addition to the valid purpose requirements usually beneft the public. Even groups not discussed in this section, there are other general directly engaged in a religious, educational, or requirements that all 501(c)(3) groups must scientifc activity, but whose activities indirectly comply with to obtain 501(c)(3) status. Tese beneft or promote a 501(c)(3) purpose can other requirements are discussed below, in qualify as a 501(c)(3) charitable purpose group. “Other Requirements for 501(c)(3) Groups.” Groups that seek to promote the welfare of specifc groups of people in the community Humane Societies and (handicapped or elderly persons or members of Sports Organizations a particular ethnic group) or groups that seek to advance other exempt activities (environmental Tere are other, less commonly used exemp- or educational) will generally be considered tions available under Section 501(c)(3) that we organized for charitable purposes because these do not cover in this book. For example, groups activities beneft the public at large and are organized to prevent cruelty to children or charitable in nature. animals or to foster national or international Groups that advance religion, even if they do amateur sports competitions can claim a tax not have a strictly religious purpose or function, exemption under Section 501(c)(3). However, are often considered charitable purpose organi- these groups must meet narrowly defined 501(c) zations under Section 501(c)(3). Te IRS reasons (3) requirements, and, for humane societies, that the advancement of religion is itself a special state requirements. See IRS Publication charitable purpose. Examples of some of these 557 for specifics on each of these special 501(c)(3) charitable purpose groups include: groups and contact the state attorney general’s tMonthly Newspaper. A group that published office for special incorporation requirements for and distributed a monthly newspaper with humane societies. church news of interdenominational interest was held to accomplish a charitable purpose because it contributed to the advancement Charitable Purposes of religion. tCoffeehouse. A nonproft organization formed Te charitable purpose exemption is the by local churches to operate a super vised broadest, most all-encompassing exemption facility known as a cofeehouse was found under Section 501(c)(3). Not surprisingly, it is to have a valid 501(c)(3) charitable purpose also the most commonly used exemption. because it advanced religion and education 50 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

by bringing together college age people with tQSPWJEJOHMPBOTGPSDIBSJUBCMFPSFEVDBUJPOBM church leaders, educators, and leaders from purposes, and the business community for discussions tNBJOUBJOJOHBQVCMJDJOUFSFTUMBXëSN and counseling on religion, current events, social, and vocational problems. Class or Group of Beneﬁciaries tGenealogical Research. An organization A charitable organization must be set up to formed to compile genealogical research beneft an indefnite class of people, not parti- data on its family members to perform cular persons. Te number of benefciaries can religious observances in accordance with the be relatively small as long as the benefted class precepts of their faith was held to advance is open and the benefciaries of the group are religion and be a charitable organization not specifcally identifed. under 501(c)(3). tMissionary Assistance. A missionary group EXAMPLE 1: A charitable nonproft established to provide temporary low-cost corporation cannot be established under housing and related services for missionary Section 501(c)(3) to beneft Jefrey Smith, families on furlough in the United States an impoverished individual. But Jefrey from their assignments abroad was held to Smith can be selected as a benefciary of a be a charitable purpose organization under 501(c)(3) charitable group whose purpose is Section 501(c)(3). to beneft needy individuals in a particular Other examples of activities and purposes community (as long as he is a member of that have met the IRS organizational test for that community). charitable purpose (and possibly another 501(c)(3) purpose as well) include: EXAMPLE 2: A foundation that awards tSFMJFGPGUIFQPPS EJTUSFTTFE PSVOEFS scholarships solely to undergraduate privileged members of a designated fraternity was tBEWBODFNFOUPGFEVDBUJPOPSTDJFODF found to be a valid charitable organization tFSFDUJPOPSNBJOUFOBODFPGQVCMJDCVJMEJOHT under 501(c)(3), even though the number of monuments, or works members in the benefted group is small. tMFTTFOJOHUIFCVSEFOTPGHPWFSONFOU tMFTTFOJOHOFJHICPSIPPEUFOTJPOT tFMJNJOBUJPOPGQSFKVEJDFBOEEJTDSJNJOBUJPO EXAMPLE 3: A nonproft formed to set up tQSPNPUJPOBOEEFWFMPQNFOUPGUIFBSUT a free wireless local area network to help tEFGFOTFPGIVNBOBOEDJWJMSJHIUTTFDVSFE underprivileged and elderly members of the by law community connect to their community and tQSPWJEJOHGBDJMJUJFTBOETFSWJDFTUPTFOJPS get greater access to employment was found citizens not to have a 501(c)(3) charitable purpose. tNBJOUBJOJOHBDIBSJUBCMFIPTQJUBM Te IRS viewed the nonproft, which was tQSPWJEJOHBDPNNVOJUZGVOEUPTVQQPSU founded and controlled by a for-proft family relief and service agencies in the technology company, as promoting the for- community proft corporation’s business brand and the commercial interests of businesses where the wireless hotspots would be located. CHAPTER 3 | REQUIREMENTS FOR SECTION 501C3 TAX EXEMPTION | 51

Te following groups, all charitable in nature BDPNNVOJUZCPBSEBOEIBWFDPOìJDUPGJOUFSFTU and benefting a defned but indefnite group provisions in their bylaws. of people, were found to be valid charitable Te Afordable Care Act added new require- purpose organizations under Section 501(c)(3): ments for charitable hospitals. (See IRS Notice tBOPSHBOJ[BUJPOGPSNFEUPCVJMEOFX 2010-39 and Notice 2011-52 and ask your tax housing and renovate existing housing for adviser for more information.) sale to low-income families on long-term, low-payment plans Services Need Not Be Free tBEBZDBSFDFOUFSGPSDIJMESFOPGOFFEZ Section 501(c)(3) charitable organizations are working parents not required to ofer services or products free tBHSPVQDSFBUFEUPNBSLFUUIFDPPLJOHBOE or at cost. Nevertheless, doing so, or at least needlework of needy women providing services at a substantial discount tBTFMGIFMQIPVTJOHQSPHSBNGPSMPXJODPNF from the going commercial rate, can help families convince the IRS of your group’s bona fde tIPNFTGPSUIFBHFEXIFSFUIFPSHBOJ[BUJPO charitable intentions. Charging full retail satisfes the special needs of an aged person prices for services or products does not usually for housing, health care, and fnancial demonstrate a beneft to the public. Other security (Te requirements for housing and restrictions applicable to a non proft’s ability health care will be satisfed if the organi- to make money are discussed below in “Other zation is committed to housing resi dents Requirements for 501(c)(3) Groups.” who become unable to pay and if services are provided at the lowest possible cost.) Religious Purposes tBOPSHBOJ[BUJPOUIBUUBLFTDBSFPGQBUJFOUT For Section 501(c)(3) purposes, a religious nonmedical needs (reading, writing letters, purpose group can be either a loosely defned and so on) in a privately owned hospital religious organization that practices or tBOPSHBOJ[BUJPOUIBUQSPWJEFTFNFSHFODZ promotes religious beliefs in some way or a BOESFTDVFTFSWJDFTGPSTUSBOEFE JOKVSFE PS formal institutional church. Groups formed lost persons to advance religion often qualify as charitable tBESVHDSJTJTDFOUFSBOEBUFMFQIPOFIPUMJOF purpose organizations under Section 501(c)(3). for persons with drug problems, and tBMFHBMBJETPDJFUZPêFSJOHGSFFMFHBMTFSWJDFT Qualifying as a Religious Organization to indigent persons. Health care nonprofts, whether hospitals or Traditionally, the IRS and the courts have been less formal, noninstitutional health care facilities reluctant to question the validity or sincerity or programs, can qualify as charitable 501(c)(3) of religious beliefs or practices held by a group organizations. However, the IRS is particularly trying to establish itself as a religious purpose DPODFSOFEBCPVUDPOìJDUTPGJOUFSFTUBOECVTJOFTT organization. As long as the organization’s dealings between doctors who do work for the beliefs appear to be “truly and sincerely held” nonproft and also rent space or have other and their related practices and rituals are commercial dealings with the nonproft. Te IRS not illegal or against public policy, the IRS recommends that the health care nonproft form generally does not challenge the validity of the religious tenets or practices. However, the IRS 52 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

will question the nature and extent of religious RESOURCE activities (as opposed to religious beliefs) if they Te IRS has a guide to assist churches do not appear to foster religious worship or and clergy in complying with the religious advance a religious purpose, or if they appear purpose requirement of the Internal Revenue commercial in nature. Code. Te publication is intended to be a user- friendly compilation, set forth in question-and- EXAMPLE: A group that holds weekly answer format. You can download the guide, IRS meetings and publishes material celebrating Publication 1828, Tax Guide for Churches and the divine presence in all natural phenomena Religious Organizations, from the Nolo website (see should qualify as a religious purpose group. Appendix A for the link). Or you can ﬁnd a copy of How ever, an organization that sells a large the publication on the IRS website. Most church and volume of literature to the general public, religious-purpose groups will ﬁnd the information in some of which has little or no connection to this publication extremely helpful when preparing their federal exemption application (see Chapter 8). the religious beliefs held by the organization, could be regarded by the IRS as a regular Under IRS rulings, a religious organization trade or business, not as a tax-exempt should have the following characteristics to religious organization. qualify as a church (not all are necessary but A religious group need not profess belief the more the better): in a supreme being to qualify as a religious tBSFDPHOJ[FEDSFFEPSGPSNPGXPSTIJQ organization under Section 501(c)(3). tBEFëOJUFBOEEJTUJODUFDDMFTJBTUJDBM Religious corporations also have the widest government ìFYJCJMJUZJONBOBHJOHUIFJSJOUFSOBMBêBJST tBGPSNBMDPEFPGEPDUSJOFBOEEJTDJQMJOF (See the Attorney General’s Guide for Charities tBEJTUJODUSFMJHJPVTIJTUPSZ available on the Nolo website (see Appendix tBNFNCFSTIJQOPUBTTPDJBUFEXJUIBOZPUIFS A for the link), which contains a statement church or denomination regarding the attorney general’s overall hands- tBDPNQMFUFPSHBOJ[BUJPOPGPSEBJOFE of policy with respect to oversight of religious ministers corporations.) tBMJUFSBUVSFPGJUTPXO tFTUBCMJTIFEQMBDFTPGXPSTIJQ Qualifying as a Church tSFHVMBSDPOHSFHBUJPOT BOE You can also qualify under the 501(c)(3) religious tSFHVMBSSFMJHJPVTTFSWJDFT purpose category as a church, but doing so Courts have used similar criteria to determine is more difcult than simply qualifying as a whether or not a religious organization qualifes 501(c)(3) religious organization. One of the as a church. In one case, the court looked for advantages of qualifying as a church is that the presence of the following “church” factors: a church automatically qualifes for 501(c)(3) tTFSWJDFTIFMEPOBSFHVMBSCBTJT public charity status—a status that all 501(c)(3) tPSEBJOFENJOJTUFSTPSPUIFSSFQSFTFOUBUJWFT groups want to obtain, as we explain later, in tBSFDPSEPGUIFQFSGPSNBODFPGNBSSJBHF Chapter 4. other ceremonies, and sacraments tBQMBDFPGXPSTIJQ tTPNFTVQQPSUSFRVJSFEGSPNNFNCFST CHAPTER 3 | REQUIREMENTS FOR SECTION 501C3 TAX EXEMPTION | 53

tGPSNBMPQFSBUJPOT BOE or the design or construction of equipment tTBUJTGBDUJPOPGBMMPUIFSSFRVJSFNFOUTPG and buildings) does not qualify as a scientifc federal tax law for religious organizations. purpose under Section 501(c)(3). In an IRS All religious purpose groups that claim church case involving a pharmaceutical company, the status must complete a special IRS schedule company’s clinical testing of drugs was held not with specifc questions on some of the church to be “scientifc” under Section 501(c)(3) characteristics listed above. We discuss this tax because the clinical testing in question was application and the special IRS schedule for incidental to the pharmaceutical company’s churches in Chapter 8. commercial operations. Traditional churches, synagogues, associations, Generally, research is considered in the public or conventions of churches (and religious orders interest if the results (including any patents, or organizations that are an integral part copyrights, processes, or formulas) are made of a church and engaged in carrying out its available to the public; that is, the scientifc functions) can qualify as 501(c)(3) churches research must be published for others to study without difculty. Less traditional and less and use. Research is also considered in the formal religious organizations may have a public interest if it is performed for the United harder time. Tese groups often have to answer States or a state, county, or city government, additional questions to convince the IRS that or if it is conducted to accomplish one of the they qualify as tax-exempt churches. following purposes: tUPBJEJOUIFTDJFOUJëDFEVDBUJPOPGDPMMFHF EXAMPLE: A nonproft “online ministry” or university students and “virtual church” that provided ministry tUPEJTDPWFSBDVSFGPSBEJTFBTF PS materials and services (through online sales) tUPBJEBDPNNVOJUZPSSFHJPOCZBUUSBDUJOH was denied IRS classifcation as a church new industry, or by encouraging the because, in the IRS’s view, its website did not development or retention of an existing qualify as a “place of worship,” nor did the industry. persons who accessed the website constitute “a congregation assembled for worship.” EXAMPLE: An organization was formed by a group of physicians specializing in heart Some churches stand a greater chance of being defects to research the causes and treatment audited by the IRS than others. Not sur pris- of cardiac and cardiovascular conditions and ingly, the IRS is more likely to examine and diseases. Te physicians practiced medicine in question groups that promise members sub- a private practice facility that was separate and stantial tax benefts for organizing their house- apart from the organization’s research facility, holds as tax-deductible church organizations. which was used exclusively for the research program. Although some patients from the Scientiﬁc Purposes physicians’ private practice were accepted for Groups that engage in scientifc research carried the research program, they were selected on on in the public interest are also eligible for the same criteria as other patients. Te IRS tax-exempt status under 501(c)(3). Under IRS found that the physician’s research group met regulations, research incidental to commercial the scientifc purpose organizational test for or industrial operations (such as the normal Section 501(c)(3) purposes. inspection or testing of materials or products, 54 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

If you are applying for a scientifc exemption mercial rates, then you might qualify as a under Section 501(c)(3), your federal exemp tion 501(c)(3) literary purpose organi zation. How- application (covered in Chapter 8) should show ever, if your material seems aimed primarily at that your organization is conducting public a commercial market and is sold at standard interest research and you should provide the rates through regular commercial channels, following information: chances are that your literary organization tBOFYQMBOBUJPOPGUIFOBUVSFPGUIFSFTFBSDI will be viewed by the IRS as a regular business tBEFTDSJQUJPOPGQBTUBOEQSFTFOUSFTFBSDI enterprise ineligible for a 501(c)(3) tax exemp- QSPKFDUT tion. For example, publishing textbooks at tIPXBOECZXIPNSFTFBSDIQSPKFDUTBSF standard rates will probably not qualify as a tax- determined and selected, and exempt literary purpose under Section 501(c)(3) tXIPXJMMSFUBJOPXOFSTIJQPSDPOUSPMPGBOZ because the activity is more private than public patents, copyrights, processes, or formulas in nature. On the other hand, pub lishing resulting from the research. material to promote highway safety or the education of handicapped children is likely to RESOURCE qualify as a bona fde 501(c)(3) literary purpose. For a list of the specific information the EXAMPLE: A publishing house that only IRS requires from scientific groups, see “Scientific Organizations,” in IRS Publication 557, Tax-Exempt published books related to esoteric Eastern Status for Your Organization. philosophi cal thought applied for 501(c)(3) literary exemption. Teir books were sold com mercially but at modest prices. Te IRS Literary Purposes granted the tax exemption after requesting and reviewing the manuscript for the Tis is a seldom-used Section 501(c)(3) cate- nonproft’s frst publication. Te IRS found gory because most literary purpose nonprofts that the material was sufciently specialized are classifed as educational by the IRS. Never- to render it noncommercial in nature. theless, valid 501(c)(3) literary purposes include traditional literary eforts, such as publishing, distribution, and book sales. Tese activities Educational Purposes must be directed toward promoting the public Te type of educational activities that qualify interest as opposed to engaging in a commercial as educational purpose under 501(c)(3) are literary enterprise or serving the interests of broad, encompassing instruction both for particular individuals (such as the proprietors of self-development and for the beneft of the a publishing house). Generally, this means that community. Te IRS allows advocacy of a literary material must be available to the general particular intellectual position or viewpoint if public and must pertain to the betterment of there is a “sufciently full and fair exposition of the community. pertinent facts to permit an individual or the A combination of factors helps distinguish public to form an independent opinion or public interest publishing from private pub- conclusion. However, mere presentation of lish ing. If you publish materials that are clearly unsupported opinion is not (considered) educa tional and make them available to the educational.” public at cost, or at least below standard com- CHAPTER 3 | REQUIREMENTS FOR SECTION 501C3 TAX EXEMPTION | 55

If a group takes political positions, it may organize as a formal school facility with a not qualify for an exemption (see discussion regular faculty, established curriculum, and a on political activities in “Other Requirements regularly enrolled student body. for 501(c)(3) Groups,” below). An educational group that publishes a newsletter with a CAUTION balanced analysis of issues, or at least with You may need formal school attributes some room devoted to debate or presentation of for other reasons. Groups setting up nontraditional opposing opinions, should qualify as a 501(c)(3) schools aren’t required to have a regular faculty, full- educational purpose group. If its newsletter time students, or even a ﬁxed curriculum to qualify is simply devoted to espousing one side of an for a 501(c)(3) educational purpose tax exemption. issue, platform, or agenda, the educational As a practical matter, however, they may need purpose tax exemption may not be granted. some or all of these things to qualify for state or Examples of activities that qualify as educa- federal support, participate in federal student loan tional purpose include: programs, and obtain accreditation. tQVCMJTIJOHQVCMJDJOUFSFTUFEVDBUJPOBM materials tDPOEVDUJOHQVCMJDEJTDVTTJPOHSPVQT Child Care Centers forums, panels, lectures, and workshops Providing child care outside the home qualifes tPêFSJOHBDPSSFTQPOEFODFDPVSTFPSBDPVSTF as a 501(c)(3) educational purpose under special that uses other media such as television or provisions contained in Internal Revenue Code radio Section 501(k) if: tPQFSBUJOHBNVTFVN [PP QMBOFUBSJVN tUIFDBSFFOBCMFTQBSFOU T UPCFFNQMPZFE BOE symphony orchestra, or performance group tUIFDIJMEDBSFTFSWJDFTBSFBWBJMBCMFUPUIF tTFSWJOHBOFEVDBUJPOBMJOTUJUVUJPO TVDIBT general public. a college bookstore, alumni association, or A child care facility that gives enrollment athletic organization, or preference to children of employees of a specifc tQVCMJTIJOHFEVDBUJPOBMOFXTMFUUFST employer, however, will not be considered a pamphlets, books, or other material. 501(c)(3) educational purpose organization.

RESOURCE Private School Nondiscrimination Requirements See Education, Propa ganda, and the Methodology Test for guidelines used by the IRS and If you set up a 501(c)(3) private school, you courts to determine if a nonproﬁt qualiﬁes as an must include a nondiscrimination statement educational purpose organization under Section in your bylaws and publicize this statement 501(c)(3). You can download a copy of the document to the community served by the school. Tis from the Nolo website (see Appendix A for the link). statement must make it clear that the school does not discriminate against students or applicants on the basis of race, color, or national Formal School Not Necessary or ethnic origin. To qualify as a 501(c)(3) educational organi- Here is a sample statement taken from IRS zation, a group does not need to provide Revenue Procedure 75-50: JOTUSVDUJPOJOUSBEJUJPOBMTDIPPMTVCKFDUTPS 56 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

NOTICE OF NONDISCRIMINATORY valid 501(c)(3) purposes. Tis section discusses POLICY AS TO STUDENTS some of the requirements that keep a 501(c)(3) Te [name of school] admits students of from straying too far from its exempt-purpose any race, color, national and ethnic origin activities. to all the rights, privileges, programs, For more information on these rules, see and activities generally accorded or made Every Nonproft’s Tax Guide: How to Keep Your available to students at the school. It does Tax-Exempt Status & Avoid IRS Problems, by not discriminate on the basis of race, color, Stephen Fishman (Nolo). national and ethnic origin in administration of its educational policies, admissions policies, Unrelated Business Activities scholarship, and loan programs, and athletic To obtain 501(c)(3) status, a corporation cannot and other school-administered programs. substantially engage in activities unrelated to the group’s tax-exempt purposes. Or, put diferently, your nonproft corporation can conduct activities RESOURCE not directly related to its exempt purpose as long Additional information on the history and as these activities don’t represent a substantial status of 501(c)(3) private school nondiscrimination portion of your total activities. Some unrelated requirements is on the IRS website (www.irs.gov), activity is allowed because as a practical matter, in a tax topic update titled Private School Update. For further information on IRS private school most nonprofts need to do some unrelated antidiscrimination rules and procedures, see IRS business to survive. For example, a nonproft Revenue Procedure 75-50 and Private Schools, in IRS dance group might rent unused portions of its Publication 557, available on the Nolo website (see studio space to an outside group for storage. Appendix A for the link). Another nonproft might invest surplus funds to augment its income. Most groups need not be overly concerned RESOURCE with this limitation unless activities unrelated You can download copies of the following to exempt purposes start to involve a signifcant IRS-related material from the Nolo website (see amount of the group’s energy or time, or if Appendix A for the link): these activities produce “substantial” income. t Tax-Exempt Status for Your Organization If the activities are themselves nonproft, they t Private School Update should be included in the organization’s exempt t *343FWFOVF1SPDFEVSF purposes and classifed as related activities. Te IRS keeps an eye out for tax-exempt groups that regularly engage in proft-making Other Requirements businesses with little or no connection to their for 501(c)(3) Groups exempt purposes (a church running a trucking company). Business activities necessary to In addition to being organized primarily for further the group’s exempt purposes, such as one or more allowable tax-exempt purposes, a hiring and paying employees and paying rent nonproft must not engage in other activities for space used for the group’s exempt purpose, UIBUDPOìJDUPSTVCTUBOUJBMMZJOUFSGFSFXJUIJUT are considered related activities. CHAPTER 3 | REQUIREMENTS FOR SECTION 501C3 TAX EXEMPTION | 57

Most new nonprofts work full time simply Note that a non proft can pay reasonable tending to their exempt purposes and do not salaries to directors, ofcers, employees, or explore unrelated moneymaking activities until agents for services rendered in furtherance of later, if at all. However, if you plan to engage in the corporation’s tax-exempt purposes. unrelated business from the start, be careful. It’s hard to pin down exactly when these activities Excess Benefit Rules CFDPNFTVCTUBOUJBMFOPVHIUPKFPQBSEJ[FUIF Te IRS has adopted strict rules and regulations corporation’s tax-exempt status. Also, income regarding the payment of money, benefts, derived from unrelated business activities is or property to nonproft directors, ofcers, TVCKFDUUPGFEFSBMBOETUBUFDPSQPSBUFJODPNF sponsors, donors, and others associated with tax, even if it is not substantial enough to afect the nonproft. Te main purpose for these the group’s 501(c)(3) tax-exempt status. rules, called the excess beneft rules, is to make sure nonproft organizations do not pay out RESOURCE lavish benefts or skim of program funds to For more information on the federal line the pockets or serve the private interests unrelated business income tax that applies to of individuals associated with the nonproft. nonprofit 501(c)(3) groups, see UBIT: Current Te excess beneft rules are also called the IRS Developments (available on the Nolo website; see intermediate sanctions, a euphemism that is Appendix A for the link). meant to have an appropriately harsh ring. Tese rules are contained in Section 4958 of the Internal Revenue Code and Section 53.4958 of Limitation on Profits and Benefits the IRS Regulations. A 501(c)(3) nonproft corporation cannot be Te excess beneft rules apply to individuals organized or operated to beneft individuals associated with 501(c)(3) nonproft public associated with the corporation (directors, charities. (As explained more fully in ofcers, or members) or other persons or entities Chapter 4, in all likelihood you will be forming related to, or controlled by, these individuals a public charity nonproft.) Te individuals (such as another corporation controlled by a TVCKFDUUPUIFSVMFTJODMVEFOPOQSPëUEJSFDUPST director). In tax language, this limitation is PïDFST BOEUSVTUFFTBTXFMMBTNBKPSTQPOTPST known as the prohibition on private inurement donors, or anyone else in a position to exercise and means that 501(c)(3) groups can’t pay TVCTUBOUJBMJOìVFODFPWFSUIFBêBJSTPGUIF profts to, or otherwise beneft, private interests. nonproft. Te rules also apply to family Two specifc 501(c)(3) requirements imple- members and entities owned by any of the ment this prohibition on self-inurement: JOEJWJEVBMTTVCKFDUUPUIFSVMFT tOPQBSUPGUIFOFUFBSOJOHTPGUIFDPSQPSB Under the rules, an excessive beneft trans- tion can be distributed to individuals action is any transaction where the nonproft associated with the corporation, and gives cash, property, or anything of value to a tVQPOEJTTPMVUJPO UIFBTTFUTPGB D recipient that exceeds the value of the services group must be irrevocably dedicated to performed by the recipient (or the value of any another tax-exempt group (another 501(c)(3) other cash, property, or thing of value given to or a federal, state, or local government for a the nonproft by the recipient). If a nonproft public purpose). pays $100 to an ofcer who has contributed 58 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

$75 worth of services, the excess beneft is $25. tEJTJOUFSFTUFENFNCFSTPGUIFCPBSEPSDPN Of course, the IRS is looking for much bigger mittee must approve the transaction in numbers, sometimes in the realm of thousands, advance or hundreds of thousands of dollars worth of tUIFEFDJTJPONVTUCFCBTFEPODPNQBSBCJMJUZ extra benefts paid by the nonproft to directors, data reviewed and relied on by the board ofcers, consultants, sponsors, and donors. that shows the property is transferred Te sanctions include a tax that must be paid at fair market value or compensation is by both the recipient of the excess beneft as paid at a rate similar to that paid by other well as the nonproft managers (the directors organizations for comparable services, and and executive ofcers) who approved the excess tUIFEFDJTJPONVTUCFEPDVNFOUFEJO beneft transaction. Te recipient of the excess the corporate records at the time the beneft can be assessed a 25% tax on the transaction is approved. excess beneft, and the manager or managers Falling within the safe harbor provision who approved it can be assessed a 10% tax, creates a presumption that your deal or decision with a limit on a manager’s liability capped was fair. Te IRS can rebut this presumption if at $20,000 per transaction. A director must it obtains evidence to the contrary. PCKFDUUPUIFUSBOTBDUJPOUPCFFYDMVEFEGSPN If you are interested in reading more infor ma- those considered to have approved it—silence tion about these rules, you can use the resources or abstention at a board meeting that results in listed below. the excess beneft payment is not a defense. Te recipient must repay or return the excess beneft RESOURCE to the nonproft or the recipient will be charged Te following information on the excess an additional 200% tax. Te message is clear— beneﬁt rules and regulations is available on the Nolo if you receive an undeserved beneft from your website (see Appendix A for the link): nonproft, you and others in your nonproft may t*3$4FDUJPO Taxes on Excess Beneﬁt have to pay large penalties. Transactions Te IRS regulations add detail about the t*343FHVMBUJPOT4FDUJPO Table scope and operation of the excess beneft rules. of Contents (contains the IRS regulations For example, disqualifed persons is broadly promulgated under Section 4958) defned to include all sorts of people paid by t'JOBMSFHVMBUJPODIBOHFT4FFInternal or associated with the nonproft organization. Revenue Bulletin No 2008-18, T.D. 9390, and Excess salaries, contract payments, benefts, tIntermediate Sanctions (IRC 4958) Update. privileges, goods, services, or anything else of value paid or provided to almost anyone Te last thing you want to have happen is to associated with your nonproft can potentially TVCKFDUCPBSENFNCFST PïDFST DPOUSBDUPST trigger the excess beneft tax rules. sponsors, donors, and others who deal with Te regulations also contain a safe-harbor your nonproft to the prospect of having to pay provision for deals or decisions that provide an back money or the value of benefts previously economic beneft to a director, ofcer, contractor, paid out or provided by your nonproft plus or other key nonproft person. To qualify for the very hefty taxes, interest, and penalties. protection of the safe harbor rule, a number of conditions must be met, including: CHAPTER 3 | REQUIREMENTS FOR SECTION 501C3 TAX EXEMPTION | 59

Conflict of Interest Provisions Voter Education Activities Article 9 of the bylaws included in this book Section 501(c)(3) groups can conduct certain contains rules and procedures for approving voter education activities if they are done in a PSBWPJEJOHDPOìJDUPGJOUFSFTUUSBOTBDUJPOT nonpartisan manner (see IRS Revenue Ruling including compensation arrangements. Tis 78-248). If you want to engage in this type of CZMBXQSPWJTJPODPOUBJOTUIFDPOìJDUTPG political activity, we recommend you consult an interest language recommended by the IRS attorney. Your organization can request an IRS JODMVEFEJOUIFTBNQMFDPOìJDUPGJOUFSFTU letter ruling on its voter education activities by policy in the instructions to IRS Form 1023, writing to the address listed in IRS Publication in Appendix B). It also has language for the 557, Chapter 3, “Political Activity.” approval of compensation arrangements that attempts to comply with the safe harbor RESOURCE provisions of the excess beneft rules (see Article For information on restrictions on political 9, Section 5). You will need to become familiar candidate campaign activity by 501(c)(3) organizations, with Article 9 of your bylaws and refer to those see Election Year Issues. It also contains information provisions whenever your board, or a committee about other laws and restrictions applicable to of your board, decides to set or increase salaries, political campaign nonprofits—non-501(c)(3) enter into contracts, or approve deals with groups organized primarily to support or oppose individuals or other organizations. political candidates under Internal Revenue Code If you have any question about whether a § 527. You can download a copy of the document transaction, contract, compensation decision, from the Nolo website (see Appendix A for the link). or other economic decision is reasonable or whether it may be outside the safe harbor Influencing Legislation provisions of the excess beneft rules, ask a nonproft lawyer for help. Section 501(c)(3) organizations are prohibited GSPNBDUJOHUPJOìVFODFMFHJTMBUJPO iFYDFQUUP Limitation on Political Activities an insubstantial degree.” In the past, courts have found that spending more than 5% of A 501(c)(3) corporation is prohibited from an organization’s budget, time, or efort on participating in any political campaigns for political activity was substantial. More recently, or against any candidate for public ofce. courts have tended to look at the individual Participation in or contributions to political facts of each case. Generally, if a nonproft campaigns can result in the revocation of corporation contacts, or urges the public to 501(c)(3) tax-exempt status and the assessment contact, members of a legislative body, or of special excise taxes against the organization JGJUBEWPDBUFTUIFBEPQUJPOPSSFKFDUJPOPG and its managers. (See Internal Revenue Code legislation, the IRS considers it to be acting to §§ 4955, 6852, and 7409.) JOìVFODFMFHJTMBUJPO 60 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

-PCCZJOHUPJOìVFODFMFHJTMBUJPOBMTP Political Expenditures Test includes: tBOZBUUFNQUUPBêFDUUIFPQJOJPOTPGUIF Under the political expenditures test in IRC general public or a segment of the public, and § 501(h), limitations are imposed on two types tDPNNVOJDBUJPOXJUIBOZNFNCFSPS of political activities: lobbying expenditures and employee of a legislative body, or with any grassroots expenditures. Lobbying expenditures government ofcial or employee who might are those made for the purpose of influencing participate in the formulation of legislation. legislation, while grassroots expenditures are )PXFWFS MPCCZJOHUPJOìVFODFMFHJTMBUJPOEPFT those made to influence public opinion. not include: For examples of these two types of activities, tNBLJOHBWBJMBCMFUIFSFTVMUTPGOPOQBSUJTBO see IRS Publication 557, the “Lobbying analysis, study, or research Expend itures” section. Te monetary limits tQSPWJEJOHUFDIOJDBMBEWJDFPSBTTJTUBODFUP are different for each of the categories and the a government body, or to its committee or formulas for computing them are somewhat other subdivision, in response to a written complicated. request from it, where such advice would If your 501(c)(3) nonprofit elects the political PUIFSXJTFDPOTUJUVUFUIFJOìVFODJOHPG expenditures test, you must file IRS Form legislation 5768, Election/Revocation of Election by an tBQQFBSJOHCFGPSF PSDPNNVOJDBUJOH Eligible Section 501(c)(3) Organization To Make with, any legislative body with respect to Expenditures To Influence Legislation, within a possible decision that might afect the the tax year in which you wish the election organi zation’s existence, powers, tax-exempt to be effective. A copy of this form can be status, or the deductibility of contributions downloaded from the Nolo website (see to it, or Appendix A for the link). tDPNNVOJDBUJOHXJUIBHPWFSONFOUPïDJBM or employee, other than for the purpose of JOìVFODJOHMFHJTMBUJPO In determining whether a group’s legislative Also excluded from the defnition of lobbying activities are substantial in scope, the IRS looks eforts are communications between an at the amount of time, money, or efort the organization and its members about legislation group spends on legislative lobbying. If they are (or proposed legislation) of direct interest to the sub stantial in relation to other activities, organization and the members, unless these 501(c)(3) tax status might be revoked and, communications directly encourage members again, special excise taxes can be levied against

UPJOìVFODFMFHJTMBUJPO the organization and its managers. (See IRC § 4912.) EXAMPLE: A Housing Information Exchange keeps its members informed of proposed Te Alternative Political Expenditures Test legislation afecting low-income renters. Tis Since it is impossible to know ahead of time should not be considered legislative lobbying how the IRS will assess the substantiality of activity unless members are urged to contact a group’s legislative activity, the IRC allows their political representatives in support of, 501(c)(3) public charities (most 501(c)(3) groups or in opposition to, the proposed legislation. will qualify as public charities—see Chapter 4) to elect an alternative expenditures test to CHAPTER 3 | REQUIREMENTS FOR SECTION 501C3 TAX EXEMPTION | 61

measure permissible legislative activity. Under See “Is Your Group a Nonproft Tat Can Use this test, a group may spend up to 20% of the Tis Book?” in Chapter 1, and IRS Publication frst $500,000 of its annual expenditures on 557 for further information on 501(c)(4) lobbying, 15% of the next $500,000, 10% of organizations. the next $500,000, and 5% of its expend itures beyond that, up to a total limit of $1 million CAUTION each year. Additional limitations. Federally funded groups may be subject to even more stringent CAUTION political expenditure tests than those discussed Some groups can’t use the political here (for example, political activity and expenditure expenditures test. Tis expenditures test and its restrictions imposed by the federal Oﬃce of provisions for lobbying and grassroots expenditures Management and Budget). are not available to churches, an integrated auxiliary of a church, a member of an aﬃliated group of RESOURCE organizations that includes a church, or to private For a thorough discussion of the rules that foundations. apply to lobbying activities by 501(c)(3) organizations and detailed information on the Section 501(h) If your nonproft corporation plans to do political expenditures test election, see Lobbying considerable lobbying activity, mostly by Issues, available on the Nolo website (see Appendix A unpaid volunteers, then electing the expen di- for the link). tures test might be a good idea. Why? Because the minimal outlay of money to engage in these activities will probably keep you under Political Action Organizations the appli c able expenditure limits. If you Te IRS can also challenge a 501(c)(3) group’s didn’t make this election, your 501(c)(3) tax political activities by fnding that it is an action FYFNQUJPONJHIUCFQMBDFEJOKFPQBSEZJGUIF organization: one so involved in political IRS considers your political activities to be a activities that it is not organized exclusively substantial part of your overall purposes and for a 501(c)(3) tax-exempt purpose. Under program. these circumstances the IRS can revoke the If you plan to engage in more than a mini- organization’s tax-exempt status. Intervention mum amount of political lobbying or legislative in political campaigns or substantial attempts eforts, you need to decide whether it is to your UPJOìVFODFMFHJTMBUJPO BTEJTDVTTFEBCPWF BSF advantage to elect the expenditures test based grounds for applying this sanction. In addition, on the facts of your situation. If you fnd that if a group has the following two characteristics, these alternative political expenditures rules it will be classifed as an action organization are still too restrictive, you might consider and lose its 501(c)(3) status: forming a social welfare organization or civic *UTNBJOPSQSJNBSZPCKFDUJWFPS league under Section 501(c)(4) of the Internal PCKFDUJWFTOPUJODJEFOUBMPSTFDPOEBSZ Revenue Code—this exemption requires a PCKFDUJWFTNBZCFBUUBJOFEPOMZ diferent federal exemption application, IRS by legislation or defeat of proposed Form 1024, and does not carry with it all the legislation, and attractive benefts of 501(c)(3) status (access to grant funds, tax deductible contributions, etc.). 62 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

2. It advocates or campaigns for the attain- CAUTION NFOUPGTVDIPCKFDUJWFTSBUIFSUIBO Check the Federal Election Commission engaging in nonpartisan analysis, study, website (FEC). Politically active groups should go or research and making the results to the FEC website at www.fec.gov to read about available to the public. the ever-changing federal election campaign laws In determining whether a group has these and how they may impact their nonprofit’s political characteristics, the IRS looks at the surrounding activities. facts and circumstances, including the group’s articles and activities, and its organizational and operational structure. RESOURCE Te point here is to be careful not to state Te IRS provides illustrations for clarifica tion your exempt purposes in such a way that they on what constitutes political campaign activities. IRS seem only attainable by political action. Even Revenue Ruling 2007-41 has 21 fact situations that if you indicate that your activities will not help explain when the IRS will and will not consider be substantially involved with legislative or a group to be conducting unpermitted political lobbying eforts, the IRS may decide otherwise campaign activities. (See Appendix A for a link to the Revenue Ruling.) and invoke this special classifcation to deny or rescind 501(c)(3) status. If the IRS classifes a group as an action Information for Specific organi zation, the group can still qualify as a social welfare group under 501(c)(4). Questions About Your Group’s Activities EXAMPLE: A group that has a primary QVSQPTFPGiSFGPSNJOHUIFKVEJDJBMTZTUFN Even after reading through this chapter, you in the United States” will likely sound like might still have some questions about whether a political action organization to the IRS, your specifc nonproft activities meet the IRS because this sounds like a political goal that defnition of educational, charitable, or religious must be accomplished mostly by political purposes under Section 501(c)(3) of the Internal means. However, if the group rephrases its Revenue Code. Or, after you take a closer look primary purpose as “educating the public at Chapter 4, you might wonder whether your on the efcacy of mediation, arbitration, nonproft can qualify for special public charity BOEPUIFSBMUFSOBUJWFOPOKVEJDJBMEJTQVUF treatment as a school or church. resolution mechanisms,” it stands a better Answers to these types of questions used to be chance of having the IRS approve its left to the expertise of highly paid lawyers and application, even if it lists some political tax professionals—this is no longer true. It is activity as incidental to its primary remarkably easy to fnd out more about how the educational purpose. IRS might look at your nonproft organiza tion when it reviews your tax exemption appli cation. Te IRS website disseminates most of the material necessary to answer many technical CHAPTER 3 | REQUIREMENTS FOR SECTION 501C3 TAX EXEMPTION | 63

questions as long as you are persistent enough see the heading, “7.25 Exempt Organizations to search the site thoroughly and uncover the Determinations Manual.” Click on the link material. Specifcally, IRS publications and under this heading to “7.25.3, Religious, regulations, as well as the technical manuals Charitable, Educational, Etc., Organizations.” the IRS examiners use when reviewing tax Tis chapter contains examples of groups that exemption applications, are available online. have and have not qualifed under each of the Tis chapter refers to special IRS training 501(c)(3) tax-exempt purposes. materials from the IRS website and includes If you want to learn even more, you can this material on the Nolo website (see Appendix examine any IRS rulings and cases that you A for the link). We describe how each of these uncover in your website search. Rulings are articles helps explain and illustrate a specifc compiled in IRS Cumulative Bulletins, the issue related to obtaining and maintaining a most recent of which are available for browsing 501(c)(3) tax exemption. Tere is a lot more on the IRS website. Type “Internal Revenue helpful material on the IRS website, and we Bulletins” in the search box and then select the encourage you to browse it to learn as much volume for the year when the ruling was issued. as you’d like about nonproft organization tax Scroll through the beginning table of contents issues. to fnd the page where the ruling begins (the Here is one way to search the IRS site for frst four numbers of a ruling indicate its nonproft tax exemption answers: year—for example, Ruling 2004-51 was issued Go to the main page of the IRS website, at in 2004, so you would look at the Bulletin www.irs.gov, and click “Help & Resources,” for 2004 to fnd the text of the ruling). Most then “Charities & Non-Profts” link. Tis page years have more than one Bulletin volume, contains special nonproft tax topics, resources, and some rulings are placed in the next year’s and links to additional information. If you volume. It takes persistence to track down don’t fnd what you’re looking for, type a word rulings, but they can be enormously helpful in or phrase in the search box that succinctly VOEFSTUBOEJOHXIZUIF*34BDDFQUFEPSSFKFDUFE describes your question. a nonproft organization’s application for a For a more advanced approach, you can go 501(c)(3) tax exemption. For more information directly to the Internal Revenue Manual by on doing your own research, see Chapter 11. typing “Internal Revenue Manual” in the search box and clicking on the link. Tis will RESOURCE take you to a table that lists diferent sections For an in-depth discussion and analysis of the IRS procedures manual used by IRS of the requirements that apply to each type of examiners and feld agents. Part 7 is the main 501(c)(3) nonproﬁt, supplemented annually with the area of interest for nonproft groups applying latest IRS and court rulings in each area, see Te Law for their 501(c)(3) tax exemption. Select this of Tax-Exempt Organizations, by Bruce R. Hopkins link, then scroll down the heading list until you (John Wiley & Sons, New York, N.Y.). ●

CHAPTER

Public Charities and Private Foundations 4

Te Importance of Public Charity Status ...... 66 How to Qualify for Public Charity Status ...... 67 Automatic Public Charity Status ...... 68 Public Support Test ...... 70 Exempt Activities Support Test ...... 77 Private Foundations ...... 81 Background ...... 81 Operating Restrictions ...... 82 Limitation on Deductibility of Contributions ...... 82 Special Types of Private Foundations ...... 82 66 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

n this chapter, we explain why it is not Te Importance of enough to simply obtain your 501(c)(3) tax- Iexempt status—you also need to be recog- Public Charity Status nized as a 501(c)(3) public charity. Getting this Te IRS classifes all 501(c)(3) tax-exempt non- extra recognition is essential to make your life proft corporations as either private foun dations as a nonproft easier to manage. Even though or public charities. Initially, most 501(c)(3) the last thing you may be interested in at this corporations are presumed to be private founda- point is delving into more tax technicalities, tions. It’s extremely important to understand it will help you enormously to have a general that your group, too, will initially be viewed understanding of the distinction between public as a private foundation. Te problem with this charity and private foundation tax status before classifcation is that private foundations are you do your federal tax exemption application. TVCKFDUUPTUSJDUPQFSBUJOHSVMFTBOESFHVMBUJPOT You will understand the importance of some of that don’t apply to groups classifed as public the most technical questions on the application charities. You’ll want to get yourselves out and you’ll know how to answer questions to from under this presumption because, like show you qualify for public charity tax status. most 501(c)(3) groups, you would probably fnd We help you get through this information it impossible to operate under the rules and by explaining the diferent public charity restrictions imposed on private foundations. To classifcations and requirements in plain avoid this classifcation, you will want to apply English. You don’t need to master this material. for public charity status when you apply for In fact, many nonprofts let the IRS decide your federal 501(c)(3) tax exemption. which public charity category works for them. A few special groups are not presumed to be For now, simply read through the information private foundations and do not have to apply to get a general understanding of the concepts. for public charity status—the same groups You can come back to this chapter when you that are not required to fle a 501(c)(3) tax do your federal tax exemption application and exemption application. We think it’s foolhardy reread the sections that apply to you. in most cases not to apply for, and obtain, Troughout this chapter, we refer to the ofcial notifcation from the IRS that you are Internal Revenue Code sections that apply a public charity. (For a discussion of this issue, to the diferent public charity classifcations. see “Do You Need to File Form 1023?” in You don’t need to pay attention to these Chapter 8.) section references. Tey will be useful later as a reference when you prepare your federal tax How to Start Out as a Public Charity exemption application. A new 501(c)(3) group can qualify as a public charity for the first five years if it reasonably expects to receive qualifying public support. We explain how to fill in your 501(c)(3) tax exemption application to apply for public charity status in Chapter 8. CHAPTER 4 | PUBLIC CHARITIES AND PRIVATE FOUNDATIONS | 67

How to Qualify for tReceive most of your revenue from activities related to your tax-exempt purposes. If your Public Charity Status group receives most of its revenue from As explained above, almost all 501(c)(3) non- activities related to its tax-exempt purposes, profts want to overcome the private founda tion you can qualify under a special public presumption and establish themselves as a public charity support test that applies to many charity. Tere are three basic ways to do this: smaller nonprofts. tForm one of the types of nonproﬁts that EXAMPLE: An arts group deriving most of automatically qualify. Particular types of its income from exempt-purpose activities nonproft organizations, such as churches, (lessons, performances, and renting studio schools, or hospitals, automatically qualify facilities to other arts groups) would probably for public charity status because of the choose the support test. Tis public charity nature of their activities. test, unlike those that apply to publicly EXAMPLE: A church that maintains a facility supported organizations, allows groups to for religious worship would most easily count income derived from the performance obtain automatic public charity status. A of their exempt purposes as qualifed support. church qualifes for recognition as a public charity because of the nature of its activities RESOURCE rather than its sources of support. For additional information on the rules tDerive most of your support from the public. that apply to each of the three public charity tests, If your group receives support primarily see Public Charity or Private Foundation Status Issues from individual contributions, government, under IRC §§ 509(a)(1)–(4), 4942(j)(3), and 507. You or other public sources, you can qualify for can download a copy of the document from the Nolo website (see Appendix A for the link). For information public charity status as a publicly supported on the public charity requirements associated with organization. each type of automatically recognized public charity EXAMPLE: An organization formed to operate (churches, schools, hospitals, and others), see the a center for rehabilitation, counseling, or section titled, “Type A. Organizations Tat Engage in Inherently Public Activity (IRC 509(a)(1) and IRC similar services that plans to carry on a 170(b)(1)(A)(i)–(v)).” For information on the public broad-based solicitation program and depend charity test we call the public support test, see the primarily on government grants, corporate section titled, “Publicly Supported Organizations contributions, and individual donations Described in IRC §§ 509(a)(1) and 170(b)(1)(A)(vi).” would most likely seek public charity status For information on the public charity test we call as a publicly supported organization. the exempt activities support test, see the section titled, “Publicly Supported Organizations Described in IRC § 509(a)(2).” 68 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Schools You Can Let the IRS Decide Your Public Charity Classification Certain educational institutions that have the institutional attributes of a school automatically It’s sometimes hard to figure out whether your qualify as public charities. (IRC §§ 509(a)(1) organization will meet the public support test and 170(b)(1)(A)(ii).) Generally, these are educa- or the exempt activities test discussed below. tional organizations whose primary function To make this decision, an organization must is to present formal instruction. Tese schools second-guess future sources of support and usually have a regular faculty and curriculum, a tackle quite a few tax technicalities. Fortunately, regularly enrolled body of students, and a place if you have doubts, the IRS will help. Simply where their educational activities are carried on. check a box on the federal tax exemption Tis school category for automatic public application and the IRS will decide this question charity recognition is geared toward primary for you based upon the financial and program or secondary preparatory or high schools, and information you submit with your application. colleges and universities with regularly enrolled For the specifics on making this election, see student bodies. Te further an educational the Chapter 8 instructions to Part X, Line 5(i), of group strays from the institutional criteria the federal tax exemption application. mentioned above, the harder it will be to qualify as a public charity. Tis doesn’t mean that less structured educational institutions Automatic Public Charity Status can’t automatically qualify for public charity TUBUVTBTTDIPPMT JUKVTUNBZCFNPSFEJïDVMU Te IRS automatically recognizes certain Nontraditional groups have a better chance 501(c)(3) groups as public charities because they of obtaining automatic public charity status perform particular services or engage in certain if they have some conventional institutional charitable activities. Te following groups attributes, such as regional accreditation and a automatically qualify: state-approved curriculum. If your educational purpose 501(c)(3) group does not fall within Churches this school category for automatic recognition, Religious purpose groups that qualify as it can still qualify for public charity status churches for 501(c)(3) tax exemption purposes under the public support test or exempt activi- also automatically qualify as a public charity. ties support test, described below. (IRC §§ 509(a)(1) and 170(b)(1)(A)(i).) Quali- fying as a church under Section 501(c)(3) is Hospitals and Medical more difcult than qualifying as a 501(c)(3) Research Organizations religious purpose organization. To qualify as a Nonproft health care groups that operate church, the organization must have the insti- charitable hospitals or facilities and whose tutional and formal characteristics of a church. main function is to provide hospital or medical (See “Religious Purposes,” in Chapter 3.) If care, medical education, or medical research your religious purpose 501(c)(3) group does not automatically qualify as public charities. (IRC qualify as a church, it can still qualify for public §§ 509(a)(1) and 170(b)(1)(A)(iii).) Tese charity status under one of the other public charitable hospitals generally have the following charity tests, described below. characteristics: CHAPTER 4 | PUBLIC CHARITIES AND PRIVATE FOUNDATIONS | 69

tEPDUPSTTFMFDUFEGSPNUIFDPNNVOJUZBU Public Safety Organizations large who are part of the courtesy staf Groups organized and operated exclusively for tBDPNNVOJUZPSJFOUFECPBSEPGEJSFDUPST public safety testing automatically qualify for tFNFSHFODZSPPNGBDJMJUJFTBWBJMBCMFPOB public charity status. Generally, these organi- community-access basis zations test consumer products to deter mine tBENJTTJPOPGBUMFBTUTPNFQBUJFOUTXJUIPVU their ftness for use by the general public. (IRC charge (on a charitable basis) § 509(a)(4).) tOPOEJTDSJNJOBUJPOXJUISFTQFDUUPBMM admissions (particularly Medicare or Government Organizations Medicaid patients), and Certain organizations operated for the beneft tBNFEJDBMUSBJOJOHBOESFTFBSDIQSPHSBN of a governmental college or university (such that benefts the community. as a state college or university) automatically Other 501(c)(3) health care organizations, qualify as public charities. (IRC §§ 509(a)(1) such as rehabilitation groups, outpatient clinics, and 170(b)(1)(A)(iv).) Most likely, you won’t community mental health programs, or drug be forming a corporation of this sort, but we treatment centers, can qualify as hospitals if their mention it because this type of organization is principal purpose is to provide hospital or medical included in the list of public charities on the care. A health organization that uses consultation federal tax exemption application form. services of certifed medical personnel such as doctors and nurses will have an easier time Supporting Organizations meeting the hospital criteria. Te IRS does not, however, recognize convalescent homes, homes for Organizations operated solely for the beneft of, children or the aged, or institutions that provide or in connection with, one or more of the above vocational training for the handicapped as ftting organizations, or publicly supported groups or within this public charity category. groups that meet the exempt activities support Medical education and research organizations test (described below in “Public Support Test” do not qualify under these IRC sections unless and “Exempt Activities Support Test”), are they actively provide on-site medical or hospital also automatically classifed as public charities care to patients as an integral part of their (except those that beneft a public safety organi- functions. Medical research groups must also zation). (IRC § 509(a)(3).) be directly and continuously active in medical research with a hospital, and this research must RESOURCE be the organization’s principal purpose. For further information on organizations listed above, see IRS Publication 557, Tax-Exempt TIP Status for Your Organization, “Section 509(a)(1) Organizations.” For supporting organizations, see Hospitals and other tax-exempt health Publication 557, “Section 509(a)(3) Organizations.” care organizations may want to adopt a com- Also, note that federal rules have been enacted as munity board and a conﬂict-of-interest policy in part of the Pension Protection Act of 2006 that their bylaws. We explain how hospitals and medical impose additional requirements on supporting care groups can modify the conﬂict-of-interest organizations and private foundations that fund provisions in the bylaws included in this book to add them. Ask your tax adviser for more information. provisions recommended by the IRS. (See Chapter 8, “Filling Out the Schedules.”) 70 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Public Support Test works for you. In most cases, unless you know your nonproft easily fts within the auto- To be classifed as a publicly supported public matic public charity classifcation, the best charity, a group must regularly solicit funds and easiest approach is to let the IRS decide from the general community. It must normally whether the public support test (covered in this receive money from government agencies and/ section) or the exempt activities support test or from a number of diferent private contri- (discussed below) works for your nonproft. butors or agencies. (IRC §§ 509(a)(1) and After all, the technical staf on the IRS Exempt 170(b)(1)(A)(vi).) Te term “normally” has Organizations Determinations staf knows this a special meaning in this context, which is material inside out. Why not use their expertise explained below. We call this public charity and let them apply the public charity support test the public support test because the main UFTUTUPZPVSHSPVQTQBTUBOEQSPKFDUFETPVSDFT requirement is that the organization must of public support, which you will disclose in receive a substantial portion of its funds from your federal tax exemption application? broad-based public support sources. In general, museums, libraries, and com- RESOURCE munity centers that promote the arts should qualify under this public charity test if they For more detailed information on rely on broad-based support from individual qualify ing as a public charity using the public see IRS Publication 557, Tax-Exempt members of the community or from various support test, Status for Your Organization, “Publicly Supported public and private sources. Organizations Organizations.” You can download a copy of that expect to rely primarily on a few private IRS Publication 557 from the Nolo website (see sources or occasional large grants to fund Appendix A for the link). Also check the IRS website their operations will probably not meet the at www.irs.gov under “Help & Resources,” then requirements of this section. Tis support test “Charities and Non-Proﬁts.” is difcult for small, grassroots groups to meet because income from the performance of tax- How Much Public Support Do You Need? exempt purposes does not count as qualifying public support income—a source of support Te IRS will usually consider an organization commonly relied upon by these groups. qualifed under the public support test if it To determine whether your group qualifes as a meets one of the following tests: publicly supported public charity, you will need tɨFHSPVQOPSNBMMZSFDFJWFTBUMFBTUPOF to do some basic math and understand some third of its total support from governmental technical rules. Try not to get overwhelmed or units, from contributions made directly discouraged by this technical material. For now, or indirectly by the general public, or you can simply read through the information from a combination of the two (including to get a sense of the basic criteria for this test contributions from other publicly supported and whether or not you might qualify. You can organizations), or revisit anything that might seem applicable tɨFPSHBOJ[BUJPOSFDFJWFTBUMFBTUPOFUFOUI to you later when you fll in your federal tax of its support from these sources and meets exemption application. an additional “attraction of public support” More importantly, you may decide to let requirement (we discuss the attraction of the IRS fgure out which public support test public support test below). CHAPTER 4 | PUBLIC CHARITIES AND PRIVATE FOUNDATIONS | 71

We call this one-third or one-tenth fgure What Does “Normally” Mean? “public support.” To keep your percentage high An organization must “normally” receive either enough, you’ll want the IRS to classify as much one-third or one-tenth of its total support of your income as possible as public support from public support sources. Tis means (the numerator amount), and keep your total that one tax year won’t make or break your support fgure (the denominator amount) as low chances of meeting the test—the IRS bases its as possible. Tis will make your fnal percentage decision on fve years’ cumulative receipts. Your of public support as high as possible. Of course, organization will meet either the one-third or the IRS has many rules, and exceptions to one-tenth support test for the current tax year the rules, to defne public support and total if, during the current tax year and the four support. We provide a guide to the basic prior tax years (fve years total), its cumulative technical terms used, below. public support equals one-third or one-tenth of Some basic math must be used to estimate its cumulative total support. your organization’s percentage of support. If your nonproft meets the support test in the As we explain later, only certain types of current year (based on support received over the support can be included in the numerator of fve-year testing period that includes the current the fraction—the support funds classifed as tax year and the previous four tax years), it will qualifed public support. Te denominator be classifed as a public charity for the current of the fraction includes the organization’s and the next tax year. total support, which includes most sources of support received by the nonproft. You will EXAMPLE: Open Range, Inc., is a nonproft want as much support as possible to show up organiza tion for medical research on the in the numerator as qualifed public support. healthful efects of organic cattle ranching. If some support received by the nonproft does ORI’s cumulative total support was $60,000 not qualify as public support, then it is better for 2011 through 2015, and its cumulative to have the support also excluded from the total public support was $25,000. Te organi za- support. Tis will keep the excluded support tion will, therefore, be considered a publicly from reducing your public support percentage supported public charity for 2015 and the since both the numerator and denominator will following tax year, 2016. Tis remains true be left intact. even if, for one or more of the previous four years or the current tax year (which we’re What Is Public Support? assuming is 2015), public support did not Qualifed public support (support included in equal one-third of the total support—it’s the the numerator of the fraction) includes funds cumulative total that counts. from private and public agencies as well as contributions from corporate and individual EXAMPLE: If World Relief, a 501(c)(3) donors. However, the IRS limits how much nonproft, meets the public support test qualifed support your group can receive from for the year 2014 because of grants and one individual or corporation. Also, some contributions received from the public from membership fees can be included as qualifed the start of 2010 through the end of 2014 support. We discuss these special rules in more (the fve-year testing period that includes the detail, below. current year), the nonproft will be classifed 72 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

as a public charity for both 2014 and 2015. EXAMPLE: If your total support over the Let’s assume that in 2015 World Relief fails current and previous four-year period was the support test (using the new fve-year $60,000, then only $1,200 (2% of $60,000) testing period of 2011 through and including contributed by any one person, private agency, 2015). It retains its public charity status for or other source can count as public support. 2015 because it met the support test in the prior year. But if World Relief also fails the Note that the total amount of any one support test in 2016 (using a new fve-year contribution, even if it exceeds this 2%, fve- testing period of 2012 to and through 2016), year limitation, is included in the corporation’s it will lose its public charity status as of the total support. Paradoxically, therefore, large start of its 2016 tax year. In other words, it contributions from an individual or private will be classifed as a private foundation as of agency can have a disastrous efect on your the beginning of its 2016 tax year. status as a publicly supported charity. You get to include such contributions as public support only to the extent of 2% of the current and What Is a “Government Unit”? previous four years’ total income, but the total Money received from a government unit is income fgure is increased by the full amount considered public support. Government units of the contribution. Tis makes it more difcult include federal or state governmental agencies, for you to meet the one-third or one-tenth county, and city agencies, and so on. Te most public support requirement. common example of governmental support is a EXAMPLE: On Your Toes, a ballet troupe, federal or state grant. received the following contributions from Te 2% Limit Rule 2011 through 2015: Direct or indirect contributions from the 2011 $10,000 from individual X general public are considered public support. 2012 20,000 from individual Y Indirect contributions include grants from 2013 50,000 from business Z, private trusts or agencies also funded by contri- a one-owner butions from the general public, such as grants unincorporated dance supply business from Community Chest or the United Fund. 2014 10,000 additional )PXFWFS UIFSFJTBNBKPSSFTUSJDUJPOBQQMJ contribution cable to these contributions. Te total con tri bu- from individual X tions from one individual, trust, or cor po ra tion 2015 10,000 additional made during the current and preceding four contribution from business Z tax years can be counted only to the extent that they do not exceed 2% of the corpo ration’s $100,000 Total Support total support for those fve years. Contributions from government units, publicly supported All support for the fve-year period is from organizations, and unusual grants are not contributions, direct or indirect, from the TVCKFDUUPUIJTMJNJUɨFTFFYDFQUJPOTBSF general public. However, in view of the discussed below. 2% limit, On Your Toes will have trouble maintaining its publicly supported public CHAPTER 4 | PUBLIC CHARITIES AND PRIVATE FOUNDATIONS | 73

charity status. While all contributions count dollars as a grant. If Sax made the contri- toward total support, only $2,000 (2% x bution to NPM on the condition that the $100,000) from any one contributor counts foundation give it to your organization, it as public support. is considered earmarked for you and the Terefore, the troupe’s public support for 2% limit applies. If not, the limit doesn’t this period is only $6,000 ($2,000 from each apply—and you can count the whole contributor, X, Y, and Z), which falls $4,000 donation as public support. short of the minimum one-tenth public support requirement. Except for earmarked contributions or grants, Now, suppose On Your Toes received you can rely on large contributions or grants $2,000 each from 50 contributors over the from specifc government agencies or other fve-year period. It still has $100,000 total publicly supported organizations every year, support, but because no one contributor since all such contributions will be counted as gave more than 2% of the fve years’ total public support. support, it can count the entire $100,000 as Money From Unusual Grants public support. "OPUIFSNBKPSFYDFQUJPOUPUIFMJNJUJTGPS unusual grants from the private or public sector. TIP A grant is unusual if it: Increase your chances of qualifying as tJTBUUSBDUFECZUIFQVCMJDMZTVQQPSUFEOBUVSF a publicly supported public charity. One way to of your organization do this is to solicit smaller contributions through tJTVOVTVBMUIJTNFBOTZPVEPOUSFHVMBSMZ a broad-based fundraising program and don’t rely rely on the particular grant and it is an constantly on the same major sources. Tis way, unexpectedly large amount, and you’ll beat the 2% limit and have a better chance of qualifying contributions as public support. tXPVME CFDBVTFPGJUTMBSHFTJ[F BEWFSTFMZ afect the publicly supported status of your organization (as we’ve seen, because of the Exceptions to the 2% Limit Rule 2% limit, large grants can cause trouble). ɨFSFBSFUXPNBKPSFYDFQUJPOTUPUIFMJNJU If a grant qualifes as an unusual grant, you can exclude the grant funds from both your Money From Government Units or public support and total support fgures for the Publicly Supported Organizations year in which they are given. Contributions received from a government unit or other publicly supported organization EXAMPLE: Te National Museum of BSFOPUTVCKFDUUPUIFMJNJU FYDFQUUIPTF Computer Memo ra bilia, Inc., is a nonproft specifcally earmarked for your organization corporation that operates a museum by the original donor. of computers and artifcial intelligence memorabilia. Te years 2011 through 2014 EXAMPLE: Ebeneezer Sax gives $1 million to are difcult ones and the museum raises very National Public Music, a national government little money. But in 2015 the organization foun da tion that promotes musical arts. NPM receives an unexpected windfall grant. A then gives your organization the million look at the receipts for 2011 to 2014 helps illustrate the importance of the unusual 74 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

grant exception. All amounts are individual Te museum meets the 10% support test contributions from the general public unless because total public support of $500 equals indicated otherwise: 10% of the total support of $5,000 received over the fve-year period. If the organization 2011 $1,000 from A also meets the attraction of public support 2012 1,000 from B requirement (which must be met by groups 2013 1,000 from C whose public support is less than one-third 2014 1,000 from D of total support), it will qualify as a publicly 1,000 from E supported public charity for 2015 and 2016. 2015 100,000 from Z, a private grant (If you meet the fve-year support test, you agency qualify as a public charity for the current $105,000 Total Receipts and next tax year.) If the $100,000 contribution did not Assume that the 2015 grant qualifes as qualify as an unusual grant, the nonproft an unusual grant. Te total support compu- would not meet the 10% public support tation for the fve-year period would be: test. Total support would equal total receipts 2011 $1,000 from A of $105,000; a maximum of 2% times 2012 1,000 from B $105,000, or $2,100, from each individual 2013 1,000 from C and the grant agency would be classifed as 2014 1,000 from D public support. Public support received over 1,000 from E the fve-year period would consist of $1,000 2015 0 the $100,000 grant from individuals A, B, C, D, and E, and the drops out from maximum allowable sum of $2,100 from the total support grant agency, for a total public support fgure

$5,000 Total Support of $7,100. Te percentage of public support for the fve-year period would equal $7,100 Because the total support is $5,000, the ÷ $105,000, or less than 7%, and the group museum can only count a maximum of would meet the support test in 2015. Again, 2% times $5,000, or $100, received from you can see how a large grant can hurt you if any one individual during this period as it does not qualify as an unusual grant. public support. Terefore, the public support computation for this period looks like this: Membership Fees as Public Support 2011 $100 from A Membership fees are considered public support as long as the member does not receive some- 2012 100 from B thing valuable in return, such as admis sions, 2013 100 from C merchandise, or the use of facilities or services. 2014 100 from D If a member does receive direct benefts in 100 from E exchange for fees, the fees are not considered 2015 0 the $100,000 public support. Tese fees are, however, always contribution also drops out from the public included in the total support computation. support computation $500 Total Public Support CHAPTER 4 | PUBLIC CHARITIES AND PRIVATE FOUNDATIONS | 75

What’s Not Public Support? tReceipts from performing tax-exempt We’ve already mentioned some sources of purposes. Examples include money received support that are excluded because of special from admis sions to performances of a tax- circumstances (they exceed the 2% limit or are exempt symphony, fees for classes given by paid by members in return for something of a dance studio, and tuition or other charges value). Tere are additional types of support paid for attending seminars, lectures, or that are never included as public support. Te classes given by an exempt educational following types of income are not considered organization. public support and, in some cases, are also Since we’re dealing with tax laws, you’d not included in the total support fgure (in probably expect at least one complicating which case they would drop entirely from the exception. Here it is. If your organization percentage of one-third or one-tenth support relies primarily on gross receipts from activities calculation). related to its exempt purposes (such as an educational nonproft that receives most of its Unrelated Activities and Investment support from class tuition), this exempt-purpose not Net income from activities unrelated to exempt income will be considered public support. purposes as well as gross investment income, Instead it will be computed in total support which includes rents, dividends, royalties, and (so it will decrease your percentage of support returns on investments, are not considered calculation by making the fraction smaller). If public support. Both these types of income are your group falls in this category, it will probably added to the total support fgure (they stay in not be able to qualify as a publicly supported the denominator of your one-third or one-tenth public charity and should attempt to qualify support calculation). under the public charity exempt activities support test, discussed below. Sales of Assets or Performing Tax-Exempt Activity Attraction of Public Support Test Te following types of income are not consid- Groups that can’t meet the one-third public ered as public support or part of total support support requirements can qualify for public (as with unusual grants, they drop out of both charity status if they receive at least one-tenth computations): of their total support from qualifed public tGains from selling a capital asset. Generally, income sources and meet the additional capital assets are property owned by the attraction of public support requirement. Only corporation for use in its activities. Note groups trying to qualify for public charity that capital assets do not include any status using the one-tenth (as opposed to one- business inventory or resale merchandise, third) public support requirements must satisfy business accounts or notes receivable, or real this attraction of public support test. Te IRS property used in a trade or business. Gains considers a number of factors in determining from selling these noncapital asset items are whether a group meets the test. Only Factor 1, characterized as gross investment income below, must be met; none of the other factors and are not considered public support, but are required. are added to the total support fgure. 76 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Te IRS looks favorably on organizations in your activities, it will more likely meet the that meet one or more of the attraction of attraction of public support requirement. public support factors listed below. Meeting as many of these factors as possible will not Factor 4. Representative Governing Body only help you obtain public charity status, it A nonproft corporation whose governing body also shows that you satisfy the basic 501(c) (3) represents broad public interests, rather than tax-exempt status requirements—namely, that the personal interest of a limited number of your nonproft is organized and operated in the donors, is considered favorably by the IRS. Te public interest and has broad-based community IRS is more likely to treat an organization’s support and participation. governing body as representative if it includes: tQVCMJDPïDJBMT Factor 1. Continuous Solicitation tQFPQMFTFMFDUFECZQVCMJDPïDJBMT of Funds Program tQFPQMFSFDPHOJ[FEBTFYQFSUTJOUIF Your group must continually attract new public organization’s area of operations or governmental support. You will meet this tDPNNVOJUZMFBEFSTPSPUIFSTSFQSFTFOUJOH requirement if you maintain a continuous a cross section of community views and program for soliciting money from the general interests (such as members of the clergy, public, community, or membership—or if you teachers, and civic leaders), or solicit support from governmental agencies, tGPSNFNCFSTIJQPSHBOJ[BUJPOT QFPQMF churches, schools, or hospitals that also qualify elected under the corporate articles or as public charities (see “Automatic Public bylaws by a broad-based membership. Charity Status,” above). Although this factor concerns broad-based support, the IRS allows Factor 5. Availability of Public new groups to limit initial campaigns to Facilities or Services seeking seed money from a select number of the If an organization continuously provides most promising agencies or people. facilities or services to the general public, the IRS will consider this favorably. Tese Factor 2. Percentage of Financial Support facilities and services might include a museum At least 10% of your group’s total support must open to the public, an orchestra that gives come from the public. However, the greater public performances, a group that distributes the percentage of public support, the better. educational literature to the public, or an old- Remember that if your public support amounts age home that provides nursing or other services to one-third or more, you do not have to meet to low-income members of the community. the attraction of public support factors listed in this subsection. Factor 6. Additional Factors Corporations are also more likely to meet the Factor 3. Support From a attraction of public support requirement if: Representative Number of People tNFNCFSTPGUIFQVCMJDXJUITQFDJBMLOPX If your group gets most of its money from ledge or expertise (such as public ofcials, or government agencies or from a broad cross civic or community leaders) participate in section of people as opposed to one particular or sponsor programs individual or a group with a special interest CHAPTER 4 | PUBLIC CHARITIES AND PRIVATE FOUNDATIONS | 77

tUIFPSHBOJ[BUJPONBJOUBJOTBQSPHSBNUP we do not in this chapter. For purposes of this do charitable work in the community (such chapter, publicly supported organi zations are BTKPCEFWFMPQNFOUPSMPXJODPNFIPVTJOH those that qualify under the public support rehabilitation), or test described above. We use the term “exempt tUIFPSHBOJ[BUJPOHFUTBTJHOJëDBOUQPSUJPO activities support test” in this chapter to of its funds from another public charity or a describe this test. governmental agency to which it is, in some For more detailed information on this public way, held accountable as a condition of the charity category, see IRS Publication 557, Tax- grant, contract, or contribution. Exempt Status for Your Organization, “509(a)(2) Organizations.” Factor 7. Additional Factors for Membership Groups Only TIP A membership organization is more likely Let the IRS do the work for you. You can to meet the attraction of public support let the IRS do the hard part of deciding how each requirement if: of the special rules described below applies to your tUIFTPMJDJUBUJPOGPSEVFTQBZJOHNFNCFST group’s anticipated sources of financial support. attempts to enroll a substantial number We show you how to check a box on the federal of people in the community or area, or in exemption application to do this. For now, just read a particular profession or feld of special through this material and you can come back to a particular section if you need to later when you fill in interest your IRS tax exemption application. tNFNCFSTIJQEVFTBSFBêPSEBCMFUPBCSPBE cross section of the interested public, or tUIFPSHBOJ[BUJPOTBDUJWJUJFTBSFMJLFMZUP What Type of Support Qualifies appeal to people with some broad common and How Much Do You Need? interest or purpose—such as musical To qualify under the exempt activities public activities in the case of an orchestra or charity support test, a 501(c)(3) nonproft diferent forms of dance in the case of a organization must meet two requirements: dance studio. 1. Te organization must normally receive more than one-third of its total support in each tax Exempt Activities Support Test year as qualifed public support. Qualifed Don’t worry if your Section 501(c)(3) group public support is support from any of the does not qualify as a public charity either following sources: automatically or through the one-third or one- t HJGUT HSBOUT DPOUSJCVUJPOT PSNFNCFS tenth public support test described above. Tere ship fees, and is another way to qualify as a public charity. Te t HSPTTSFDFJQUTGSPNBENJTTJPOT TFMMJOH exempt activities support test is likely to meet merchandise, performing services, or your needs if your 501(c)(3) group intends to providing facilities in an activity related derive income from performing exempt-purpose to the exempt purposes of the nonproft activities and services (IRC § 509(a)(2)). organization. Although IRS publications sometimes include 2. Te organization also must normally not groups that meet the support test described in receive more than one-third of its annual this section as publicly supported organizations, support from unrelated trades or businesses 78 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

or gross investment income. Gross invest ment Membership Fees and Dues income includes rent from unrelated sources, Get Special Treatment interest, dividends, and royalties—sources Dues paid to provide support for or to parti- of support far removed from the activities cipate in the nonproft organization, or in of most small nonproft organizations. return for services or facilities provided only However, it does not include any taxes you to members, are considered valid membership pay on income from unrelated businesses or dues and can be counted in full as qualifed activities—these amounts are deducted before public support. On the other hand, fees or the one-third fgure is calculated. dues paid in return for a discount on products Again, the most important aspect of this or services provided to the public, or in return test, and the one that makes it appropriate for for some other monetary beneft, are not valid many 501(c)(3) groups, is that it allows the membership fees. However, these payments can one-third qualifed public support amount to still be counted as qualifed public support if include the group’s receipts from performing the fee entitles the member to special rates for its exempt purposes. Hence, this public charity exempt-purpose activities—in which case the classifcation is appropriate for many self- payments would qualify as receipts related to sustaining nonprofts that raise income from the group’s exempt purposes, but the payments their tax-exempt activities, such as performing NBZCFTVCKFDUUPUIFPS MJNJUBUJPO arts groups, schools, and other educational- discussed in the next section below. purpose organizations, and nonproft service organizations. School tuition, admissions to EXAMPLE: People pay $50 to become concerts or plays, or payments for classes at a members of All Tumbs, a nonproft group pottery studio count as qualifed public support dedicated to rebuilding interest in the unitar, under this public charity test. a near-extinct one-stringed guitar-like musical instrument. All Tumbs’ members Support Must Be From Permitted Sources are allowed $50 worth of reduced rate passes Qualifed public support under this test must to all unitar concerts nationwide. Although come from permitted sources including: these fees can’t be counted as valid member- tJOEJWJEVBMT ship fees because they are paid in return tHPWFSONFOUBHFODJFT BOE for an equivalent monetary beneft (a $50 tPUIFS D QVCMJDDIBSJUJFTHFOFSBMMZ discount at unitar concerts), they still count those that qualify as public charities under as receipts related to the performance of the one of the tests described in “Automatic group’s exempt purposes (putting on these Public Charity Status” or “Public Support concerts is an exempt purpose and activity Test,” above. of the group). Terefore, the fees can be Permitted sources do not include disqualifed counted by the organization as qualifed persons (defned under IRC Section 4946)— public support (we assume the fees paid by people who would be considered disqualifed each individual do not exceed the 1% or if the organization were classifed as a private $5,000 limitation that applies to exempt- foundation. Tese include substantial contributors, purpose receipts, as discussed in the next the organization’s founders, and certain related section below). persons. CHAPTER 4 | PUBLIC CHARITIES AND PRIVATE FOUNDATIONS | 79

to the performance of the group’s exempt Are You Selling Services or purposes. Any amount over $5,000 paid Information Tat the Federal by any one individual cannot be included Government Offers for Free? in computing its qualifed public support If your nonprofit plans to sell services or for the year, although the full amount is information, check to see if the same service included in total support. Of course, if Van- or information is readily available free (or for a Go’s total support for any year is more than nominal fee) from the federal government. If $500,000, then the limitation on individual so, you may need to tell potential clients and contributions will be 1% of the year’s total customers of this alternate source. Tis rule support, since this fgure exceeds $5,000. applies to all tax-exempt nonprofits (including any 501(c)(3) organization, whether classified Some Gifts Are Gross Receipts as a public charity or private foundation). (IRC When someone gives money or property with- § 6711.) Failure to comply with this disclosure out getting anything of value in return, we requirement can result in a substantial fine. think of it as a gift or contribution. But when For further information on these disclosure people give a nonproft money or property in requirements, see IRS Publication 557. return for admissions, merchandise, services performed, or facilities furnished to the contributor, these aren’t gifts. Tey are considered Te 1% or $5,000 Limit for gross receipts from exempt-purpose activities Exempt-Purpose Income BOEBSFTVCKFDUUPUIF PSMJNJUBUJPO ɨFSFJTPOFNBKPSMJNJUBUJPOPOUIFBNPVOU of income from exempt-purpose activities that EXAMPLE: At its annual fundraising drive, can be included in the one-third qualifed the Cali fornia Cormorant Preservation public support fgure. In any tax year, receipts League rewards $100 contributors with a from individuals or government units from the book containing color prints of cormorants. performance of exempt-purpose services that Te book normally retails for $25. Only $75 exceed $5,000 or 1% of the organization’s total of each contribution is considered a gift; the support for the year, whichever is greater, must remaining $25 payments are classifed as be excluded from the organization’s qualifed gross receipts from the performance of the public support fgure. Tis limitation applies HSPVQTFYFNQUQVSQPTFTBOEBSFTVCKFDUUP only to exempt-purpose receipts and not to the $5,000 or 1% limitation. gifts, grants, contributions, or membership fees received by the organization. Some Grants Are Gross Receipts EXAMPLE: Van-Go is a visual arts group It is sometimes hard to distinguish money that makes art available to people around received as a grant from exempt-purpose the nation by toting it around in specially gross receipts. Te IRS rule is that when the marked vans. In 2015, Van-Go derives granting agency gets some economic or physical $30,000 total support from the sale of beneft in return for its grant, such as a service, paintings. Te funds are receipts related facility, or product, the grant is classifed as 80 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

gross receipts related to the exempt activities To avoid this result for nonprofts that would of the nonproft organization. Tis means that otherwise qualify under the exempt activities UIFGVOETXJMMCFTVCKFDUUPUIFPS support test, unusual grants are ignored—that limitation that applies to exempt-purpose is, they drop out of both the numerator and receipts. Money contributed to beneft the denominator of the support calculation. (Tere public will be treated as bona fde grants by the is a similar exclusion for unusual grants under IRS, not as exempt-purpose receipts. Tis type the public support test, discussed above.) A PGCPOBëEFHSBOUJTOPUTVCKFDUUPUIFPS grant will be classifed as unusual if the source $5,000 limitation. of the grant is not regularly relied on or actively sought out by the nonproft as part of its EXAMPLE 1: A pharmaceutical company, support outreach program and if certain other Amalgamated Mortar & Pestle, provides conditions are met. If you want to learn more a research grant to a nonproft scientifc about these unusual grant requirements for and medical research organization, Safer groups that qualify as a public charity under Sciences, Inc. Te company specifes that the the exempt-activities support test, see IRS nonproft must use the grant to develop a Publication 557, available on the Nolo website more reliable childproof cap for prescription (see Appendix A for the link). drug containers (the results of the nonproft research will be shared with the commercial Rents Related to Exempt Purposes company). Te money is treated as receipts Are Not Gross Investment Income received by Safer Sciences in carrying out its Rents received from people or groups whose FYFNQUQVSQPTFTBOEJTTVCKFDUUPUIF activities in the rented premises are related to or 1% limitation. the group’s exempt purpose are generally not considered gross investment income. Tis is EXAMPLE 2: Safer Sciences gets a grant from a good thing. Why? Remember: Under this the federal Centers for Disease Control public charity test, the organization must and Preven tion to build a better petri dish normally not receive more than one-third for epidemio logical research. Since the of its total support from unrelated trades or money is used to beneft the public, the full businesses or from gross investment income. amount will be included in the nonproft organization’s qualifed public support fgure. EXAMPLE: Good Crafts, Inc., a studio that provides facilities for public education in historic crafts, rents a portion of its premises Unusual Grants Drop Out to an instructor who teaches stained glass of the Computation classes. Tis rent would probably not fall To be included as qualifed support (in the into the gross investment income category. numerator of the support fraction), the support However, if the tenant’s activities in the must be from permitted sources. Disqualifed leased premises were not related to the persons include founders, directors, or executive nonproft’s purposes, then the rent would be ofcers of the nonproft. A large grant from included as gross investment income and, if one of these sources could undermine the all the unrelated and investment income of ability of the nonproft to qualify under this the nonproft exceeded one-third of its total public charity test. CHAPTER 4 | PUBLIC CHARITIES AND PRIVATE FOUNDATIONS | 81

support, the non proft could lose its public as a public charity instead. Because you are charity status under the exempt activities probably interested in public charity status, you support test. can skip this section or read through it quickly if you want learn about private foundations Keep this exception in mind if your group and the operating limitations and restrictions owns or rents premises with extra space. It may applicable to them. If you want to form a be important to rent (or sublease, if you are private foundation, you can use this book as renting, too) to another person or group whose BOJOUSPEVDUJPOUPUIFTVCKFDU CVUZPVXJMM activities are directly related to your exempt probably also need the help of a nonproft purposes. (If you’re renting, be sure the terms lawyer or tax specialist with experience setting of your lease allow you to sublease; most of the up private foundations. Te rules that apply to time, you’ll need your landlord’s permission.) private foundations are very complicated and the penalties for not obeying the rules are stif. SEE AN EXPERT When to consult a tax expert. If you plan RESOURCE to supplement your support with income from Need more information on private activities unrelated to your exempt purposes (as foundations? See IRS Publication 4221-PF, more and more nonproﬁts must), check with your Compliance Guide for 501(c)(3) Private Foundations, tax adviser. You’ll want to make sure this additional available at the IRS website, at www.irs.gov. income will not exceed one-third of your total support and jeopardize your ability to qualify under this public charity category. Background Broadly speaking, the reason that private Tere’s Tat Word “Normally” Again GPVOEBUJPOTBSFTVCKFDUUPTUSJDUPQFSBUJOH To qualify as a public charity under the support limitations and special taxes, while public test, groups must “normally” meet the one- charities are not, is to counter tax abuse schemes third quali fed support requirements set forth in by wealthy individuals and families. Before “Public Support Test,” above. As with publicly the existence of private foundation restrictions, supported organizations, this means that the a person with a lot of money could set up his IRS looks at the total amount of support over own 501(c)(3) tax-exempt organization (such the current tax year and the previous four years as Te William Smith Foundation) with a to decide if the organization meets the support high-sounding purpose (to wipe out the potato test for the current tax year. (See “What Does bug in Northern Louisiana). Te potato bugs, ‘Normally’ Mean?” above.) though, were never in any danger, because the real purpose of the foundation was to hire all of William Smith’s relatives and friends down Private Foundations to the third generation. Instead of leaving the money in a will and paying heavy estate taxes, Initially, the IRS will classify your 501(c)(3) William Smith neatly transferred money to the corporation as a private foundation. As we next generation tax free by use of a tax-exempt mentioned at the beginning of this chapter, GPVOEBUJPOUIBUKVTUIBQQFOFEUPIJSFBMMPG almost all non profts will want to overcome his relatives. this presumption and establish themselves 82 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

To prevent schemes such as this, Congress Of course, the overwhelming number of enacted the private foundation operating individual contributors do not contribute an restrictions, special excise taxes, and other amount even close to the 30% limit, so this private foundation disincentives discussed in limitation is not very important. Te real the next section. question of importance to contributors is whether you are a qualifed 501(c)(3) organization so that Operating Restrictions charitable contributions to your group are tax Private foundations must comply with oper- deductible. ating restrictions and detailed rules, including: tSFTUSJDUJPOTPOTFMGEFBMJOHCFUXFFO RESOURCE private foundations and their substantial For more on IRS rules about deduction contributors and other disqualifed persons limitations. IRS Publication 526, Charitable Contri- tSFRVJSFNFOUTUIBUUIFGPVOEBUJPOBOOVBMMZ butions, discusses the rules limiting deductions to distribute its net income for charitable private foundations (called 30% limit organizations) and public charities (50% limit organizations), purposes including special rules that apply to donations tMJNJUBUJPOTPOIPMEJOHTJOQSJWBUFCVTJOFTTFT of real estate, securities, and certain types of tQSPWJTJPOTUIBUJOWFTUNFOUTNVTUOPU tangible personal property. You can search for KFPQBSEJ[FUIFDBSSZJOHPVUPGUIFHSPVQT qualifying 501(c)(3) organizations (both public 501(c)(3) tax-exempt purposes, and charities and private foundations) and other tQSPWJTJPOTUPBTTVSFUIBUFYQFOEJUVSFT qualiﬁed groups eligible to receive tax-deductible further the group’s exempt purposes. charitable contributions by using the IRS Exempt Violations of these provisions result in sub- Organizations Select Check tool which can be stan tial excise taxes and penalties against the found online at http://apps.irs.gov/app/eos/. private founda tion and, in some cases, against JUTNBOBHFST NBKPSDPOUSJCVUPST BOEDFSUBJO related persons. Keeping track of and meeting Special Types of Private Foundations these restrictions is unworkable for the average Te IRS recognizes two special types of private 501(c)(3) group, which is the main reason why foundations that have some of the advantages of you’ll want to avoid being classifed by the IRS public charities: private operating, and private as a private foundation. nonoperating foundations. We mention them CSJFìZCFMPXCFDBVTFUIFZBSFJODMVEFEJO*34 Limitation on Deductibility nonproft tax publications and forms. Few of Contributions readers will be interested in forming either of Generally, a donor can take personal income these special organizations. tax deductions for individual contributions to private foundations of up to only 30% of Private Operating Foundations UIFEPOPSTBEKVTUFEHSPTTJODPNF%POBUJPOT To qualify as a private operating foundation, to public charities, on the other hand, are the organization generally must distribute generally deductible up to 50% of the donor’s most of its income to tax-exempt activities BEKVTUFEHSPTTJODPNF and must meet one of three special tests (an assets, support, or endowment test). Tis special CHAPTER 4 | PUBLIC CHARITIES AND PRIVATE FOUNDATIONS | 83

UZQFPG D QSJWBUFGPVOEBUJPOFOKPZT Private Nonoperating Foundations a few benefts not granted to regular private Tis special type of private foundation is one foundations, including the following: that either: tMore generous deductions for donors. As tEJTUSJCVUFTBMMUIFDPOUSJCVUJPOTJUSFDFJWFT with public charities, individual donors can to public charities and private operating EFEVDUVQUPPGBEKVTUFEHSPTTJODPNF GPVOEBUJPOT EJTDVTTFEKVTUBCPWF FBDI for contributions to the organization. year, or tExtended time to distribute funds. Te tQPPMTJUTDPOUSJCVUJPOTJOUPBDPNNPOUSVTU organization can receive grants from a fund and distributes the income and funds private foundation without having to to public charities. distribute the funds received within one Individual contributors to private non- year (and these funds can be treated as operating foundations can deduct 50% of their qualifying distributions by the donating EPOBUJPOT)PXFWFS UIFPSHBOJ[BUJPOJTTVCKFDU private foundation). to all excise taxes and operating restrictions tNo excise tax. Te private foundation excise applicable to regular private foundations. ● tax on net investment income does not apply. All other private foundation restrictions and excise taxes apply to private operating foundations.

RESOURCE For additional information on the rules that apply to private operating foundations, see Public Charity or Private Foundation Status Issues under IRC §§ 509(a)(1)–(4), 4942(j)(3), and 507. Te section titled, “IRC 4942(j)(3)—Private Operating Foundations” has information on private operating foundations. You can download a copy of the document from the Nolo website (see Appendix A for the link).

CHAPTER

Other Tax Beneﬁts and Requirements 5

Federal and State Tax Deductions for Contributions ...... 86 What Can Be Deducted ...... 86 What Cannot Be Deducted ...... 86 Donations Tat Can Be Partially Deducted ...... 87 Reporting Requirements ...... 87 Federal Estate and Gift Tax Exemptions ...... 87 Federal Unrelated Business Income Tax ...... 88 Activities Tat Are Taxed ...... 89 Activities Tat Are Not Taxed ...... 89 California Unrelated Business Income Tax ...... 90 California Nonprofit Tax Exemption ...... 90 California Attorney General Reporting Requirements ...... 91 California Welfare Exemption ...... 92 Section 214 Exemption Requirements ...... 93 Special Statutory Categories ...... 94 Educational Purposes Tat Entitle Nonprofits to Use the Welfare Exemption ...... 95 Scientific Purposes Tat Entitle Nonprofits to Use the Welfare Exemption ...... 97 Religious Purposes Tat Entitle Nonprofits to Use the Welfare Exemption...... 97 Leasing and the Welfare Exemption ...... 98 Other California Tax Exemptions...... 99 State Solicitation Laws and Requirements ...... 100 86 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

n this chapter we discuss additional federal deduction they take for donating appreciated tax issues that afect nonprofts, such as the property—see IRS Publication 526, Charitable Ideductibility of contributions made to 501(c)(3) Contributions, “Giving Property Tat Has non profts and what happens if a 501(c)(3) Increased In Value.” makes money from activities not related to its tUnreimbursed car expenses. Tese include the tax-exempt purposes. We also cover nonproft cost of gas and oil incurred by the donor tax benefts and tax and nontax requirements while performing services for the nonproft that apply to 501(c)(3) nonprofts under organization, and California law. tUnreimbursed travel expenses. Tese include expenses incurred by the donor while away from home and performing services for the Federal and State Tax nonproft organization, such as the cost of Deductions for Contributions transportation, meals, and lodging. A donor (corporate or individual) can claim What Cannot Be Deducted a personal federal income tax deduction for Certain types of gifts cannot be deducted as contributions made to a 501(c)(3) tax-exempt charitable contributions. Nondeductible gifts organization. Tese contributions are called include: charitable contributions. Generally, California tTe value of volunteer services. For example, follows the federal tax deductibility rules for if you normally are paid $40 per hour charitable contributions made to nonproft for bookkeeping work, and you volunteer corporations. ten hours of your time to a nonproft to Corporations can make deductible charitable help them prepare their annual fnancial contributions of up to 10% of their annual statements, you cannot claim a charitable taxable income. Individuals can deduct up deduction for the value of your time UPPGBEKVTUFEHSPTTJODPNFJOBOZZFBS donated to the nonproft (you can’t claim a for contributions made to 501(c)(3) public charitable deduction of $400). charities and to some types of 501(c)(3) private tTe right to use property. If you rent out foundations, as explained in Chapter 4. ofce space for $1,000 per month and allow Donations to most types of private foundations a nonproft to use one-tenth of the total BSFMJNJUFEUPPGBOJOEJWJEVBMTBEKVTUFE space for a small ofce, you cannot claim a gross income in each year. charitable deduction of $100 per month for What Can Be Deducted letting the nonproft use the space for free. tContributions to political parties. Tese A donor can deduct the following types of contributions, however, can be taken as a contributions: UBYDSFEJU TVCKFDUUPEPMMBSBOEQFSDFOUBHF tCash. limitations. t Property. Generally, donors can deduct the tDirect contributions to needy individuals. fair market (resale) value of donated property. tTuition. Even amounts designated as dona- Technical rules apply to gifts of appreciated tions, which must be paid in addition to property (property that has increased in tuition as a condition of enrollment, are value) that may require donors to decrease the not deductible. CHAPTER 5 | OTHER TAX BENEFITS AND REQUIREMENTS | 87

tDues paid to labor unions. returns. Receipts must describe the contribution tTe cost of raﬄe, bingo, or lottery tickets, or and show the value of any goods or services other games of chance. received from the nonproft by the donor as tChild care costs paid while performing services part of the transaction. See IRS publications for a nonproﬁt organization. mentioned below for more information on how to prepare donor receipts for your organization. Donations Tat Can Be Partially Deducted RESOURCE Contributions that a nonproft receives in Te IRS requirements for deducting return for a service, product, or other beneft and reporting charitable contributions change from year to year. For current information, see (such as membership fees paid in return for IRS Publication 526, Charitable Contributions. For special membership incentives or promotional information on valuing gifts, see IRS Publication 561, products, or donations charged for attending Determining the Value of Donated Property. a performance) are only partially deductible. Donors may deduct for these only to the extent that the value of the contribution exceeds the fair market value of the service, product, or Federal Estate and Gift beneft received by the donor. Tax Exemptions

EXAMPLE: If a member of a 501(c)(3) Gifts made as part of an individual’s estate plan organization pays a $30 membership fee and (through a will or trust document) can be an receives a record album that sells for $30, important source of contributions for 501(c)(3) nothing is deductible. But if a $20 product is nonprofts. When the individual dies, the given in return for the $30 payment, $10 of 501(c)(3) organization receives the money and the fee paid is a bona fde donation and may the money is excluded from the taxable estate be deducted by the member as a charitable of the individual. Tis can provide signifcant contribution. tax savings for donors. Hence, many people are motivated to engage in estate planning, 501(c)(3) nonproft groups should always including making charitable gifts to nonproft clearly state the dollar amount that is deductible organizations. when receiving contributions, donations, or Traditionally, colleges and universities and membership fees in return for providing a larger environmental and health organizations service, product, discount, or other beneft to have actively solicited estate charitable giving the donor. by providing information to members and donors about estate planning and the benefts Reporting Requirements of charitable bequests. Increasingly, smaller Individuals can claim deductions for charitable nonprofts are starting to understand the game contributions by itemizing the gifts on IRS and are pursuing similar strategies in their Schedule A and fling this form with their fundraising eforts. If you understand how annual 1040 income tax return. IRS rules charitable giving afects the donor’s taxes, you’ll require donors to obtain receipts for all be better able to persuade potential donors to charitable contributions claimed on their tax give to your cause. 88 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Generally, an individual does not pay taxes Federal Unrelated on gifts made during his or her lifetime. However, gifts to an individual (who isn’t Business Income Tax the giver’s spouse) or to a nonqualifed All tax-exempt nonproft corporations, whether organization will reduce the donor’s unifed private foundations or public charities, may estate and gift tax credit to the extent the have to pay tax on income derived from gifts exceed a set amount each year (the activities unrelated to their exempt purposes. current gift tax exclusion rules are posted on Te frst $1,000 of unrelated business income the IRS website). On the other hand, gifts is not taxed. After that, the normal federal made to a 501(c)(3) nonproft that qualifes corporate tax rate applies: 15% on the frst as a public charity (even if they exceed the $50,000 of taxable corporate income; 25% on exclusion amount) do not reduce this federal the next $25,000, and 34% on taxable income and estate gift tax credit. Hence, tax-wise over $75,000 (with a 5% surtax on taxable you might be better of giving the money income between $100,000 and $335,000). to a literary nonproft that, in turn, gives Higher corporate tax rates (35% and an interim grants to promising writers, rather than 38% surtax) apply to corporate taxable incomes directly donating the money to a writer. over $10 million. (Unfortunately, your recipient could not earmark the money donated to a literary CAUTION nonproft for a particular writer, as explained Be careful with unrelated income. As in “Charitable Purposes,” in Chapter 3.) Tere explained in “Unrelated Business Activities,” in are many twists and turns to fnding the best Chapter 3, if unrelated income is substantial, it may way to gift funds to deserving individuals and jeopardize the organization’s 501(c)(3) tax exemption. organizations. Consult a knowledgeable tax In addition, the federal income tax rates are likely to adviser or fnancial planner before deciding on change. Check the IRS website for current rates. a charitable or estate gifting plan.

CAUTION RESOURCE Estate and gift tax laws change frequently. For past history and current develop- Check with your tax adviser for the latest rules. ments in the federal treatment of an exempt organization’s unrelated business income tax, see UBIT: Current Developments. You can download a RESOURCE copy of the document from the Nolo website (see Appendix A for the link). For further information on federal and state estate and gift taxes and individual estate planning techniques, see Plan Your Estate, by Denis Cliﬀord (Nolo). CHAPTER 5 | OTHER TAX BENEFITS AND REQUIREMENTS | 89

Activities Tat Are Taxed employees (such as a hospital gift shop for patients or employees) Unrelated business income comes from activi- tJOWPMWFUIFTBMFPGNPTUMZEPOBUFENFSDIBO ties that are not directly related to a group’s dise, such as thrift shops exempt purposes. An unrelated trade or busi- tDPOTJTUPGUIFFYDIBOHFPSSFOUBMPGMJTUTPG ness is one that is regularly carried on and not donors or members substantially related to a nonproft group’s tJOWPMWFUIFEJTUSJCVUJPOPGMPXDPTUJUFNT exempt purposes. It is irrelevant that the such as stamps or mailing labels worth less organi zation uses the profts to conduct its than $5, in the course of soliciting funds, and exempt-purpose activities. tJOWPMWFTQPOTPSJOHUSBEFTIPXTCZ D EXAMPLE 1: Enviro-Home Institute is a groups—this exclusion extends to the 501(c)(3) non proft organized to educate the exempt organization’s suppliers, who may public about environmentally sound home educate trade show attendees on new design and home construction techniques. developments or products related to the Enviro-Home develops a model home organization’s exempt activities. kit that applies its ideas of appropriate Some of these exceptions have been hotly environmental construction and is very contested by commercial business interests at successful in selling the kit. Te IRS DPOHSFTTJPOBMIFBSJOHTɨFQSJNBSZPCKFDUJPO considers this unrelated business income is that nonprofts receive an unfair advantage by because it is not directly related to the being allowed to engage, tax free, in activities educational purposes of the organization. that compete with their for-proft counterparts. Expect more hearings and future developments in this volatile area of nonproft tax law. EXAMPLE 2: A halfway house that ofers Also excluded from this tax is income not room, board, therapy, and counseling derived from services (termed gross investment to recently released prison inmates also income in the Internal Revenue Code). Remem- operates a furniture shop to provide full-time ber, this tax applies to unrelated activities, not employment for its residents. Tis is not an necessarily to unrelated income. Examples of unrelated trade or business because the shop nontaxable income include: directly benefts the residents (even though it tEJWJEFOET JOUFSFTU BOESPZBMUJFT also produces income). tSFOUGSPNMBOE CVJMEJOHT GVSOJUVSF BOE equipment (some forms of rent are taxed Activities Tat Are Not Taxed if the rental property was purchased or JNQSPWFETVCKFDUUPBNPSUHBHF PSJGUIF A number of activities are specifcally excluded rental income is based on the profts earned from the defnition of unrelated trades or by the tenant), and businesses. Tese include activities in which tHBJOTPSMPTTFTGSPNUIFTBMFPSFYDIBOHFPG nearly all work is done by volunteers, and property. those that: See Section 512(b) of the Internal Revenue tBSFDBSSJFEPOCZ D UBYFYFNQU Code for the complete list of these untaxed organizations primarily for the beneft of sources of income and the exceptions that exist members, students, patients, ofcers, or for certain items. 90 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

SEE AN EXPERT their California taxable unrelated business It is often difficult to predict whether income. Te California franchise tax rate and the IRS will tax an activity or income as unrelated the minimum annual franchise tax rates may business. Furthermore, IRS regulations and change. Check the Franchise Tax Board website rulings and U.S. Tax Court decisions contain a to confrm the current annual franchise tax rate number of rules classifying specific activities as and the current annual minimum franchise tax unrelated businesses that are subject to tax. In payment amount (www.ftb.ca.gov). short, you should do more research or consult a tax specialist if you plan to engage in activities or EXAMPLE: A Section 501(c)(3) traveler’s aid derive income from sources not directly related to society earns $7,000 a year selling baked your exempt purposes. Please note, this isn’t the goods to passersby. Cost of the ingredients same thing as saying you shouldn’t engage in an and all expenses related to this proft-making unrelated activity—many nonprofits must engage activity total $3,000. Te society pays state in commercial businesses unrelated to their exempt unrelated business taxes on the $3,000 purposes to survive. But to avoid jeopardizing your net amount ($7,000 − $1,000 deduction − 501(c)(3) tax-exempt status and to understand the $3,000 cost of goods sold). tax effects of engaging in unrelated business, you simply need good tax advice. Te state does not tax certain activities as unrelated trade or business. Te state exceptions California Unrelated are similar to the IRS exceptions and include any trade or business: Business Income Tax tXIFSFNPTUPGUIFXPSLJTQFSGPSNFECZ volunteers California, like the federal government, taxes tUIBUFYJTUTNPTUMZGPSUIFDPOWFOJFODFPG the unrelated business income of a tax-exempt the members, students, patients, ofcers, or nonproft corporation. Te state’s defnition of employees, or an unrelated trade or business is similar to that tUIBUTFMMTNFSDIBOEJTF NPTUPGXIJDI used by the IRS. Basically, any trade or business was given to the organization as gifts or not substantially related to the organization’s contributions. exempt purposes is considered an unrelated Like the federal law, California also generally trade or business. excludes specifc kinds of passive income, such Te tax rate for unrelated income is the as rent and interest income, from unrelated standard California corporate franchise tax business income tax. rate. (Franchise tax is the name of the tax in California that applies to the taxable income of most corporations.) Tis rate is currently California Nonprofit set at 8.84%, and it applies to the net amount of unrelated business income (gross unrelated Tax Exemption business income minus deductions for expenses $BMJGPSOJBDPSQPSBUJPOTBSFTVCKFDUUPBO directly connected with carrying on the unrelated annual corporate franchise tax of 8.84% on the business activity). Tax-exempt organizations are net income of the corporation. A minimum allowed a $1,000 deduction before computing franchise tax of $800 must be paid annually, CHAPTER 5 | OTHER TAX BENEFITS AND REQUIREMENTS | 91 starting in the corporation’s second tax year. California Attorney General California nonproft corporations that qualify for a federal 501(c)(3) tax exemption qualify Reporting Requirements for a parallel state corporate tax exemption All charitable corporations and trustees holding under California Revenue and Taxation Code property for charitable purposes must register Section 23701(d). with the California Attorney General’s Ofce, Section 23701(d) of the California tax law Registry of Charitable Trusts. After registering exempts the same groups that are exempt under with the attorney general, you will fle annual Section 501(c)(3) of the Internal Revenue Code. fnancial disclosure returns showing how you Tis means that religious, charitable, scientifc, operate your nonproft and how your chari table literary, and educational organizations—the funds are used. Most public beneft corpo- most common types of nonproft corporations SBUJPOT OPUKVTUUIPTFGPSNFEGPSBTQFDJëD and the ones this book is primarily concerned chari table purpose) are considered charitable with—can qualify for a state exemption from corporations for the purpose of these regis- corporate franchise taxes. To do this, frst tration and annual reporting requirements. obtain your federal 501(c)(3) tax exemption, 3FMJHJPVTDPSQPSBUJPOTBSFOPUTVCKFDUUPUIFTF then send the state a copy of your federal reporting requirements. Te registration and 501(c)(3) determination letter with a request annual reporting requirements are meant to form (see “Obtain Your State Tax Exemption,” ensure that the corporate funds are not misused in Chapter 9). in any way. California tax law, like the federal 501(c)(3) After you incorporate a California nonproft scheme, imposes restrictions on the political public beneft corporation, you will receive a activity of 23701(d) tax-exempt groups. California letter from the attorney general’s ofce. Te rules are very similar to the federal rules in letter will include a pamphlet with information that California recognizes both the substantial on the registration requirements, other activities test and the alternative political statutes afecting charitable organizations, expenditures test. Tese tests limit the amount and a regis tration form and instructions. of political lobbying and expenditures that can %POUCFDPOGVTFECZUIFMFHBMKBSHPOJOUIFTF be undertaken by tax-exempt nonprofts. (See documents—basically, the registration and “Other Requirements for 501(c)(3) Groups,” in annual reporting requirements apply to all Chapter 3.) 501(c)(3) nonproft groups, except for religious California does not make a separate deter- corpo rations and certain schools and hospitals. mina tion as to whether your tax-exempt non- Te attorney general registration and report- proft corpo ration is a private foundation or ing requirements are a formality for most public charity. Te state simply follows the Section 501(c)(3) groups. However, if your deter mination made by the IRS. If your public beneft corporation solicits funds for organ iza tion is classifed by the IRS as a 501(c)(3) specifc charitable purposes (such as to provide public charity, it will be considered a public a free meal program), and the attorney general charity in California once the state acknowl- receives numerous complaints from the public edges your federal 501(c)(3) tax exemption. claiming that your organization misrepresents itself when asking for donations or misapplies 92 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

donated funds to nonprogram purposes, the Te welfare exemption can provide tremen dous attorney general will probably look over your savings for your organization. For example, annual reports closely. If the complaints sound if you own property and pay relatively high credible and your reports look incomplete or taxes, your property tax bills will go down to inaccurate, you will probably receive an inquiry zero after you incorporate and obtain a welfare letter from the attorney general asking for exemption. Or, if you lease property from a more information. If the attorney general is not nonproft group that has itself qualifed for the satisfed with your response, it can take your welfare exemption, the property tax attributed nonproft to court and sue both the nonproft to your portion of the premises will be dropped corporation and its principals for the payback from the property tax rolls once you obtain a of funds fraudulently solicited from the public welfare exemption. or misapplied to non-program purposes. For further information on submitting these TIP required forms, see “File an Initial Report With If you’re a tenant, remember the welfare the Attorney General,” in Chapter 9. exemption when negotiating your lease. Your landlord (assuming the landlord is a nonproﬁt that also qualiﬁes for the exemption) will enjoy a tax California Welfare Exemption break when you qualify for the welfare exemption. Ask the landlord to pass some of his tax savings on Many California tax-exempt nonproft to you, in the form of decreased rent, as soon as you corporations own or lease real property (or qualify. (See “Leasing and the Welfare Exemption,” portions of property). Real property includes below, for more information.) land, buildings, and fxtures attached to a building. For example, your group may own its building; or perhaps you are a tenant in RESOURCE someone else’s structure. Your group may Te material in this section is based on the also own (or lease) movable property, known Assessors’ Handbook, published by the California as personal property, such as equipment or State Board of Equalization. A copy of the “Welfare, vehicles. Church and Religious Exemptions” section of the For-proft businesses pay property taxes on the Handbook is included on the Nolo website (see Appendix A for the link). If you want to see if there’s land and buildings they own and personal taxes an updated version, go to the California State Board on their business equipment and inventory. of Equalization website, at www.boe.ca.gov. Select the However, when a qualifed 501(c)(3) uses real “Forms & Pubs” tab, then select Assessors’ Handbook, or personal property exclusively to carry out then select Section AH 267. Tis contains the welfare its exempt purposes, it gets a wonderful tax exemption information, as well as information on the break—no taxes! Tis rule is known as the church and religious exemptions discussed later in welfare exemption, contained in Section 214 this chapter. of the California Revenue and Taxation Code. To apply for the welfare exemption, call your local county tax assessor and ask for a welfare exemption application and materials. CHAPTER 5 | OTHER TAX BENEFITS AND REQUIREMENTS | 93

Section 214 Exemption use is clearly incidental to a primary religious, Requirements hospital, scientifc, or charitable purpose. tɨFQSPQFSUZNVTUCFJSSFWPDBCMZEFEJDBUFE Many nonproft corporations qualify for the to religious, charitable, scientifc, or hospital California welfare exemption. Te general purposes, and upon the liquidation, requirements for the exemption under Section dissolution, or abandonment by the owner, 214 of the California Revenue and Taxation will not inure to the beneft of any private Code are: person except a fund, foundation, or tɨFQSPQFSUZNVTUCFVTFEFYDMVTJWFMZGPS corporation organized and operated for religious, hospital, scientifc, or charitable religious, scientifc, or charitable purposes. purposes and be owned and operated by Irrevocable dedication is explained below, in community chests, funds, foundations, or “Irrevocable Dedication of Property.” corporations organized and operated for Most 501(c)(3) nonproft corporations meet religious, hospital, scientifc, or charitable the welfare exemption requirements because purposes. they are the same as, or similar to, those that tɨFPXOFSNVTUCFBOPOQSPëUDPSQPSBUJPO must be met to obtain federal and state income or other organization exempt from taxes tax exemptions. Although certain types of under Section 501(c)(3) of the Internal property owned and operated for religious Revenue Code or under Section 23701(d) of purposes are covered by the welfare exemption, the California Revenue and Taxation Code. religious purpose groups generally seek property t/PQBSUPGUIFOFUFBSOJOHTPGUIFPXOFS FYFNQUJPOTVOEFSUIFNPSFìFYJCMFDIVSDIBOE can inure to the beneft of any private religious exemptions discussed below. shareholder or individual (see “No Beneft to Individuals,” below, for more No Beneﬁt to Individuals information on this point). Te State Board of Equalization will deny the tɨFQSPQFSUZNVTUCFVTFEGPSUIFBDUVBM exemption if the use of the property benefts an operation of the exempt purposes of the individual. In making this determination, the group, and it must not exceed the amount Board takes into account: of property reasonably necessary to tXIFUIFSBDBQJUBMJOWFTUNFOUNBEFCZUIF accomplish the group’s exempt purposes. owner or operator for expansion of a physical tɨFQSPQFSUZDBOOPUCFVTFEPSPQFSBUFE QMBOUJTKVTUJëFECZUIFDPOUFNQMBUFESFUVSO by the owner or by any other person so on the investment and is required to serve as to beneft any ofcer, trustee, director, the interests of the community shareholder, member, employee, contri butor, tXIFUIFSUIFQSPQFSUZGPSXIJDIUIFFYFNQ bondholder of the owner or opera tor, or tion is claimed is used for the actual any other person, through the distri bution opera tion of an exempt activity (under of profts, payments of excessive charges or Section 214, the welfare exemption provi- compensation, or the more advantageous sion) and does not exceed the amount pursuit of their business or profession. of property necessary to accomplish the tɨFQSPQFSUZDBOOPUCFVTFECZUIFPXOFSPS exempt purpose members for fraternal or lodge purposes or for social club purposes, except where such 94 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tXIFUIFSUIFTFSWJDFTBOEFYQFOTFTPGUIF Special Statutory Categories owner or operator are excessive, based upon Under California law, certain nonproft uses of like services and salaries in comparable property are specifcally mentioned as eligible public institutions, and for the welfare exemption. In some cases, all tXIFUIFSUIFPQFSBUJPOTPGUIFPXOFSPS of the welfare exemption requirements must operator, either directly or indirectly, be met; sometimes, specifc requirements are materially enhance the private gain of any waived. Here are a few examples. individual or individuals. Homeless Shelters Irrevocable Dedication of Property Property owned by a qualifying organization To qualify for the welfare exemption, property that is used wholly or partially to provide must be dedicated to religious, charitable, temporary shelter for homeless people qualifes scientifc, or hospital purposes irrevocably, for the welfare exemption. Te exemption on which means the dedication can’t be rescinded. the property is granted in proportion to the Since an irrevocable dedication clause of all of space used for this purpose. the nonproft corporation’s property is required by Section 501(c)(3) of the Internal Revenue Educational TV and FM Stations Code and by Section 23701(d) of the California Revenue and Taxation Code to obtain the Property used exclusively by a noncommercial federal and state income tax exemptions, you educational FM broadcast station or an can satisfy all three of these requirements with educational TV station that is owned and one irrevocable dedication clause in the articles operated by a religious, hospital, scientifc, or of incorporation. You can make a specifc charitable fund, foundation, or corporation is dedication to a particular group or (as is more within the meaning of the welfare exemption. common) the dedication can be for general In addition, one or both of the following purposes. Te standard articles forms used with requirements must be satisfed: TV. this book contain a general dedication clause t Te educational TV station must that dedicates assets to charitable purposes, a receive at least 25% of its operating expense category that falls under the requirements of revenues from contributions from the federal and state tax exemption rules as well as general public or dues from its members. FM radio. the requirements of the welfare exemption. t Te station must be a noncommercial educational FM broadcast station Dedication Clause for Educational licensed and operated under Federal Com- and Scientiﬁc Purposes muni cations Commission rules (Section 73.501 and following of Title 47 of the If property is dedicated to scientifc or educational Code of Federal Regulations). purposes, these purposes must fall within the specifc meaning of scientifc and educational Preservation of the Environment or Animals for the welfare exemption. (We explain the requirements for scientifc and educational Property used for the preservation of native purpose below.) plants or animals, preserved or protected for its geographical formations of scientifc or educational interest, or open space land used solely GPSSFDSFBUJPOBOEGPSUIFFOKPZNFOUPGTDJFOUJëD CHAPTER 5 | OTHER TAX BENEFITS AND REQUIREMENTS | 95 beauty (nature trails, tidal pool explora tion, Educational Purposes Tat and the like) can qualify as exempt from Entitle Nonproﬁts to Use taxa tion. Te property must be open to the the Welfare Exemption HFOFSBMQVCMJD TVCKFDUUPSFBTPOBCMFSFTUSJDUJPOT concerning the uses of the land, and be owned Educational purposes and activities that beneft and operated by a scientifc or charitable fund, UIFDPNNVOJUZBTBXIPMF OPUKVTUBTFMFDU foundation, or corporation that meets the other membership of the nonproft organization) requirements of Section 214. qualify as charitable purposes under the welfare exemption. Below are examples of the types of Property Leased to the Government educational purposes and activities that meet the requirements of the welfare exemption. Property that is leased to, and exclusively used by, a government entity for its interest and Elementary and High Schools beneft is exempt if all the other requirements of Section 214 are met, except for the irrevocable Real and personal property used by elementary dedication requirement. Te dedication will be and high schools owned and operated by deemed to exist if the lease provides that the religious, hospital, or charitable funds, owner’s entire interest in the property will pass foundations, or corporations fall within completely to the government entity upon the the welfare exemption if all of the other liquidation, dissolution, or abandonment of the requirements of Section 214 are met and the owner, or when the last rental payment is made school is an institution of learning with one of under the lease, whichever occurs frst, and if the following characteristics: certain other formal requirements are met. tBUUFOEBODFBUUIFTDIPPMFYFNQUTBTUVEFOU from attendance at a public full-time Property Under Construction or Demolition elementary or secondary day school under Section 12154 of the Education Code, or Facilities under construction, together with tBNBKPSJUZPGJUTTUVEFOUTIBWFCFFOFYDVTFE the land where the facilities are located, fall from attending a full-time elementary or under the welfare exemption, as long as the secondary day school under Section 12152 property and facilities will be used exclusively or 12156 of the Education Code. for religious, hospital, or charitable purposes. Basically, this special provision exempts the Te same is true for property that is being property of an educational purpose group that demolished with the intent of replacing it with sets up a private, institutionalized elementary or facilities to be used exclusively for religious, high school with state-approved curriculum and hospital, or charitable purposes. other state-approved institutionalized attributes Volunteer Fire Departments, (such as regular attendance and certifed Zoos, and Public Gardens faculty). If you set up a private college in con- KVODUJPOXJUIBQSJWBUFFMFNFOUBSZPSIJHI Property used by volunteer fre departments will school, you can also seek to obtain the welfare fall within the welfare exemption, as long as it exemption under this provision. If, however, also meets certain other requirements. Property your educational purpose is to set up a private used exclusively for the operation of a zoo or for college by itself, you will usually have to meet horticultural displays by a zoological society can the requirements of the separate California also qualify for the welfare exemption. 96 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

college exemption to be exempt from personal EXAMPLE 1: In a leading case, the court and real property taxes (see “Other California ruled that a theater group whose primary Tax Exemptions,” below). activities consisted of charging admissions Special rules extend the welfare exemption to to theatrical performances open to the certain property owned by colleges and certain general public was charitable in nature and property used for housing facilities for elderly its educational purpose was one within or handicapped persons. Check with the tax the meaning of the welfare exemption. In assessor’s ofce for further information on these reaching this conclusion, the court took special rules. note of the fact that the only real estate owned by the group was a playhouse used Other Educational Purpose Groups for the production of popular plays and Many general purpose educational groups musical comedies. Te real estate was not qualify for the welfare exemption. For example, used to beneft any ofcer, trustee, director, groups that give instruction in dance, music, or shareholder, member, employee, contributor, other art forms, or groups that publish instruc- or bondholder of the corporation. All tional literature can qualify for the welfare productions were of amateur standing. exemp tion. Te courts and the assessor’s ofce Membership in the theater group was have set up a number of general guidelines for unrestricted and was obtained by anyone determining whether a general educational who purchased a season ticket. In addition, purpose group is eligible for the welfare the theater obtained revenue from the sale exemption. Tese include: of tickets to the general public for single tɨFPSHBOJ[BUJPODBOUCFBGPSNBMDPMMFHF performances and from gifts. secondary, or elementary school (see the Te court considered these facts favorably, defnition of elementary and secondary as well as the fact that the theater group schools in “Elementary and High Schools,” was dedicated to providing educational above). benefts both to those who took part in the tɨFPSHBOJ[BUJPODBOUSFDFJWFTVQQPSUGSPN productions and to members of the general public (governmental) agencies. public (members of the audience). Tese tɨFFEVDBUJPOBMQSPHSBNTIPVMECF benefts were found to be benefcial to the available to the community at large and community, and therefore charitable, so the provide a social beneft to the general group’s educational purposes were found QVCMJDOPUKVTUBTFMFDUOVNCFSPGQFPQMF to be within the meaning of the welfare In other words, the educational program exemption. Te group was granted the must have some charitable attributes that welfare exemption and the real and personal instruct or beneft those who attend as property owned by the group was held well as the general public. Te fact that exempt. (Stockton Civic Teatre, 66 Cal.2d admission fees are charged for attendance at 13 (1967).) performances, or that tuition is charged for EXAMPLE 2: In another important case, an instruction, does not negate the charitable educational-purpose group was denied the nature of the educational activities. welfare exemp tion. Tis case involved an educational-purpose mortuary school that CHAPTER 5 | OTHER TAX BENEFITS AND REQUIREMENTS | 97

XBTBOBDDSFEJUFEKVOJPSDPMMFHFPêFSJOHB Religious Purposes Tat one-year course in mortuary science leading Entitle Nonprofits to Use toward an AA degree. Te court found that the Welfare Exemption because the school was a quasi-diploma mill, it did not qualify for the college exemption; Property owned by religious purpose groups and because it was of collegiate grade, it did and used for religious purposes is eligible for the not meet the welfare exemption’s statutory welfare exemption. Te courts have interpreted requirements. Te court went on to say that the terms religious and religion broadly under the organization was ineligible in any event, the welfare exemption. For example, property because its educational program (mortuary owned and operated for religious worship science) did not beneft the community (such as a church building) and property used at large or an ascertainable and indefnite for general religious purposes (such as church portion of the community. All benefts went schools, retreats, summer camps, reading rooms, to a specifc segment of the community (the and licensed church nursery schools) qualifes funeral service industry) by providing it with for the welfare exemption. Although the welfare competently trained personnel. (California exemption applies to this broad range of religious College of Mortuary Science, 23 Cal.App.3d purposes, most religious groups use California’s 702 (1972).) separate religious welfare exemption because it is easier to qualify for and use. Whether the tax assessor’s ofce will consider Te religious exemption is a separate exemp- your educational activities charitable in nature tion under Section 207 of the California will depend on the particular activities of your Revenue and Taxation Code. Tis exemption group. If you show the assessor’s ofce that your provides a streamlined and coordinated proce- educational purpose activities (seminars, lectures, dure that many nonproft religious groups publications, courses, and performances) beneft can now use to obtain their real and personal the community at large (which most do), you property tax exemptions. In the past, religious should qualify for the welfare exemption. groups applied for both the church exemption (discussed below) and the welfare exemption. Scientific Purposes Tat Te church exemption was used for religious Entitle Nonprofits to Use worship property, such as a church building; the Welfare Exemption and the welfare exemption was used for other religious uses not involving religious worship. Scientifc purposes are narrowly defned for Te religious exemption exempts property purposes of the welfare exemption. Under owned and used by a nonproft religious Section 214, scientifc purposes are limited PSHBOJ[BUJPOGPSSFMJHJPVTQVSQPTFT OPUKVTU UPNFEJDBMSFTFBSDIXIPTFPCKFDUTBSFUIF religious worship) and involves a simplifed encouragement or conduct of scientifc application and renewal procedure. Tis investigation, research, and discovery for the consolidated exemption specifcally lists church beneft of the community at large, unless property used for preschool, nursery school, the research is carried on by an institution kindergarten, elementary, and secondary school chartered by the U.S. government. purposes as exempt religious purposes. Like 98 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

the welfare exemption, the religious exemption Cedars of Lebanon Hospital v. County of Los does not exempt college-level institutions. As Angeles, 35 Cal.2d 729 (1950)). Consequently, a result, under this exemption a church need church property includes not only property used fle only a single form to obtain an exemption directly for religious worship, but also property on property owned by the church and used for used for activities related to the function of religious worship as well as property used for churches, such as administrative and business school purposes. meetings of the church governing body, All religious corporations, whether or not religious instructional sessions, practice sessions they own and operate church schools, should of the choir, and most activities of auxiliary call their local county tax assessor’s ofce organizations accountable to the local church (exemption division) and determine if they authority. For further information on the church are eligible to use the religious exemption exemption, call the local tax assessor’s ofce or and its simplifed application and reporting the main headquarters of the California State requirements. Board of Equalization in Sacramento. Te religious exemption does not apply to particular uses such as hospitals, educational Leasing and the Welfare Exemption FM radio or television stations, and certain We have looked at some types of ownership, housing owned by churches. In these cases, use operation, and uses of property that will be the welfare exemption. considered religious, hospital, scientifc, or California law also provides certain religious charitable under the welfare exemption. Te groups with another property tax exemption: the above discussion, for the most part, assumes church exemption. Although religious purpose that the group seeking the exemption both uses groups usually use the religious exemp tion and owns the property. But what about leasing? FYQMBJOFEBCPWF XFCSJFìZEJTDVTTUIJTUIJSE How does a tax-exempt group that leases exemption in case you don’t qualify for the other property beneft from the welfare exemption? exemptions and need to use this one instead. What problems are encountered when the tax- Te church exemption applies to personal exempt group is the landlord? and real property used exclusively by a church. Even groups that do not qualify for the Tis includes property owned or leased from welfare exemption can obtain a property another nonproft or proft-making group. tax exemption on leased premises rented to Tis is a broader exemption than the welfare government or charitable organizations and exemption or religious exemption, because used for public libraries, museums, public under this special religious exemption, it is schools, colleges, or educational purposes by strictly the use, and not the ownership of the nonproft colleges or universities. (See Revenue property, that is determinative. As with the term and Taxation Code §§ 251 and 442.) religious, property used for church purposes has been liberally interpreted by the courts. Your Nonproﬁt Is the Renter Broadly speaking, the courts defne property Let’s frst consider the situation in which that qualifes for this separate exemption as “any your group, qualifed as tax-exempt under the property or facility that is reasonably necessary welfare exemption, leases property from another for the fulfllment of a generally recognized person or group. function of a complete, modern church” (see CHAPTER 5 | OTHER TAX BENEFITS AND REQUIREMENTS | 99

Your group will be exempt from paying any group owns a building that is too large for your personal property taxes on property located on needs, it makes sense to lease out some of the the premises, regardless of the status (exempt extra space. or nonexempt) of your landlord. Although t*GZPVMFBTFUIFQSPQFSUZUPBOPSHBOJ[BUJPO you don’t own and operate the real property, that meets the welfare exemption as required by Section 214, your group does requirements, the leased premises will own and operate the personal property located continue to be exempt from real property on the premises. You will therefore be exempt taxes. from paying any personal property taxes that t*GZPVMFBTFUPBHSPVQUIBUNFFUTUIF are levied on equipment, furniture, and other requirements of some other real property movable items located on the premises. exemption provided under other provisions If your group is renting from another group of California law, the leased premises will that itself qualifes for and obtains the welfare continue to be exempt from real property exemption, then the exemption will apply taxes. to both the personal and real property taxes t*GZPVMFBTFUIFQSPQFSUZUPBHSPVQUIBU associated with the leased property. If you lease cannot meet any of the above three tests, from a tax-exempt qualifed lessor, you and the you won’t lose your entire exemption. landlord should agree clearly in writing that However, your welfare exemption will the rent you pay will be lessened by an amount apply to only the buildings or portions of equal to the real property tax exemption for buildings that you occupy or use. Your the leased premises for each year in which your group will receive a real property tax bill group qualifes for the welfare exemption. Tis for any portion of the facilities rented out is a way of making sure that the benefts of to nonexempt tenants and, as the owner the welfare exemption that apply to the leased of the property, you’ll have to pay these premises will be passed on to you. taxes. Of course, in this case, the owner Te only other way to obtain an exemption organization will want to make sure that from payment of both personal and real the lease agreement passes these taxes on to property taxes on leased premises is for your the nonexempt tenants in the form of rent. group to fall within another exemption, other than the welfare exemption (see “Other California Tax Exemptions,” below). Again, if Other California this is true, the lease agreement should clearly Tax Exemptions state that a reduction or elimination of real property taxes on the owner’s tax bill should Section 501(c)(3) nonprofts and other groups be passed on to you for each year in which you that do not qualify for the welfare exemption qualify for the particular exemption. may be eligible for other tax exemptions under diferent provisions of California law. Your Nonproﬁt Is the Landlord We’ve already touched on the separate college, religious, and church exemptions above. Te Now let’s look at the situation where your following is a partial list of special property tax group qualifes for the welfare exemption and exemptions that can beneft nonproft groups. you lease property or portions of property to ɨJTJTPOMZBQBSUJBMMJTUBOEJTTVCKFDUUP another organization. For example, if your change—for current information on property 100 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tax exemptions that might apply to your Te rules that apply to fundraising are beyond nonproft group, call your local county tax the scope of this book, but we recommend assessor’s ofce or the main headquarters of that you make learning about state charitable the California State Board of Equalization in solicitation rules one of your top priorities Sacramento. after you incorporate. Te U.S. Supreme Court has put the brakes on attempts by states Other Property Tax Exemptions to regulate what a nonproft must disclose directly to potential contributors. However, Type of Personal Real California, like many other states, has enacted Owner or Property Property Property Exemption Exemption laws regulating disclosures by commercial fund raisers paid by a nonproft. California also Cemeteries X X regulates the activities of consultants hired by Churches X X nonprofts to help them raise funds. Both fund- Colleges X X raisers and consultants are required to make Exhibitions X X periodic reports to the California Attorney Free museums X X General. California also imposes annual Religious organizations X X reporting requirements for any charity soliciting Veterans’ organizations X X contributions or sales that collects more than Works of art X 50% of its annual income and more than $1,000,000 in contributions from California donors during the calendar year, if the charity spent more than 25% of its annual income State Solicitation Laws on nonprogram expenses. (See Business and and Requirements Professions Code §§ 17510.9 and 17510.95 for the complete text.) Fundraising is a way of life for most nonproft Te best way to learn about the rules is to go organizations because these organizations to the California Attorney General’s website depend on contributions solicited from the and view or download the latest California general public, and public and private grants, Attorney General’s Ofce Guide to Charitable for their operating funds. Most states, including Solicitation. It contains a thorough discussion California, regulate how a 501(c)(3) public of the various state operational and reporting charity can solicit contributions from the general requirements that apply to charitable solicita- public. State regulation of charitable solicitations tions by fundraisers in California. Te Guide is meant to serve two main purposes: is also available on the Nolo website; see tUPDVSCGVOESBJTJOHBCVTFTCZNPOJUPSJOH Appendix A for the link. the people involved and their activities, and Te California Nonproft Integrity Act of tUPHJWFUIFQVCMJDBDDFTTUPJOGPSNBUJPOPO 2004 imposes additional restrictions on the how much an organization spends to raise fundraising activities of charitable nonprofts. whatever ultimately goes into funding its It primarily applies to nonproft public beneft charitable, educational, religious, or other corporations (except schools and hospitals) and nonproft purpose. the commercial fundraisers (and lawyers) that they pay. Here is a partial summary of the Act: CHAPTER 5 | OTHER TAX BENEFITS AND REQUIREMENTS | 101

t$PNNFSDJBMGVOESBJTFSTIJSFECZBDIBSJUBCMF must apply any contributions only in a nonproft must notify the attorney general manner consistent with that purpose. To before starting to work on a solici tation help ensure accountability under the Act, campaign, and they must have a written fundraisers are required to keep records of contract with the charitable organi zation. fundraising drives for at least ten years. A charitable organization can cancel a contract with a fundraiser if the commercial RESOURCE fundraiser is not registered with the attorney For more information on fundraising general’s Registry of Charitable Trusts. registration requirements, see Nonproft t'VOESBJTJOHDPOUSBDUTNVTUDPOUBJOPUIFS Fundraising Registration: Te 50-State Guide, by disclosures and provisions, including Stephen Fishman (Nolo) and Nolo’s website. the charitable purpose of the solicitation campaign and the fees or percentages that Here are some Internet resources you can will be paid to the fundraiser. Te contract use to learn more about the rules under the must require that all contributions the California Nonproft Integrity Act of 2004: fundraiser receives either be deposited in a t(PUPUIF$BMJGPSOJB"UUPSOFZ(FOFSBMT bank account controlled by the charitable website and under Programs A–Z, See All organization or delivered in person to the Programs on the Publications page, select charitable organization within fve days. “Charities/Nonprofts” and you will fnd a Te charitable organization must have the link to the Nonproft Integrity Act of 2004. right to cancel the contract without liability t5PSFBEUIFTFDUJPOTPG$BMJGPSOJBMBX for ten days after the date it is signed. Te amended or added by the Act, go to the organization must also have the right to Ofcial California Legislation Information cancel the contract for any reason at any website at http://leginfo.legislature.ca.gov. time on 30 days’ notice to the fundraiser. Select and read under California Law, t Te Act imposes numerous other obliga tions Government Code Sections 12581, 12582, and restrictions on charitable organiz ations 12583, 12584, 12585, 12586, 12599, and their commercial fundraisers. Tese rules 12599.1, 12599.3, 12599.6, and 12599.7, were designed to ensure that donations and Business and Professions Code Section solicited from the public are used for the stated 17510.5. purposes of each fundraising campaign and to Regulation of charitable solicitation is an protect the public from misrepresentations and active and changing area of law. At the federal fraudulent fundraising practices. For example, level, Congress has proposed putting multistate the new rules say that a charity may accept nonproft fundraising activities under Federal contributions only for a charitable purpose that Trade Commission (FTC) regulation, and is expressed in the solicitation for contributions UIFSFCZVOEFSGFEFSBMDPVSUKVSJTEJDUJPO XIJMF and that conforms to the charitable purpose single-state fund raising would remain under expressed in the articles of incorporation TUBUFBOEMPDBMKVSJTEJDUJPO:PVTIPVMEEPZPV or other governing instrument of the best to keep your nonproft network antennae charitable organization, and the nonproft tuned to developments in this area. ●

CHAPTER

Choose a Name and File Your Articles of Incorporation 6

Choose a Corporate Name ...... 105 Your Name Must Be Unique ...... 106 You Can’t Use Certain Terms ...... 107 No Need to Use “Inc.” ...... 107 Using Two Names and Changing Your Name...... 107 Practical Suggestions for Selecting a Name ...... 107 Use Common Nonproﬁt Terms in Your Name ...... 107 Names to Avoid ...... 107 Pick a Descriptive Name ...... 109 Limit Your Name Geographically or Regionally...... 109 Choose a New Name Instead of Trying to Distinguish Yourself ...... 110 Use a Corporate Designator in Your Name ...... 110 Take Your Time ...... 110 Check Name Availability ...... 110 Check Your Proposed Name by Mail ...... 110 Check Existing Corporate Names Online ...... 111 What to Do When Tere’s a Name Conﬂict ...... 111 Reserve Your Corporate Name ...... 112 Perform Your Own Name Search...... 113 Who Should Perform Tis Search? ...... 113 Who Gets to Use a Name? ...... 114 Finding Users of Your Name ...... 114 Further Searching ...... 115 Te Consequences of Using Another’s Name ...... 115 Protect Your Name ...... 116 104 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Prepare Articles of Incorporation ...... 116 Preparing Articles for a Public Beneﬁt Corporation ...... 117 Special Instructions for Public Beneﬁt Corporations ...... 117 Preparing Articles for a Religious Corporation ...... 120 Special Instructions for Religious Corporations ...... 120 Preparing Articles for an Unincorporated Association ...... 123 File Your Articles ...... 124 Don’t Rush to File ...... 124 Your Filing Package ...... 125 Prepare Your Cover Letter ...... 125 File Your Documents With the Secretary of State ...... 128 Appoint Initial Corporate Directors ...... 129 CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 105

his chapter shows you how to form your guide only—they can’t be completed online or California nonproft corporation. To copied and mailed in. T do this, you must frst choose a name for your corporation; then you prepare and fle TIP articles of incorporation with the California Plan ahead. With the recent closures of Secretary of State. You’ll see that it is a relatively secretary of state’s offices, it can take two months simple and straightforward process and mostly or more to file your articles of incorporation by mail. involves flling in blanks on standard forms If you need to create your corporation in a hurry, using information you already have at your you can choose to file your articles in person, as fngertips. Take your time and relax; you’ll be explained in this chapter. surprised at how easy it all is. As you begin the process of forming your TIP corporation, we suggest that you use the Forming your corporation will be the Incorporation Checklist to chart your way first step you take to obtain nonprofit status. through the incorporation steps in Chapters 6 Your corporation must be in existence when you through 9. Look through the steps on the chart apply for your state and federal tax exemptions. and check the box labeled “My Group” for each We recommend, however, that before you file your step that applies to you. When you complete articles, you read through and prepare some of the each step, go back and mark the “Done” box. other documents required later in the process, such Tis will help you keep track of where you as your bylaws and tax exemption applications. are and can greatly simplify the incorporation Tat way you’ll know what is required to complete process for you. the process before you form your corporation. (See “Don’t Rush to File,” below.) CAUTION Check the California Secretary of State’s We go over all the forms you need to prepare website (the Business Entities section) for changes and fle your articles. Tese forms include to the forms, fees, and filing address before you the name availability and name reservation prepare or file your incorporation documents. forms, articles of incorporation for a public We will also post updates on the Nolo website (see beneft or religious corporation, and a cover Appendix A for the link). letter for fling your articles of incorporation. Instructions for downloading forms from the Nolo website are in Appendix A. Te California Secretary of State’s website has Choose a Corporate Name forms, such as the name availability and name Te frst step in forming your corporation is reservation form, that you can com plete online, to choose a name that you like and one that print, and mail in. Te secretary of state’s also meets the requirements of state law. Te website also has sample corporate documents, California Secretary of State will approve your such as articles of incorporation and certifcates corporate name when you fle your articles of amendment to articles of incorporation. of incorporation. As explained more below, Go to the Business Entities section and click you can check name availability and reserve a on “Forms, Samples, and Fees.” Tese sample corporate name before you fle your articles. corporate documents are intended for use as a 106 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tFYJTUJOH$BMJGPSOJBDPSQPSBUJPOT Keeping or Changing Your Name tPVUPGTUBUFDPSQPSBUJPOTRVBMJëFEUPEP If you are incorporating an existing organiza tion, business in California you may want to use your current name as your tOBNFTSFHJTUFSFEXJUIUIFTFDSFUBSZPGTUBUF corporate name, particularly if it has become by out-of-state corporations, and associated with your group, its activi ties, fund- tOBNFTSFTFSWFEGPSVTFCZPUIFS raising eﬀorts, products, or services. Many new corporations. corporations do this by simply adding “Inc.” In deciding whether a corporate name is too to their old name (for example, Te World similar to one already on fle, the secretary of Betterment Fund decides to incorporate as Te state’s ofce will usually look only at similarities World Betterment Fund, Inc.). Using your old between the corporate names themselves, not name is not required, however. If you have been at similarities in the types and locations of the thinking about a new name for your organiza- corporations using the names. If you attempt to tion, this is your chance to change it. form a corporation with a name that is similar in sound or wording to the name of another corporation on the corporate name list, the As a practical matter, your corporate name is TFDSFUBSZPGTUBUFTPïDFNBZSFKFDUZPVSOBNF one of your most important assets. It represents and return your articles of incorporation to the goodwill of your organization. We don’t you. For example, suppose your proposed name use the term goodwill here in any legal, is “Open Spaces.” If another corporation is on account ing, or tax sense; rather, your name is fle with the secretary of state with the name signifcant because people in the community, “Open Spaces International, Inc.,” your name grant agencies, other nonprofts, and those XJMMQSPCBCMZCFSFKFDUFEBTUPPTJNJMBS with whom you do business will identify Te secretary of state does not compare your nonproft primarily by its name. For this proposed corporate names against the names reason, as well as to avoid having to print new of other types of legal entities on fle with stationery, change promotional literature, or its ofce. For example, it does not check create new logos, you should pick a name you’ll proposed corporate names against the names be happy with for a long time. of limited liability companies (LLCs), limited Tere are certain legal requirements for corpo- partnerships, or registered limited liability rate names in California. If you don’t meet partnerships (RLLPs). However, you should these requirements, the secretary of state will do your best to avoid names used by all other SFKFDUZPVSDPSQPSBUFOBNF BOEXJMMBMTPSFKFDU types of organizations and businesses, not your articles of incorporation). KVTUDPSQPSBUJPOT*GZPVSOBNFJTMJLFMZUP mislead the public or create confusion because Your Name Must Be Unique it is too similar to the name of an existing business, then you can be stopped from using Your proposed corporate name must not be the that name, regardless of the types of business same as, or confusingly similar to, a corporate entities involved. For information on trademark name already on fle with the secretary of state. and trade name law, see “Perform Your Own Te list of corporate names maintained by the Name Search,” below. For information on how secretary of state includes: CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 107

to compare your proposed corporate name CAUTION to corporate and LLC names already on fle Having your name approved by the with the secretary of state, see “Check Existing secretary of state when you ﬁle your articles of Corporate Names Online,” below. incorporation does not guarantee that you will have the absolute legal right to use it. As explained You Can’t Use Certain Terms in more detail in “Perform Your Own Name Search,” below, another organization or business may already A California nonproft corporation cannot use be using the name as its business name or may be the words “bank,” “trust,” or “trustee” in its using it as a trademark or service mark. If someone name. Tese fnancial institutions are regulated else is using the name, they may be able to prevent by special California laws and there are special you from using it, depending on their location, type regulations that govern their formation. of business, and other circumstances. We show you how to do some checking on your own to be No Need to Use “Inc.” relatively sure that no one else has a prior claim to your proposed corporate name based on trademark Unlike many other states, California does not or service mark. require a corporate designator in corporate names, such as “Corporation,” “Incorporated,” “Limited,” or an abbreviation of one of these words (“Corp.,” “Inc.,” or “Ltd.”). For example, Practical Suggestions Te Actors’ Workshop and Te Actors’ Work- for Selecting a Name shop, Inc., are both valid corporate names Now that we’ve looked at the basic legal in California. Most incorporators, however, requirements related to your choice of a want to use one of these corporate designators corporate name, here are some practical precisely because they want others to know that suggestions to help you do it. their organization is incorporated.

Using Two Names and Use Common Nonproﬁt Changing Your Name Terms in Your Name Tere are a number of words that broadly If you want to adopt a formal corporate name suggest 501(c)(3) nonproft purposes or in your articles that’s diferent than the one activities. Choosing one of these names can you have used (or plan to use) to identify your simplify the task of fnding the right name for nonproft organization, you can do so. You’ll your organization and will alert others to the need to fle a fctitious business name statement nonproft nature of your corporate activities. (also known as a “dba statement”) with the “Common Nonproft Names,” below, shows a local county clerk. few examples. You can also change your corporate name after you’ve fled your articles. After making sure that the new name is available for use Names to Avoid (as explained further below), you can amend When selecting a corporate name, we suggest your articles and fle the amendment with the you avoid, or use with caution, the types of secretary of state. words described and listed below. Of course, there are exceptions. If one of these words 108 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

relates to your particular nonproft purposes or Common Nonprofit Names activities, it may make sense to use the word in your name. Academy House Avoid words that, taken together, signify Aid Human a proft-making business or venture, such American Humane as Booksellers Corporation, Jef Baxter & Appreciation Institute Company, Commercial Products Inc., or Assistance International Entrepreneurial Services Corp. Association Learning Avoid words that describe or are related to Benefit Literary special types of nonproft organizations (those Betterment Mission that are tax exempt under provisions of the IRC Care Music other than Section 501(c)(3)), such as Business Center Orchestra League, Chamber of Commerce, Civic League, Charitable Organization Hobby, Recreational or Social Club, Labor, Coalition Philanthropic Agricultural or Horticultural Organization, Community Philharmonic Political Action Organization, Real Estate Congress Program Board, and Trade Group. Conservation Project Consortium Protection RELATED TOPIC Council Public For a listing of these special tax-exempt Cultural Refuge nonprofit groups and a brief description of each Education Relief group, see “Special Nonprofit Tax-Exempt Organi- Educational Religious zations,” in Appendix B. Environmental Research Exchange Resource EXAMPLE: Fellowship Scholarship Foundation Scientific Te name Westbrook Social Club, Inc., Friends Service would clearly identify a social club, tax Fund Shelter exempt under IRC Section 501(c)(7)—for Health Social this reason, you shouldn’t use this type of Help Society name for your 501(c)(3) nonproft. However, Heritage Study Te Social Consciousness Society might Home Troupe be an appropriate name for a 501(c)(3) Hope Voluntary educational purpose organization. Also, Hospice Welfare although Te Trade Betterment League Hospital of Pottersville would identify a 501(c)(6) business league and Te Millbrae Civic Betterment League a 501(c)(4) civic league, Te Philanthropic League of Castlemont might be a suitable name for a 501(c)(3) charitable giving group. CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 109

Avoid words or abbreviations associated Unlimited Inc.) are usually less advisable with nationally known nonproft causes, because it might take a while for people to organizations, programs, or trademarks. You fgure out what they stand for, although can bet that the well-known group has taken occasionally their uniqueness can provide better steps to protect its name as a trademark or identifcation over the long term. service mark. Steer clear of the names in “Tese Names Are Already Taken,” below. EXAMPLE: Although the name Northern California Feline Shelter, Inc., will alert people at the start to the charitable purposes Tese Names Are Already Taken of the nonproft group, Cats’ Cradle, Here is a small sampling of some well-known Inc., may stay with people longer once —and oﬀ-limits—nonproﬁt names and they are familiar with the activities of the abbreviations: organization. AAA American Red Cross Limit Your Name Geographically American Ballet Teatre or ABT American Conservatory Teatre or ACT or Regionally Audubon If you use general or descriptive terms in your Blue Cross name, you may need to further qualify it by Blue Shield geographic or regional descriptions to avoid Environmental Defense Fund DPOìJDUTPSQVCMJDDPOGVTJPO National Geographic EXAMPLE 1: Your proposed name is Te National Public Radio or NPR Philharmonic Society, Inc. Your secretary Sierra Club PGTUBUFSFKFDUTUIJTOBNFBTUPPDMPTFUPB Public Broadcasting System or PBS number of phil harmonic orchestras on fle. You refle using the proposed name, Te Avoid words with special symbols or punctua- Philharmonic Society of East Creek, and tion that might confuse the secretary of state’s your name is accepted. computer name-search software, such as: @ # $ % ^ & * () + ? and > or <. EXAMPLE 2: Suppose you are incorporating Pick a Descriptive Name the AIDS Support Group, Inc. Even if this OBNFEPFTOPUDPOìJDUXJUIUIFOBNFPG It’s often a good idea to pick a name that clearly another corporation on fle in your state, it is SFìFDUTZPVSQVSQPTFTPSBDUJWJUJFT GPSFYBNQMF still a good idea to limit or qualify the name Downtown Ballet Teater, Inc.; Good Health to avoid confusion by the public with other Society, Ltd.; Endangered Fish Protection groups in other parts of the country that League, Inc.). Doing this allows potential share the same purposes or goals. You could members, donors, benefciaries, and others to do this by changing the name to the AIDS easily locate and identify you. More fanciful Support Group of Middleville. OBNFT ɨF8BWF1SPKFDU *OD 4FSFOEJQJUZ 110 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Choose a New Name Instead of Take Your Time Trying to Distinguish Yourself Finding an appropriate and available name for Instead of trying to distinguish your proposed your corporation will take time and patience. name from another established group by using It’s usually best not to act on your frst impulse— a regional or other identifer, it’s usually better try a few names before making your fnal to choose a new and diferent name if the choice. Ask others both inside and outside the public is still likely to confuse your group with organization for feedback. And remember: the other group. Your proposed name might not be available for your use—have one or more alternate names in EXAMPLE: Your proposed nonproft name is reserve in case your frst choice isn’t available. Te Park School, Inc. If another corporation (specializing in a nationwide network of apprentice training colleges) is already listed Check Name Availability with the name Park Training Schools, your ɨFTFDSFUBSZPGTUBUFXJMMSFKFDUZPVSBSUJDMFT TFDSFUBSZPGTUBUFNBZSFKFDUZPVSOBNFBT of incorporation if the name you’ve chosen for too similar. your corporation is not available. Any name You may be able to limit your name and already being used by another corporation make it acceptable (Te Park Street School of on fle with the secretary of state’s ofce is West mont, Inc.) but this may not be a good considered unavailable. To avoid having your idea for two reasons: First, members of the BSUJDMFTSFKFDUFE JUTPGUFOXJTFUPDIFDLJGUIF public who have heard of the Park Training name you want is available before you try to fle Schools might think that your school is simply your articles. a Westmont afliate of the national training program. Second, you might still be infringing Check Your Proposed Name by Mail the trademark rights of the national group (they You can request a corporate name check by may have registered their name as a state or sending a Name Availability Inquiry Letter to federal trademark). the secretary of state’s ofce in Sacramento. You can check up to three corporate names per Use a Corporate Designator request and there is no fling fee. Te secretary in Your Name will respond to your written request within one to two weeks. Even though not legally required in California, Te Name Availability Inquiry Letter is avail- you might want to include a corporate designator able online at the secretary of state’s business in your name to let others know that your portal website. You can fll out the form online, organization is a corporation. Here are some print it, and mail it to the secretary of state. examples: Hopi Archaeological Society, Inc., Te Children’s Museum Corporation, Mercy Hospital, Incorporated, and Te Hadley School Corp. CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 111

CAUTION name availability or reserving your name with Checking the availability of a name the secretary of state. If you discover a match doesn’t reserve the name or give you any rights to to your proposed name, and the corporation is the name. Even if the secretary of state indicates by still active (the name search tells you whether return mail that a corporate name is available, it may the corporation is active or not), you need to not be available when you ﬁle your articles. To avoid look for another name. If you discover a similar this problem and to save time, you can check and corporate name, the secretary of state may fnd reserve a name for a small fee, as explained in the that it is too similar to your proposed name to next section. let you use it. Te only way to tell whether the secretary of state will allow you to use a name Check Existing Corporate that is similar to an existing corporate name is Names Online to do a formal name availability check or try to reserve the name. If the secretary of state You can check the names of existing corpo- reports that the name is not available or won’t rations registered with the secretary of state reserve it for your use, you know the name was online at the secretary of state’s business portal too similar to the existing corporation’s name. website (see Appendix B for more information). Go to the Business Programs Section, then go to What to Do When Tere’s “Business Entities,” then “Business Search.” Enter a Name Conﬂict your proposed name in the search box. Click the appropriate button and then check your If using your proposed name is crucial to you proposed name against existing corporations, and the secretary of state’s ofce tells you that LLCs, and limited partnerships. Even though it is too similar to an existing corporate name the secretary of state may let you use a corporate already on fle, there are a few things you can do. OBNFUIBUDPOìJDUTXJUIBO--$OBNF XF Appeal the Decision advise against doing this. To avoid legal disputes, it’s best to stay clear of any business name You can ask the secretary of state’s legal counsel (whether a corporate, LLC, or unincorporated to review the staf’s determination regarding business name) that is the same as or similar your name’s acceptability. Tis will involve to your proposed corporate name. Te fact fling a written request, and you may decide that an LLC name has a diferent ending than to seek the help of a lawyer. Here’s why: Te your corporate name (for example, “Racafrax, legal question of whether or not a name is so LLC” and you want to use “Racafrax” as your close to another name so as to cause confusion corporate name) does not mean you will be to the public is a difcult one, and involves allowed to use your proposed name. If the names looking at a number of criteria contained in are substantially similar, a court may stop you court decisions. Factors such as the nature from using your proposed name, even if you use of each trade name user’s business (the term it for a corporation and the competing business “trade name” simply means a name used in name is used by an LLC. DPOKVODUJPOXJUIUIFPQFSBUJPOPGBUSBEFPS If your proposed corporate name is not the business), the geographical proximity of the same as or similar to an existing name listed two businesses, and other factors work together online, you may decide it’s safe to go ahead and in ways that are difcult to predict. We cover fle your articles without formally checking trade name issues in more detail below but, 112 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

for now, we simply note that if you do get into be fling your articles immediately—available this sort of debate, you will probably want to corporate names are hard to fnd, and reserving see a lawyer who is versed in the complexities a name allows you to hold on to the name of trade name or trademark law or do some while you complete your initial paperwork for additional reading on your own. incorporation. To reserve a name, you can prepare and fle Get Permission a Name Reservation Request Form with the An obvious resolution would be to obtain the secretary of state. When flling in the form, written consent of the other corporation. Some- you can list up to three names in order of times, proft corporations that have registered preference. Te frst available name will be a name similar to the proposed name of a non- reserved for your use. If a name is accepted, proft corporation will be willing to allow the only the person who flled in the Name nonproft corporation to use the similar name. Reservation form can fle articles with the We think this is too much trouble. Besides, reserved name or a similar name during the NPTUCVTJOFTTFTKFBMPVTMZHVBSEUIFJSOBNF BOE 60-day reservation period. it is unlikely any business or organization will Te Name Reservation Request Form is avail- let you ride on the coattails of their existing able online at the California Secretary of State’s name. If you are told your proposed corporate website (go to the Business Entities section). name is too similar to another name, we recom- You can fll out the form online, print it, and mend you move on and choose another name mail it to the secretary of state. Tere is a $10 that is available for your use. fling fee. You can also reserve a corporate name in Pick Another Name person at one of the secretary of state’s regional You may decide that it’s simpler (and less ofces: trouble all the way around) to pick another Sacramento Main Ofce name for your nonproft corporation. We 1500 11th Street usually recommend this approach. Sacramento, CA 95814 (916) 657-5448 CAUTION Los Angeles Regional Ofce A name check gives you only a prelimi- 300 South Spring Street, Room 12513 nary indication whether your proposed corporate Los Angeles, CA 90013 name is available. Don’t order your stationery, (213) 897-3062 business cards, or oﬃce signs until the secretary of state has formally accepted your name by approving Te fee for reserving a name in person is $20. your Name Reservation Request or ﬁling your articles Te clerk will ask for two $10 checks. If your of incorporation. proposed name is not available, the clerk will keep $10 and return one $10 check to you. If your proposed name is accepted, the secre- Reserve Your Corporate Name tary of state will send you a certifcate of reser- For a small fee, you can reserve an available vation that is valid for 60 days from the date corporate name with the secretary of state. It it is issued. If you cannot fle your articles makes sense to reserve a name if you will not within that time, you can rereserve the name by CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 113

preparing a new reservation letter. Te secretary to have the legal right to use the name in of state must receive the second reservation a particular county if they are using it as a letter at least one day after the frst certifcate trade name (as the name of their business or expires. You are not allowed two consecutive organization) and have fled a fctitious business reservations of corporate name—therefore the name statement with their county clerk. requests must be separated by at least one day. Te secretary of state will send you a letter after you fle your articles, repeating everything CAUTION XFWFKVTUTBJEɨFTFDSFUBSZQVUTJUBCJUNPSF Te person whose name is on the reser- legalistically, warning you that fling articles vation form must sign the articles of incor poration. of incorporation does not, in itself, authorize Make sure that the person submitting the reservation the use of a corporate name if that use would form (whose name is inserted in the top box of the violate another person’s right to use the name, form) will be available to sign articles of incorporation including rights in a trade name, rights on behalf of your organization. Te corporate name is under state or federal trademark laws, or state reserved for this person’s use only. fctitious business name laws, and rights that arise under principles of common law (the law expressed in court decisions). You’re probably Perform Your Own wondering—If someone is using my proposed Name Search name already, does that mean that I can’t use the name either? And how can I discover Approval by the secretary of state’s ofce of your whether someone is using the name in the frst corporate name doesn’t necessarily mean that you place? Te sections below will give you some have the legal right to use this name. Acceptance guidance. of your corporate name by the secretary of state’s ofce simply means that your name does Who Should Perform Tis Search? OPUDPOìJDUXJUIUIBUPGBOPUIFSDPSQPSBUJPO In many circumstances, you will know that already on fle with the secretary of state. Te your name is unique and unlikely to infringe secretary of state does not, however, check the on another organization’s name. Tis would state trademark/service mark registration lists probably be the case, for example, if you called maintained in the secretary of state’s ofce, nor your group the Sumner County Crisis Hotline, does it check your corporate name against the or the Southern California Medieval Music names of non corporate entities on fle with the Society. By qualifying your name this way, ofce—such as LLCs, limited partnerships, you know that you are the only nonproft in and registered limited liability partnerships your area using the name. However, in some (RLLPs). Tus, another organization (corporate circumstances you may be less sure of your or noncorporate, proft, or nonproft) may right to use a name. For example, the names already have the right to use this same name (or Legal Rights for All or Te Society to Cure one similar to it) as a federal or state trademark Lyme Disease may be in use by a group in any or service mark used to identify their goods or part of the country. Read on. services. Also, another organization (corporate or noncorporate) may already be presumed 114 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Who Gets to Use a Name? at no charge. You can also check the Business Programs/Trademarks and Service Marks section Te basic rule is that the ultimate right to of the secretary of state’s website. use a particular name will usually be decided based on who was frst in time to actually Check Directories use the name in connection with a particular trade, business, activity, service, or product. $IFDLNBKPSNFUSPQPMJUBOQIPOFCPPL In deciding who has the right to a name, listings, nonproft directories, business and the similarity of the types of businesses or trade directories, and so on to see if another organizations and their geographical proximity company or group is using a name similar to are usually taken into account. your proposed corporate name. Large public libraries keep phone directories for many Finding Users of Your Name NBKPSDJUJFTUISPVHIPVUUIFDPVOUSZ BTXFMM as trade and nonproft directories. A local Below we list self-help name checking nonproft resource center or business branch of procedures you may want to use to be more a public library may have a special collection certain that your proposed corporate name of nonproft research materials—check these is unique. Do these name search procedures frst for listings of local and national nonprofts. before you fle your articles. Obviously, you One commonly consulted national directory can’t be 100% certain—you can’t possibly of nonproft names is the Encyclopedia of check all names in use by all other groups. Associations, published by Gale Research However, you can check obvious sources likely Company. to expose names similar to the one you wish to use. Here are some places to start. Consult the Federal Trademark Register

Fictitious Business Name Files If your name is the type that might be used to market a service or product or to identify a Check the county clerk in the county or business activity of your nonproft corporation, counties where you plan to operate to see if you should check federal trademarks and your name has already been registered by service marks. You can check the Federal another person, organization, or business as a Trademark Register for free at www.uspto.gov. fctitious business name. Most county clerks You can also go to a large public library or will require you to come in and check the special business and government library in your ëDUJUJPVTCVTJOFTTëMFTZPVSTFMGJUUBLFTKVTUB area that carries the Federal Trademark Register, few minutes to do this. which lists trademark and service mark names broken into categories of goods and services. State Trademarks and Service Marks Call the California Secretary of State’s trade- Use Other Internet Databases mark and service mark registration section (the Most of the business name listings mentioned phone number is 916-653-3984) and ask if your above, including yellow page listings and busi- proposed corporate name is the same as or similar ness directory databases and the federal and to trademarks and service marks registered with state trademark registers, are available as part the state. Tey will check up to two names over of several commercial computer databases. For the phone against their list of registered marks example, the federal and state registers can be CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 115

If You Use Another Company’s Trade Name or Trademark

Legal remedies for violation of trade name or catalogs and the Internet. For the first seven to trademark rights vary under federal and state eight years, Foul Weather averaged gross annual laws and court decisions. Most of the time, the sales of approximately $2 million. Another business with the prior claim to the name can company, calling itself Rainy Day Gearheads, sue to enjoin (stop) you from using your name starts selling competing products, and Foul or can force you to change it. Te court may also Weather’s gross revenues slip by about 25% over award the prior owner money damages for loss the next two years. If Foul Weather can prove of sales or goodwill caused by your use of the that the Rainy Day Gearheads trademark likely name. If you violate a trademark or service mark caused customer confusion that resulted in registered with the U.S. Patent and Trademark Foul Weather‘s decrease in sales, Foul Weather Office, the court may award treble damages can recover its lost profits. Or, if prior to the (three times the actual money damages suffered infringement, Foul Weather had registered as a result of the infringement), any profits you its name on the Principal Trademark Register make from using the name, and court costs; and maintained by the U.S. Patent and Trademark may order the goods with the offending labels or Office, it could choose to go after Rainy Day’s marks to be confiscated and destroyed. profits (instead of recovering its own losses), Here’s an example of how this works. A attorneys’ fees, and treble damages. company called Foul Weather Gearheads has For further information see Patent, Copyright been in business for ten years selling foul weather & Trademark: An Intellectual Property Desk gear such as rain slicks and hip boots via Reference, by Rich Stim (Nolo).

accessed through the TRADEMARKSCAN PSMPDBMMZCBTFEOBNFJTOPUMJLFMZUPDPOìJDU databases using SAEGIS, Dialog, or Westlaw with anyone else’s name, will not feel the need online services. (Use your browser’s search to do this and will be content to undertake engine to fnd links to these services.) Subscrip- the more modest self-help search procedures tion databases charge fees for your research time mentioned above. (unlike the www.uspto.gov site, which is free). Te Consequences of Further Searching Using Another’s Name Of course, if you wish to go further in your To avoid problems, we suggest using the name search, you can pay a private records name selection techniques discussed above, search company to check various databases and and performing the kind of commonsense OBNFMJTUJOHT"MUFSOBUJWFMZ PSJODPOKVODUJPO checking described earlier. Disputes involving with your own eforts or search procedures, trade names, trademarks, and service marks you can pay a trademark lawyer to oversee or tend to arise in the private, commercial sector. undertake these searches for you (or to render a It is unlikely that your nonproft will wish to legal opinion if your search turns up a similar market products and services as aggressively name). Most organizers of smaller nonprofts, as a regular commercial concern and thereby particularly those who believe that a specialized run afoul of another business’s trademark or 116 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

TFSWJDFNBSL ZPVEBMTPCFKFPQBSEJ[JOHZPVS yourself—your local county law library should tax-exempt status by engaging in a substantial have practice guides available to help you amount of commercial activity). Nonetheless, handle state and federal trademark and service as a matter of common sense, and to avoid legal mark fling formalities. disputes later on, you should do your best to avoid names already in use by other proft and Applying for a Federal Trademark nonproft organizations, or in use as trademarks or service marks. To apply for a federal trademark, go to the website of the Patent and Trademark Office Protect Your Name (PTO) at www.uspto.gov and download a Once you have fled your articles of incorpo- trademark application. Fill out the form ration, you may want to take some additional following the instructions. A month or so after steps to protect your name against later users. mailing the form, you should hear from the For example, if your name is also used to PTO. If there are any problems, you will receive identify your products or services, you may a written list of questions together with the wish to register it with the California Secretary telephone number of a trademark examiner. of State and the United States Patent and Te examiner should be able to address any Trademark Ofce as a trademark or service questions and issues you can’t handle yourself mark. You may also want to register in other and should help you finalize your application states if you plan to conduct operations there. without undue difficulty or delay. You can register your name if: tZPVIBWFBDUVBMMZVTFEUIFOBNFJOJOUFS state commerce (that is, in two or more states) in connection with the marketing of Prepare Articles of goods or services, or Incorporation tZPVJOUFOEUPVTFUIFOBNFJOJOUFSTUBUF commerce in connection with the Te next step in organizing your corporation marketing of goods or services. is to prepare articles of incorporation. Tis is If you specify the second ground in your your primary incorporation document—your trademark application, you must fle an af- corporation becomes a legal entity on the davit (sworn statement) within six months date you fle your articles with the California stating that the name has been placed in Secretary of State. You must complete this step actual use—and pay an additional fee. Tis before you send in your federal tax exemption six-month period may be extended for addi- application because the IRS requires you to tional six-month periods (at a fee for each submit a fled copy of your articles with your extension), up to a total extension of two and tax exemption application. one-half years. To obtain these extensions, you have to convince the Patent and Trademark TIP Ofce that you have good cause for delaying Prepare your bylaws and look over the your use of the name. Because trademark tax application early in the process. Even though application procedures are relatively simple and you have to file your articles before you send in your inexpensive, you may wish to tackle this task federal tax exemption application, we recommend CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 117 that you prepare bylaws and review or complete Special Instructions for Public some of the work on the federal tax application Benefit Corporations before you file your articles. Tat way, you’ll know what else is required to obtain nonprofit status and First, look at the “Filing Tips” for Articles of you won’t be surprised late in the process (after Incorporation—Domestic Nonproft Corpora- you’ve already incorporated) about a condition or tions on the Secretary of State’s website. Tese other requirement you can’t or don’t want to meet. instructions provide useful information and See the discussion in “Don’t Rush to File,” below. guidance if you wish to prepare your own form instead of flling in and printing the online form. Tere are two types of articles used by readers Next, refer to the following instructions of this book: one for California public beneft as you fll in the form. Te numbers, below, corporations (ARTS-PB-501(c)(3)) and one for correspond to circled numbers on the online California religious corporations (ARTS-RE). ARTS-PB-501(c)(3) form. Both forms are provided as fllable PDF forms on the California Secretary of State website. Corporate Name To access the forms, go to the California ➊ Type the name of your corporation. If you Secretary of State’s website and fnd the link have reserved a corporate name, make sure the in “Business Programs” to “Forms, Samples name shown here is exactly the same as the and Fees,” or you can type “Cal Secretary of name shown on your Certifcate of Reservation. State forms” in the search box of your browser. If you are incorporating an existing nonproft Corporate Purpose organization that was organized and operated ➋ (a) Check “charitable” purposes. Public as an unincorporated association (with formal beneft corporations must be organized under articles of association, a charter, or association state law for a charitable or public purpose, and bylaws), you will need to add an additional page the accepted practice for nonreligious 501(c)(3) with some special provisions to the standard public beneft groups—the type of group you state articles form (as explained below). Most are incorporating—is to indicate a charitable preexisting nonproft organizations are not (as opposed to public) purpose in this sentence. unincorporated associations and will not need (b) Complete the statement of specifc to concern themselves with these provisions. purposes. Tere is very little space here. Te key is to specify one or more of the keywords Preparing Articles for a Public associated with one or more of the nonreligious Benefit Corporation 501(c)(3) tax exemption categories (charitable, To prepare articles for a public beneft educational, scientifc, or literary). For example, a corporation, access the fllable Articles of nonproft environmental group may complete this Incorporation of a Nonproft Public Beneft sentence by inserting “provide environmental Corporation (ARTS-PB-501(c)(3)) from education.” A performance arts group might the California Secretary of State website as indicate “provide education in dance, music, explained above. Fill them in from your theatre, and other performance arts.” A group browser following the sample form and special that provides assistance to those in need, may instructions below. Ten print and sign the state “to provide charitable assistance to ….” form as explained below. 118 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Remember: although you may qualify as (b) If the mailing address of the corporation tax exempt under one or more categories of is diferent from the street address, insert the Section 501(c)(3) (for example, a charitable mailing address here. If the mailing address is and educational organization), you cannot also the same as the street address, insert “Same as fall within another tax-exempt section of the street address, above.” Internal Revenue Code. For example, you can’t be both a charitable group under 501(c)(3) Additional Statements and a social welfare group under Section Tis articles of incorporation form contains 501(c)(4). Hence, be careful to avoid using additional statements that meet the require- key words associated with these other tax- ments for obtaining a 501(c)(3) tax exemption. exempt sections—such as social, fraternal, or Tey indicate that the organization is organized recreational. For example, an educational and and operated for charitable purposes, will not social welfare organization would not be eligible provide private beneft to individuals, will not for a 501(c)(3) tax exemption because social engage in substantial lobbying activities or welfare groups are exempt under the provisions intervene in political campaigns, and dedicates of a diferent Internal Revenue Code section. any assets remaining upon its dissolution to allowable 501(c)(3) purposes. Note that even Service of Process though these are general statements, they do ➌ (a) & (b) Type the name and residence or OPUDPOìJDUXJUIZPVSTUBUFNFOUPGTQFDJëD business address of the corporation’s initial purpose(s) in Article 2(b), which indicates the agent for service of process—this is the person specifc 501(c)(3) purpose(s) that your organiz- to whom legal documents in any future lawsuit ation will carry out (charitable, educational, against the corporation must be sent. Te agent scientifc, and/or literary). must be a California resident, and the address must be a street address in California. Do not Incorporator’s Signature use a post ofce box address or abbreviate the You only need one person to sign your articles city name, and don’t use “in care of” or “c/o.” as incorporator. Your incorporator should be Also, don’t designate a corporation as an agent 18 years old or older. Typically, one of the unless you check the state’s instructions frst on corporation’s founders signs as the incorporator. how to do this. Normally, you’ll use the name Insert the incorporator’s name in the blank to of the incorporator (see special instruction ➑) the right of the signature. After printing the and give the address of the corporation. You form, have the incorporator sign the form. cannot use a post ofce box number in this address. Adding Pages or Preparing Your Own Articles Most nonprofts will fnd the ofcial standard Corporate Addresses articles of incorporation form sufcient and ➍ (a) Insert the street address of the principal won’t need to alter or add provisions to the ofce of the corporation (not a P.O. box), which form. If you do prepare your own pages to add should be in California. to or replace the ofcial state form, print your page(s) on letter-sized paper, using one side of a page only. CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 119 120 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Adding information. If the ofcial form does Preparing Articles for a not contain sufcient space for a response, you Religious Corporation can add pages to the ofcial form. If you do, To prepare articles for a religious corporation, make sure to indicate how the information fts access the fllable Articles of Incorporation of a on the ofcial form (for example, “Continuation Nonproft Religious Corporation (ARTS-RE) of (or “Response to”) Item 5: ….” from the California Secretary of State website Preparing your own form. If you want to modify as explained above. Fill them in from your the articles and prepare your own form, do so browser following the sample form and special only after making sure your changes conform instructions below. Ten print and sign the to the California Nonproft Corporation Law. form as explained below. (See Chapter 11 for suggestions on doing your own research or fnding a lawyer to help you make modifcations.) Also, to avoid problems, Special Instructions for do not include the name of your corporation Religious Corporations in the title of your self-prepared articles form. First, look at the “Filing Tips” for Articles Instead, follow the format of the state form and of Incorporation—Domestic Nonproft only include the name of your corporation in a Corporations on the California Secretary of section on your form. State’s website. Tese instructions provide helpful information and guidance if you wish Delaying the Filing of Your Articles to prepare your own form instead of flling in You may be able to incorporate on a specifc date and printing the online form. (to establish a particular tax year). California Next, refer to the following instructions law allows you to request a delayed fling date as you fll in the form. Te numbers, below, for your articles as long as this date is no more correspond to circled numbers on the online than 90 days from the date of receipt of your ARTS-RE form. articles by the secretary of state (the delayed date may be a weekend day or a holiday, but Corporate Name your articles must be received by the secretary ➊ Type the name of your corporation. If you of state at least one business day before the have reserved a corporate name, make sure the requested future fling date). name shown here is exactly the same as the Here is an additional article you can add name shown on your Certifcate of Reservation. on an attachment page to the ofcial articles of incorporation form to request a delayed Corporate Purpose fling date: ➋ Tere is nothing to fll in here—the ofcial Delayed Eﬀective Date. Tese Articles shall be form indicates that you are forming your withheld from fling until the following future corporation for religious purposes. Remember, date: (insert future ﬁling date here) . a religious corporation can be formed to establish a formal church or it may be formed for more general religious purposes (see Chapter 3, “Religious Purposes”). CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 121

Service of Process Incorporator’s Signature ➌ (a) & (b) Type the name and residence or You only need one person to sign your articles business address of the corporation’s initial as incorporator. Your incorporator should be agent for service of process—this is the person 18 years old or older. Typically, one of the to whom legal documents in any future lawsuit corporation’s founders signs as the incorporator. against the corporation must be sent. Te agent Insert the incorporator’s name in the blank to must be a California resident, and the address the right of the signature. After printing the must be a street address in California. Do not form, have the incorpo ator sign the form. use a post ofce box address or abbreviate the Adding information. If the ofcial form does city name, and don’t use “in care of” or “c/o.” not contain sufcient space for a response, you Also, don’t designate a corporation as an agent can add pages to the ofcial form. If you do, unless you check the state’s instructions frst on make sure to indicate how the information fts how to do this. Normally, you’ll use the name of on the ofcial form (for example, “Continuation the incorporator (see special instruction ➑) and of (or “Response to”) Item 5: ….” give the address of the corporation. You cannot Preparing your own form. If you want to modify use a post ofce box number in this address. the articles and prepare your own form, do so only after making sure your changes conform Corporate Addresses to the California Nonproft Corporation Law. ➍ (a) Insert the street address of the principal (See Chapter 11 for suggestions on doing your ofce of the corporation (not a P.O. box), which own research or fnding a lawyer to help you should be in California. make modifcations.) Also, to avoid problems, (b) If the mailing address of the corporation do not include the name of your corporation is diferent from the street address, insert the in the title of your self-prepared articles form. mailing address here. If the mailing address is Instead, follow the format of the state form and the same as the street address, insert “Same as only include the name of your corporation in a street address, above.” section on your form.

Additional Statements Delaying the Filing of Your Articles Tis form contains additional statements that You may be able to incorporate on a specifc meet the requirements for obtaining a 501(c)(3) date (to establish a particular tax year). tax exemption. Tey indicate that the organization California law allows you to request a delayed is organized and operated for religious purposes, fling date for your articles as long as this will not provide private beneft to individuals, date is no more than 90 days from the date of will not engage in substantial lobbying activities receipt of your articles by the secretary of state or intervene in political campaigns, and (the delayed date may be a weekend day or a will dedicate any assets remaining upon its holiday, but your articles must be received by dissolution to allowable 501(c)(3) purposes. the secretary of state at least one business day before the requested future fling date). 122 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 123

Here is an additional article you can add on of association board members or officer) an attachment page to the ofcial articles of of (name of unincorporated association) , incorporation form to request a delayed fling date: and that said association has approved its Delayed Effective Date. Tese Articles shall be incorporation by means of the attached Articles withheld from fling until the following future of Incorporation (in accordance with the date: (insert future filing date here) . association’s rules and procedures). Date: (date of signing) Preparing Articles for an (signature of association board member or officer) Unincorporated Association (typed name) (signature of association board member or officer) Tis section is for unincorporated associations (typed name) that want to incorporate. An unincorporated Any two ofcers (for example, a president, association is a group of people who operate a vice president, secretary, or treasurer) or any collective organization according to a formal two members of the governing board of the set of rules (such as articles of association, a unincorporated association (such as directors charter, or bylaws) and under the supervision or trustees) can sign the above declaration. of a governing board (usually directors, ofcers, State their names and positions in the blanks or similar ofcials). A typical example is an provided and, after printing the form, have unincorporated church organized and operated the two association ofcers or two association under a formal church charter and governed governing members sign in the blanks below by a board of directors or elders. Most existing the declaration. nonproft organizations are not organized as After incorporation, the corporation can fle unincorporated associations and do not need to a certifed copy of the articles in the county read this section. or counties where real property of the prior If you are incorporating a formal unincorpo- association is located. Tis fling serves as rated association of the type described above, evidence of ownership of the property by the start by preparing standard articles for a public newly-formed corporation. beneft or religious corporation as explained All rights of creditors of the association and above. Ten, prepare an attachment page to the all liens on the property of the association standard articles form. remain intact after the incorporation. Tis On the attachment page, add the following means that creditors can still look to property provisions: transferred to the new corporation to satisfy Name of Unincorporated Association. Te name creditor claims. If legal action is pending of the existing unincorporated association, now against the association at the time of its being incorporated by the fling of the attached JODPSQPSBUJPO BOZKVEHNFOUJOUIFMFHBMBDUJPO Articles of Incorporation, is (type name of will bind the corporation, and creditors can unincorporated association here) . TBUJTGZUIFJSKVEHNFOUTCZHPJOHBGUFSUIFBTTFUT Declaration. (Name of association board of the corporation that were transferred to it member or officer) and (name of association from the unincorporated association. board member or officer) declare under QFOBMUZPGQFSKVSZUIBUUIFZBSFUIF (titles 124 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Special Rules When Incorporating an Don’t Rush to File Unincorporated Association Even though fling your articles is the frst step in the process, we recommend that you Te incorporation of the association must be prepare bylaws and at least start your federal approved by the association in accordance tax exemption application before you fle your with its rules and procedures (usually at least articles with the secretary of state. Taking these a majority vote of association members is additional steps gives you the opportunity to required). A failure to obtain proper association think through your decision to incorporate approval of its incorporation could result more thoroughly. When you prepare bylaws, in legal action being taken against the new you must decide on basic organizational corporation by the previous members of the matters, such as the composition of your board unincorporated association. of directors and whether you want to set up a Once an unincorporated association becomes member ship or nonmembership structure for a corporation, the property of the association your nonproft. Having to think through some becomes the property of the corporation. Also, of these issues may lead you to rethink your if association members had any voting rights decision to incorporate. similar to those that entitle members of a When preparing your federal exemption corporation to be formal members (for example, applica tion, you might realize that your the right to vote for directors or dissolution), organiza tion will have difculty qualifying for then these association members become formal the tax exemp tion. Tere may be questions on members of the corporation (you must organize the appli cation that you didn’t anticipate or as a membership corporation). See Chapter 2 for require ments that you realize you can’t meet. a discussion of the rules and consequences of You might decide that it’s best to postpone your formal membership in a corporation. decision to form a nonproft corporation until you get tax or legal advice. Or, if preparing the GFEFSBMUBYFYFNQUJPOBQQMJDBUJPOJTKVTUUPP much trouble, you might decide to put of your File Your Articles nonproft plans for now. You might decide to form your tax-exempt nonproft corporation When you fle your articles of incorporation later when you have more enthusiasm for the with the California Secretary of State, your task (or at least a little more help). corporation becomes a legal entity. Filing your If you change your mind at this point (before articles is also the frst step along the way to fling your articles), you won’t incur any obtaining 501(c)(3) tax-exempt status, since additional cost and there won’t be additional you must include a fle-stamped copy of your work involved. On the other hand, if you rush articles of incorporation with your federal tax to fle your articles right away and then decide exemption application. Tus, your corporation you really don’t want to form a nonproft must already be in existence when you apply for corporation, it’s too late. Your nonproft legal tax-exempt status from the IRS. CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 125

entity will already be formed and you will either returned to you (and you will pay an additional have to dissolve your corporation immediately $5 certifcation fee). Te certifcation states (see “Dissolving a Nonproft Corporation,” in that the certifed copy conforms to the original Chapter 10), or you will have to prepare and articles fled with the secretary of state. When fle regular state and federal corporate income you get the certifed copy back, you will keep a tax returns each year and pay income taxes on copy as proof that your corporation was formed any revenue remaining after the payment of and is a valid legal entity (some tax and other deductible expenses. ofcial forms may require you to submit a certifed copy of your articles when you prepare CAUTION the form). You only need one certifed copy Tere’s always some uncertainty and from the secretary of state—you can make risk. Tere is no guaran tee that you will obtain additional copies of the certifed copy once you your federal income tax exemption. Without receive it from the secretary of state. this exemption, your nonprofit corporation will not obtain the benefits you undoubtedly Prepare Your Cover Letter wanted when you started this whole process (tax Prepare the cover letter to the California exemption, eligibility for grant funds, tax-deductible Secretary of State, Cover Letter for Filing contributions). But there is no way around it. Filing articles to form a nonprofit corporation is always Articles. Tis cover letter requests the secretary a bit of a gamble. All you can do is reduce the risk to fle the original articles and certify and by reading this book carefully and going through return one copy of the articles. Prepare the Chapter 8 ahead of time to get a sense of what the cover letter following the sample form and IRS expects from you to qualify for a nonprofit tax special instructions below. exemption. By reading our examples and sample tɨFQBSFOUIFUJDBMCMBOLT UIBUJT responses in that chapter, you can learn how to best “(______),” in the sample form below characterize and describe your organization’s goals indicate information that you must and programs to qualify for your tax exemption and complete on the online form. to make your nonprofit corporation a viable, tax- t3FQMBDFUIFCMBOLTJOUIFPOMJOFGPSNXJUI exempt entity. the information indicated in the sample form below. Your Filing Package Each circled number in the sample form ➊ You will need your original articles of incorpo- (such as, ) refers to a special instruction, ration for the fling package you submit to the which provides specifc information to help you California Secretary of State. Make one copy of complete an item. ➊ your articles, and place this copy in your corpo- Your incorporator who signed your articles rate records book. should prepare and sign this letter. If you have Send the original articles to the California reserved a corporate name, the person who Secretary of State. In your cover letter, you reserved the corporate name should prepare and will ask to have a certifed copy of your articles sign this cover letter. 126 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

➋ In this blank, indicate whether you are CAUTION fling articles for a public beneft or a religious Check that your fee amounts are current. corporation. Te fee for filing your articles (as well as other fees, ➌ If you decide you want additional copies of such as the charge for comparing and certifying extra your articles, change the cover letter to state the copies of the articles) changes from time to time. number of copies you want sent back to you. Be Find the latest fee information on the California sure to state if you want the copies certifed and Secretary of State’s website. change the amount of your check to cover the additional cost. ➍ If you have reserved the corporate name Te total cost for fling and obtaining one shown in your articles and are fling your certifed copy of your articles is $35. Te fling articles within 60 days of the efective date fee is $30 and there is an additional $5 fee for of your Certifcate of Reservation, type this the certifcation by the secretary of state that optional paragraph at the bottom of your cover the certifed copy conforms to the original fled letter, supplying the number and date of your articles. Staple a check payable to the California Certifcate of Reservation. Secretary of State for this amount to your cover ➎ Type your incorporator’s name under letter. You should ask for one certifed copy of the signature line and print two copies of the your articles in case you need to send a certifed cover letter. Te incorporator should sign at the copy to the IRS or another federal or state tax bottom of the letter. Make sure to place a copy agency. You can make copies of the certifed of the printed cover letter in your corporate copy you receive for your corporate records records book. book and to provide to any other institutions or agencies that request a copy of your articles. CAUTION Te secretary of state will not accept copies Check to see if online filing is available from you that you want the secretary to fle- in California before mailing your articles to the stamp or certify and return to you. Instead, you secretary of state. Te California Secretary of State must pay the secretary to make the additional has been charged with implementing an online filing copies for you. If you want additional copies service called “California Business Connect Project,” of your articles, you must pay $1 for copying which is planned to be operational by the middle of 2016. Go online to the California Secretary of State’s the frst page of each articles copy you request website to check any progress on this initiative and $.50 for any additional pages of each before you mail in your articles. If the service is articles copy. Tese copying fees apply to available, you probably will wish to use it instead of any extra copies you request, whether or not preparing and mailing paper articles to the corporate they are certifed. If you want the additional filing office. You can also check Nolo’s website (see copies certifed, you must pay an additional Appendix A for the link) for updates and instructions $5 certifcation fee for each certifed copy you on how to proceed if there are any significant request. See the California Secretary of State’s changes for filing articles in California. website for more information on fling fees and to make sure you pay the correct amount if you request additional copies. CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 127

Cover Letter to Secretary of State

(address of incorporator) ➊ (telephone number) . (date)

Secretary of State Document Filing Support Unit P.O. Box 944260 Sacramento, California 94244-2600 Dear Secretary of State: I enclose one original of the proposed articles of incorporation of (name of corporation) , a proposed California (“nonprofit public benefit” or “religious”) ➋ corporation. Please file the enclosed original articles of incorporation. After filing, please return to me, at the above address, one copy ➌ of the articles, compared and certified by your office. A check in the amount of $35, ➌ made payable to your office is also enclosed. Optional: [“Please note that above corporate name has been reserved for use by the undersigned pursuant to Reservation Certificate No. (number) , issued (date) .”] ➍

Sincerely, (signature of incorporator) _ ➎ (typed name), Incorporator 128 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

File Your Documents With When you receive your certifed copy of your the Secretary of State articles from the secretary of state, you will need to make copies for the following purposes: Mail your fling package to the Document tPOFDPQZUPNBJMUPUIF*34XJUIZPVS Filing Support Unit of the secretary of state’s federal tax exemption if you use the Sacramento ofce at the address indicated in the standard Form 1023 federal tax exemption cover letter. Your fling package should include: (instead of Form 1023-EZ, which is tPOFPSJHJOBMBSUJDMFTPGJODPSQPSBUJPO prepared and submitted online) tBDPWFSMFUUFSXJUIBDIFDLNBEFQBZBCMFUP tPOFDPQZUPCFëMFEXJUIUIFQPTUPïDF the Secretary of State, and to obtain a nonproft mailing permit (see tBTUBNQFE TFMGBEESFTTFEFOWFMPQF “Apply for a Mailing Permit,” in Chapter 9) tUXPDPQJFTUPCFëMFEXJUIUIFMPDBMUBY If You’re in a Hurry, File in Person assessor’s ofce if you wish to obtain an exemption from payment of local personal Articles can be filed in person for $15 extra and real property taxes (see “Apply for Your at the Sacramento or Los Angeles office of Property Tax Exemption,” in Chapter 9) the secretary of state. (See Appendix B for tBEEJUJPOBMDPQJFTUPCFëMFEJODPOOFDUJPO contact information.) (Always check the with any licenses or permits you wish to California Secretary of State’s website for obtain (see “Licenses and Permits,” in changes to filing fees.) When you file in person Chapter 10), and at a secretary of state office other than the tJGZPVBSFJODPSQPSBUJOHBOVOJODPSQPSBUFE Sacramento office, you must submit an extra association, one copy to be fled with the copy of your articles, which will be forwarded county recorder of each county in which to the main Sacramento office. Te processing the unincorporated association owns time for dropped off articles is approximately property (see “File Your Articles With the one month (instead of the two-month period County Recorder,” in Chapter 9). it takes to process mailed articles). You can If there are any problems, the secretary of also do an expedited filing, which is same state will usually return your articles, indicating or next day service, for substantially higher the items that need correction. Often the fees ($350–$750 and more). Expedited filing problem is technical, not substantive, and requests must be made in person at the easy to fx. If the problem is more complicated Sacramento office. For more information, (such as an improper or insufcient corporate check the secretary of state’s website. purpose clause), you may be able to solve the problem by rereading our examples and Your next step is to wait. Te secretary of state suggestions for completing the articles. If you will make sure your corporate name is available get stuck, you will need to do a little research for use and that your articles conform to law. If or obtain further help from a nonproft lawyer there are no problems, the secretary of state will with experience in drafting and fling nonproft fle your articles and return the certifed copies articles (see Chapter 11). to you. Expect to wait two to four weeks or longer before receiving the fled copies. CHAPTER 6 | CHOOSE A NAME AND FILE YOUR ARTICLES OF INCORPORATION | 129

to receive most public and private grant funds, Sign Documents on Behalf of the or assure donors that contributions made to the Corporation corporation will be tax deductible. You must Congratulations! Once your articles are ﬁled, follow through with the procedures contained your organization is a legally recognized in the succeeding chapters—doing so is vital to

nonprofit corporation. But before you rush out the success of your new corporation. to pursue your nonprofit objectives, remember that your corporation is the one that is now doing business, not you as an individual. Tis Appoint Initial means that signatures on any document, such Corporate Directors as an agreement with a vendor, application for Your next step after preparing and fling your a grant, lease, or other financial or legal form, articles of incorporation is to have your incor- must clearly show that you’re acting on behalf porator, who is the person who signed your of the corporation (and not for yourself). Your articles, appoint initial corporate directors. Tis signature should be a block of information (plus is an extremely simple step. Te incorporator a signature), which looks like this: flls in an Incorporator’s Statement to show the Parents for a Better Society, Inc. (the names and addresses of the initial directors who name of your nonprofit) will serve on the board until the frst meeting By: (your signature) for the election of directors (which will be Sarah Hovey, Director (your corporate scheduled in your bylaws). Te incorporator title, such as director, president, dates and signs the statement, types his or her secretary, and so on). name in the blank in the body of the form and under the incorporator’s signature at the If you fail to sign documents on behalf of bottom of the statement, and places a copy in the corporation and in your capacity as a the corporate records book. corporate director, officer, or employee, you To complete this step, have your incorporator are leaving yourself open to possible personal complete the “Incorporator’s Statement,” liability for corporate obligations. From now on, following the sample form and instructions it is extremely important for you to maintain below. A copy of the form is available on the the distinction between the corporation that Nolo website; see Appendix A for the link. you’ve organized and yourself. As we’ve said, the corporation is a separate legal person and Instructions you want to make sure that other organizations, ➊ Indicate the full names and business or businesses, the IRS, and the courts respect this residence addresses of your initial director(s). distinction. You can organize a public beneft corporation XJUIKVTUPOFEJSFDUPS CVUXJMMQSPCBCMZXBOU Remember that until you obtain your federal to provide for more (see Chapter 7 on preparing and state tax exemptions, your corporation bylaws for information on what the IRS likes to is liable for the payment of federal and state see). You can give the business address (usually corporate taxes. Furthermore, until you obtain the address of the corporation) or the residence your federal 501(c)(3) tax exemption and public address of each initial director. Remember, charity status, your corporation will be unable public beneft corporations must have at least 130 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Incorporator’s Statement

Te undersigned, the incorporator of (name of corporation) , who signed and ﬁled its Articles of Incorporation with the California Secretary of State, appoints the following individuals to serve as the initial directors of the corporation, who shall serve as directors until the ﬁrst meeting of directors for the election of directors and until their successors are elected and agree to serve on the board:

Initial Directors’ Names and Addresses ______➊ ______

Date: ➋ Signature: ➋ , Incorporator Typed Name of Incorporator:

two unpaid directors for each paid director, of religions corporation bylaws defne the and the two unpaid directors must be unrelated corporation’s director-quorum requirement— to the one paid director (see “Directors,” in UZQJDBMMZ BNBKPSJUZPGUIFBVUIPSJ[FEOVNCFS Chapter 2). of directors is specifed. Jump ahead at this Your bylaws will show the full number of point to Chapter 7 and skim the instructions directors who will serve on your board—this to the directors’ quorum section of the bylaws full number is called the “authorized” number to get an idea of the number of initial directors of directors of the corporation. Normally, the you need to appoint to ensure that you appoint initial directors that you appoint here in your at least a quorum of initial directors in your Incorporator’s Statement will be the same as Incorporator’s Statement (public beneft corpo- the anticipated authorized number that you rations should refer to instruction 8 for public will specify for your full board in your bylaws. beneft corporation bylaws; religious corpo- However, if you must leave a seat open at this rations should refer to special instruction 8 for time because you have not yet found all the religious corporation bylaws). right people to serve on your board, that’s ➋ Have the incorporator date and sign the okay. Just make sure that you appoint enough form, insert his or her typed name under the initial directors to meet your bylaws’ quorum signature, then place a copy in the corporate requirement. Article 3, Section 13, of nonproft records book. ● corporation bylaws and Article 3, Section 12, CHAPTER

Bylaws 7

Choose a Membership or Nonmembership Structure ...... 133 Bylaws for a Public Beneﬁt Corporation ...... 134 General Instructions ...... 134 Sample Bylaws ...... 134 Instructions for Completing Your Bylaws ...... 135 Bylaw Provisions for Schools and Federally Funded Groups ...... 143 Membership Bylaw Provisions for a Public Beneﬁt Corporation ...... 144 General Instructions ...... 144 Sample Membership Provisions ...... 145 Special Instructions ...... 145 Bylaws for a Religious Corporation ...... 150 Special Rules for Religious Corporations ...... 150 General Instructions ...... 152 Sample Bylaws ...... 152 Special Instructions ...... 153 Membership Bylaw Provisions for a Religious Corporation ...... 161 General Instructions ...... 161 Sample Membership Provisions ...... 162 Special Instructions ...... 162 132 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

our next step is to prepare your bylaws. and compensation approval provisions Tis document is, for all practical that the IRS recommends as one way to Ypurposes, your corporation’s internal comply with the IRS regulations. We also afairs manual. It sets forth the rules and pro- include a requirement that the nonproft cedures for holding meetings, electing directors contemporaneously prepare its minutes and ofcers, and taking care of other essential of meetings. You’ll see that the IRS asks corporate formalities. Specifcally, the bylaws: you if you have these provisions in place t$POUBJOJOGPSNBUJPODFOUSBMUPUIFPSHBOJ when you complete your federal income zation and operation of your corporation tax exemption application and your annual (for example, dates of meetings, quorum federal 990 returns. Although these are requirements). optional provisions, including these and t3FTUBUFUIFNPTUTJHOJëDBOUMFHBMBOE other IRS-recommended provisions in your tax provisions applicable to tax-exempt bylaws can go a long way toward making nonproft corporations. Tis is useful for your dealings with the IRS a lot easier, both your own reference and necessary to assure now and in future years. the IRS that you are eligible for these tax exemptions. RESOURCE t1SPWJEFBQSBDUJDBM ZFUGPSNBM TFUPG For an excellent guide to the type of rules for the orderly operation of your govern ance policies the IRS likes to see in an organi- corpo ration: to resolve disputes, provide zation’s bylaws, see the Panel on the Nonprofit certainty regarding procedures, and manage Sector’s Te Principles Workbook: Steering Your corporate operations. Board Toward Good Governance and Ethical Practice, t$POUBJOQSPWJTJPOTJOUFOEFEUPIFMQZPV available at www.nonprofitpanel.org. get and keep your 501(c)(3) tax exemp tion. 'PSFYBNQMF XFJODMVEFDPOìJDUPGJOUFSFTU Preparing bylaws for a nonproft corporation is not difcult. It simply involves flling in several Customizing Your Bylaws blanks in the appropriate bylaws for your group. Tere are four sets of bylaws available on this Te bylaws in this book contain standard, book’s companion web page; you’ll use the one workable provisions for running a corporation. that corresponds to your group’s purpose and Any changes to these standard provisions that follow along with us as we show you how to affect only administrative matters can be made complete the forms. Before you begin work on without researching the law. For example, your bylaws, you’ll need to decide whether your matters related to the payment of salaries, nonproft will have members. We guide you duties of officers, and composition of advisory through that issue below. or standing committees are usually left to Te bylaw sets you will choose from are: the discretion of the nonprofit corporation. t#ZMBXTGPSB1VCMJD#FOFëU/POQSPëU However, if you want to change basic legal Corporation provisions in your bylaws (such as notice or t.FNCFSTIJQ#ZMBX1SPWJTJPOTGPSB1VCMJD call of meeting rules, or voting or quorum Beneft Corporation provisions), you should check the Nonprofit t#ZMBXTGPSB3FMJHJPVT$PSQPSBUJPO BOE Corporation Law prior to making these changes t.FNCFSTIJQ#ZMBX1SPWJTJPOTGPSB or let an experienced nonprofit lawyer help you. Religious Corporation. CHAPTER 7 | BYLAWS | 133

Form 990—See What the IRS Looks for in Bylaws

Te IRS 990 annual nonprofit return and instruc- Our bylaws help you meet the first two tions reveal a lot about what the IRS likes to see recom mendations. We suggest you give thought in bylaws. By going through the form, you’ll see to adding provisions to your bylaws that address what the IRS asks about (and likes to see) in bylaws. one or more of the additional policies listed Namely, you’ll see that the IRS is interested in: above. Tis will help you meet the other good t UIFBWPJEBODFPGFYDFTTCFOFmUBOEDPOnJDUPG governance policies and practices the IRS asks interest transactions about. t UIFDPOUFNQPSBOFPVTSFDPSEJOHPGOPOQSPmU What the IRS doesn’t like to see authorized or minutes of meetings and written consents allowed in bylaws is: t JOEFQFOEFOU OPODPNQFOTBUFE CPBSENFNCFST t BTNBMMCPBSEPGEJSFDUPSTDPNQPTFEPGSFMBUFE t UIFBCJMJUZPGOPOQSPmUJOTJEFSTUPSFQPSUXSPOH people. (Even for a smaller nonprofit, four or doing (documented by a written whistle-blowing five board members looks better than just two policy) or three.) t EPDVNFOUSFUFOUJPOBOEEFTUSVDUJPO FWJEFODFE t CPBSENFNCFSTXIPBSFQBJEPSSFMBUFEUP by a written document retention and destruction paid people. If all or most of the board is paid policy), and or related to paid people in your nonprofit, t QVCMJDEJTDMPTVSFPGUIFPSHBOJ[BUJPOTFYFNQUJPO expect questions from the IRS (which will be application and annual tax returns on its website trying to determine whether your nonprofit is and/or on request by the public (through a set up to benefit the paid directors instead of written public disclosure policy). the public).

CAUTION decision. See “Membership Nonprofts,” in Don’t think of your bylaws as meaningless Chapter 2, for a discussion of the two diferent fine print. On the contrary, bylaws are crucial to the types of structures and the legal consequences functioning of your organization. Be sure to read them of setting up a membership versus a nonmem- carefully, making sure you understand the purpose bership structure. and effect of the different provisions included. Most groups want a nonmembership corporation because it is simpler to establish and operate. Nonmembership corporations are Choose a Membership or run by a board of directors, as opposed to Nonmembership Structure membership corporations, where members have UIFSJHIUUPWPUFPONBKPSDPSQPSBUFEFDJTJPOT Your frst step in preparing bylaws is to decide (the election of directors, dissolution of the whether you want your nonproft corporation corporation, sale of substantially all of the to be a membership or nonmembership corporation’s assets, or changes to the articles corpo ration. Tere are signifcant diferences or bylaws of the corporation). And you don’t between the two structures and signifcant lose any signifcant advantages by not having legal conse quences that will result from your members—most people who might want to 134 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

support your group aren’t interested in having Don’t Be Confused by References to the technical legal rights given to members. Members in Bylaw Provisions Some groups, however, will decide that the nature of their activities requires a membership Te basic public benefit corporation bylaws structure. Tis is a reasonable decision in contain references to “the members, if any,” of circumstances where membership participation the corporation, and make certain provi sions in the afairs of the nonproft corporation is applicable to the corporation only if the corpo- essential or desirable (for example, to increase ration has members. Tese provisions have no member involvement in the nonproft’s mission effect on nonmembership corporations. As a and program). practical matter, nonmembership corporations will simply approve, by normal board approval, matters that reference approval by the member- Bylaws for a Public ship of a membership corporation. Leaving Benefit Corporation in the refer ences to members simply allows member ship corporations to use the same basic All public beneft corporations start by pre- provisions as nonmembership corporations. It paring the public beneft corporation bylaws also allows nonmembership corpo rations to included with this book. Tese bylaws are for more easily amend their bylaws later if they ever any type of 501(c)(3) public beneft corporation: decide to adopt a membership structure. membership or nonmembership; and charitable, educational, scientifc, or literary (for 501(c)(3) purposes). Groups with a formal membership structure need to add special provisions to these basic public beneft corporation bylaws. t3FQMBDFUIFCMBOLTJOUIFPOMJOFGPSNXJUI California religious corporations will use a the information indicated in the sample diferent form to prepare their bylaws. form below. t&BDIDJSDMFEOVNCFSJOUIFTBNQMFGPSN General Instructions (e.g., ➊) refers to a special instruction that To prepare bylaws for a public beneft corpo- provides specifc information to help you ration, fll in the Bylaws for a Public Beneft complete an item. Corporation. You can download the bylaws t"WFSUJDBMTFSJFTPGEPUTJOUIFTBNQMF form from the Nolo website (see Appendix form below indicates a gap where we have A for the link). Follow the sample form and skipped over language in the online form. special instructions below. Here are some general instructions to help you Sample Bylaws prepare your bylaws: Te sample bylaws below are an abbreviated tɨFQBSFOUIFUJDBMCMBOLT i @@@@@@@@ wJO version of the online version that is available on the sample form indicate information that the Nolo website (see Appendix A for the link). you must complete on the form that you In the text below, we provide sample language download. and instructions for the few sections that contain blanks. CHAPTER 7 | BYLAWS | 135

Instructions for Completing In all cases, refer back to “Prepare Articles Your Bylaws of Incorporation,” in Chapter 6, and reread the sections on nonproft purposes (which you Download the Bylaws for a Public Beneft Cor- studied when preparing a statement of purposes poration from the Nolo website (see Appendix for your articles of incorporation). Tese A for the link) and follow these instructions. considerations apply here too, except that you Te numbers on the instructions correspond to don’t need (and probably don’t want) to be as the relevant place on the bylaw form. brief this time. ➊ Type the name of your corporation in the Below you’ll see an example of an expanded list heading of the bylaws. PGPCKFDUJWFTBOEQVSQPTFTUIBUBOFEVDBUJPOBM ➋ Type the name of the county where the dance group could use. Tis is the same group corporation’s principal ofce is located. Te we used when illustrating how to prepare a short principal ofce is the legal address of the statement of specifc purposes (see “Prepare corporation. If your nonproft is ever sued, most Articles of Incorporation,” in Chapter 6). of the time the lawsuit will have to be fled in the county where your principal ofce is located. Response for an Educational Group ➌ Don’t fll in the blanks in this section at ARTICLE 2 this time. Use these blanks later to change the PURPOSES principal ofce of the corporation to another SECTION 1. OBJECTIVES AND location, within the same county, by showing PURPOSES the new address and date of the address change. ɨFQSJNBSZPCKFDUJWFTBOEQVSQPTFTPG ➍ Tis section allows you to state in more this corporation shall be: EFUBJMUIFQSJNBSZPCKFDUJWFTBOEQVSQPTFTPG (a) to provide instruction in dance forms your nonproft corporation. (Remember, your such as jazz, ballet, tap, and modern statement of specifc purposes in your articles of dance; incorporation is brief.) Here you can go into as (b) to provide instruction in body much detail as you want, describing the specifc movement and relaxation art forms, purposes and activities of your corporation. such as tumbling, tai-chi, and yoga; You can be concise, but we suggest you provide (c) to give public performances in dance some detail about your organization. You forms and creative dramatics; TIPVMETUBUFZPVSNBKPSPCKFDUJWFTBOEEFTDSJCF (d) to sponsor special events involving the the activities that you plan to engage in. Doing public performance of any or all of this will give insiders a sense of certainty the above art forms as well as other regarding the specifc goals you intend to performing arts by the corporation’s achieve and the means by which you plan to performing troupe as well as by other achieve them. A more detailed statement here community performing arts groups; and will also give the IRS additional information, (e) to directly engage in and to provide which they will use to determine if the specifc facilities for others to engage in the activities you plan to engage in entitle you to promotion of the arts, generally. the necessary 501(c)(3) tax exemption. 136 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Bylaws of Name of Corporation ➊

a California Public Beneﬁt Corporation

ARTICLE 1 OFFICES SECTION 1. PRINCIPAL OFFICE Te principal oﬃce of the corporation for the transaction of its business is located in (name of county) County, California. ➋

SECTION 2. CHANGE OF ADDRESS Te county of the corporation’s principal office can be changed only by amendment of these bylaws and not otherwise. Te board of directors may, however, change the principal office from one location to another within the named county by noting the changed address and effective date below, and such changes of address shall not be deemed an amendment of these bylaws: (Fill lines in below later, if and when address changes) ➌ ______Dated: ______Dated: ______Dated: ______SECTION 3. OTHER OFFICES Te corporation may also have offices at such other places, within or without the State of California, where it is qualified to do business, as its business may require, and as the board of directors may, from time to time, designate.

ARTICLE 2 PURPOSES SECTION 1. OBJECTIVES AND PURPOSES Te primary objectives and purposes of this corporation shall be: ➍ (provide speciﬁc statement of your group’s nonproﬁt purposes and activities) ______CHAPTER 7 | BYLAWS | 137

ARTICLE 3 DIRECTORS SECTION 1. NUMBER Te corporation shall have (number of directors) ➎ directors and collectively they shall be known as the board of directors. Te number may be changed by amendment of this bylaw, or by repeal of this bylaw and adoption of a new bylaw, as provided in these bylaws. . . . SECTION 5. COMPENSATION Directors shall serve without compensation except that they shall be allowed and paid (“their actual and necessary expenses incurred in attending directors’ meetings” or state other provisions allowing reasonable compensation for attending meetings) . ➏ In addition, they shall be allowed reasonable advancement or reimbursement of expenses incurred in the performance of their regular duties as speciﬁed in Section 3 of this Article. Directors may not be compensated for rendering services to the corporation in any capacity other than director unless such other compensation is reasonable and is allowable under the provisions of Section 6 of this Article. Any payments to directors shall be approved in advance in accordance with this corporation’s conﬂict of interest policy as set forth in Article 9 of these bylaws. . . . SECTION 8. REGULAR AND ANNUAL MEETINGS Regular meetings of directors shall be held on (date) ➐ at (time) M, ➐ unless such day falls on a legal holiday, in which event the regular meeting shall be held at the same hour and place on the next business day. If this corporation makes no provision for members, then, at the annual meeting of directors held on (date) , ➐ directors shall be elected by the board of directors in accordance with this section. Cumulative voting by directors for the election of directors shall not be permitted. Te candidates receiving the highest number of votes up to the number of directors to be elected shall be elected. Each director shall cast one vote, with voting being by ballot only. . . . SECTION 13. QUORUM FOR MEETINGS A quorum shall consist of (state number or percentage, e.g., “a majority of the board of”) ➑ directors. . . . 138 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

SECTION 15. CONDUCT OF MEETINGS Meetings of the board of directors shall be presided over by the chairperson of the board, or, if no such person has been so designated or in his or her absence, the president of the corporation or, in his or her absence, by the vice president of the corporation or, in the absence of each of these persons, by a chairperson chosen by a majority of the directors present at the meeting. Te secretary of the corporation shall act as secretary of all meetings of the board, provided that, in his or her absence, the presiding officer shall appoint another person to act as secretary of the meeting. Meetings shall be governed by (“Robert’s Rules of Order” or state other rules or procedures for conduct of directors’ meeting) , ➒ as such rules may be revised from time to time, insofar as such rules are not inconsistent with or in conflict with these bylaws, with the articles of incorporation of this corporation, or with provisions of law. . . . ARTICLE 5 COMMITTEES SECTION 1. EXECUTIVE COMMITTEE Te board of directors may, by a majority vote of directors, designate two (2) or more of its members (who may also be serving as officers of this corporation) to constitute an executive committee and delegate to such committee any of the powers and authority of the board in the management of the business and affairs of the corporation, except with respect to: (a) Te approval of any action which, under law or the provisions of these bylaws, requires the approval of the members or of a majority of all of the members. (b) Te filling of vacancies on the board or on any committee which has the authority of the board. (c) Te fixing of compensation of the directors for serving on the board or on any committee. (d) Te amendment or repeal of bylaws or the adoption of new bylaws. (e) Te amendment or repeal of any resolution of the board which by its express terms is not so amendable or repealable. (f) Te appointment of committees of the board or the members thereof. (g) Te expenditure of corporate funds to support a nominee for director after there are more people nominated for director than can be elected. (h) Te approval of any transaction to which this corporation is a party and in which one or more of the directors has a material financial interest, except as expressly provided in Section 5233(d)(3) of the California Nonprofit Public Benefit Corporation Law. By a majority vote of its members then in office, the board may at any time revoke or modify any or all of the authority so delegated, increase or decrease but not below two (2) the number of its members, and fill vacancies therein from the members of the board. Te committee shall keep regular minutes of its proceedings, cause them to be filed with the corporate records, and report the same to the board from time to time as the board may require. ➓ CHAPTER 7 | BYLAWS | 139

. . . ARTICLE 8 FISCAL YEAR SECTION 1. FISCAL YEAR OF THE CORPORATION Te fiscal year of the corporation shall begin on the (day and month, e.g., “first day of January”) ⓫ and end on the (day and month, e.g., “last day of December”) ⓫ in each year. . . . ARTICLE 9 ⓬ CONFLICT OF INTEREST AND COMPENSATION APPROVAL POLICIES SECTION 1. PURPOSE OF CONFLICT OF INTEREST POLICY . . . ARTICLE 13 ⓭ MEMBERS SECTION 1. DETERMINATION OF MEMBERS ⓮ If this corporation makes no provision for members, then, pursuant to Section 5310(b) of the Nonprofit Public Benefit Corporation Law of the State of California, any action which would otherwise, under law or the provisions of the articles of incorporation or bylaws of this corporation, require approval by a majority of all members or approval by the members, shall only require the approval of the board of directors.

WRITTEN CONSENT OF DIRECTORS ADOPTING BYLAWS ⓯ We, the undersigned, are all of the persons acting as the initial directors of (name of corporation) , ⓯ a California nonproﬁt corporation, and, pursuant to the authority granted to the directors by these bylaws to take action by unanimous written consent without a meeting, consent to, and hereby do, adopt the foregoing bylaws, consisting of (number of pages) ⓯ pages, as the bylaws of this corporation.

Dated: (date) (signature of director) ⓯ (typed name) , Director

(typed name) , Director

(typed name) , Director 140 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

CERTIFICATE Tis is to certify that the foregoing is a true and correct copy of the bylaws of the corporation named in the title thereto and that such bylaws were duly adopted by the board of directors of said corporation on the date set forth below. (Fill in Certiﬁcate date and signature of secretary later, after ﬁrst board meeting) ⓰ Dated: (date) (signature of secretary) (typed name) , Secretary

➎ Indicate the total number of persons ➏ Indicate in this blank any specifc payments author ized to serve on your board. Tis that will be allowed to board members for number will usually be the same as the attend ing meetings of the board (note that number of people you’ve already indicated reasonable advancement and reimbursement of as the initial directors of the corporation in expenses for performing other director duties your Incorporator’s Statement (see Chapter 6). are allowed by this section). You can enter a However, you may at this time state a greater specifc per-meeting amount (or you can use number to allow for additional directors to be the sample language shown in the blank on elected at a future meeting of the board. Don’t the sample form above to authorize payment forget to abide by the “51% Rule,” which means of “actual and necessary” expenses incurred UIBUBNBKPSJUZPGUIFCPBSENVTUOPUCFQBJE by directors in attending board meetings). by the corporation or related to another person If, as is often the case, you do not wish to who is paid by the corporation. See “Directors,” pay directors for attending meetings, simply in Chapter 2, for more information on public type “no payments authorized” in this blank. beneft corporations and the 51% rule. Paying a director (a small amount) solely for A few groups might want to change this attending board meetings does not make a section to provide for a range of numbers of director an “interested person” for purposes of directors, with the exact number to be later the 51% rule (Corp. Code § 5227). fxed by resolution of the board of directors. For example, you might want to retype this section Payments to Directors to provide as shown in the sample below. Directors shall serve without compensation except that they shall be allowed and paid Variation on Numbers of Directors $50 for attending each meeting of the SECTION 1. NUMBER board of directors. Te corporation shall have not fewer than fve (5) nor more than eleven (11) Directors shall serve without compensation directors, with the exact number to be except that they shall be allowed and paid no payment authorized. fxed within these limits by approval of the board of directors or the members, if any, in the manner provided in these bylaws. CHAPTER 7 | BYLAWS | 141

➐ In the blanks in the frst paragraph, If this corporation makes no provision for indicate the date and time when regular members, then, at the annual meeting of meetings of the board will be held. Many directors held on the ﬁrst Friday of July, nonprofts hold regular board meetings, while directors shall be elected… others simply schedule regular meetings once Te provisions in the second paragraph of each year and call special meetings during the this section apply only to nonmembership year when required. In any case, make sure corporations. Membership corporations can to indicate in the blanks that you will hold a leave this line blank, since they will add regular board meeting at least annually. provisions to their bylaws specifying that the Responses members, not the directors, elect directors of the corporation. Regular meetings of directors shall be held ➑ A quorum (a minimum number of directors) on the ﬁrst Friday of each month at must be present at a directors’ meeting in order 9 o’clock AM… to conduct business. Indicate the number of directors who will constitute a quorum. Regular meetings of directors shall be held Although the usual practice is to provide for on the second Monday of December at BNBKPSJUZ ZPVDBODIPPTFBMBSHFSPSTNBMMFS 1 o’clock PM… number. However, you cannot choose a quorum Regular meetings of directors shall be held of less than one-ffth of the authorized number July 1 and February 20 of directors (the number given in special on at ➎ 9 o’clock AM… instruction , above), or two, whichever is larger. Of course, one-director corporations can In the second paragraph of this section, fll and will provide for a quorum of one director. in the blank to indicate which one of your For example, a seven-director corporation regular board meetings will be specifed as the can’t provide for a quorum of fewer than two annual regular meeting of the board to elect directors, while a 15-director corporation must (or reelect) directors of your corporation. In have at least a three-director quorum. a nonmembership corporation, the directors Whatever number or percentage you decide vote for their own reelection or replacements, on, you should realize that this section of with each director casting one written vote. the bylaws concerns a quorum, not a vote Of course, if a corporation has provided for requirement. A meeting can be held only if at only one regular meeting each year in the frst least a quorum of directors is present, but a vote paragraph of this section, then the date of this on any matter before the board must, generally, regular meeting will be repeated in this blank CFQBTTFECZUIFWPUFPGBNBKPSJUZPGUIPTF as the date of the annual meeting of directors. present at the meeting.

Responses for Annual Meeting Date EXAMPLE: If a public beneft corporation with seven directors provides for a minimum If this corporation makes no provision for RVPSVNPGUXP BOEKVTUUXPEJSFDUPST members, then, at the annual meeting of hold a meeting, action can be taken by the directors held on January 1, directors shall unanimous vote of these two directors. be elected… However, if all seven directors attend the 142 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

meeting, action must be approved by at least cate the beginning and ending dates of the GPVSEJSFDUPST BNBKPSJUZPGUIPTFQSFTFOUBU corporation’s fscal year in this space. You can the meeting). choose the calendar year from January 1 to December 31, which most nonprofts do. Or, Many public beneft corporations will want a you can use what the IRS considers a true fscal MFTTUIBONBKPSJUZRVPSVNSVMFɨFSFBTPOJT year, consisting of a 12-month period ending on CFDBVTFUIFTFDPSQPSBUJPOTNVTUIBWFBNBKPSJUZ the last day of any month other than December of “disinterested” directors on their board. (for example, from July 1 to June 30). Sometimes, corporations have difculty getting ⓬ Article 9 of the bylaws included in this nonsalaried directors to attend board meetings book contains rules and procedures for approv- on a regular basis. A lower quorum requirement JOHPSBWPJEJOHDPOìJDUPGJOUFSFTUUSBOTBDUJPOT can help ensure that enough directors for a including compensation arrangements, between quorum will be present at meetings. your nonproft and its directors, ofcers, ➒ In this blank, indicate the rules of order employees, contractors, and others. Tis bylaw that will be used at directors’ meetings. Most QSPWJTJPODPOUBJOTUIFDPOìJDUTPGJOUFSFTU nonprofts specify Robert’s Rules of Order here, language recommended by the IRS (included but you may choose any set of procedures for JOUIFTBNQMFDPOìJDUPGJOUFSFTUQPMJDZJO proposing, approving, and tabling motions. Appendix A of the instructions to IRS Form With a small board, you can leave this line 1023). It also contains language for the approval blank if you see no need to specify formal of compensation arrangements that attempts to procedures for introducing and discussing items comply with the safe harbor provisions of the of business at your board meetings. excess beneft rules (see the discussion on the ➓ Tis section follows a state law provision excess beneft rules in “Limitation on Profts that allows the board of a public beneft and Benefts,” in Chapter 3). You will need to corporation to set up an executive committee become familiar with this provision, and make of the board consisting of board members only. sure you are comfortable with its procedures Te law allows the executive committee to for the approval and review of fnancial trans- have much of the management power of the actions with, and salary and other compen- full board (as specifed in this section of the sation paid to, your directors, ofcers, and bylaws). Although at least two board members PUIFSTXIPBSFJOBQPTJUJPOUPJOìVFODFZPVS must serve on this committee, in practice, most nonproft. If you decide to make changes to nonproft corporations establish an executive this provi sion, do so only after reading “Prepare board committee of from three to fve board Your Tax Exemption Application,” instructions members. Of course, you don’t have to set up to Part V, in Chapter 8, where we refer to an executive committee of the board, and you this bylaw provision when providing sample can set up other types of committees with or responses to question on the application. If you without board members (see Section 2 of this make any changes, you will need to create your Article in the bylaws). own responses to some of the questions on the ⓫ Te fscal year of the corporation is the 501(c)(3) application. period for which the corporation keeps its ⓭ Te last portion of the basic bylaws books (its accounting period), and will deter- (Article 13, Written Consent of Directors, and mine the corporation’s tax year for purposes the Certi fcate section) is for nonmembership of fling certain tax returns and reports. Indi- groups only. Membership public beneft CHAPTER 7 | BYLAWS | 143

corporations do not need to fll in and use this see the discussion on Part III in “Prepare Your last portion of the basic bylaws—we show you Tax Exemption Application,” in Chapter 8. how to add membership provisions to complete your bylaws, below. Participants in Federal Programs ⓮ Section 1 of Article 13 makes it clear that If your nonproft corporation plans to receive the directors of nonmembership corporations federal or other public grants or money, some can take the place of members in taking any funding agencies may require that you include action that, under law, otherwise requires provisions in your bylaws stating that no board member ship approval. In other words, the member, ofcer, or other person exercising directors can act in place of the members in supervisory power in the corporation, or any of nonmembership corporations. their close relatives, can beneft from the receipt ⓯ Fill in the Written Consent of Directors of grant funds. Generally, provisions of this sort paragraph, showing the name of the corpora- are meant to prohibit board members, ofcers tion and the number of pages in your fnal (president, vice president, secretary, treasurer), bylaws. Type your directors’ names (the initial and their families from being paid from, or directors appointed by your incorporator (see directly benefted by, grant monies given to the Chapter 6)) below the signature lines. After organization. printing and dating the form, have each initial director sign the form. TIP ⓰ Don’t fll in the blanks following the If you plan to receive grant funds from Certifcate at the bottom of the bylaws at this government or other public sources, ask the time. Your corporate secretary will complete funding agency for the exact language of any these blanks after the frst meeting of your special provisions that you should include in your board. bylaws. In many cases, you won’t want to provide for payment of directors or officers and should Bylaw Provisions for Schools delete or modify Article 3, Sections 5 and 6; Article and Federally Funded Groups 4, Section 10; and Article 11, Section 1, of the bylaws we provide. Some groups may need to add language or make other modifcations to the bylaws we State Audit Requirements for Nonprofits provide. Here are three examples: schools, With Revenues of $2 Million or More federally funded groups, and larger public Public beneft nonprofts with annual gross beneft groups (with annual gross revenues of revenues of $2 million or more may wish to add $2 million or more). BVEJUQSPWJTJPOTUPUIFJSCZMBXTUPSFìFDUTQFDJBM Schools requirements under the California Nonproft Integrity Act of 2004 that apply to them. Tese If your nonproft activities will consist of audit rules generally do not apply to schools or operat ing a formal school, you will need to hospitals, and the $2 million threshold doesn’t add an article to the sample bylaws consisting include grants received from government of a “nondiscriminatory policy statement.” agencies if the nonproft must provide an For information on the applicability of this accounting of how it uses the governmental statement to your group and how to prepare it, grant funds. However, if your nonproft falls 144 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA within the scope of these rules, you may want Membership Bylaw to include provisions in your bylaws that cover these requirements. Provisions for a Public Here is a brief summary of the “larger non- Benefit Corporation proft” audit rules under the Act: tɨFOPOQSPëUNVTUQSFQBSFBVEJUFEBOOVBM Tis section applies only to membership fnancial statements, which it must submit corporations and shows how to add special to the attorney general and make available membership provisions to the basic public for public inspection. beneft corporation bylaws. If you have decided tɨFOPOQSPëUCPBSENVTUBQQPJOUBO to form a nonmembership public beneft audit committee that (1) helps hire and set corporation, this section does not apply to you the compensation of the auditors (CPAs) and you should skip ahead to the next chapter. that prepare the organization’s fnancial statements, (2) reviews the organization’s General Instructions audited statements, and (3) reports to the To add membership provisions to your public board its fnding as to whether the non- beneft corporation bylaws, fll in the blanks proft’s fnancial afairs and fnancial in the membership provisions fle included statements are in order. with this book, following the sample form and tɨFBVEJUDPNNJUUFFDBOOPUJODMVEFTUBê instructions below. Once completed, copy these members, the president or chief executive membership provisions to your basic bylaws as ofcer, the treasurer, or the chief fnancial explained in special instruction ➊ below. ofcer of the nonproft. If an organization tɨFQBSFOUIFUJDBMCMBOLT i @@@@@@@@ wJO has a fnance committee, members of the sample form below indicate information that committee may serve on the audit you must complete on your form. committee, but cannot make up 50% or t3FQMBDFUIFCMBOLTJOUIFGPSNZPVdownload more of the audit committee. with the information indicated in the sample To learn more about the California Nonproft form below. Integrity Act of 2004: t&BDIDJSDMFEOVNCFSJOUIFTBNQMFGPSN GPS t(PUPUIF$BMJGPSOJB"UUPSOFZ(FOFSBMT instance, ➊) refers to a special instruction website and in the search box type that provides specifc information to help “Summary of New Law: Nonproft you complete an item. Te special instruc- Integrity Act of 2004.” tions immediately follow the sample form. t5PSFBEUIFTFDUJPOTPG$BMJGPSOJBMBX t"WFSUJDBMTFSJFTPGEPUTJOUIFTBNQMFGPSN amended or added by the Act, go to http:// indicates a gap where we have left out some leginfo.legislature.ca.gov. Select and read of the language. Tis is an abbreviated under California Law, Government Code version of the complete form. Sections 12581, 12582, 12583, 12584, 12585, 12586, 12599, 12599.1, 12599.3, 12599.6, and 12599.7, and Business and Professions Code Section 17510.5. CHAPTER 7 | BYLAWS | 145

Sample Membership Provisions directors’ meeting (you might make it slightly before the annual directors’ meeting). Below is an example of membership provisions ➏ Type the date and time of any regular that a nonproft with members might use. Don’t meetings of members. Many nonprofts will be alarmed by the short size of the sample—it’s leave this line blank and decide to provide an abbreviated version of the form, with sample only for the annual meeting of members in language and instructions only for the sections their bylaws (in the previous paragraph). Tose on the form that contain blanks. with a more active membership will indicate Special Instructions monthly or semiannual regular meetings of members here. ➊ After completing these membership provi- ➐ You can set the quorum requirement for sions, add them to your basic bylaws—this members’ meetings at any number, whether material replaces Article 13, the Written HSFBUFSPSMFTTUIBOBNBKPSJUZ)PXFWFS BT Consent, and the Certifcate sections and indicated in the last paragraph of this section, signature lines at the end of your basic bylaws if your public beneft corporation sets a quorum that you prepared above. at less than one-third of the voting power and ➋ Use this blank to indicate any special quali - less than one-third of the members actually fcations required for members (for example, attend a meeting, then no action may be taken over the age of 18 or currently enrolled students at the meeting unless the notice of the meeting in a school’s curriculum). Be careful here. Te stated the general nature of the proposals to IRS likes 501(c)(3) tax-exempt corporations to be acted upon. Fixing a quorum at less than have an open-admissions policy for members, one-third of the voting power, therefore, can and for membership in the corporation to be make matters more complicated. Te normal open to the general public. As a result, most rule is that any action may be taken at a regular public beneft corporations don’t specify any members’ meeting, whether or not it was stated qualifcations for membership (see the suggested in the notice of the meeting (see Subsection (c) wording in the blank on the sample form). of this article in the computer form). In any ➌ Most public beneft corporations do not case, it’s a good idea to have at least a one-third require formal application for membership in quorum to help make members’ meetings more the corporation. However, some will indicate representative of the entire membership. that members must pay an admission fee and/or ➑ Indicate whether the corporation will allow annual dues prior to acceptance as a member in proxy voting by members. (A proxy is simply the corporation (see the suggested wording in a written authorization by a member allowing the blank on the sample form). another person to vote for the member.) Many ➍ Indicate the manner of determining, or small membership corporations decide that the amount of, admission fees and/or annual proxy voting will not be permitted, which dues for members in the appropriate blanks avoids problems and complications that (see the suggested wording in the blanks on can arise in times of controversy or difcult the sample form). decisions, such as proxy wars or solicitations of ➎ Indicate the date and time of the annual proxies by outside or competing interests. meeting of members. Te members elect If you decide to allow proxies, the restrictions directors at this annual meeting. You may relating to proxies contained in the next wish to coordinate this date with your annual sections of this article will apply. 146 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Membership Provisions of (name of corporation) a California Public Beneﬁt Corporation

ARTICLE 13 ➊ MEMBERS SECTION 1. DETERMINATION AND RIGHTS OF MEMBERS Te corporation shall have only one class of members. No member shall hold more than one membership in the corporation. Except as expressly provided in or authorized by the articles of incorporation or bylaws of this corporation, all memberships shall have the same rights, privileges, restrictions, and conditions.

SECTION 2. QUALIFICATIONS OF MEMBERS Te qualifications for membership in this corporation are as follows: (specify qualifications or, if none, type “Any person is qualified to become a member of this corporation”) . ➋

SECTION 3. ADMISSION OF MEMBERS Applicants shall be admitted to membership (state procedure, e.g., “on making application therefor in writing” and indicate if payment will be required, e.g., “and upon payment of the application fee and/or ﬁrst annual dues, as speciﬁed in the following sections of this bylaw”) . ➌

SECTION 4. FEES, DUES, AND ASSESSMENTS (a) Te following fee shall be charged for making application for membership in the corporation: (state speciﬁc admission fee or leave to discretion of board, e.g., “in such amount as may be speciﬁed from time to time by resolution of the board of directors charged for, and payable with, the application for membership,” or, if no fee, type “None”) . ➍ (b) Te annual dues payable to the corporation by members shall be (state amount of annual dues, leave to discretion of board, e.g., “in such amount as may be determined from time to time by resolution of the board of directors,” or type “None”) . ➍ (c) Memberships shall be nonassessable. . . . CHAPTER 7 | BYLAWS | 147

ARTICLE 14 MEETINGS OF MEMBERS SECTION 1. PLACE OF MEETINGS Meetings of members shall be held at the principal oﬃce of the corporation or at such other place or places within or without the State of California as may be designated from time to time by resolution of the board of directors.

SECTION 2. ANNUAL AND OTHER REGULAR MEETINGS Te members shall meet annually on (date, e.g., “the first Monday of July, September 30”) ➎ in each year, at (time) _M, ➎ for the purpose of electing directors and transacting other business as may come before the meeting. Cumulative voting for the election of directors shall not be permitted. Te candidates receiving the highest number of votes up to the number of directors to be elected shall be elected. Each voting member shall cast one vote, with voting being by ballot only. Te annual meeting of members for the purpose of electing directors shall be deemed a regular meeting and any reference in these bylaws to regular meetings of members refers to this annual meeting. Other regular meetings of the members shall be held on (date) ,➏ at (time) M.➏ If the day fixed for the annual meeting or other regular meetings falls on a legal holiday, such meeting shall be held at the same hour and place on the next business day. . . . SECTION 5. QUORUM FOR MEETINGS A quorum shall consist of (state percentage, which may be more or less than a majority) ➐ of the voting members of the corporation. Te members present at a duly called and held meeting at which a quorum is initially present may continue to do business notwithstanding the loss of a quorum at the meeting due to a withdrawal of members from the meeting provided that any action taken after the loss of a quorum must be approved by at least a majority of the members required to constitute a quorum. In the absence of a quorum, any meeting of the members may be adjourned from time to time by the vote of a majority of the votes represented in person or by proxy at the meeting, but no other business shall be transacted at such meeting. When a meeting is adjourned for lack of a sufficient number of members at the meeting or otherwise, it shall not be necessary to give any notice of the time and place of the adjourned meeting or of the business to be transacted at such meeting other than by announcement at the meeting at which the adjournment is taken of the time and place of the adjourned meeting. However, if after the adjournment a new record date is fixed for notice or voting, a notice of the adjourned meeting shall be given to each member who, on the record date for notice of the meeting, is entitled to vote at the meeting. A meeting shall not be adjourned for more than forty-five (45) days. 148 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Notwithstanding any other provision of this Article, if this corporation authorizes members to conduct a meeting with a quorum of less than one-third (⅓) of the voting power, then, if less than one-third (⅓) of the voting power actually attends a regular meeting, in person or by proxy, then no action may be taken on a matter unless the general nature of the matter was stated in the notice of the regular meeting. . . . SECTION 8. PROXY VOTING Members entitled to vote (type “shall” or “shall not”) ➑ be permitted to vote or act by proxy. If membership voting by proxy is not allowed by the preceding sentence, no provision in this or other sections of these bylaws referring to proxy voting shall be construed to permit any member to vote or act by proxy. If membership voting by proxy is allowed, members entitled to vote shall have the right to vote either in person or by a written proxy executed by such person or by his or her duly authorized agent and filed with the secretary of the corporation, provided, however, that no proxy shall be valid after eleven (11) months from the date of its execution unless otherwise provided in the proxy. In any case, however, the maximum term of any proxy shall be three (3) years from the date of its execution. No proxy shall be irrevocable and may be revoked following the procedures given in Section 5613 of the California Nonprofit Public Benefit Corporation Law. If membership voting by proxy is allowed, all proxies shall state the general nature of the matter to be voted on and, in the case of a proxy given to vote for the election of directors, shall list those persons who were nominees at the time the notice of the vote for election of directors was given to the members. In any election of directors, any proxy which is marked by a member “withhold” or otherwise marked in a manner indicating that the authority to vote for the election of directors is withheld shall not be voted either for or against the election of a director. If membership voting by proxy is allowed, proxies shall afford an opportunity for the member to specify a choice between approval and disapproval for each matter or group of related matters intended, at the time the proxy is distributed, to be acted upon at the meeting for which the proxy is solicited. Te proxy shall also provide that when the person solicited specifies a choice with respect to any such matter, the vote shall be cast in accordance therewith.

SECTION 9. CONDUCT OF MEETINGS Meetings of members shall be presided over by the chair of the board, or, if there is no chairperson, by the president of the corporation or, in his or her absence, by the vice president of the corporation or, in the absence of all of these persons, by a chair chosen by a majority of the voting members, present in person or by proxy. Te secretary of the corporation shall act as secretary of all meetings of members, provided that, in his or her absence, the presiding oﬃcer shall appoint another person to act as secretary of the meeting. CHAPTER 7 | BYLAWS | 149

Meetings shall be governed by (type “Robert’s Rules of Order” or indicate other rules or procedures) , ➒ as such rules may be revised from time to time, insofar as such rules are not inconsistent with or in conﬂict with these bylaws, with the articles of incorporation of this corporation, or with any provision of law. . . . WRITTEN CONSENT OF DIRECTORS ADOPTING BYLAWS We, the undersigned, are all of the persons acting as the initial directors of (name of corporation) , ➓ a California nonproﬁt corporation, and, pursuant to the authority granted to the directors by these bylaws to take action by unanimous written consent without a meeting, consent to, and hereby do, adopt the foregoing bylaws, consisting of (number of pages) ➓ pages, as the bylaws of this corporation.

Date: ______

(signatures of director(s)) ➓ (typed name) , Director ______, Director ______, Director ______, Director ______, Director . . . CERTIFICATE Tis is to certify that the foregoing is a true and correct copy of the bylaws of the corporation named in the title thereto and that such bylaws were duly adopted by the board of directors of said corporation on the date set forth below. (Fill in Certiﬁcate date and signature of secretary later, after ﬁrst board meeting) ⓫ Dated: (date) (signature of secretary) (typed name) , Secretary 150 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

➒ Indicate, if you wish, the sets of rules that irrespective of the name or names by which will govern for proposing and taking action at such rules are designated.” In essence, the state your membership meetings. Robert’s Rules of recognizes that religions are often governed by Order is the standard, of course, but you may canons or other ecclesiastical documents instead specify another set of procedures or “none” if of bylaws. you wish to run your membership meetings loosely and informally. Special Rules for Religious ➓ Fill in the Written Consent of Directors Corporations paragraph, showing the name of the corpo- Te law that applies to religious corporations is ration and the number of pages in your fnal DPOTJEFSBCMZNPSFìFYJCMFBOEMJCFSBMUIBOUIF bylaws. Type your directors’ names (the initial law that applies to other nonproft corporations. directors appointed by your incorporator—see Tis is particularly true with respect to the Chapter 6) below the signature lines. After form and content of a religious corporation’s printing and dating the form, have each initial bylaws, which set forth the general operating director sign the form. rules for a corporation. Te state is reluctant ⓫ Do not fll in the blanks following the to get overly involved in this aspect of a Certifcate at the bottom of the bylaws at this religious corporation’s afairs because of the time. Your corporate secretary will complete these constitutional protections aforded religions, the blanks after the frst meeting of your board. inappropriateness of state intrusion into most You’re almost done! Replace the correspond- religious disputes, and the wide diversity of ing sections of your basic bylaws (Article 13 religious activities. (See the California Attorney through the end of the bylaws) with these General’s Guide for Charities, which contains completed membership provisions. Now turn a statement regarding the attorney general’s UP$IBQUFSGPSUIFOFYUTUFQJOZPVSKPVSOFZ overall “hands-of” policy with respect to toward nonproft status. oversight of religious corporations.)

Bylaws for a Religious State Law Will Apply by Default While the Nonproft Religious Corporation Corporation Law provides certain fundamental rules regard- To form a religious corporation, you need ing the operation of religious corpo rations, special religious corporation bylaws or some many of these rules apply only if the corpo- other similar document that sets forth the ration’s own canons or bylaws do not provide ground rules for your corporation. Te reason otherwise. In general, in areas most likely to we mention a “similar document” is that the involve doctrinal matters and First Amendment law governing religious corporations (Section rights, such as membership meetings and 9150 of the Nonproft Religious Corporation member voting, religious corporations are given Law) defnes the bylaws of religious corpora- UIFNPTUìFYJCJMJUZGPSFTUBCMJTIJOHUIFJSPXO tions as “the code or code of rules used, rules. See “Religious Purposes,” in Chapter 3, adopted, or recognized for the regulation or GPSNPSFPOUIFìFYJCJMJUZBêPSEFESFMJHJPVT management of the afairs of the corporation corporations in general. CHAPTER 7 | BYLAWS | 151

Directors’ Terms and Meetings such as lawyers and accountants, when making Religious corporations can set their own rules business and fnancial decisions. Directors regarding the terms of ofce, election, selection, in religious corporations can also rely on designation, removal, and resignation of direc- information provided by religious authorities, UPST4VCKFDUUPBGFXFYDFQUJPOT SFMJHJPVT ministers, priests, rabbis, or other people whose corpo rations can also set their own rules about positions or duties in the religious organization calling, noticing, and holding meetings of UIFEJSFDUPSTCFMJFWFKVTUJGZUIFJSSFMJBODFBOE members or obtaining the approval of members. confdence in them. Tis more lenient duty of "TNFOUJPOFEBCPWF JGBOZPGUIFTFTVCKFDUTBSF care for religious corporations also applies to not dealt with specifcally in a religious corpo- decisions relating to compensation for directors, ration’s bylaws, then the rules set forth in the loans to directors, guaranties of obligations Nonproft Religious Corporation Law will apply. of directors, and management of corporate You may remember from your reading of investments. By contrast, for public beneft Chapter 2 that public beneft corporations corporations, loans or guaranties to directors BSFTVCKFDUUPUIFSVMF XIJDISFRVJSFTBU usually must be approved by the attorney least 51% of the board to be “disinterested” general and there are stricter standards for (not paid for performing services other than managing corporate investments. See Chapter 2 as directors or related to any paid persons). for more on directors’ duty of care. Unlike public beneft corporations, all of the Te rules regarding the approval of self- directors of a religious corporation can, if they dealing transactions for religious corporations wish, also serve as salaried ofcers, employees, (a transaction in which a director has a material or independent contractors of the corporation. fnancial interest, and that hasn’t been properly (See Chapter 2 for a discussion of public beneft approved by the board or a committee) are corporations and the 51% rule.) generally the same as those that apply to public beneft corporations, except for loans and Directors’ Duty of Care guaranties to directors, as mentioned above. However, directors of religious corporations can Te general standard of conduct (“duty of take into account the religious purposes of the care”) for directors of religious corporations is corporation when considering approval of a self- similar to the standard that applies to public dealing transaction. beneft corporation directors. Directors must act responsibly and in the best interests of Membership Inspection Rights the corporation. (See Chapter 2 for discussion about duty of care.) Te duty of care for reli gious In public beneft corporations, members have corporation directors is more lenient, however, the right to inspect the corporation’s member- because religious corporation directors can s hip list, fnancial books, and records of take into account the religious purposes of the members’ and board meetings. For religious corporation and its religious tenets, canons, laws, nonprofts, these membership inspection rights policies, and authority when making decisions. may be limited or totally eliminated by the In a public beneft corporation, directors can corpo ration’s bylaws. Tis is an area where the rely on business and fnancial reports prepared state felt it was inappropriate—or perhaps, or presented by ofcers, employees, and experts, unconstitutional—to require broad inspection 152 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

rights or fnancial disclosure of corporate afairs a formal membership structure should start to members. In the absence of any limi ta tion on by preparing the basic religious corporation inspection rights, members of religious corpo- bylaws, then add the membership provisions as rations have basically the same right to inspect explained below. as members of a public beneft corporation. To prepare bylaws for a religious corporation (member or nonmember), download and fll in Attorney General Supervision the bylaws for a religious corporation following Te Nonproft Religious Corporation Law man- the sample form and special instructions below. dates a hands-of policy by the attorney general Here are some general instructions to help you toward religious corporations, except to the prepare your bylaws: extent the attorney general is empowered to act tɨFQBSFOUIFUJDBMCMBOLT i @@@@@@@@ wJO in the enforcement of the criminal laws. A few the sample form below indicate information exceptions are also provided for the attorney that you must complete on your form. general to step in based on the authority of the t3FQMBDFUIFCMBOLTJOUIFGPSNXJUIUIF Religious Corporation Law. (See the Cali fornia information indicated in the sample form Attorney General’s Guide for Charities, which below. contains a statement regarding the attorney t&BDIDJSDMFEOVNCFSJOUIFTBNQMFGPSN GPS general’s overall hands-of policy with respect to example, ➊) refers to a special instruction oversight of religious corporations.) that provides specifc information to Te California Attorney General’s traditional help you complete an item. Te special role of enforcing the charitable trust theory instructions follow the sample form. has, since 1980, been severely curtailed. A t"WFSUJDBMTFSJFTPGEPUTJOUIFTBNQMF charitable trust, under Section 9142 of the form below indicates a gap where we have Religious Corporation Law, is deemed to skipped over parts of the form. exist only under certain narrowly defned conditions. Moreover, the attorney general’s Sample Bylaws ofce is, for the most part, prohibited from Te sample bylaws below are an abbreviated enforcing the terms of any implied or express version of the complete form available on the trust (except with respect to certain property Nolo website. In the sample bylaws, we provide received by the corporation for a specifc sample language and instructions for the few QVSQPTFGSPNUIFHFOFSBMQVCMJD BHBJOTVCKFDU sections that contain blanks. to further restrictions; see Section 9230). Many of you will want to take advantage PGUIFìFYJCJMJUZBMMPXFEVOEFSUIF/POQSPëU General Instructions Religious Corporation Law and add customized Te bylaws for a religious corporation included provisions to these basic bylaws, tailoring them with this book are basic, nonmembership religious to your organization’s specifc operating proce- corporation bylaws with standard provisions dures. If you do this, make sure your changes from the Nonproft Religious Corporation Law. conform to law. Review the legal provisions Nonmembership religious corporations can use of the Nonproft Religious Corporation Law these bylaws “as is.” Religious corporations with (Sections 9110 through 9690 of the Nonproft CHAPTER 7 | BYLAWS | 153

Corporation Law). You can read these provi sions give the IRS additional information it will use online at the California Legislative Information to determine if the specifc activities you plan to website (http://leginfo.legislature.ca.gov). Under engage in entitle you to the necessary California Law, go to Corporations Code— 501(c)(3) tax exemption. (See “Prepare Articles CORP. Under Title 1. Corporations, you will of Incorporation,” in Chapter 6, for examples of fnd Nonproft Religious Corporations in sample responses by nonreligious groups.) Division 2, Part 4 (Section 9110–9690). You ➎ Indicate the total number of persons can also examine the law at a local county law authorized to serve on your board. Most of library. You can also ask a lawyer to make sure the time, this number will be the same as the your variations are allowable (it shouldn’t take number of people you’ve already indicated the lawyer more than one or two hours to check as the initial directors of the corporation in the bylaws against the statutes). your Incorporator’s Statement (see Chapter 6). However, you may state a greater number Special Instructions to allow for additional directors who will be Here are the instructions to fll in the blanks in elected at a future meeting of the board. the standard religious corporation bylaws: For information on providing for a variable ➊ Type the name of your corporation in the number of directors, see “Bylaws for a Public heading of the bylaws. Beneft Nonproft Corporation,” above, special ➎ ➋ Type the name of the county where the instruction . ➏ corporation’s principal ofce is located. Te Use this blank if you wish to pay your principal ofce is the legal address of the directors a per-meeting fee or other compen- corporation and, if your nonproft is sued, will sation arrangement (such as a yearly payment) usually be the county where the lawsuit must be for attending board meetings. If, as is often brought. the case, you do not wish to pay directors for ➌ Don’t fll in the blanks in this section at attending meetings, simply type “no payments this time. You may want to use these blanks authorized” in this blank. Te last sentence later to change the principal ofce of the allows the corporation to advance or reimburse corporation to another location, within the directors for actual expenses they incur in same county, by showing the new address and attending meetings (gas, tolls, and the like) and date of the address change. for performing other director duties. ➐ ➍ Tis section allows you to state in more In the blanks in the frst paragraph, EFUBJMUIFQSJNBSZPCKFDUJWFTBOEQVSQPTFTPG fll in the date when the board will hold its your religious corporation (remember, your regular meetings. It’s not uncommon to hold statement of specifc purposes in your articles regular board meetings, while others simply of incorporation should have been brief). Here schedule regular meetings once each year (and you can go into as much detail as you want, call special meetings during the year when describing the religious purposes and activities required). In any case, make sure to indicate of your corporation. You can be brief here if that you will hold a regular board meeting at you want, but a more detailed statement will least annually. 154 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Bylaws of (Name of Corporation) ➊ a California Religious Corporation

ARTICLE 1 OFFICES SECTION 1. PRINCIPAL OFFICE Te principal oﬃce of the corporation for the transaction of its business is located in (name of county) County, California.➋

(Fill lines in below later, if and when address changes) ➌ ______Dated: ______Dated: ______Dated: ______SECTION 3. OTHER OFFICES Te corporation may also have offices at such other places, within or without the State of California, where it is qualified to do business, as its business may require and as the board of directors may, from time to time, designate. ARTICLE 2 PURPOSES SECTION 1. OBJECTIVES AND PURPOSES Te primary objectives and purposes of this corporation shall be: ➍ (provide specific statement of your group’s nonprofit purposes and activities) ______CHAPTER 7 | BYLAWS | 155

ARTICLE 3 DIRECTORS SECTION 1. NUMBER Te corporation shall have (number of directors) ➎ directors and collectively they shall be known as the board of directors. Te number may be changed by amendment of this bylaw, or by repeal of this bylaw and adoption of a new bylaw, as provided in these bylaws. . . . SECTION 5. COMPENSATION Directors shall serve without compensation except that they shall be allowed and paid (“their actual and necessary expenses incurred in attending directors’ meetings” or state other provisions allowing reasonable compensation for attending meetings) . ➏ In addition, they shall be allowed reasonable advancement or reimbursement of expenses incurred in the performance of their regular duties as speciﬁed in Section 3 of this Article. Any payments to directors shall be approved in advance in accordance with this corporation’s conﬂict of interest policy set forth in Article 9 of these bylaws. . . . SECTION 7. REGULAR AND ANNUAL MEETINGS Regular meetings of directors shall be held on (date) ➐ at (time) M,➐ unless such day falls on a legal holiday, in which event the regular meeting shall be held at the same hour and place on the next business day. If this corporation makes no provision for members, then, at the annual meeting of directors held on (date) , ➐ directors shall be elected by the board of directors in accordance with this section. Cumulative voting by directors for the election of directors shall not be permitted. Te candidates receiving the highest number of votes up to the number of directors to be elected shall be elected. Each director shall cast one vote, with voting being by ballot only. . . . SECTION 12. QUORUM FOR MEETINGS A quorum shall consist of (state number or percentage, e.g., “a majority of the Board of”) ➑ directors. . . . 156 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

SECTION 14. CONDUCT OF MEETINGS Meetings of the board of directors shall be presided over by the chairperson of the board, or, if no such person has been so designated or in his or her absence, the president of the corporation or, in his or her absence, by the vice president of the corporation or, in the absence of each of these persons, by a chairperson chosen by a majority of the directors present at the meeting. Te secretary of the corporation shall act as secretary of all meetings of the board, provided that, in his or her absence, the presiding officer shall appoint another person to act as secretary of the meeting. Meetings shall be governed by (“Robert’s Rules of Order” or state other rules or procedures for conduct of directors’ meeting) , ➒ as such rules may be revised from time to time, insofar as such rules are not inconsistent with or in conflict with these bylaws, with the articles of incorporation of this corporation, or with provisions of law. . . . ARTICLE 5 COMMITTEES SECTION 1. EXECUTIVE COMMITTEE Te board of directors may, by a majority vote of directors, designate two (2) or more of its members (who may also be serving as officers of this corporation) to constitute an executive committee and delegate to such committee any of the powers and authority of the board in the management of the business and affairs of the corporation, except with respect to: (a) Te approval of any action which, under law or the provisions of these bylaws, requires the approval of the members or of a majority of all of the members. (b) Te filling of vacancies on the board or on any committee which has the authority of the board. (c) Te fixing of compensation of the directors for serving on the board or on any committee. (d) Te amendment or repeal of bylaws or the adoption of new bylaws. (e) Te amendment or repeal of any resolution of the board which by its express terms is not so amendable or repealable. (f) Te appointment of committees of the board or the members thereof. By a majority vote of its members then in office, the board may at any time revoke or modify any or all of the authority so delegated, increase or decrease but not below two (2) the number of its members, and fill vacancies therein from the members of the board. Te committee shall keep regular minutes of its proceedings, cause them to be filed with the corporate records, and report the same to the board from time to time as the board may require. ➓ CHAPTER 7 | BYLAWS | 157

. . . ARTICLE 8 FISCAL YEAR SECTION 1. FISCAL YEAR OF THE CORPORATION Te fiscal year of the corporation shall begin on the (day and month, e.g., “first day of January”) ⓫ and end on the (day and month, e.g., “last day of December”) ⓫ in each year. . . . ARTICLE 9 ⓬ CONFLICT OF INTEREST AND COMPENSATION APPROVAL POLICIES SECTION 1. PURPOSE OF CONFLICT OF INTEREST POLICY . . . ARTICLE 13 ⓭ MEMBERS SECTION 1. DETERMINATION OF MEMBERS ⓮ If this corporation makes no provision for members, then, pursuant to Section 9310(b) of the Nonprofit Religious Corporation Law of the State of California, any action which would otherwise, under law or the provisions of the articles of incorporation or bylaws of this corporation, require approval by a majority of all members or approval by the members, shall only require the approval of the board of directors. 158 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

WRITTEN CONSENT OF DIRECTORS ADOPTING BYLAWS We, the undersigned, are all of the persons acting as the initial directors of (name of corporation) , ⓯ a California nonproﬁt corporation, and, pursuant to the authority granted to the directors by these bylaws to take action by unanimous written consent without a meeting, consent to, and hereby do, adopt the foregoing bylaws, consisting of (number of pages) ⓯ pages, as the bylaws of this corporation. Date: ______(signatures of director(s)) ⓯ (typed name) , Director ______, Director ______, Director ______, Director ______, Director . . . CERTIFICATE Tis is to certify that the foregoing is a true and correct copy of the bylaws of the corporation named in the title thereto and that such bylaws were duly adopted by the board of directors of said corporation on the date set forth below.

(Fill in Certiﬁcate date and signature of secretary later, after ﬁrst board meeting) ⓰

Dated: (date) (signature of secretary) (typed name) , Secretary CHAPTER 7 | BYLAWS | 159

Responses for Board Meeting Dates to their bylaws indicating the procedure for the election of directors by the members, as Regular meetings of directors shall be explained below. held on the ﬁrst Friday of each month at ➑ Indicate the number of directors who must 9 o’clock A.M.… be present at a directors’ meeting to constitute a quorum so that business can be conducted. Regular meetings of directors shall be held Although the usual practice is to provide for a on the second Monday of December at NBKPSJUZ BOPOQSPëUSFMJHJPVTDPSQPSBUJPODBO 1 o’clock P.M.… provide for a larger or smaller number. Regular meetings of directors shall Whatever number or percentage you decide be held on July 1 and February 20 at on, understand that this section of the bylaws 9 o’clock A.M.… concerns a quorum, not a vote requirement. A meeting can be held only if at least a quorum In the second paragraph of this section, fll of directors is present, but a vote on any matter in the blank to indicate which of your regular before the board must be passed by the vote of a board meetings will be the annual regular NBKPSJUZPGUIPTFQSFTFOUBUUIFNFFUJOH ɨFSF meeting of the board, when you’ll elect (or re- BSFTPNFFYDFQUJPOTUPUIFNBKPSJUZPGUIPTF elect) directors of your corporation. Note that present rules—see Section 13 of Article 3 of the in a nonmembership corporation, the directors religious corporation bylaws.) vote for their own reelection or replacements, with each director casting one written vote. EXAMPLE: If a religious corporation with fve Of course, if a corporation has provided for EJSFDUPSTQSPWJEFTGPSBNBKPSJUZRVPSVN only one regular meeting each year in the frst then a quorum of at least three directors paragraph of this section, then the date of this must be present to hold a meeting of regular meeting will be repeated in this blank directors. If three directors actually attend, as the date of the annual meeting of directors. then action can be taken at the meeting by the vote of two of the directors present Responses for Annual Meeting Dates UIFNBKPSJUZWPUFPGUIPTFQSFTFOUBUUIF meeting). If this corporation makes no provision for members, then, at the annual meeting of ➒ In this blank, indicate the rules of order directors held on January 1, directors shall that directors will use at their meetings. be elected… Although many nonprofts specify Robert’s Rules of Order here, religious groups may If this corporation makes no provision for wish to refer to rules established by their members, then, at the annual meeting of organization for the conduct of business at directors held on the ﬁrst Friday of July, directors’ meetings. Alternatively, you may directors shall be elected… wish to leave this item blank if you see no need Te provisions in the second paragraph to specify formal procedures for introducing of this section afect only nonmembership and discussing items of business at your board corporations. Membership corporations can meetings. leave this line blank. Membership religious ➓ Te Nonproft Religious Corporation Law corporations will add membership provisions allows you to form an executive committee 160 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

of the board, which must have at least two provision, and make sure you are comfortable board members and can have much of the with its procedures for the approval and review management power of the full board. Tis of fnancial transactions with, and salary and section of the bylaws provides for an executive other compensation paid to, your directors, committee of board members only. Although ofcers, and others who are in a position to at least two board members must serve on JOìVFODFZPVSOPOQSPëU*GZPVEFDJEFUP this committee, in practice most nonproft make changes to this provision, do so only corporations establish an executive committee after reading “Prepare Your Tax Exemption of from three to fve board members. Of course, Application,” instructions to Part V, in Chapter you can set up other types of committees with 8, where we refer to this bylaw provision when or without board members (see Section 2 of this providing sample responses to questions on the article in the complete bylaws). application. If you make any changes, you will ⓫ Indicate the beginning and ending dates need to create your own responses to some of of the fscal year of the corporation. Te fscal the questions on the 501(c)(3) application. year of the corporation is the period for which ⓭ Last portion of Basic Religious Corpora- the corporation keeps its books (its accounting tion Bylaws: Te last portion of the basic bylaws period) and will determine the corporation’s tax (consisting of Article 13, Written Consent of year for purposes of fling certain tax returns Directors, and Certifcate sections) is intended and reports. It may be the calendar year, from only for nonmembership groups. Membership January 1 to December 31 (this is the usual religious corporations do not need to fll in and case for nonprofts); or it may be what the use this last portion of the basic bylaws—we IRS considers a true fscal year, consisting of a show you how to add membership provisions to 12-month period ending on the last day of any complete your bylaws below. month other than December (for example, from ⓮ Section 1 of Article 13 makes it clear that July 1 to June 30). the directors of nonmembership corporations ⓬ Article 9 of the bylaws included in can take the place of members in taking any this book contains rules and procedures for action which, under law, otherwise requires BQQSPWJOHPSBWPJEJOHDPOìJDUPGJOUFSFTU membership approval (in other words, the transactions, including compensation arrange- directors can act in place of the members in ments, between your nonproft and its directors, nonmembership corporations). ofcers, employees, contractors, and others. ⓯ Fill in the Written Consent of Directors ɨJTCZMBXQSPWJTJPODPOUBJOTUIFDPOìJDUT paragraph, showing the name of the corpora- of-interest language recommended by the IRS tion and the number of pages in your fnal JODMVEFEJOUIFTBNQMFDPOìJDUPGJOUFSFTU bylaws. Type your initial directors’ names (the policy, in Appendix A, of the instructions to initial direc tors appointed by your incorporator IRS Form 1023). It also contains language for pursuant to your Incorporator’s Statement (see the approval of compensation arrangements Chapter 6)) below the signature lines. After that attempts to comply with the safe harbor printing and dating the form, have each initial provisions of the excess beneft rules (see the director sign the form. discus sion on the excess beneft rules in “Limi- ⓰ Do not fll in the blanks following the tation on Profts and Benefts,” in Chapter 3). Certifcate at bottom of the bylaws at this time. You will need to become familiar with this Your corporate secretary will complete these blanks after the frst meeting of your board. CHAPTER 7 | BYLAWS | 161

Membership Bylaw Provisions t&BDIDJSDMFEOVNCFSJOUIFTBNQMFGPSN GPS instance, ➊) refers to a special instruction for a Religious Corporation that provides specifc information to help Tis section applies only to religious member- you complete an item. ship corporations. If you have decided to form t"WFSUJDBMTFSJFTPGEPUTJOUIFTBNQMFGPSN a nonmembership religious corporation, this below indicates a gap where we have skipped section does not apply to you and you can skip over language in the complete form. ahead to Chapter 8. t5PBEENFNCFSTIJQQSPWJTJPOTUPZPVSCBTJD Before we show you how to fll in your bylaws, religious corporation bylaws, fll in the blanks let’s deal with one possible area of confusion. in the membership provisions fle, following Your religious corporation will probably want the sample form and instructions below. to refer to its supporters as “members”—of the Once completed, copy these membership congregation or church, for example. Tis gives provisions to your basic bylaws as explained ➊ your participants a feeling of participation, in special instruction below. which will be important for you. Calling supporters members is perfectly okay, and Customizing Your Membership you can do so without thereby establishing a Bylaw Provisions formal membership corporation in the eyes of the IRS. In fact, most religious groups will not Te Nonprofit Religious Corporation Law want a formal membership structure because gives religious groups considerable flexibility of the active role legal members assume in the to fashion many of their bylaw provisions. afairs of a membership corporation. As long as Accordingly, we’ve borrowed several member- you don’t, in your bylaws, give your members ship provisions from the public benefit corpo- the legal status of formal members, you will ration bylaws discussed earlier. We think not have established a formal membership they make sense for most small membership corporation. See “Membership Nonprofts,” in religious organizations. Chapter 2, for a complete discussion of member You may want to take advantage of the and nonmembership corporations. flexibility allowed religious corporations and customize these provisions. If you make General Instructions modifications, make sure that they comply with the Nonprofit Religious Corporation Law (or Here are general instructions for flling in have an attorney check your work). Most of the membership provisions for bylaws of a religious statutory religious corporation membership nonproft corporation: provisions are contained in Sections 9310 tɨFQBSFOUIFUJDBMCMBOLT i @@@@@@@@ wJO through 9420 of the Corporations Code. (See the sample form below indicate information “Sample Bylaws,” above, for instructions on how that you must complete. to find the Religious Corporation Law online). t3FQMBDFUIFCMBOLTJOUIFGPSNXJUIUIF information indicated in the blanks in the sample form below. 162 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Sample Membership Provisions ship termination provisions in Section 9 of this Article are taken from the Public Beneft Te sample bylaws below are an abbreviated Corporation Law. Tey give due process to version of the complete form available on the members, allowing them notice and an oppor- Nolo website (see Appendix A for the link). We’ve tunity to be heard before the board decides provided sample language and instructions for whether they will be expelled. Although we the few sections that contain blanks. UIJOLUIFTFQSPWJTJPOTSFìFDUBTFOTJCMFTFU Special Instructions of rules, religious corpo rations are free to fashion their own proce dures (Calif. Corp. Here are the instructions for flling in the Code § 9340(d)). If you wish to do so, replace blanks in the religious corporation membership the language of Section 9 with your own provisions: termination of membership rules. ➊ After completing these membership ➏ Under Section 9410(a) of the Corpora- provisions, copy the full text of this fle to your tions Code, religious corporations can specify basic religious bylaws—this material replaces any reason able method of calling, noticing, Article 13, the Written Consent and Certifcate and holding regular or special meetings of sections, and signature lines at the end of your members (though there are some limitations, basic bylaws. as mentioned below). Terefore, you may wish ➋ Use this blank to indicate any special to replace the default procedures for calling, qualifcations required for members. Please noticing, and holding meetings contained in realize, however, that the IRS likes 501(c)(3) the various sections of this Article with your tax-exempt corporations to have membership own rules. For example, you might want to in the corporation open to the general public. allow directors to call special meetings of Consequently, most religious corporations will members upon two days’ telephone notice. not specify any qualifcations for membership Tere are notice rules that apply when (see the suggested wording in the blank on the members approve certain types of actions sample form). by less than unani mous consent. Tese rules ➌ Most religious corporations do not require cannot be waived. Tese rules are listed in members to formally apply for membership in Section 4(f) of Article 14 of the religious the corporation. However, a few may wish to corporation membership provisions. We won’t require members to pay an admission fee and/or list all the special cases here. If you wish to annual dues prior to acceptance as a member in change the notice rules and wish to check the corporation (see the suggested wording in these special cases, see Section 9410(b) of the the blank on the sample form). Corporations Code. If you have a lawyer review ➍ If you’re going to require admission fees your changes, ask him or her to make sure and/or annual dues for members, enter the your changes conform to this section of the amount or explain how you’ll determine what Corporations Code. the amount will be (see the suggested wording ➐ Indicate the date and time of the annual in the blanks on the sample form). If you won’t meeting of members. Te members elect charge application or admission fees (most directors at this annual meeting. You may groups won’t), type “None” in both blanks. wish to coordinate this date with your annual ➎ A membership corporation will need a directors’ meeting (for example, slightly before process for removing members. Te member- the annual directors’ meeting). CHAPTER 7 | BYLAWS | 163

Membership Provisions of (name of corporation) a California Religious Corporation . . . ARTICLE 13 ➊ MEMBERS SECTION 1. DETERMINATION AND RIGHTS OF MEMBERS Te corporation shall have only one class of members. No member shall hold more than one membership in the corporation. Except as expressly provided in or authorized by the articles of incorporation or bylaws of this corporation, all memberships shall have the same rights, privileges, restrictions, and conditions.

SECTION 2. QUALIFICATIONS OF MEMBERS Te qualifications for membership in this corporation are as follows (specify qualifications or, if none, type “Any person is qualified to become a member of this corporation”) . ➋

SECTION 4. FEES, DUES, AND ASSESSMENTS (a) Te following fee shall be charged for making application for membership in the corporation: (state speciﬁc admission fee or leave to discretion of board, e.g., “in such amount as may be speciﬁed from time to time by resolution of the board of directors charged for, and payable with, the application for membership,” or, if no fee, type “None”) . (b) Te annual dues payable to the corporation by members shall be (state amount of annual dues, leave to discretion of board, e.g., “in such amount as may be determined from time to time by resolution of the board of directors,” or type “None”) . ➍ (c) Memberships shall be nonassessable. . . . 164 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

SECTION 9. TERMINATION OF MEMBERSHIP ➎ (a) Grounds for Termination. Te membership of a member shall terminate upon the occurrence of any of the following events: (1) Upon his or her notice of such termination delivered to the president or secretary of the corporation personally or by mail, such membership to terminate upon the date of delivery of the notice or date of deposit in the mail. (2) Upon a determination by the board of directors that the member has engaged in conduct materially and seriously prejudicial to the interests or purposes of the corporation. (3) If this corporation has provided for the payment of dues by members, upon a failure to renew his or her membership by paying dues on or before their due date, such termination to be effective thirty (30) days after a written notification of delinquency is given personally or mailed to such member by the secretary of the corporation. A member may avoid such termination by paying the amount of delinquent dues within a thirty- (30) day period following the member’s receipt of the written notification of delinquency. (b) Procedure for Expulsion. Following the determination that a member should be expelled under subparagraph (a)(2) of this section, the following procedure shall be implemented: (1) A notice shall be sent by first-class or registered mail to the last address of the member as shown on the corporation’s records, setting forth the expulsion and the reasons therefor. Such notice shall be sent at least fifteen (15) days before the proposed effective date of the expulsion. (2) Te member being expelled shall be given an opportunity to be heard, either orally or in writing, at a hearing to be held not less than five (5) days before the effective date of the proposed expulsion. Te hearing will be held by the board of directors in accordance with the quorum and voting rules set forth in these bylaws applicable to the meetings of the Board. Te notice to the member of his or her proposed expulsion shall state the date, time, and place of the hearing on his or her proposed expulsion. (3) Following the hearing, the board of directors shall decide whether or not the member should, in fact, be expelled, suspended, or sanctioned in some other way. Te decision of the board shall be final. (4) If this corporation has provided for the payment of dues by members, any person expelled from the corporation shall receive a refund of dues already paid. Te refund shall be prorated to return only the unaccrued balance remaining for the period of the dues payment. SECTION 10. RIGHTS ON TERMINATION OF MEMBERSHIP All rights of a member in the corporation shall cease on termination of membership as herein provided. CHAPTER 7 | BYLAWS | 165

ARTICLE 14 MEETINGS OF MEMBERS ➏ SECTION 1. PLACE OF MEETINGS Meetings of members shall be held at the principal oﬃce of the corporation or at such other place or places within or without the State of California as may be designated from time to time by resolution of the board of directors.

SECTION 2. ANNUAL AND OTHER REGULAR MEETINGS Te members shall meet annually on (date, e.g., “ the first Monday of July, September 30)” ➐ in each year, at (time) M, ➐ for the purpose of electing directors and transacting other business as may come before the meeting. Cumulative voting for the election of directors shall not be permitted. Te candidates receiving the highest number of votes up to the number of directors to be elected shall be elected. Each voting member shall cast one vote, with voting being by ballot only. Te annual meeting of members for the purpose of electing directors shall be deemed a regular meeting and any reference in these bylaws to regular meetings of members refers to this annual meeting. Other regular meetings of the members shall be held on (date) , ➑ at (time) .M. ➑ If the day fixed for the annual meeting or other regular meetings falls on a legal holiday, such meeting shall be held at the same hour and place on the next business day. . . . SECTION 8. PROXY VOTING Members entitled to vote (“shall” or “shall not”) ➒ be permitted to vote or act by proxy. If membership voting by proxy is not allowed by the preceding sentence, no provision in this or other sections of these bylaws referring to proxy voting shall be construed to permit any member to vote or act by proxy. If membership voting by proxy is allowed, members entitled to vote shall have the right to vote either in person or by a written proxy executed by such person or by his or her duly authorized agent and filed with the secretary of the corporation, provided, however, that no proxy shall be valid after eleven (11) months from the date of its execution unless otherwise provided in the proxy. In any case, however, the maximum term of any proxy shall be three (3) years from the date of its execution. No proxy shall be irrevocable and may be revoked following the procedures given in Section 9417 of the California Nonprofit Religious Corporation Law. If membership voting by proxy is allowed, all proxies shall state the general nature of the matter to be voted on and, in the case of a proxy given to vote for the election of directors, shall list those persons who were nominees at the time the notice of the vote for election of directors was given to the members. In any election of directors, any proxy which is marked by a member “withhold” or otherwise marked in a manner indicating that the authority to vote for the election of directors is withheld shall not be voted either for or against the election of a director. 166 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

If membership voting by proxy is allowed, proxies shall aﬀord an opportunity for the member to specify a choice between approval and disapproval for each matter or group of related matters intended, at the time the proxy is distributed, to be acted upon at the meeting for which the proxy is solicited. Te proxy shall also provide that when the person solicited speciﬁes a choice with respect to any such matter, the vote shall be cast in accordance therewith.

SECTION 9. CONDUCT OF MEETINGS Meetings of members shall be presided over by the chairperson of the board, or, if there is no chairperson, by the president of the corporation or, in his or her absence, by the vice president of the corporation or, in the absence of all of these persons, by a chairperson chosen by a majority of the voting members, present in person or by proxy. Te secretary of the corporation shall act as secretary of all meetings of members, provided that, in his or her absence, the presiding officer shall appoint another person to act as secretary of the meeting. Meetings shall be governed by (“Robert’s Rules of Order” or indicate other rules or procedures) , ➓ as such rules may be revised from time to time, insofar as such rules are not inconsistent with or in conflict with these bylaws, with the articles of incorporation of this corporation, or with any provision of law. . . . WRITTEN CONSENT OF DIRECTORS ADOPTING BYLAWS We, the undersigned, are all of the persons acting as the initial directors of (name of corporation) , ⓫ a California nonprofit corporation, and, pursuant to the authority granted to the directors by these bylaws to take action by unanimous written consent without a meeting, consent to, and hereby do, adopt the foregoing bylaws, consisting of (number of pages) ⓫ pages, as the bylaws of this corporation.

Date: ______

(signatures of director(s)) ⓫ (typed name) , Director ______, Director ______, Director ______, Director ______, Director CHAPTER 7 | BYLAWS | 167

CERTIFICATE Tis is to certify that the foregoing is a true and correct copy of the bylaws of the corporation named in the title thereto and that such bylaws were duly adopted by the board of directors of said corporation on the date set forth below. (Fill in Certiﬁcate date and signature of secretary later, after ﬁrst board meeting) ⓬ Dated: (date) (signature of secretary) (typed name) , Secretary

➑ Type the date and time of any regular ➓ Indicate, if you wish, the sets of rules that meetings of members. Many nonprofts will will govern the proposing and taking of action leave this line blank and decide to provide for at your membership meetings. Robert’s Rules only the annual meeting of members in their of Order is the standard, but you may specify bylaws (you did this in the previous paragraph). another set of procedures. Tose with a more active membership will ⓫ Fill in the Written Consent of Directors indicate monthly or semiannual regular meet- paragraph, showing the name of the corpora tion ings of members here. and the number of pages in your fnal bylaws. ➒ Indicate whether the corporation Type your initial directors’ names (the directors will allow proxy voting by members. (A appointed pursuant to your Incorporator’s proxy is simply a written authorization by Statement (see Chapter 6)) below the signature a member allowing another person to vote lines. After printing and dating the form, have for the member.) Many small membership each initial director sign the form. corporations decide against proxy voting, ⓬ Don’t fll in the blanks following the to avoid problems and compli cations that Certifcate at the bottom of the bylaws at this can arise in times of controversy or difcult time. Your corporate secretary will complete decisions (such as proxy wars or solicitations these blanks after your board’s frst meeting. of proxies by outside or competing interests). Replace the corresponding sections of your If you decide to allow proxies, the restrictions basic bylaws (Article 13 through the end of relating to proxies contained in the next the bylaws) with these completed membership sections of this Article will apply. provisions. ●

CHAPTER

Apply for Your Federal 501(c)(3) Tax Exemption 8

Getting Started ...... 170 Forms and Publications ...... 171 Ways to Complete the Exemption Application ...... 171 Preliminary Reading...... 173 Te Standard Form 1023: Schedules, Attachments, and Exhibits ...... 174 Public Inspection Rights ...... 175 Te Consequences of Filing Late ...... 176 Do You Need to File Form 1023? ...... 176 Prepare Your Tax Exemption Application ...... 177 Instructions to Form 1023-EZ ...... 178 Instructions to Form 1023 ...... 181 Filling Out the Schedules ...... 218 Schedule A—Churches ...... 219 Schedule B—Schools, Colleges, and Universities ...... 219 Schedule C—Hospitals and Medical Research Organizations ...... 219 Schedule D—Section 509(a)(3) Supporting Organizations ...... 220 Schedule E—Organizations Not Filing Form 1023 Within 27 Months of Formation ...... 220 Schedule F—Homes for the Elderly or Handicapped and Low-Income Housing ...... 223 Schedule G—Successors to Other Organizations ...... 224 Schedule H—Organizations Providing Scholarships, Educational Loans, or Other Educational Grants ...... 225 Assemble and Mail Your Application to the IRS...... 225 What to Expect From the IRS ...... 227 Te Federal Determination Letter ...... 227 170 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

ow that you’ve fled your articles and Whichever form you use for your IRS tax prepared your bylaws, it’s time to prepare exemption application (the online Form 1023- Nyour federal exemption application EZ, or the interactive, accessible, or hard copy (IRS Form 1023). Obtaining your federal tax Form 1023), reading and following our line-by- exemption is a critical step in forming your line instructions should help you accomplish nonproft organization, because most of the real the task in substantially less time than it would CFOFëUTPGCFJOHBOPOQSPëUìPXGSPN D otherwise take. We provide a lot of handholding tax-exempt status. To make your tax exemption and suggestions for responses to make the task retroactive to the date of your incorporation, of flling in your tax exemption application your 1023 application must be postmarked easier and less time consuming. And keep the within 27 months from the end of the month in following suggestion in mind: If you get stuck which you fled your articles of incorporation. on a difcult question or run low on energy (as Te standard Form 1023 tax exemption many do), take a break and return to it when you application is long and complicated; completing feel better able to follow and absorb the material. it can be a daunting task. Fortunately, the You will be well rewarded in the end for the time IRS now has a streamlined Form 1023-EZ tax and efort you devote to this task. exemption application that is much easier to prepare. Te 1023-EZ application is only three CAUTION pages long (as opposed to the 26-page standard Special purpose nonprofits may use a 1023 form) and it is completed and fled online. different IRS form. If yours is a special purpose If you qualify for the 1023-EZ form, you will nonprofit group (formed for other than religious, want to use it because it is so much shorter educational, charitable, scientific, or literary purposes), and easier than the standard 1023 form. Most you’re likely to be exempt under subsections of smaller nonprofts (those with gross receipts of Section 501(c) other than subsection (3). To apply $50,000 or less and assets of $250,000 or less) for your federal tax exemption, you may need to will be eligible to use the Form 1023-EZ. use IRS Form 1024 instead of IRS Form 1023. Certain If you don’t qualify for the 1023-EZ application, cooperative hospital service organizations and cooperative educational service organizations can you will have to prepare the standard Form 1023. use Form 1023. See the Instructions to Form 1023 Tere are two diferent PDF versions of the and 1023-EZ for more information on the application 1023 form available on the IRS website—an process for special purpose groups. interactive and accessible—that allow you to fll the application out on your computer. Whichever one you choose, you must print out and mail the form in to the IRS; the Form Getting Started 1023 cannot be fled online. Nevertheless, flling the form out on your computer or other Before diving into the task at hand, take a device should be easier and less time consuming moment to read this section, which sets out the than flling out a hard copy by hand. If you various tax forms and other IRS publications decide to do a hard copy by hand, remember you’ll encounter. We’ll also give you tips on that you will need to add attachment pages if how to select and fll out the forms and deal the paper form does not have sufcient space with the additional information you may need for your responses (which is likely to occur). to supply. Tink of this portion of the chapter as your orientation. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 171

Forms and Publications Organization To Make Expenditures To Infuence Legislation. Tis is a special form You’ll encounter several IRS forms as you make that only applies to certain politically your way toward federal exempt status. We go active nonprofts. over these forms and provide information on We have made available on the Nolo website how to complete them: some federal IRS tax publi cations (see Appendix A t*34'PSN&; Streamlined Application for the link). Tese publications are surprisingly for Recognition of Exemption Under Section readable and give a lot of practical information. 501(c)(3) of the Internal Revenue Code. You can get copies or updated versions by Tis is a simple form that many small going online to www.irs.gov or by calling the organizations can use to easily apply for IRS forms and publi cations request number, their federal income tax exemption. 800-TAX-FORM. t*34'PSN 1BDLBHF Application t1VCMJDBUJPO Tax-Exempt Status for Your for Recognition of Exemption Under Section Organization 501(c)(3) of the Internal Revenue Code. Tis t1VCMJDBUJPO Applying for 501(c)(3) is the “long form” that your organization Tax-Exempt Status uses to apply for an exemption if it does t1VCMJDBUJPO1$ Compliance Guide for not qualify to use the streamlined 1023- 501(c)(3) Public Charities EZ form. Tere are a few versions that t1VCMJDBUJPO1' Compliance Guide for you can use. Best is the downloadable 501(c)(3) Private Foundations, and “interactive” PDF version of Form 1023. t1VCMJDBUJPO Tax Guide for Churches It provides help text, and automatically and Religious Organizations. provides extra space for long responses so you don’t have to prepare attachment RESOURCE pages. Next best is the online “accessible” PDF version. It allows you to fll in the You can ﬁnd additional helpful infor- form within your browser, but you still mation, including articles on special exempt need to manually create attachment pages organization issues, from the IRS website at www.irs.gov. Under “Help & Resources,” go to for responses that don’t ft in the pre- the “Charities & Nonproﬁts” page. Also, see the allocated space on the form. And if all IRS online workshops and mini courses at IRS Stay else fails, you can download and fll in a Exempt—Tax Basics for Exempt Organizations printed hard copy 1023 form manually (www.stayexempt.org). (with a pen). Follow the instructions provided on the IRS website to open and use each version of the 1023 form. Ways to Complete the t'PSN44 Application for Employer Exemption Application Identifcation Number. You can use this form to apply for an EIN for your Most incorporators will fll in one of the organization (but it’s easier to get your computer-enabled versions of the 1023 form: the EIN online). online 1023-EZ or one of the PDF (interactive t'PSN Election/Revocation of or accessible) versions of the standard 1023 Election by an Eligible Section 501(c)(3) form. Te 1023-EZ form, which is the easiest form to prepare, can be flled in, paid for, 172 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

and submitted online; no printing or mailing portions of the form and to include additional necessary. Te ofcial instructions to the fnancial information. (Our instructions, below, 1023-EZ, available on the IRS website, contain also include this updated information). Te an Eligibility Worksheet that you must use to reason for including the notice is that the determine if your group qualifes for the *34IBTOPUVQEBUFEUIFGPSNUPSFìFDU 1023-EZ form. If you use Form 1023-EZ, you changes in the law that afect the form. More will be charged the lower $400 application fee specifcally, the IRS adopted regulations that and will not need to provide fnancial data or eliminated the advance ruling process for 501(c)(3) complete extra schedules. organizations. Tis was a technical process that some new organizations had to use when TIP applying for their income tax exemption. Te One downside to the Form 1023-EZ. Te good news is that new organizations no longer 1023-EZ form asks you to select the public charity have to be concerned with advance rulings and status that applies to you, while the standard 1023 the technical rules that apply to them. Te form lets you hand off this decision to the IRS by bad news is that the 1023 form still includes checking a special box on the form. No worries, questions that apply to advance rulings as well though. In Chapter 4, we go over what you need to as an incomplete fnancial data section to fll know to be able to make an informed decision as to in. Hence, the notice at the beginning of the the most appropriate public charity classification to standard 1023 form tells you to ignore the select for your nonprofit on the 1023-EZ form. advance ruling questions on the form and tells you how to provide additional fnancial data. If you use the standard 1023 form, you will Te 1023 PDF forms that you fll in on have more paperwork to complete, including your computer—the downloadable interactive providing fnancial data and possibly preparing form and the browser-friendly accessible 1023 additional schedules. Tere are several versions form—do not include the updated notice with of the standard 1023 form. We recommend a summary of the new rules for completing using the downloadable interactive PDF your 1023 application. However, the interactive version of this form, which provides help text form blocks out the old information that you and eliminates the need for manually creating do not need to fll in and provides an extra attachment pages. Next best is the accessible column in the fnancial data section for you PDF version, which you can open and fll in to provide the required additional fnancial from your browser. Both the interactive and information under the new rules. Te accessible accessible PDF forms must be printed and GPSNJTOPUVQEBUFEJOBOZXBZUPSFìFDUUIF mailed to the IRS along with a check for the new rules. user fee. You will be charged the higher $850 Before completing either the downloadable application fee if you expect to have annual interactive Form 1023 PDF or the accessible gross receipts (total receipts before subtracting Form 1023 PDF, be sure to do the following: expenses) over $10,000; otherwise you pay the Read the notice (Notice 1382) that is printed at lower $400 fee. the beginning of the latest standard Form 1023 Technical law changes that affect how you fill in (included at the top of the Form 1023 in Appendix the 1023 form. If you use the printed 1023 form, B) and/or refer to our instructions below, which you’ll see that it starts with a notice (Notice are updated to reflect the new rules. By reading 1382) that instructs you to ignore certain the notice, you’ll get a good idea of what to do CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 173

and not to do when flling in PDF versions of the standard 1023 form, be sure to read the the form on your computer; by following our instructions to that form that are available on the instructions as you work your way through the IRS website. form, you’ll be sure to include and exclude the All groups should skim through Chapters 1, appropriate information. 2, and 3 of IRS Publication 557, Tax-Exempt All versions of the 1023 form are available Status for Your Organization, and also look at online from the IRS website. Go to the IRS Publications 4220, Applying for 501(c)(3) Tax- website (www.irs.gov), and type “1023” in the Exempt Status, and 4221-PC, Compliance Guide search box to see links to each of the 1023 for 501(c)(3) Public Charities. Te information in forms. If you use the hard copy standard 1023 these publications covers the basic requirements form in Appendix B, make sure it is the current for obtaining a 501(c)(3) tax exemption. version by going to the IRS website to check In addition, take a look at IRS Form 990, the revision date of the latest 1023 form posted Return of Organization Exempt From Income there. You also can obtain the latest IRS forms Tax. Tis form must be fled each year with by calling 800-TAX-FORM. the IRS by 501(c)(3) organizations whose Tere may be one more way to prepare and annual receipts are more than $25,000. If submit your exemption application. On the IRS your nonproft has receipts of $25,000 or less, website, check to see if the IRS has launched it must fle Form 990-N (e-Postcard). It is an the “Cyber Assistant” program, an online information return, which the IRS uses to program that will allow users to prepare and monitor the structure, activities, and fnances fle the standard Form 1023 application online of 501(c)(3) nonprofts. Te annual disclosure for a reduced fling fee. Tis program has been requirements of the Form 990 are substantial, delayed several times and there is no new launch so look at the form and its schedules before date. Tis program may have been put on hold you leap into applying for your tax exemption. indefnitely since the IRS now has the online You’ll see that you will need to monitor and Form 1023-EZ. In any case, it doesn’t hurt to account for many of your nonproft’s fnancial check to see if this additional service is available. and operational details throughout its life. Tere are some exceptions to the Form 990 Preliminary Reading fling requirements. Churches and certain Before starting your federal tax exemption other types of nonprofts are not required to fle application, read the instructions to Form 1023- Form 990. Also, if your nonproft normally has EZ (available on the IRS website). Ten complete receipts of $50,000 or less, it can fle Form 990- the Eligibility Worksheet (included with the N (an e-Postcard) instead of Form 990. Smaller instructions) to see if your group qualifes to use nonprofts that don’t qualify to fle the 990-N the 1023-EZ form. Most smaller new groups postcard may qualify to fle a simplifed 990- with modest expectations as to gross receipts EZ form instead of the standard 990 form. See ($50,000 in receipts annually before deducting the Form 990, 990-EZ, and 990-N instructions expenses) and assets ($250,000 or less) that on the IRS website for more information on are not setting up an institutional nonproft Form 990 fling requirements. (such as a school, hospital, or church) should If you fnd this reading a bit technical, qualify. If you do not qualify, you will need to don’t let it bog you down. Te information use the standard 1023 form. If you need to use in this book, together with our line-by-line instructions, should be enough to get you 174 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

through the process. If necessary, you can paper (8½” x 11”) and include the following always refer back to the IRS publications and information: instructions when answering questions or flling tUIFOBNFBOE&*/ &NQMPZFS*EFOUJëDBUJPO out schedules. Number) of your corporation, at the top of each attachment page Te Standard Form 1023: Schedules, tGPSFBDISFTQPOTF TUBUFUIFQBSUBOEMJOF Attachments, and Exhibits number to which the response relates. Also provide a description, if appropriate (see the If you use Form 1023 (instead of Form 1023- sample attachment page below). EZ), you will need to provide fnancial data tUIFQBHFOVNCFSJOUIFIFBEFSPSGPPUFS QBTU JGBQQMJDBCMF BOEQSPKFDUFE BOEQPTTJCMZ of each page if you include more than one fll in one or more schedules that apply to attachment page to your application. (Many certain nonprofts, such as schools, churches, groups will have multiple attachment pages.) and hospitals. Our instructions will help you You do not need to have a separate attach ment prepare the fnancial data and any schedules QBHFGPSFBDISFTQPOTFKVTUMJTUZPVSSFTQPOTFT that apply to your nonproft. one after the other on your attach ment pages Adding Attachment Pages as Needed (as shown on the sample below). Attachments can also be used to indicate If you complete the online Form 1023-EZ or you are including additional information as the interactive Form 1023, you won’t need to exhibits to your application. For example, manually add pages to your application (the with all 1023 forms (except Form 1023-EZ), interactive PDF form expands if you need more you will need to attach documents, such as space for responses). However, if you prepare articles and bylaws, and other materials, such the accessible PDF Form 1023 or manually as copies of solicitations for fnancial support, fll in the printed 1023, you may need to to your application. Mark each document as an continue some of your longer responses on an exhibit and label them in alphabetical order. attachment page or pages. If so, use letter-sized You can write the exhibit letter at the top of the document, or you can staple a page or note

Attachment Page Example

GoodWorks, Inc. EIN # XXXXXXXX

Part IV, Narrative Description of Activities: Te nonproﬁt organization also will engage in the following activities: …

Part V, Line 1a, Names, titles, mailing addresses, and compensation of oﬃcers, directors, and trustees (continuation): Name Title Mailing Address Compensation (actual or proposed) CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 175

to the frst page of the document and write the below), and you do not have to disclose the exhibit reference (for example “Exhibit A”) on names and addresses of contributors if you the cover page or note. We recommend that qualify as a public charity—which we assume you use a separate cover page or note for your you will. certifed copy of your articles of incorporation, If your organization regularly maintains since the articles you include as an exhibit one or more regional or district ofces having should exactly match the articles you fled with three or more employees (defned as ofces the secretary of state. Make sure each document that have a payroll consisting of at least has a heading that identifes its content and 120 paid hours per week), you must make the name and EIN of your nonproft. Te copies of the documents available for public copies of your legal documents should have inspection at each of these ofces. Copies of headings printed on the frst page already, such your organization’s three most recent annual as “Articles of [name of your corporation]” or information returns must also be available for “Bylaws of [name of your corporation].” Put public inspection at your principal ofce (and, similar identifying headings on all fnancial if applicable, your regional or district ofce). statements and other exhibits you prepare Members of the public can also make a yourself and number each page if the document written request for copies of your organiza tion’s has multiple pages. tax exemption application and its tax returns for the last three years. You must comply within 30 Public Inspection Rights days and are allowed to charge only reasonable As you begin entering information on the copying and postage costs. Te public also federal form (whether online or manually), can request copies or public inspection of keep in mind that members of the public, not your organization’s exemption application KVTUBOPOZNPVT*34BQQMJDBUJPOFYBNJOFST or its annual returns by calling IRS Exempt can obtain access to the information you Organizations Customer Account Services provide in your exemption application. So don’t at 877-829-5500. Tese public inspection include Social Security numbers, bank account requirements apply to 501(c)(3) public charities, information, home addresses, or other personal not to 501(c)(3) private foundations—again, we information that you do not wish to disclose to expect most incorporators to qualify as public the public in your tax-exemption application charities. or the attachments. Your federal 1023 tax It’s important to comply with inspection exemption application, any papers submitted requests. If you don’t permit public inspection, with the application, and your tax exemption you could face a $20-per-day penalty. Te IRS determination letter from the IRS must be will impose an automatic $5,000 additional made available by your organization for public penalty if your failure to comply is willful. inspection during regular business hours at Tese penalties are not imposed on the your organization’s principal ofce. However, organiza tion—they are applied against “the any information that has been submitted to the person failing to meet (these) requirements.” IRS and approved by it as confdential is not (See IRS Publication 557 and IRC §§ 6104(e), required to be publicly disclosed (see “How to 5562(c)(1)(C) and (D), and 6685 for further Keep Form 1023 Information Confdential,” information on these rules.) 176 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

RESOURCE How to Keep Form 1023 Information For additional information about IRS Confidential regulations on required disclosures by 501(c)(3) nonprofits, see: Update: Te Final Regulations on Any information submitted with your 1023 the Disclosure Requirements for Annual Information is open to public inspection. However, if an Returns and Applications for Exemption, available attachment or response to your application on Nolo’s website (see Appendix A for the link). See contains information regarding trade secrets, Disclosure, FOIA and the Privacy Act, for additional patents, or other information that would information on the restrictions applicable to the IRS and its employees regarding disclosures of adversely affect your organization if released to information submitted to the IRS. the public, you can clearly state “NOT SUBJECT TO PUBLIC INSPECTION” next to the material and include your reasons for requesting secrecy. Te Consequences of Filing Late If the IRS agrees, the information will not be You should fle your 1023 within 27 months open to public inspection. after the end of the month in which you IRS Regulation 301.6104(a)-5 says that the fled your articles of incorporation. In our IRS will agree if you convince them that “the experience, the most common problem faced by disclosure of such information would adversely nonprofts is failing to fle their Form 1023 on affect the organization.” time. What happens if you fle late? First, if you fle on time (within 27 months of incorporating) and the IRS grants your exemption, the exemption takes efect on the Do You Need to File date on which you fled your articles. Te same is true if you can show “reasonable cause” for Form 1023? your delay (this means you have convinced the Almost all nonproft groups that want 501(c)(3) IRS that your tardiness was understandable tax-exempt status will fle an application for and excusable). If you fle late and don’t have a federal tax exemption (Form 1023 or Form reasonable cause (or the IRS doesn’t buy your 1023-EZ). Your application for recognition of story), your tax-exempt status will begin as exemption serves these important purposes: of the postmark date on your form. For more t*UJTVTFECZOPOQSPëUPSHBOJ[BUJPOTUP information, see “Prepare Your Tax Exemption apply for 501(c)(3) tax-exempt status. Application,” Part VII, below, and the t*UTFSWFTBTZPVSOPUJDFUPUIF*34UIBU instructions to Schedule E in “Filling Out the your organization is a public charity, not a Schedules,” below. private foundation. Remember, as discussed If your nonproft has been organized for several earlier, the IRS will presume that 501(c)(3) ZFBSTBOEZPVSFKVTUOPXHFUUJOHBSPVOEUP nonproft groups are private foundations fling your Form 1023, don’t despair—you’ve got unless you notify the IRS that you qualify plenty of good company. Te important point for public charity status. here is to persevere, complete your application, Tere’s an additional reason that California and mail it to the IRS as soon as possible. nonprofts should apply for their federal tax exemption. Namely, once a California nonproft gets its federal exemption, all it needs to obtain a CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 177

California tax exemption is to fle a FTB3500A tBDIVSDI BiDIVSDIwJODMVEFTTZOBHPHVFT form, Submission of Exemption Request, with temples, and mosques), interchurch organi- a copy of the federal determination letter. zation, local unit of a church, convention, Tis FTB3500A form is a whole lot simpler or association of churches, or an integrated than separately applying for a California tax auxiliary of a church, or exemption (by flling out the full FTB 3500 tBTVCPSEJOBUFPSHBOJ[BUJPODPWFSFECZB form). Further, the information required to group exemption letter (but only if the fll out the California application is the same parent organization timely submits a or similar to that required to complete the notice to the IRS covering the subordinate federal form, so why do this (arduous) work organization—see the group exemption twice—once to apply for the state exemption, letter requirements in IRS Publication 557). and possibly later when you are required or wish Even if one of the above exceptions applies to apply for the federal tax exemption? Tis to you, we recommend that you fle a tax book assumes that all organizations will seek to exemption application anyway. Why? First, it’s obtain a California income tax exemption after risky to second-guess the IRS. If you’re wrong successfully applying for and obtaining their and the IRS denies your claim to 501(c)(3) federal 501(c)(3) income tax exemption (and will, tax status several years from now, your therefore, be eligible to use Form FTB3500A to organization may have to pay substantial back request a California income tax exemption). taxes and penalties. Second, the only way, on Tis said, there are a few groups that are a practical and legal level, to assure others that not required to fle a Form 1023. You aren’t you are a bona fde 501(c)(3) group is to apply required to fle if you are: for an exemption. If the IRS agrees and grants tBHSPVQUIBURVBMJëFTGPSQVCMJDDIBSJUZ your tax exemption, then, and only then, can status and normally has gross receipts of you assure contributors, grant agencies, and not more than $5,000 in each tax year (the others that you are a qualifed 501(c)(3) tax- IRS uses a special formula to determine exempt, tax-deductible organization listed whether a group “normally” has annual with the IRS. gross receipts of not more than $5,000— for specifcs, see IRS Publication 557, “Organizations Not Required to File Form Prepare Your Tax 1023,” “Gross Receipts Test”) Exemption Application

TIP Now it’s time to fll in your tax exemption application (either online, in your browser, or Something to keep in mind. You need manually, depending on which application form to ﬁle an application for a 501(c)(3) tax exemption within 90 days of the date your organization has you use). First, go through the Form 1023-EZ annual gross receipts over $5,000. (See “Schedule Eligibility Worksheet at the end of the ofcial E,” Line 2(a)–2(b) instructions, below, for more instructions to the 1023-EZ form to see if you information on how this works.) If you think it is qualify to use the 1023-EZ. If you qualify to likely that your organization will exceed this gross use the 1023-EZ, answer the online questions as receipts threshold sometime in the near future, it’s you follow our frst set of instructions for Form probably best to go ahead and apply for your 501(c)(3) 1023-EZ, below. If you don’t qualify, you’ll have income tax exemption now. to use one of the 1023 forms (the interactive, 178 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

accessible, or printed version, as explained Line 7. Insert “$400,” which is the lower user earlier), and should go on to our second set of fee that you pay if you qualify to use Form instructions for Form 1023, below. 1023-EZ. Line 8, List the names, titles, and mailing Instructions to Form 1023-EZ addresses of your ofcers, directors, or trustees. Below are the instructions to help you answer Only list fve; if you have more than fve, the online Form 1023-EZ questions. Many are select the one to be listed as explained in the self-explanatory and easy to answer. We provide ofcial instructions to Form 1023-EZ. Most a few pointers to help you understand what the smaller nonprofts have a president (or CEO), IRS is looking for. For some items, we point treasurer (or CFO), secretary, and perhaps a you to instructions that we provide for Form vice president and/or chairman of the board. 1023. Also look at the ofcial instructions to If a person serves in more than one capacity, Form 1023-EZ, viewable on the IRS website, only list the person once and show the title of for additional guidance as you fll in this form all positions held by that person. You can use online from the IRS website. the address of the corporation as the mailing address of your directors and ofcers. Part I: Identiﬁcation of Applicant Line 9. If applicable, list the website address of your nonproft and its email address. Any Line 1(a)–(e). Write the name of your corporation website content should be consistent with your exactly as it appears in your articles of incor- nonproft purposes and program as described poration. Provide the mailing address of the in your 1023 application. Insert “N/A” if either corporation. If you do not have a street address, item is not applicable. provide a post ofce box address. Te IRS wants you to include the full nine-digit zip code in Part II: Organizational Structure your address. Include it if you know it. (Zip code information can be obtained online at the Line 1. Check the corporation box. U.S. Postal Service Zip Code lookup page.) Line 2. Check this box to indicate that you Line 2. You’ll need an EIN for your nonproft have the required organizing document, namely, corporation. See Form 1023 instructions, below, articles of incorporation that have been certifed Part I, Item 4, for information on how to get one. as having been fled with the state. Line 3. Insert the month your corporation’s Line 3. Insert the date your articles were fled tax year ends. Use a two-digit month number by the California Secretary of State in mm/dd/ for your response. See Form 1023 instructions, yyyy format, such as 01/05/2016. below, Part I, Line 5, for more information. Line 4. Insert “California” as the state of Lines 4–6. State the name of a director or incorporation. ofcer the IRS can contact regarding your Lines 5–7. If you followed our instructions application, the phone number where this in Chapter 6 for preparing your articles, person can be contacted during business you should be able to check each of these hours, and a fax number. Te fax number is three boxes to indicate that your articles of optional—if you don’t want to provide one, incorporation contain the required provisions insert “not applicable.” with respect to 501(c)(3) purposes, limitation of activities, and dedication of assets. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 179

Part III: Your Speciﬁc Activities and their managers if they pay unreasonable In this section, the IRS wants to get an idea of compensation to insiders and outsiders (see how your nonproft will actually operate. In the discussion on the excess beneft rules some cases, your response may result in follow- in “Limitation on Profts and Benefts,” in up questions from the IRS (for example, if you Chapter 3). indicate that you will pay ofcers or directors Lines 6–11. If you check “Yes” to any or engage in legislative activity, the IRS may responses, the IRS may ask for additional want to make sure that the compensation is details in follow-up questions to ensure that reasonable or the political activities insubstantial your nonproft is operating with allowable before granting your exemption). It’s best to be 501(c)(3) limits. Tese are: no private inurement as honest as you can at the start, and dispose of or special benefts to individuals (including any issues the IRS raises early on, to avoid any directors and ofcers); only incidental—not potential problems later. Before flling in this substantial—unrelated business income; no section, read the ofcial 1023-EZ instructions support to restricted foreign entities; and no for each of the questions in this section; these bingo or gaming activities. Here are some instructions provide or point you to more pointers for more information on some special information on some of the issues, activities, issues associated with these items: and purposes listed in this section. tUnrelated Business Income. If you anticipate Line 1. Te list of 3-character NTEE Codes is that your organization will earn $1,000 or included in the ofcial 1023-EZ instructions. more annual unrelated business income, Select the one that best matches your 501(c)(3) the IRS may send you additional questions purposes and/or activities. to determine, based on the description Line 2. Check the box that matches the 501(c)(3) you provide of your proposed operations, purpose contained in Article FIVE of your that such business income will not be a articles (see instructions in Chapter 6 to primary activity of your nonproft (see preparing Article FIVE). Chapter 3, “Unrelated Business Activities”). Line 3. You should be able to check this box to Also be prepared to fle annual 990-T show that you will abide by these 501(c)(3) forms as explained in Chapter 10, “Federal operational requirements (see Chapter 3, Corporate Tax Returns”). “Other Requirements for 501(c)(3) Groups,” for tBingo and gaming. See IRS Publication more information on these requirements). 3079, Gaming Publication for Tax-Exempt Line 4.*GZPVXJMMBUUFNQUUPJOìVFODF Organizations. legislation, check this box. For the 501(c)(3) tForeign operations. Special tax exemption limits on this activity, and to consider whether and deductibility of contribution rules apply you should make an election using Form to nonprofts created or operated abroad. 5768, see Chapter 3, “Limitation on Political If you plan to operate or provide assistance Activities.” abroad, you may wish to seek guidance Line 5. If you will pay your ofcers or directors from a nonproft adviser who has experience (or think you will), check the “Yes” box. in advising nonprofts that operate in We’ve already explained the basic 501(c)(3) the foreign countries where you plan to prohibition against private inurement and the operate. Also see “Foreign Organizations excess beneft rules that penalize nonprofts in General” in the ofcial standard Form 1023 instructions for basic information on 180 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

nonprofts formed abroad. Finally, realize Form 1023-EZ; (they have to check “Yes” to a that a big part of the IRS’s energies is now question on the 1023-EZ Eligibility Worksheet, devoted to scrutinizing the operations of and hence do not qualify to use 1023-EZ). foreign-based nonprofts as part of the Tese “institutional” nonprofts must use Form service’s participation in antiterrorism. 1023 to apply for their tax exemption and Here is an excerpt from the IRS 2005 EO public charity status. Terefore, this section of (Exempt Organization) report: the 1023-EZ only applies to groups that can In FY 2005, EO will examine a sample qualify as a public charity because of the types of foreign grant making organizations; the of public support or exempt-purpose revenue primary focus of the examinations is to they receive (they qualify as a public charity ensure that funds are used for their intended under either the “Public Support Test” or the charitable purpose and not diverted for “Exempt Activities Support Test” as described terrorist activity. Te project will gather in Chapter 4). information about current practices, that is, Line 1. Check one of the boxes in this section the existence and efectiveness of controls put to tell the IRS how you plan to qualify as a in place to monitor the distribution of overseas public charity: grants and other assistance. Tis committee (a) Check this box if you anticipate qualifying will also address the need for possible guidance as a public charity under the “Public or other modifcations to the laws in this area. Support” test covered in Chapter 4. tDisaster Relief. Te IRS may prioritize the (b) Check this box if you anticipate qualifying processing of your application if your as a public charity under the “Exempt organization provides disaster relief. For Activities Test” test covered in Chapter 4. more information, see IRS Publication (c) Certain organizations operated for the 3833, Disaster Relief: Providing Assistance beneft of a governmental (e.g., state) Trough Charitable Organizations. college or university qualify as public charities. We assume you are not forming Part IV: Foundation Classiﬁcation this special type of nonproft, but if Tis is a technical section, which seeks to you are, see a nonproft specialist with determine whether your 501(c)(3) will be a public experience with this sort of organization charity or a private foundation. To help you for guidance in forming your nonproft answer the questions in this section, reread and obtaining your tax exemption and Chaper 4, where we explain the importance of qualifying as a public charity. qualifying your 501(c)(3) tax-exempt organization Line 2. We assume readers will check box 1(a) as a public charity and explain the three basic or (b) to seek public charity status for their ways your organization can qualify as a public 501(c)(3) tax-exempt organization. If you do charity. Also read the ofcial 1023-EZ instructions not think you qualify to check either the 1(a) or for this section. (b) box, and end up prepared to check box 2, Te frst thing to note is that certain nonprofts you should get the help of a nonproft adviser that may qualify for public charity status (we to form a private foundation and obtain its call this category “Automatic Public Charity 501(c)(3) tax exemption (see Chapter 4, “Private Status” in Chapter 4), including churches, Foundations” for more information). schools, and hospitals, do not qualify to use CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 181

Part V: Reinstatement After as the “c/o name.” Otherwise, insert “not Automatic Revocation applicable.” You can ignore this section. It is used by Line 3. Provide the mailing address of the cor- nonprofts that have already obtained and lost poration. If you do not have a street address, their 501(c)(3) exemption due to a failure to fle provide a post ofce box address. Te IRS their annual IRS Form 990 informational tax wants you to include the full nine-digit zip code returns. (Read the ofcial 1023-EZ instruction in your address. Include it if you know it. (Zip to this section for more information.) It’s good code information can be obtained online at the to know that Form 1023-EZ can be used for U.S. Postal Service Zip Code lookup page.) this purpose, but by staying on top of your Line 4. All nonproft corporations (whether ongoing nonproft tax fling responsibilities or not they have employees) must obtain a after you obtain your tax exemption (see federal Employer Identifcation Number (EIN) Chapter 10), you will never need to do so. prior to applying for 501(c)(3) tax exemption. You will insert this number here on your 1023 Submit 1023-EZ Online form and use this identifcation number on all your future nonproft federal information, You fll in, submit, and pay the fling fee for income, and employee tax returns. Even Form 1023-EZ online. Follow the instructions if your organization held an EIN prior to on the IRS website to submit the form and pay incorporation, you must obtain a new one for the user fee. the nonproft corporate entity. If your nonproft Instructions to Form 1023 corporation has not yet obtained an EIN, it should do so now. Below are the instructions to help you answer Te easiest and quickest (and IRS preferred) the questions on the Form 1023 tax exemption way to get an EIN is to apply online from application. If you do not qualify to use the the IRS website. Go to www.irs.gov and type 1023-EZ online application as explained in “EIN” in the upper search box. Ten click the previous section, you will need to apply for “Go” to open a page that lists links to EIN- your tax exemption by completing one of the related Web pages. You should see a link to the 1023 forms (interactive, accessible, or printed online EIN application. Te online form is an version, which we describe at the beginning of electronically fleable version of IRS Form SS-4, this chapter). Te ofcial IRS instructions along Application for Employer Identifcation Number. with our instructions, below, should help you Fill in the online version of the SS-4 form and perform this task. submit the application to receive your EIN immediately. Part I: Identiﬁcation of Applicant Follow the instructions, below, when complet- Line 1. Write the name of your corporation ing the SS-4 form: exactly as it appears in your articles of tName and SSN of oﬃcer. You will need incorporation. to specify the name and Social Security Line 2. If you have designated one person in Number of one of your principal ofcers. your organization to receive return mail from Normally the chief fnancial ofcer or the IRS regarding your 1023 application, such treasurer will provide a name and SSN here. as one of the founders, list this person’s name 182 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tType of entity. Check “church or church- You also can apply for an EIN by phone. controlled organization” if you are forming To do this, fll in the SS-4 form (included one; if not, check “other nonproft organi- in appendix B, with separate instructions, or zation” and specify its 501(c)(3) purpose available on the IRS’s website). Ten call the (educational, charitable, and so on). IRS at 800-829-4933—be sure to complete tGEN number. Most groups will ignore this the form before making the phone call. If you item—it applies only to a group exemption apply by phone, you will be assigned an EIN application request. Members of an afli- number immediately. Write this number in the ated group of nonprofts can specify a upper right-hand box of a printed SS-4 form, previously assigned Group Exemption then date and sign it, and keep a copy for your Number. records. Te IRS telephone representative may tReason for applying. Check “started new ask you to mail or fax a copy of your signed business,” then specify “formed nonproft SS-4 form to the IRS. corporation” in the blank. If you are You also can apply for an EIN by fax and converting an existing unincorporated get your EIN faxed back to you within four association (that has previously fled any business days. See the instructions to Form appropriate tax returns for its association SS-4 for more information on using the IRS tax years with the IRS) to a nonproft Fax-TIN program. corporation, you can check “changed Finally, you can get an EIN the slow way type of organization” instead, then insert by simply mailing your SS-4 form to the “incorporation” in the blank. IRS. Have an ofcer—typically the CFO or tDate Business Started. Te date you started treasurer—sign the form, stating his or her title. your business is the date your articles were Expect to wait at least four weeks. Remember, fled with the state fling ofce. Use the fle- you can’t complete line 4 of your 1023 form stamped date on the copy of your articles until you have your EIN. returned by the state ofce. Line 5. Specify the month your accounting tEmployees. You can enter zeros in the next period will end. Use a two-digit month item that asks the number of employees you number for your response. For example, if expect to have in the next 12 months. your accounting period will end December Make sure to write down your EIN number 31, insert “12.” Te accounting period must immediately before changing Web pages—you be the same as your corporation’s tax year. will not be able to back up and retrieve the EIN Most nonprofts use a calendar year as their after you navigate away from the Web page. accounting period and tax year. If you choose Print a copy of the online form (you can do this to do the same, specify “12” here. by clicking the “Print Form” button on the IRS If you anticipate special seasonal cycles for Web page after receiving your EIN), write the your activities or noncalendar-year record- assigned EIN in the upper-right of the printed keeping or grant accountability procedures, you form, then date and sign it and place the copy may wish to select a noncalendar accounting in your corporate records. period for your corporation. For example, a federally funded school may wish to specify +VOF iw JOUIJTCMBOL XIJDISFìFDUTBO accounting period of July 1 to June 30. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 183

If you have any questions regarding the best unpaid lawyers and accountants who serve accounting period and tax year for your group, as volunteers to their board. If this is your check with your (probable) funding sources situation, you can answer “No,” since this item and consult your accountant or bookkeeper for is asking about paid advice from an outsider. further guidance. Tere is nothing wrong in paying an outsider Line 6(a)–6(c). State the name of a director for help. Te purpose of this question is to or ofcer the IRS can contact regarding your require full disclosure of any paid relationships application, the phone number where this between your nonproft and its advisers, to person can be contacted during business make sure the compensation arrangement hours, and a fax number. Te fax number is is fair to the nonproft, and to see that there optional—if you don’t want to provide one, JTOPPCWJPVTDPOìJDUPGJOUFSFTUCFUXFFO insert “not applicable.” We suggest you list the the person’s role and their paid status. An name and telephone number of the director overriding concern of the IRS is to make sure or ofcer who is preparing and will sign your that one person is not personally directing the tax exemption application (see Part XI, below). organization and operation of your nonproft Nevertheless, don’t expect the IRS to call to ask to further his or her own personal fnancial RVFTUJPOT PSKVTUUPTBZi)Jw *GUIF*34IBT interests and agenda. questions about your application, it will usually Many professionals are being more careful contact you by mail. these days and will shy away from providing Line 7. We assume you are flling in your 1023 professional advice on nonproft boards unless form yourself, and will mark “No” to this item. they are indemnifed and covered by Directors’ However, if you are being helped by a lawyer, Liability Insurance. Some paid advisers will accountant, or other professional representative, automatically say “No” when asked to sit on a mark “Yes” to allow the representative to talk nonproft board because they do not want to on your behalf with the IRS about your 1023 confuse their role as adviser to the nonproft application. If you mark “Yes,” you will need to entity (their real client to whom they owe complete and attach an IRS Form 2848, Power a professional duty) with the separate task of Attorney and Declaration of Representative of acting as an adviser to the board and its (available from the IRS website) to your 1023 individual members. application. Line 9(a) and 9(b). Insert the URL for your Line 8. We assume most readers will answer nonproft’s website, if you have one. Any website “No” here. However, if you have paid or content should be consistent with your nonproft plan to pay an outside lawyer, accountant, or purposes and program as described in your other professional or consultant to help you 1023 application. Also provide an email address set up your nonproft or advise you about to receive educational information from the IRS its tax status, and the person is not acting as in the future. If you leave either of these items your formal representative (named in Form blank, insert “not applicable” in the blank. 2848, as explained in line 7, above) and the Line 10. Some nonprofts using this box will person is not a director, ofcer, or employee be eligible for an exemption from fling IRS of your nonproft, answer “Yes” and provide Form 990, the annual information return for the requested information. Traditionally many nonprofts or the shorter 990-EZ form for nonprofts get professional guidance from smaller groups—see “Federal Corporate Tax 184 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Returns,” in Chapter 10. If you are reasonably Part II: Organizational Structure sure you will be exempt—for example, if you Line 1. Most tax-exempt nonprofts are formed are forming a church or know that you will as nonproft corporate entities, and we expect have gross receipts of less than $25,000 per you to follow the standard practice of forming year—mark “Yes” and state the reason why you a corporation too. Check “Yes” to indicate that are exempt on an attachment page. All other your group is a corporation. Attach a copy nonprofts using this book should mark “No” of your articles to your application. Te copy here. Remember—even if your nonproft has should be a certifed copy you received from $25,000 or less in gross receipts, it must fle a the state fling ofce. It should show a fle-date Form 990-N (e-Postcard) each year. stamp or include a certifcation statement or We think it is wise to fle 990 returns each page that states it was fled with the state and is year, even if you and the IRS initially agree that a correct copy of the original fled document. your group should be exempt from fling the Line 2. We assume you will check “No” to returns. Why? Because you may fail to continue indicate that you are not seeking a tax exemp- to meet the requirements for the exemption tion for an LLC. Very few nonprofts are from fling, and may get hit with late-fling formed as limited liability companies. If this penalties if you have to go back and fle your is what you are attempting to do, you should returns for prior years that you missed. By fling consult with an experienced lawyer. a return, even if not required, you normally Line 3. We assume you will check “No” here start the running of the time frame during because we expect readers to form a tradi- which the IRS can go back and audit your tional nonproft tax-exempt corporation, not nonproft tax returns. And your fled 990 can an unincorporated association. An un incor- come in handy in many states for meeting your porated association requires special paper work state income tax and any state attorney general (associa tion charter or articles and association fling requirements. operating agreement), and it leaves the members Groups exempt from the 990 fling require- poten tially personally liable for the debts of and ments may still have to fle a Form 990-N claims made against the association. If you are postcard or make the 990-N fling online from applying for a tax exemption for an unincor- the IRS website. See Chapter 10 for the federal porated association, you should check with a tax fling requirements. lawyer before applying for your tax exemption. Line 11. Insert the date your articles were fled Line 4(a) and 4(b). Check “No” to show by the secretary of state in mm/dd/yyyy format, that you are not applying for a tax exemption such as 01/05/2013. for a non proft trust. If you are interested in Line 12. We assume you will mark “No.” If establishing a tax-exempt trust, see an expert. you are seeking an IRS 501(c)(3) tax exemption Line 5. Check “Yes” and attach a copy of the for a corporation formed abroad, mark “Yes,” bylaws you have prepared as part of Chapter 7. insert the name of the country, and seek Make sure you have flled in all the blanks in additional help from an adviser who can assist your printed bylaws and include a completed you through your more complicated tax- Adoption of Bylaws page at the end of your exemption application process. bylaws. Te adoption page should show the date of adoption and include the signatures of your initial directors. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 185

Part III: Required Provisions in SIX: Te property of this corporation Your Organizing Document is irrevocably dedicated to [state one or Line 1. Your articles must contain a 501(c)(3) more of your actual tax-exempt purposes, tax-exempt purpose clause (in Chapter 6, such as “charitable,” “religious,” “educa- see Instruction 6 in “Prepare Articles of tional,” “literary,” and/or “scientifc”] Incorporation”). Check the box, and on the line purposes and no part of the net income provided insert the page, article, and paragraph or assets of this corporation shall inure where the 501(c)(3) purpose clause appears. to the beneft of any director, ofcer, or Make sure you reference the 501(c)(3) purpose member thereof or to the beneft of any clause, not your state-required lawful purpose private person. or specifc purpose clause also included in your On the dissolution or winding up of articles. (In the Sample Articles for a California the corporation, its assets remaining after Public Beneft Corporation in “Prepare Articles payment of, or provision for payment of, of Incorporation,” in Chapter 6, the lawful all debts and liabilities of this corporation purpose for state law requirements is specifed shall be distributed to a nonproft fund, in Article 2, and the 501(c)(3) required purpose foundation, or corporation which is clause is stated in Article 4.) organized and operated exclusively for Line 2. Check the 2(a) box to indicate that [repeat the same purpose or purposes your articles contain a 501(c)(3) asset dedi- stated in the frst blank] and which has cation clause and fll in the blank in 2(b) to established its tax-exempt status under state the page, article, and paragraph where the Section 501(c)(3) of the Internal Revenue dissolution clause appears in your articles. Leave Code. the box in 2(c) unchecked—it applies to groups It would check the box in 2(a), and insert the whose articles do not contain a dissolution following on the line in 2(b): “page 2, Article 6, clause and are instead relying on specifc state frst paragraph.” (Tis article provision is taken law provision that requires all 501(c)(3)s formed from “Preparing Articles for a Public Beneft in that state to dedicate their remaining assets Corporation,” in Chapter 6, special instruction upon dissolution to another 501(c)(3). number 8.) A requirement for 501(c)(3) tax-exempt status Do not check the 2(c) box. To be thorough, is that any assets of a nonproft that remain you can insert “Not Applicable” on the line at after the entity dissolves be distributed to the end of line 2(c). another 501(c)(3) tax-exempt nonproft—or Te boxes that appear in line 2 will not apply to a federal, state, or local government for a to most incorporators and should be ignored by public purpose (see “Limitation on Profts and most groups. Benefts,” in Chapter 3). Te articles in this book contain an explicit dedication clause that Part IV: Narrative Description satisfes both federal and state tax exemption of Your Activities requirements. You should be familiar with the material in For example, assume a nonproft has the Chapter 3 concerning the basic requirements following asset dedication clause on page 2 of for obtaining a 501(c)(3) tax exemption before its articles: providing the information requested in this part 186 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

of the form. We will refer to earlier explanations instructions on describing your fnancial as we go along, but you may want to look over support, below). Chapter 3 now before you proceed. Many new groups will be describing proposed activities that are not yet operational, but you TIP must still provide very thorough information. Tell it like it is. When you describe your If you plan to conduct any unrelated busi- proposed activities, don’t limit your narrative to only ness (business that doesn’t directly further your those activities that ﬁt neatly within the 501(c)(3) non proft goals), describe it here. Most non- framework if you’re simply “gilding the lily” to gain profts will not have planned unrelated business IRS approval. Sure, you’ll probably get your tax activities at this point. If you have, you will exemption, but you may not keep it. Te IRS can not want to stress the importance or scope of always decide later, after examining your sources of these incidental unrelated activities (for an support, that your actual activities go beyond the explanation of the tricky issues surrounding scope of the activities disclosed in your application. unrelated business activities, see “Unrelated In short, it’s a lot more painful and expensive to shut Business Activities,” in Chapter 3). down your nonproﬁt if it loses its tax exemption Tempting though it might be, resist copying rather than deciding at the outset not to apply for the language that already appears in the 501(c)(3) status because your proposed mission does not qualify for tax-exempt status. purpose clause in your articles—the IRS wants a narrative, not an abbreviated, legal On an attachment page, provide a detailed description of your proposed activities. You may description of all of your organization’s activities— include a reference to, or repeat the language past, present, and future—in their order of PG UIFMPOHFSTUBUFNFOUPGTQFDJëDPCKFDUJWFT importance (that is, in order of the amount of and purposes included in Article 2, Section 2, time and resources devoted to each activity). of your bylaws. However, unless your bylaw For each activity, explain in detail: language includes a detailed narrative of both tUIFBDUJWJUZJUTFMG IPXJUGVSUIFSTBOFYFNQU your activities and purposes, we suggest you use purpose(s) of your organization, and the it only as a starting point for a fuller response percentage of time your group will devote to it here. Generally, we recommend starting over tXIFOJUXBTCFHVO PS JGJUIBTOUZFUCFHVO with a fresh, straightforward statement of your when it will begin) group’s nonproft activities. tXIFSFBOECZXIPNJUXJMMCFDPOEVDUFE BOE EXAMPLE 1: A response by an environmental tIPXJUXJMMCFGVOEFE UIFëOBODJBM organi zat ion might read in part as follows: JOGPSNBUJPOPSQSPKFDUJPOTZPVQSPWJEFMBUFS Te organiza tion’s activities will consist in your application should be consistent primarily of educating the public on with the funding methods or mechanisms environ mental issues with an emphasis on you mention here). For example, if your energy conserva tion. Since January 20xx, application shows you will be obtaining the organization has published brochures the bulk of your tax-exempt revenue from promoting solar energy heating systems as providing program-related services, such an alternative to traditional energy sources. as tuition or admission fees, and/or from Te price for the brochures is slightly above grant funds, you will want to mention cost—see copies of educational material these sources of support here (see additional enclosed, Attachments A–D. Te brochures CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 187

are published in-house at [address of Schedules for Special Groups principal ofce]. Both paid and volunteer staf contribute to the research, writing, Type of Organization See Schedule editing, and production process. Tis work Church A constitutes approximately 80% of the group’s School, College, or University B activities. In addition to publishing, the Hospital and Medical Research organization’s other activities include the Organization C following [list in order of importance other Home for the Aged or current, past, or planned activities and Handicapped F percentage of time devoted to each, where Student Aid or Scholarship performed, and so on]… Beneﬁt Organization H

EXAMPLE 2: A nonproft organization plans Your description should indicate your orga- to sponsor activities for the purpose of ni zation’s anticipated sources of fnancial supporting other nonproft charities. It support—preferably in the order of magnitude should describe both the activities in which (most money to least money). Here are a few it will engage to obtain revenue at special tips to help you address this portion of your events and the manner in which this money response: will be spent to support other groups. t:PVSTPVSDFTPGTVQQPSUTIPVMECFSFMBUFE Percentages of time and resources devoted to to your exempt purposes—particularly if each should be given. you plan to be classifed as a public charity under the support test described in “Exempt If you are forming an organization that auto- Activities Support Test,” in Chapter 4, where matically qualifes for public charity status (a the group’s primary support is derived from church, school, hospital, or medical research the performance of tax-exempt activities. organization) or has special tax exemption t*GZPVQMBOUPRVBMJGZBTBQVCMJDMZ requirements, you will want to show that your supported public charity (described in organization meets the criteria that apply to “Public Support Test,” in Chapter 4), your your type of organization. See “Automatic responses here should show signifcant Public Charity Status,” in Chapter 4, for a dis- support from various governmental grants, cussion of each of these special types of non- private agency funding, or individual profts. In the 1023 form, you’ll fnd schedules contributions. and instructions that apply to each type of t*GZPVFYQFDUZPVSQSJODJQBMTPVSDFTPG special group (for example, Schedule A for TVQQPSUUPìVDUVBUFTVCTUBOUJBMMZ BUUBDI churches, Schedule B for schools, and Schedule a statement describing and explaining C for hospitals—see the table below). If you are anticipated changes—see the specifc forming one of these special types of nonprofts, instructions to Part II, line 2, in the 1023 skip ahead to “Filling Out the Schedules” and package. look over the instructions for the schedule you Your description should show how you need to complete. Tat way, you’ll have a better will fund your activities. For example, if you understanding of what the IRS is looking for in will give classes, state how you will recruit your statement about your nonproft activities. 188 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA instruc tors and attract students. If you will Part V: Compensation and Financial rely on grants, state your likely sources of Arrangements With Your Oﬃcers, grant support—for example, the particular Directors, Trustees, Employees, or general categories of grant agencies you and Independent Contractors plan to approach. If your nonproft expects Te IRS has expanded this part of the applica- to obtain funds through grant solicitations or tion to try and prevent people from creating other fundraising eforts—that is, by soliciting and operating nonprofts simply to beneft one contributions from donors either directly or or more of the nonproft’s founders, insiders, through paid fundraising—make sure you PSNBKPSDPOUSJCVUPST8FWFBMSFBEZFYQMBJOFE provide a narrative description of these eforts the basic 501(c)(3) prohibition against private here, and also refer to Part VIII, line 4, of your inurement and the excess beneft rules that application, where you will provide additional penalize nonprofts and their managers if they information on your fundraising activities (see pay unreasonable compensation to insiders instructions to Part VIII, below). and outsiders (see the discussion on the excess Include as exhibits any literature you plan to beneft rules in “Limitation on Profts and distribute to solicit support and indicate that Benefts,” in Chapter 3). In this part of the this material is attached to your application. application, the IRS tries to fnd out if your Fundraising activities include unrelated nonproft runs the risk of violating any of business activities that will bring cash into these rules. So if you have compensation or your nonproft. If you have concrete plans to other fnancial arrangements with any of engage in unrelated activities (which, of course, your founders, directors, ofcers, employees, you should be able to clearly describe as an contractors, contributors, and others, now is insubstantial part of your overall activities), the time to disclose this information. It’s better include the details if you have not done so UPëOEPVUBIFBEPGUJNFUIBUUIF*34PCKFDUT already in your response. to your proposed fnancial arrangements rather If your organization has or plans to have a than pay hefty excess beneft taxes later and run website, provide information on the existing the risk of losing your tax exemption. site (including its URL) or the planned site. Te Line 1(a). Provide the names, titles, mailing existing or proposed website content and any addresses, and proposed compensation of the revenue it generates should be related to and initial directors named in your articles and your further the exempt purposes of the group. If initial ofcers. You can ignore the instruc tions your website is used to solicit contributions or concerning trustees—your directors are the generate other revenue, explain how this is or trustees of your nonproft corporation. List your will be done. initial directors and your top-tier ofcer team, Finally, if your group intends to operate under if you know who will fll these ofcer positions a fctitious business name (an “aka”—also (such as President or Chief Executive Ofcer, known as—or “dba”—doing-business-as— Vice President, Secre tary, and Treasurer or name) that difers from your formal corporate Chief Financial Ofcer, or any other title used name as stated in your articles, make sure to in your orga ni zation). For director or ofcer mention the alternate name here, and why you mailing addresses, you can state the mailing want to use an alternate name. address of the corporation. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 189

At this stage in the organization of your ofcer arrangements, including the amount nonproft, you may not be absolutely certain of any salaries to be paid. Remember, though, what you will pay your initial directors and that putting people on the payroll who are ofcers. However, if you have a good ballpark related to directors may cause you to run afoul estimate or a maximum amount in mind, it’s of California’s disinterested director rule—see better to state it in your response instead of “Directors,” in Chapter 2. “unknown” or “not yet decided.” In the sample Line 1(b). In this section, state the names, bylaws included in this book, we say that titles, mailing addresses, and compensation directors will not be paid a salary but may be for your fve top-paid employees who will paid a per-meeting fee and reimbursed expenses earn more than $50,000 per year. You should (see Article 3, Section 6). Terefore, you may include employer contributions made to wish to respond along the following lines: employee beneft plans, 401(k)s, IRAs, expected “Pursuant to Article 3, Section 6, of the bonus payments, and the like in computing corporation’s bylaws, directors will not be the amount of compensation paid to your paid a salary. Tey may be paid a reasonable employees. You should only list employees who fee for attending meetings of the board [you are not ofcers (all ofcer salaries should be may mention a specifc amount or a range reported in line 1(a) of this Part). It’s best to if you have decided on a per-diem fee] and anticipate who will be paid more than $50,000 may be allowed reasonable reimbursement by providing estimated compensation fgures or advancement for expenses incurred in the rather than leaving this information blank. performance of their duties.” Tis response will However, if you really don’t know yet which not ft in the “Compensation amount” column, ofcers you will pay or how much you will so you’ll need to prepare your response as an pay them, you can respond as follows: “Tis attachment if you use this wording. corporation is newly formed and has not yet If you have decided on ofcers’ salaries or hired employees nor determined the amount a range or maximum compensation level for of compensation to pay employees it may hire. ofcers, you can state it in your response. However, all compensation will be reasonable If you are not sure who your board will and will be paid to employees in return appoint as initial ofcers and do not know the for furthering the exempt purposes of this compensation level for your ofcers, you may nonproft corporation.” wish to respond as follows: “Te persons who Tere is nothing special or suspect about will serve as ofcers and the compensation paying an employee more than $50,000. In fact, they will receive, if any, have not yet been compensation paid to employees who make determined by the board of directors. Any such MFTTUIBO BëHVSFUIBUJTBEKVTUFEGPS compensation will be reasonable and will be DPTUPGMJWJOHJODSFBTFT OPSNBMMZJTOPUTVCKFDU paid in return for the performance of services to scrutiny under the excess beneft rules. related to the tax-exempt purposes of the (See “Limitation on Profts and Benefts” in corporation.” Tis response will not easily ft Chapter 3 for more on the excess beneft rules. in the space provided for your 1(a) response, so If you are interested in the $80,000 category you’ll probably need to prepare your response as and how it fts within the excess beneft rules, an attachment if you use this wording. see IRS Regulation 53.4985-3(d)(3)(i) and IRC If you have decided who will be elected to Section 414(q)(1)(B)(i).) For this line item, the serve as ofcers, provide the details of these IRS wants to see exactly how much your top 190 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

fve highest paid employees are getting paid if for services with outside persons or companies. they make more than $50,000. Ignoring all If and when it does, any such contracts will the fne print of the excess beneft rules and provide for payment in commercially reasonable SFHVMBUJPOT KVTUSFNFNCFSUIBUUIFTBMBSZBOE amounts in return for services related to the other benefts you pay each employee should be exempt functions of this nonproft.” no more than what a comparably paid person Lines 2(a)–9(a). Te remaining questions in in a similar position in a similar organization this Part V seek to determine if your nonproft would receive. With nonproft symphony may run afoul of the excess beneft restrictions orchestra leaders getting paid millions in that apply to 501(c)(3) public charities—the annual salaries, it is questionable that using a type of nonproft you are trying to establish. comparability standard always produces the best Te excess beneft rules apply to “disqualifed or even reasonable results. And we’re sure that persons,” as defned under the Internal Revenue readers of this book, who work long, hard hours Code, Section 4958. For these purposes, a getting paid less than they should in pursuit of disqualifed person means anyone who exercises their public purposes, should have little to worry TVCTUBOUJBMJOìVFODFPWFSUIFOPOQSPëU TVDI about when it comes to the question of receiving as founders, directors, ofcers, and substantial unreasonably large salaries or other excess contributors. People who fall within the benefts from their nonproft. defnition of disqualifed persons are not Line 1(c). Indicate the names of individuals prohibited from being paid by your nonproft. (or names of businesses), titles (if individual), *OTUFBE UIFJSTBMBSJFTBOECFOFëUTBSFTVCKFDU mailing addresses, and compensation for your to scrutiny under the excess beneft rules. If fve top-paid independent contractors who will the IRS fnds that a disqualifed person was earn more than $50,000 per year. Independent overpaid—that is, the person received a salary, contrac tors are people and companies who bonus, or benefts that exceeded the fair market provide nonemployee services to the non proft, value of the services provided or was excessive such as a paid lawyer, accountant, outside book- compared to amounts paid to similar people in keeper, fnancial consultant, fundraiser, and other nonprofts—the disqualifed person and other outside individuals and companies hired UIFOPOQSPëUBOEJUTNBOBHFSTDBOCFTVCKFDU by the nonproft who are not on the nonproft’s to sanctions. Te sanctions include being employee payroll. Typically, your nonproft will required to pay back previously paid salaries have a separate contract for services with its and stif penalty taxes. (For more information independent contractors—particularly if it will on disqualifed persons and the excess beneft pay them more than $50,000 per year. If your rules, see “Limitation on Profts and Benefts,” newly formed nonproft has plans to contract for in Chapter 3.) more than $50,000 with one or more outside Te IRS will review your answers in this individuals or companies, list them here and section to see if there is any indication provide the expected amount of business you that an intentional or incidental purpose plan to do with each contractor annually. If, as of your nonproft is to fnancially beneft is typical, your newly formed nonproft does not the private interests of any board members, have plans to contract for outside services, you ofcers, employees, or contractors. If the IRS can respond (in the blanks or on an attachment) determines that you are using nonproft funds as follows: “Tis newly formed nonproft to excessively compensate any of these people, it corporation has no current plans to contract will deny your tax exemption. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 191

If you answer “Yes” to any of the remaining do not have an outside business relationship items in Part V, make sure to explain your with your nonproft—and we expect, even response. Provide any additional information KVTUGPSBQQFBSBODFTTBLF UIBUNPTUTNBMMFS needed to show why you marked “Yes” on an nonprofts will not appoint board members or attachment page. ofcers with whom the nonproft plans to do outside business. If you check “Yes,” disclose TIP the names of the individuals and their business Tere are numerous definitions of relationships with your nonproft on an “Disqualified Persons” in the Internal Revenue attachment page. Code. Don’t get confused or concerned if you run up Line 2(c). Tis item asks if any of your direc- against different definitions of “disqualified persons” tors or ofcers are related to the people listed that apply to nonprofits. For example, a different in 1(b) or 1(c)—that is, related to your highest- definition of disqualified person (under IRC § 4946) paid employees or independent contractors is used to determine permitted sources of public who make more than $50,000. If you answer support for 501(c)(3) public charity support tests and “Yes,” specify the names of the directors and when applying the excise tax restrictions that apply ofcers and their relationship to the highest- to private foundations (see Chapter 4). paid people. Again, it looks best if your board and ofcers are not related to your more highly Line 2(a). Check “Yes” if any of your directors compensated employees or contractors. But or ofcers are related to each other or have a in the real world of small nonprofts, it may business relationship with one another. A family be impossible to start your nonproft without relationship includes an individual’s spouse, getting Uncle Bill or Aunt Sally to provide ancestors, children, brothers, and sisters (see their expertise by volunteering as an unpaid the instructions to Form 1023 for a description board member. As long as you disclose these of family and business relationships that must arrangements and make sure to fairly pay—and be disclosed). If you check “Yes,” provide a list not overpay—anyone, the IRS should conclude of names and a description of the family or that your nonproft is on the up-and-up and business relationship between the individuals is entitled to its exemption if it meets all the on an attachment page. substantive requirements. Line 2(b). Check “Yes” if your organization Line 3(a). Tis item requests very important (“you” means your nonproft) has an outside information (on an attachment page), which business relationship with its directors or the IRS uses to determine if your nonproft will ofcers (see the Form 1023 instructions for pay excessive benefts to any insider or outsider. the types of business relationships that must Specifcally, it asks you to list the qualifcations, be disclosed). Again, these relationships will average hours worked (or to be worked), and not be an absolute bar to your obtaining a duties of your directors and ofcers listed in tax exemption, but the IRS will scrutinize 1(a) and highly compensated employees and payments made to these “related” parties to contractors (listed in 1(b) and 1(c), respectively). make sure they are being fairly, not excessively, :PVSSFTQPOTFTIFSFTIPVMEKVTUJGZBOZIJHI compensated by your nonproft (either through salaries, benefts, or per diem amounts paid to salaries and benefts or through separate your ofcers or directors. For example, if you business contracts with your nonproft). Of plan to pay ofcers a signifcant salary that course, it looks best if your board and ofcers may raise IRS examiner eyebrows, make sure 192 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

to list the extra qualifcations and experience nonproft exists to serve the purposes or foster of the highly compensated ofcer. Don’t the activities of the related nonproft. Tis hold back or be shy in touting the creden tials may be fne if the other nonproft is, itself, a (academic degrees, teaching positions, awards), 501(c)(3) tax-exempt nonproft. But if it isn’t, experience (past associations as advisers or the common control aspect probably will directors with other non profts), and other adversely afect your ability to obtain your tax qualifcations or community afli ations of exemption—your nonproft can’t be formed to your well-paid people. Te IRS really wants promote nonexempt purposes. to know why you pay people well (if, in fact, Line 4(a)–4(g). Tis item asks whether your you are lucky enough to pay your ofcers and group has established the procedures and other employees a competitive wage, salary, or practices recommended under the safe harbor CFOFëUT 0OUIFìJQTJEF PCWJPVTMZ JGZPVQBZ rules of the excess beneft provisions and ZPVSQBSUUJNFBENJOJTUSBUJWFBJEF XIPKVTU regulations (see “Limitation on Profts and happens to be your cousin Joe, a lavish hourly Benefts,” in Chapter 3, for a brief summary wage plus full benefts, expect the IRS to balk. of the safe harbor rules). Tese procedures are Unless Joe has special skills that are in high meant to minimize the risk that nonprofts will demand by other organizations and companies, pay out excess benefts. You don’t have to adopt the IRS will question this special arrangement. and follow them, but you should if you want Line 3(b). If any of the directors, ofcers, the IRS to look kindly on your tax exemption. and highly paid people listed in 1(a) through If you adopt the standard bylaws contained 1(c) get paid by another organization or com- in this book, you can mark “Yes” to each pany that has common control with your question and provide the responses to each item nonproft, you will need to mark “Yes” on shown below on an attachment page. Te IRS this item and provide an explanation on an instructions to this line do not ask you to give attachment page. As the instructions to Form more information if you answer “Yes” to an 1023 explain, organizations with common item, but we think you should do so, stating in control include those that have their boards or your response where the IRS can look in your ofcers appointed or elected by the same parent bylaws to verify that you have adopted each or overseeing organization. In addition, if a practice (as explained for each item below). NBKPSJUZPGZPVSCPBSEBOEPSPïDFSTBOEB Line 4(a). Check “Yes” and state on an attach- NBKPSJUZPGUIFCPBSEBOEPSPïDFSTPGBOPUIFS ment page: “Tis organization has adopted organization consist of the same individuals, BDPOìJDUPGJOUFSFTUQPMJDZUIBUDPOUSPMTUIF then you share common control. If common approval of salaries to directors, ofcers, and control between your nonproft and another other “disqualifed persons” as defned in organization exists, expect the IRS to attribute Section 4958 of the Internal Revenue Code. See the total compensation paid by both commonly Article 9, as well as Article 3, Section 6, and controlled organizations to your board and Article 4, Section 10, of the bylaws attached PïDFST BOEBMTPFYQFDUUIF*34UPKVEHFUIF to this application. Also, Article 9, Section 5, purposes and activities of your nonproft in of this organization’s bylaws applies additional light of the control exercised or shared by the DPOìJDUPGJOUFSFTUSFRVJSFNFOUTPOUIFCPBSE PUIFSPSHBOJ[BUJPO'PSFYBNQMF JGBNBKPSJUZ and compensation committee when approving of your ofcers are ofcers of another nonproft, compensation arrangements.” the IRS will want to know whether your CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 193

Line 4(b). Check “Yes” and state on an persons who vote on the arrangement and their attachment page: “Article 9, Section 3, of this votes. Further, and specifcally with respect organiza tion’s bylaws requires the approval of to the approval by the board or compensation compensation of directors, ofcers, and any committee of compensation arrangements, “disqualifed person” as defned in Section Article 9, Section 5(d), of the organization’s 4958 of the Internal Revenue Code in advance bylaws requires the recordation of the board or after full disclosure of the surrounding facts committee who were present during discussion and approval by disinterested members of the of the approval of compensation arrangements, governing board or committee and prior to those who voted on it, and the votes cast by entering into the compensation agreement or each board or committee member.” arrangement. Further, Article 9, Section 5(a), Line 4(e). Check “Yes” and state on an attach- of this organization’s bylaws requires specifc ment page: “Article 9, Section 5(c), of the approval of compensation arrangements prior organization’s bylaws requires that the board to the frst payment of compensation under or compensation committee considering the such arrangements.” approval of a compensation arrangement obtain Line 4(c). Check “Yes” and state on an compensation levels paid by similarly situated attach ment page: “Article 9, Section 4, of the organizations, both taxable and tax-exempt, organi za tion’s bylaws, which are attached to for functionally comparable positions; the this appli cation, require the taking of written availability of similar services in the geographic minutes of meetings at which compen- area of this organization; current compensation sation paid to any director, ofcer, or other surveys compiled by independent frms; and “disqualifed person” as defned in Section 4958 actual written ofers from similar institutions of the Internal Revenue Code, are approved. competing for the services of the person who is Te minutes must include the date and the UIFTVCKFDUPGUIFDPNQFOTBUJPOBSSBOHFNFOU terms of the approved compensation arrange- Tis article also provides that it is sufcient for ments. Further, and specifcally with respect these purposes to rely on compensation data to the approval by the board or compensation obtained from three comparable organizations committee of compensation arrangements, in the same or similar communities for similar Article 9, Section 5(d), of the organization’s services if this organization’s three-years’ bylaws requires the recordation of the date average gross receipts are less than $1 million and terms of compen sation arrangements as (as allowed by IRS Regulation 53.4958-6).” well as other specifc information concerning Line 4(f). Check “Yes” and state on an attach- the basis for the approval of compensation ment page: “Article 9, Section 5(d), of the arrangements.” organi zation’s bylaws requires that the written Line 4(d). Check “Yes” and state on an minutes of the board or compensation com- attachment page: “Article 9, Section 4, of the mittee meeting at which a compensation organiza tion’s bylaws requires the written arrange ment was discussed and approved recordation of the approval of compensation include the terms of compensation and the basis and other fnancial arrangements between this for its approval. Tis bylaw provision includes organization and a director, ofcer, employee, a list of specifc information that must be contractor, and any other “disqualifed person” included in the required written minutes.” as defned in Section 4958 of the Internal If you haven’t adopted the bylaws included Revenue Code, including the names of the with this book or have deleted or changed 194 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

the provisions in Article 9 of the bylaws, you questions 5(a) and 5(b) on an attachment page. may need to mark “No” to one or more of the Your responses should show that you will follow items in line 4. And whether you mark “Yes” or your own practices to make sure that your “No,” you will need to provide responses on an directors, ofcers, employees, and others who attach ment page that explains your particular FYFSUTJHOJëDBOUJOìVFODFPWFSZPVSOPOQSPëU DPOìJDUTPGJOUFSFTUBOEDPNQFOTBUJPOBQQSPWBM cannot feather their own nests by setting their standards and procedures. Your responses own salary levels and making their own self- should be sufcient to convince the IRS serving business deals with your nonproft. that your directors, ofcers, employees, and Line 6(a) and 6(b). Te IRS instructions to contractors will be paid fairly for work done to Form 1023 explain what the terms “fxed pay- further your organization’s exempt purposes ment” and “non-fxed payment” mean. Essen- and that disinterested directors or compensation tially, question 6(a) asks if your organization committee members—for example, nonpaid will pay its directors, ofcers, highly paid directors or committee members who are not employees, or highly paid contractors (those related to anyone paid by your organization— listed in this part, lines 1(a) through 1(c)) any set the salaries and other compensation of your discretionary amounts (such as bonuses) or ofcers, employees, and contractors. amounts based on your organization’s revenues Line 5(a)–5(c). Mark “Yes” if you have adopted (such as a salary kicker or bonus computed as a the bylaws included with this book. State on percentage of annual contributions received by the attachment page for this item: “Te board your nonproft). Question 6(b) asks this same of directors of this organization has adopted question with respect to all the other employees CZMBXTUIBUDPOUBJOBDPOìJDUTPGJOUFSFTU of your nonproft who receive compensation of policy. Te policy is set out in Article 9 of the more than $50,000 per year. Obviously, it looks attached bylaws. Tis policy is based on the best if your nonproft’s principals and employees TBNQMFDPOìJDUPGJOUFSFTUQPMJDZDPOUBJOFE do not receive these types of revenue-driven in Appendix A of the ofcial instructions incentives, which are more typical in a business, to IRS Form 1023. Te organization has not a nonproft, setting. We assume most small added additional requirements in Article 9, nonprofts will be able to answer “No” to this Section 5, of its bylaws for the approval of question. If, however, you have an overriding compensation arrangements that are based on need to pay directors, ofcers, and employees the additional requirements contained in IRS discretionary bonuses or provide them with Regulation Section 53.4958-6 to help ensure revenue- or performance-based compensation that all compensation arrangements are made or commissions, you need to provide the by disinterested members of the organization’s information requested on an attachment page. board or a duly constituted compensation Your response should show that these nonfxed committee of the board and are fair, reasonable, payments will be fairly and reasonably paid as and in furtherance of the tax-exempt purposes incentives to promote the nonproft purposes of this organization.” of your organization (this may not be easy to If you mark “Yes” to 5(a), you can skip 5(b) show), and that it won’t be used simply to pay and 5(c). If you marked “No” to 5(a) because out revenues to your principals. Remember— you did not adopt the bylaws included with private inurement is a nonproft no-no—so this book or changed them to adopt a diferent siphoning over revenue to nonproft principals DPOìJDUPGJOUFSFTUQPMJDZ JODMVEFSFTQPOTFTUP CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 195

is not allowed, even in the guise of bonus or general public for these inventory items, you performance-based employee incentives. do not have to mark “Yes” to 7(a). Frankly, if Line 7(a) and 7(b). Question 7(a) asks if your your organization plans to purchase any type organization will purchase goods, services, or of goods or services from a director, ofcer, assets from its directors, ofcers, highly paid or employee, we think it should be disclosed employees, or highly paid contractors (those in your application, since deals of this sort listed in this Part V, lines 1(a) through 1(c)). may have the appearance of a self-dealing Question 7(b) asks if your organization will sell transaction. In such a case, you can check “Yes” goods, services, or assets to these people. to line 7(a), then make it clear in your response Most nonprofts will be able to answer “No” that your organization will pay the same price to both these questions because they will for the inventory or other standard items want to stay clear of insider sales and purchase purchased from a director, ofcer, or employee transactions, simply to avoid the appearance (if as the price paid by the general public (the not the actuality) of self-dealing. Tat said, it’s current commercially competitive fair market also a fact of life that some smaller nonprofts value price). have to look to their directors, ofcers, and If you answer “Yes” to either question and principal employees or contractors to buy or sell have adopted the bylaws included with this goods or services—these may be the only people book, you can add in your response that willing to do business with the nonproft at “Article 9, Section 3, of the organization’s the start of its operations. Even more typically, CZMBXTSFRVJSFTUIFBQQSPWBMPGDPOìJDUPG a small nonproft may want to buy goods at a interest transactions or arrangements, such special discount ofered by a director or ofcer. as the purchase or sale of goods, services, or If you answer “Yes” to one of these questions, assets between the organization and one of its provide the requested information in your directors, ofcers, or any other “disqualifed response on an attachment page. Your response person” as defned in Section 4958(f)(1) of the should make clear that any such purchases Internal Revenue Code and as amplifed by or sales will be arms-length—that is, your Section 53.4958-3 of the IRS Regulations, by nonproft will pay no more and sell at no less UIFWPUFPGBNBKPSJUZPGEJTJOUFSFTUFEEJSFDUPST than the commercially competitive, fair market or members of a board committee, only after a value price for the goods, services, or assets. If fnding that a more advantageous transaction you plan to buy goods, services, or assets at a or arrangement is not available to the organi- discount from a director, ofcer, employee, or zation and that the proposed transaction contractor, make sure to say so, since this sort of or arrangement is in the organization’s best bargain purchase is better than an arms-length interest, is for its own beneft, and is fair and deal from the perspective of the nonproft. reasonable.” Te ofcial instructions to Form 1023, line Line 8(a)–8(f). Question 8(a) asks if your 7(a) and 7(b), indicate that you can ignore organization will enter into leases, contracts, purchases and sales of goods and services in the or other agreements with its directors, ofcers, normal course of operations that are available highly paid employees, or highly paid contractors to the general public under similar terms or (those listed in this part, lines 1(a) through (c)). conditions. In other words, if you buy normal If you answer “Yes,” you must supply responses inventory items from a contractor listed in to items 8(b) through 8(f) on an attachment page. Part V, line 1(c), at standard terms paid by the 196 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

To rephrase an observation made in the committee, only after a fnding that a more instructions to line 7 above, to avoid the advantageous transaction or arrangement is appearance if not the actuality of self-dealing, not available to the organization and that the it’s best not to deal with nonproft insiders proposed transaction or arrangement is in when leasing property or contracting for the organization’s best interest, is for its own goods, services, or making other business beneft, and is fair and reasonable.” arrangements. Most nonprofts will shy away Line 9(a)–9(f). Tese questions are similar to from doing this, and will answer “No” to 8(a). those in 8(a) through 8(f) above, except they However, newly formed nonprofts sometimes apply to leases, contracts, and agreements fnd it most practical (and economical) to lease between your nonproft and another business or rent property owned by a founder, director, or organization associated with or controlled or ofcer, or may otherwise have to enter into by your directors or ofcers. Specifcally, these a contract or arrangement with one of these questions apply to business deals between your people. Tere is nothing absolutely forbidden nonproft and another company or organization about doing so, but you will want to make sure in which one or more of your directors or that any lease, contract, or agreement between ofcers also serves as a director or ofcer or ZPVSOPOQSPëUBOEPOFPGUIFTFQFPQMFSFìFDUT one of your directors or ofcers owns a 35% fair market value terms or better. For example, or greater interest (for example, a 35% voting it looks best if a director leases property owned stock ownership interest in a proft-making by the director to the nonproft at a lower-than- corporation). You can ignore deals made market value rate (best of all, of course, is when between your corporation and another 501(c)(3) the director lets the nonproft use the lease tax exempt nonproft organization, even if one premises rent free). or more of your directors or ofcers also serves If you answer “Yes” to 8(a), provide the on the board or as an ofcer of the other information requested in 8(b) through 8(f) 501(c)(3) tax-exempt nonproft organization. on an attachment page. If possible, attach a copy of any lease, rental, or other agreement EXAMPLE: If one of your directors also serves as requested in 8(f). For a discussion of leases as a board member on a nonproft cooperative together with a sample assignment of lease, see that is not tax-exempt under 501(c)(3) and “Prepare Assignments of Leases and Deeds,” in your nonproft enters in leases, contracts, or Chapter 9. Also, if you have adopted the bylaws other agreements with the other nonproft, included with this book, you can add in your answer “Yes” to 9(a) and provide the informa- response to item 8(d) or 8(e) that “Article 9, tion requested in items 9(b) through 9(f). Section 3, of the organization’s bylaws requires UIFBQQSPWBMPGDPOìJDUPGJOUFSFTUUSBOTBDUJPOT EXAMPLE: If one of your ofcers owns a or arrangements, such as a lease, contract, or 35% or greater stock interest in a business other agreement between this organization corporation, and your nonproft buys goods and any of its directors, ofcers, or any other and services from the business corporation “disqualifed person” as defned in Section (either through a formal contract or a verbal 4958(f)(1) of the Internal Revenue Code and agreement), answer “Yes” to 9(a) and provide as amplifed by Section 53.4958-3 of the the infor mation requested in items 9(b) *343FHVMBUJPOT CZUIFWPUFPGBNBKPSJUZPG through 9(f). disinterested directors or members of a board CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 197

Te discussion in line 8, above, about leases purpose groups often provide goods or services and agreements between your nonproft and free to the public or at lower than market-rate individuals applies here to leases and agree- cost—such as free or low-cost meals, shelter, ments between your nonproft and afliated and clothing. But educational purpose groups or controlled companies and organizations. often charge standard or slightly reduced rates If you answer “Yes,” provide the information for admissions, tuition, and services. Doing the requested in items 9(b) through 9(f). Also, if latter is permissible. What the IRS wants to see you have adopted the bylaws included with is that your nonproft is set up to provide goods this book, you can add in your response to and services as part of a valid nonproft tax- item 9(d) or 9(e) that “Article 9, Section 3, exempt program, and that all members of the of the organization’s bylaws requires the public—or at least a segment of the public that BQQSPWBMPGDPOìJDUPGJOUFSFTUUSBOTBDUJPOT is not limited to particular individuals—will or arrange ments, such as a lease, contract, or have access to your goods or services. What other agree ment between this organization you can’t do is set up a tax-exempt nonproft and any “disqualifed person” as defned in that intends to beneft a private class or specifc Section 4958(f)(1) of the Internal Revenue group of individuals, as individuals (such as Code and as amplifed by Section 53.4958-3 your uncle Bob and Aunt Betty, or all your of the IRS Regulations, which includes 35% relatives and in-laws). Te broader the class of DPOUSPMMFEFOUJUJFT CZUIFWPUFPGBNBKPSJUZPG people that your nonproft benefts, the better. disinterested directors or members of a board Making your nonproft programs available committee, only after a fnding that a more to the public at large normally looks best to advantageous transaction or arrangement is the IRS. And providing goods and services not available to the organization and that the at rates below market rates also helps bolster proposed transaction or arrangement is in your credibility as a nonproft, as opposed to the organization’s best interest, is for its own revenue-driven, organization. beneft, and is fair and reasonable.” At this point in the process, most groups have not fully determined what they will charge for Part VI: Your Members and Other goods and services. If this is the case, explain Individuals and Organizations Tat in your response the services and benefts that Receive Beneﬁts From You will be provided to the public (or segment of Line 1(a). If you plan to implement programs the public) and explain generally how you will that provide goods, services, or funds to determine fees. For example, you may wish individuals, check “Yes” and describe these to indicate that “charges for the described programs on an attachment page. Many smaller benefts, products, and services are at present nonprofts will provide goods or services as undetermined, but will be reasonable and part of their exempt-purpose activities, such related to the cost of the service to be provided.” as a nonproft dance studio (dance lessons or And again, if you plan to provide goods or admissions to dance performances), formal services at a discount or free of charge, make and informal nonproft schools (tuition or fees sure you say so. for classes and instructional services), hospitals Line 1(b). If your nonproft will provide (health care costs), and other educational goods or services to other organizations, or charitable groups. Of course, charitable check “Yes” and explain your program plans on an attachment page. If you donate or sell 198 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

goods and services to another 501(c)(3) tax- whether your nonproft is set up primarily or exempt nonproft at fair or discounted rates directly to provide goods, services, or funds for use in their tax-exempt programs, your to individuals who have a family or business program should pass muster with the IRS. relationship with your directors, ofcers, or But if you simply plan to obtain revenue by highest-paid employees or contractors listed selling goods and services provided to proft- in Part V, lines 1(a) through 1(c). Most groups NBLJOHCVTJOFTTFT FYQFDUUPIBWFUPKVTUJGZ will answer “No” here. However, if you think this sort of commercial-looking activity. For someone who fts in one of these categories may example, an educational group may provide receive goods, products, or services incidentally seminars to the human resource managers of from your nonproft as a member of the public, business corporations on how to comply with check “Yes” and explain how these related federal and state fair employment regulations. people will have access to your nonproft’s Tis sort of program that serves the needs of benefts. If your response makes it clear that employees should be fne with the IRS. But these related people are not the focus of your simply trafcking in goods and services for a nonproft programs, but only coincidentally proft with other organizations and companies qualify as members of the general public, you will look like (and probably is in fact) a should be okay. commercially driven, proft-making enterprise that won’t qualify as a tax-exempt activity. Part VII: Your History Line 2. Most groups will answer “No” to this Line 1. Most groups will answer “No” to this question because the IRS frowns on groups that question. However, if you are a successor to an limit benefts, services, or funds to a specifc incorporated or preexisting organization (such individual or group of individuals. However, if as an unincorporated association), mark “Yes.” the group of people benefted by the nonproft “Successor” has a special technical meaning, is broad (not limited to specifc individuals) and which is explained in the ofcial IRS instruc- related to the exempt purposes of the nonproft tions to this item. Basically, you are most likely HSPVQ UIF*34TIPVMEIBWFOPPCKFDUJPO TFF to be a successor organization if your nonproft the discussion to line 1(a) of this part, above). corporation has: If you answer “Yes,” provide an explanation on tUBLFOPWFSUIFBDUJWJUJFTPGBQSJPSPSHBOJ an attachment page. You may be able to refer to zation—this is presumably the case if your information already provided in your response nonproft corporation has appointed initial to line 1(a) of this part. directors or ofcers who are the same people who served as the directors or ofcers of the EXAMPLE: A nonproft musical heritage prior association, and your nonproft has the organization plans to provide programs same purposes as the prior association and benefts to needy musicians residing in tUBLFOPWFSPSNPSFPGUIFBTTFUTPGB the community. If the overall tax-exempt preexisting nonproft, or purpose of the organization is allowed, the tCFFOMFHBMMZDPOWFSUFEGSPNUIFQSFWJPVT IRS will permit this limitation of benefts to association to a nonproft—typically by a segment of the community. fling special articles of incorporation to Line 3. In this question, the IRS is looking state the name of the prior association for prohibited self-inurement—in this case, and a declaration by the prior ofcers CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 199

of the association that the conversion during which the prior nonexempt organization to a nonproft corporation was properly was in operation. approved by the association, or by fling Line 2. Most new groups will be able to answer articles of conversion to convert a proft- “No” here because they will be submit ting making entity to your new nonproft their exemption application within 27 months corporation. after the end of month when their nonproft We assume most readers will be starting new corporation was formed. Te date of formation nonprofts, not inheriting the assets, people, is the date the corporation’s articles of incorpo- and activities of a preexisting formal nonproft ration were fled by the secretary of state and association. We also assume most readers have became efective. For example, if you fled not adopted special articles to legally convert a your articles on January 12, 2013, you would prior association or proft-making entity to a have until the end of April 2015 to submit nonproft corporation. In the real world, a formal (postmark) your exemption application. conversion of a prior association to a nonproft If you are submitting your exemption appli- corporation only occurs if the prior group was cation after this 27-month deadline, check a highly organized and visible entity with a “Yes” and fll in and submit Schedule E with solid support base that it wants to leverage your 1023 exemption application. by formally converting the association to a nonproft corporation. However, in most cases, Part VIII: Your Speciﬁc Activities small nonprofts that existed previously as Tis part asks about certain types of activities, informal nonproft groups with few assets, little such as political activity and fundraising, that support, and hardly any formal infrastructure, the IRS looks at more closely. Tese are activities normally start out fresh with a newly formed that a 501(c)(3) is prohibited from engaging in or corporation that is not a successor to the prior can only do within certain strict limitations— group. If you think your nonproft corporation namely, without benefting or catering to the is a successor organization, we suggest you special interests of particular individuals or get help from a nonproft expert to complete organizations. Please read the ofcial instructions Schedule G and make sure all the paperwork to this Part in the 1023 instructions before for your new nonproft as well as the prior reading our instructions below. group is in order. Line 1. A 501(c)(3) nonproft organization may If you are a successor to a prior organization, not participate in political campaigns (although mark “Yes,” and complete Schedule G of the some voter education drives and political debate 1023 application. See “Filling Out the Sched- activities are permitted—see “Limitation on ules,” below, for instructions on flling out Political Activities,” in Chap ter 3). Te IRS may Schedule G. Te IRS will take the history, deny or revoke your tax-exempt status if you activities, and fnancial data of your prior participate in or donate to a campaign. Most organi za tion as well as your responses to groups should answer “No” here. Schedule G into account when deciding If you think you should answer “Yes” to this whether your non proft corporation is entitled question, check with a nonproft lawyer or tax to its tax exemp tion. It may also ask you to fle consultant—a “Yes” response means you do not tax returns for the prior organization if it has qualify for a 501(c)(3) tax exemption. However, not already done so for all preceding tax years you may qualify for a 501(c)(4) tax exemption. 200 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Line 2(a). Tis question concerns your group’s Line 3(a)–3(c). Most 501(c)(3) nonprofts do plans, if any, to afect legislation. Most groups not engage in bingo and gaming activities. will answer “No” to this question. If you If you plan to do so, read the IRS ofcial answer “No,” you can move on to line 3. instruction for this line as well as IRS Publi- *GZPVQMBOUPFOHBHFJOFêPSUTUPJOìVFODF cation 3079, Gaming Publication for Tax- legislation, check “Yes” and read “Limitation Exempt Organizations, before checking “Yes” to on Political Activities,” in Chapter 3. Ten any of the questions in line 3 and providing the complete 2(b). requested information. Line 2(b). Check “Yes” if you plan to elect Line 4(a). Read the ofcial instructions to this to fall under the alternate political expen di- line to learn the defnition of fundraising and tures test discussed in “Limitation on Politi cal some of the diferent ways it may be conducted. Activities” in Chapter 3, and attach a completed Note that fundraising includes raising funds IRS Form 5768, Election/Revocation of Election for your own organization, raising funds for by an Eligible Section 501(c)(3) Organization other organizations, as well as having some To Make Expenditures To Infuence Legislation. other individual or organization raise funds for We assume you have not already fled this your group. If your nonproft is one that will form; if you have, attach a copy of the fled be obtaining revenue and operating funds only form. A copy of this simple, one-page consent from the performance of its exempt functions— form is included with this book. Te political that is by providing services or goods related expenditures test is complicated, and you’ll to your exempt purpose—you can check probably need the help of a seasoned nonproft “No” here. Make sure that none of the specifc adviser to decide whether you will be able to fundraising activity boxes listed in 4(a) apply meet the requirements and gain a beneft from to your group. However, if you expect your electing this special test for political legislative nonproft to do any type of fund raising, such as activities. Before using the Form 5768, go to soliciting government grants, attracting private the IRS website at www.irs.gov and make sure and public donations or contributions, or going it is the latest version of the form. whole hog and hiring a professional fundraiser, If you checked “Yes” to line 2(a) and do not check “Yes” and then check each box that plan to elect the political expenditures test, describes a fundraising activity that you plan to check “No” to line 2(b). On an attachment, or may pursue in your quest for program funds you must describe the extent and percentage of and revenue. On an attachment page, describe time and money you expect to devote to your each activity whose box you have checked. If legislative activities compared to your total your nonproft plans to engage in a type of activities. Be as specifc as you can about the fundraising not listed under 4(a), check the political activities you expect to promote and “other” box and describe it in your attachment how you will promote them. If possible (and response. Be specifc and as thorough as you accurate), make it clear that your legislative can in your response about the people you will activities will constitute an “insubstantial” use, any compensation you will pay, the amount part of your overall nonproft programs and and type of support you hope to raise, and the activities. If the IRS feels that your political use to which you will put raised funds for each program will be substantial, it will deny your fund raising activity. If you check “No” to 4(a), 501(c)(3) tax exemption. you can skip ahead to line 5. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 201

Line 4(b). Mark “Yes” if you plan to hire paid Here is a statement from the 2005 IRS fundraisers, and provide the fnancial and Exempt Organization (EO) Report that contract information requested on an attachment explains why the IRS is concerned about donor- page. Any fnancial information should be advised funds, and indicates that it will be BDUVBMPSQSPKFDUFEëHVSFTUIBUDPWFSUIFTBNF keeping an eye out for abuse in this area: periods as the fnancial information you will Donor-advised funds allow private donors provide in Part IX (see the ofcial 1023 Part IX to provide input as to how their charitable instructions and our Part IX instructions, below, contributions will be spent. A number of to determine the period for which you should organizations have come to light through provide fnancial infor mation). Many beginning examinations, referrals from other parts of nonprofts will not plan to use paid fundraisers the IRS, and public scrutiny which appear to right away and can state: “Tis newly formed have abused the basic concepts underlying nonproft has not entered into oral or written donor-advised funds. Tese organizations, contracts with individuals or organizations for while promoted as legitimate donor-advised the raising of funds, and has no specifc plans to funds, appear to be established for the do so in the foreseeable future.” purpose of generating questionable charitable Line 4(c). If your nonproft will do fundraising deductions, providing impermissible for other organizations, state “Yes” and provide economic beneﬁts to the donors and their the information requested on an attachment families (including tax-sheltered investment page. Most nonproft organizers using this book income for the donors), and providing will not raise funds for other organizations even management fees for the promoters. EO if they plan to raise funds for themselves and Examinations will identify organizations with will mark “No” here. a high potential for abuse in this area and Line 4(d). If you checked “Yes” to 4(a), pro- commence examinations during FY 2005. vide the information requested for this item. You should provide this information for states Line 5. Tis item is for special government- or localities where you will raise funds for your afliated groups (see the instructions to the organization or for other organizations, or 1023 form). If you check “Yes,” your nonproft where an individual or another organization, needs special assistance responding to this item including a paid fundraiser, will raise funds for and being able to meet the requirements for your organization. a 501(c)(3) tax exemption. If you check “Yes,” Line 4(e). See the ofcial instructions for consult a nonproft legal adviser. this item—it concerns the special practice Line 6. See the 1023 instructions. If you are of solici ting and using “donor-advised” or an economic development nonproft and mark “donor-directed” funds. Most nonprofts “Yes,” you’ll need expert help flling out your will not have plans to use this practice, but tax exemption to make sure your activities meet if you do, provide the information requested the 501(c)(3) requirements. on an attachment page. Te IRS will want Below is a statement from the 2005 IRS to make sure that your organization does not Exempt Organization (EO) Report that use funds to meet the private needs of donors, explains why the IRS is applying special but instead will use donor-directed funds for scrutiny to economic development nonprofts: purposes that are consistent with the tax- exempt purposes of the nonproft. 202 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

In response to referrals from HUD concern - IRS wants you to show that the managers are ing abuse by individuals setting up exempt not getting special breaks or excess payments organizations for the purpose of participating because they are family members or business in a number of HUD programs, EO initiated associates of the nonproft’s directors or ofcers. a compliance project in this area in FY 2004. Line 7(c). Tis line wants you to provide Potential abuses include lack of charitable information on all developers and managers activity, personal use of program property, of real estate or facilities owned or used by and most often, private benefit provided to your nonproft if any of these developers or for-profit construction contractors hired to managers have a business or family relationship complete the repairs to program properties. with your nonproft directors or ofcers. If this In these cases, contractors were usually question applies to your nonproft, provide the related to the organizations’ officers or information requested on an attachment page. board members, and were often the same If you have already provided the information individuals. Costs were over-stated and work in response to 7(a) and/or 7(b), you can refer to was substandard or completely lacking. your previous response. Te IRS will scrutinize Te project is currently focusing on abuses any contracts you provide and negotiation by exempt organizations in HUD’s housing processes you describe to make sure your rehabilitation/resale and down payment nonproft is not paying more than fair market assistance programs, and will expand to other value for real property development and HUD programs as staffing permits. management services. Line 8. First read the 1023 instructions for Line 7(a). Line 7 applies to nonprofts that will this line. If your nonproft plans to enter into own or develop real estate, such as land or a KPJOUWFOUVSFT CVTJOFTTEFBMT XJUIJOEJWJEVBMT building, in pursuit of its nonproft activities. or other nonprofts or commercial business See the 1023 instructions for line 7(a) through entities, see a legal adviser before providing the 7(c) for more information. If you plan to information requested and completing your develop or improve real estate, including land 1023 tax exemption application. Nonproft or buildings, mark “Yes” to 7(a) and provide PSHBOJ[BUJPOKPJOUWFOUVSFTSBJTFDPNQMFYJTTVFT the information requested on an attachment that require expert help to make sure they are page, Mostly the IRS wants to make sure that structured properly to meet the requirements of your nonproft is not planning to make any the 501(c)(3) tax exemption. sweetheart real estate development deals that Line 9(a)–9(d). if you are forming a child care beneft people associated with your nonproft organization, you may qualify for your tax and its directors and ofcers thorough family or exemption either under 501(k) of the Internal business ties. Revenue Code or 501(c)(3) as a school. Read the Line 7(b). If your nonproft will maintain instructions before answering these questions. facilities, such as a building or ofce space or If you check “Yes” to 9(a), answer 9(b) through other physical address, and plans to use anyone 9(d). If you answer “No,” go on to line 10. other than employees or volunteers to manage Line 10. Tis question asks if your nonproft the facilities—for example, if it plans to hire a plans to publish, own, or have rights in intel- management company to manage property— lec tual property, such as art, books, patents, check “Yes” and provide the information trademarks, and the like (see the 1023 requested on an attachment page. Again, the instructions for defnitions). If you answer CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 203

“Yes,” provide the information requested on Te issue of copyright ownership sometimes an attachment page about ownership of the is key to this issue. Remember: if copyrights intellectual property, if and how you will in published works are owned by a 501(c)(3) derive revenue from the property, and generally nonproft, this means that the copyrights, like how the property will be used as part of your all other assets owned by the nonproft, are nonproft activities. In essence, the IRS wants to irrevocably dedicated to tax-exempt purposes know whether your nonproft plans to acquire and must be distributed (transferred) to another and exploit copyrights, patents, and other tax-exempt nonproft when the organization forms of intellectual property and, if so, how. dissolves. Hence, the IRS is apt to look more Examples of groups that would answer “Yes” favorably on an educational nonproft that holds include a visual arts exhibit studio, educational copyrights in its published works. Conversely, if book publisher, scientifc research center that a nonproft education group does not own the engages in original (patentable) research, and copyright to its published works, but instead any group that plans to market its trade name publishes the works owned by others under the (a name used by the nonproft and associated terms of standard commercial royalty contracts, with its activities), trademark, or service (logos, the IRS may feel that the group is simply a words, and images used by the nonproft to commercial publisher that is not entitled to a market its goods and services). 501(c)(3) educational tax exemption. However, if Nonprofts that conduct scientifc research in the group publishes education material written the public interest are expected to make their by volunteers or its employees or under “work for patents, copyrights, processes, or formulae hire” contracts with outside authors, copyrights available to the public, not simply develop and in the works are owned by the nonproft, not exploit results of their research for their own by the authors. Publication of this material use (see “Scientifc Purposes,” in Chapter 3). is clearly in the public interest and contains Tere is nothing wrong or underhanded, content related to the educational purpose of the however, about a nonproft owning and nonproft. Tus, the IRS is more likely agree that exploiting intellectual property related to its the group is entitled to a tax exemption. exempt purpose—for example, a qualifed Te sale of art by nonprofts often piques the literary or education nonproft owning and interest of IRS examiners. For example, if an obtaining royalty revenue from the sale of its educational nonproft exhibits artwork owned published educational works, or a nonproft by artists and collects a commission on each selling donated art to raise funds for its exempt sale, the IRS may conclude that the organization purpose. Be careful though: If a nonproft deals runs a commercial art gallery that is not entitled in intellectual property as a routine method to a tax exemption. Tere is no bright-line test of raising revenue operating revenue—for for groups that deal in arts or sell goods and example, if a nonproft licenses its trade name services. Te IRS looks at all the facts and to obtain revenue—the IRS is likely to consider circumstances related to a group’s activities and this income unrelated business income. If this operations to determine if the group’s primary unrelated income is clearly more than a small purpose is a charitable, educational, or another portion of the group’s overall revenue, the 501(c)(3) purpose or, instead, represents a IRS will likely question or deny the group’s commercial enterprise. For examples of when 501(c)(3) tax exemption. the IRS has reached diferent conclusions after examining the activities of groups that sell art 204 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

as part of their activities, see the summaries of t3FW3VM"SUHBMMFSZ"DPPQFSBUJWF selected IRS revenue rulings below: art gallery that was formed and operated by a group of artists for the purpose of TIP exhibiting and selling their works, did How to read IRS revenue rulings. Each not charge admission but received a IRS revenue ruling is referenced with a two- or commission from sales and rental of art four-digit year preﬁx followed by a number—for sufcient to cover the cost of operating example, revenue ruling 2004-98 is a 2004 ruling and the gallery, did not qualify for exemption revenue ruling 80-106 is a 1980 ruling, distinguished under Section 501(c)(3) as an educational from other rulings during the year by the second organization. sequential number. t3FW3VM"SUFYIJCJUT"OPOQSPëU organization was created to foster and t3FW3VMɨSJGUTIPQDPOTJHONFOU develop the arts by sponsoring a public art sales. An organization operated a thrift shop exhibit at which the works of unknown that sold items that were either donated or but promising artists were selected by a received on consignment. Substantially all QBOFMPGRVBMJëFEKVEHFTGPSEJTQMBZ"SUJTUT of the work in operating the thrift shop eligible to have their works displayed was performed without compensation, all were those who were not afliated with transactions were at arm’s length, and all art galleries and who had no medium for profts were distributed to Section 501(c)(3) exhibiting their creations. Te organization organizations. Te organization qualifed did not charge the artists any fees, nor for exemption as an organization operated did the organization sell or ofer the for charitable purposes. displayed works for sale. For the exhibit, t3FW3VM"SUHBMMFSZ"OPOQSPëU the organization prepared a catalog that educational organization, formed by art listed each work displayed, the name of patrons to promote community under- its creator, and the artist’s home or studio standing of modern art trends by selecting address. Te catalog was sold for a small fee for exhibit, exhibiting, and selling art to the public. Te organization also received works of local artists, and which retained income from nominal admission fees to the a commission on sales that was less than exhibit and contributions. Funds were paid customary commercial charges and was out for renting the exhibition hall, printing not sufcient to cover the cost of operating the catalogs, and administrative expenses. the gallery, did not qualify for exemption Te organization qualifed for a 501(c)(3) under Section 501(c)(3). Te following tax exemption. statement in the ruling provides perhaps If nothing else, the above rulings reinforce UIFCFTUDMVFBTUPXIZUIF*34SFKFDUFEUIF one fundamental fact about seeking and group’s application: “Since 90% of all sales obtaining a tax exemption: Te IRS looks at proceeds are turned over to the individual the full context of a nonproft’s operations— artists, such direct benefts are substantial including its sources and uses of revenue— by any measure and the organization’s when deciding whether a group qualifes for provision of them cannot be dismissed 501(c)(3) tax exemption. Normally, no one fact as being merely incidental to its other is fatal or determinative. Te more a group purposes and activities.” demonstrates that its operations are public CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 205

rather than private or commercial interests, the royalty was divided into specifc percentages better its chances of obtaining a tax exemption. between the organi zation and the editors "OEPOBNPSFTVCKFDUJWFOPUF UIFBCPWF and authors. Te IRS concluded that: rulings also hint at the importance of couching “Although educa tional interests are served your nonproft activities in the most acceptable by the publication of better teaching (least commercial) terms—for example, it may materials, the facts in this case show only sound and look better to the IRS if your group an enterprise conducted in an essentially collects “admission” or “consignment” fees commercial manner, in which all the rather than “commissions,” since the latter term participants expect to receive a monetary typically connotes overt commercial activity. return.” Te IRS denied the organization’s Below are two revenue rulings related to 501(c)(3) tax exemption. educa tional nonprofts that involve the publi- t3FW3VM.VTJDBMSFDPSEJOHɨF cation of books and music. Te frst repeats organization was created to stimulate, the theme that the more a group looks and acts promote, encourage, and sustain interest like a regular commercial venture, the less its in and appreciation of contemporary sym- chances of qualifying for 501(c)(3) tax-exempt phonic and chamber music. Te organiza- status. Te second shows that nonprofts that tion records the new works of unrecognized cater to a small, traditionally noncommercial, composers as well as the neglected works segment of public education stand a better of more established composers. Te music chance of obtaining a tax exemption, at least selected for recording had a limited com- partially because the nonproft activity is, in mercial market and was not generally fact, less likely to reap signifcant profts. produced by the commercial music pub- t3FW3VM&EVDBUJPOBMQVCMJTIJOH lish ing and recording industry for sale An education organi zation was created to to the public. Te organization sold its meet the need for more satisfactory teaching recordings primarily to libraries and educa- materials and textbooks in economics and tional institutions. Some records were related felds. Te organization contracted provided free to radio stations operated by with commer cial publishing frms for the educational institutions. Te organization publication of these materials, which were also made sales to individuals. Te records used primarily by colleges and universities. were not made available for sale through Te organi zation did not hold the copyright commercial record dealers except in a few in its published material. Te contracts specialty shops, but were sold through mail between the organization and the publishers orders. Te organization did not engage provid ed that the publishers pay all publica- in any advertising, but relied upon those tion costs and a royalty to the organization who were interested in this type of music on sales of the publication. In return, the to communicate the availability of the publisher received the copyright, publishing, records. All sales were facilitated by the use and selling rights. Te agree ment between of a catalog published by the organization. the organization and the editors and authors Te catalog contents included informa tion provided that the royalty income would frst about the compositions and the composers. be applied to pay for the costs of preparing Tis information was retained in the the materials for publication, including catalog so that the catalog served as an funds to authors and editors. Te remaining archive with respect to these compositions 206 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

and recordings. Copies of all recordings energies is now devoted to scrutinizing the were maintained for availa bility in the operations of foreign-based nonprofts as part of future. Te liner notes on the album covers the service’s participation in antiterrorism. Here contained a biography of the composer is an excerpt from the IRS 2005 EO (Exempt and a description of the composition by its Organization) report: composer. Composers received royalties from In FY 2005, EO will examine a sample of the sale of recordings as required by federal foreign grant making organizations; the law. Due to the limited commercial market primary focus of the examinations is to for this type of music, the royalties received ensure that funds are used for their intended by the composers were not signifcant. Te charitable purpose and not diverted for group qualifed for a 501(c)(3) tax exemption. terrorist activity. Te project will gather Line 11. Tis question asks if your nonproft information about current practices, that is, will accept contributions of various types of the existence and eﬀectiveness of controls property, including works of art and auto- put in place to monitor the distribution of mobiles. If you answer “Yes,” provide the overseas grants and other assistance. Tis informa tion requested. If you receive contri- committee will also address the need for butions of art, you may be able to refer to possible guidance or other modiﬁcations to portions of your response to line 10, if you used the laws in this area. line 10 to provide information on how you sell contributed art works. Te IRS mostly wants to Line 13(a)–13(g). If your nonproft will make make sure your nonproft is not simply setting grants or loans to other organizations or receive up a contribution-conduit organization formed and disburse funds (for example as a fscal and operated primarily to generate income tax agent) for other organizations, answer “Yes” to contributions for wealthy individuals associated line 13(a), then answer 13(b) through 13(g). with your group. See IRS Publication 526, Most smaller nonprofts do not make grants or Charitable Contributions, for the latest rules on loans to other nonprofts, but may receive grant the deductibility of contributions to qualifed money as a fscal agent for another nonproft. 501(c)(3) public charities. If your group plans to do this, your responses Line 12(a)–12(d). If your nonproft plans should show that the groups you sponsor to operate in one or more foreign countries, promote activities that are related to your tax- answer “Yes” to 12(a) and provide the informa- exempt purposes and that you exercise oversight tion requested in 12(b) through 12(d) on an in making sure the funds are accounted for attachment page. Special tax-exemption and and used properly by the groups you sponsor. If deductibility of contribution rules apply to your responses demonstrate or imply that you nonprofts created or operated abroad. If you disburse funds as a feeder group to promote answer “Yes,” see a nonproft adviser who has regular com mercial or nonexempt activities, the experience in advising nonprofts that operate IRS will deny your exemption. Te questions in the foreign countries where you plan to listed here should give you an indication of what operate for help in completing your 1023 the IRS is looking for—formal applications, application. Also see “Foreign Organizations in grant proposals, fscal reporting controls, and General,” in the ofcial 1023 instructions, for other procedures that you will use to select, basic information on nonprofts formed abroad. monitor, and assess the groups that you sponsor. Finally, realize that a big part of the IRS’s CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 207

Line 14(a)–14(f). Tis question is similar to completing your tax exemption application if line 13, except it applies only to foreign groups you answer “Yes” here. that you assist or sponsor. If you answer “Yes” Line 18. We assume readers of this book are to 14(a), it asks additional questions (14(b) not setting up a charitable risk pool under through 14(f)) to make sure you apply extra Section 501(n) of the Internal Revenue Code scrutiny to any foreign groups you sponsor (see the instructions to the 1023 form). If you (see the antiterrorism note in the line 12 are, get help from an expert in this special feld instructions, above—it is one of the drivers for of nonproft activity before completing your tax this extra IRS scrutiny of groups that sponsor exemption application. or assist foreign organizations). Line 19. As explained in the 1023 instructions Line 15. First read the instructions to this line to this line, a school is defned as an educational in the ofcial 1023 instructions. Tey provide organization that has the primary function a defnition of what “close connection” means, of presenting formal instruction, normally and the defnitions cover a lot of helpful mate- maintains a regular faculty and curriculum, rial. If you answer “Yes,” provide a thorough normally has a regularly enrolled body of explanation on an attachment page of how students, and has a place where its educational your structure and/or operations are connected activities are carried on (for example, private to those of another group. Obviously, if you primary or secondary schools and colleges). do share space, people, programs, or other Check the “Yes” box and fll in Schedule B attributes or activities with another group, the if one of your purposes, whether primary or IRS will want to see that you are not diverting otherwise, is operating a nonproft school. your tax-exempt purposes or revenue to nontax- Line 20. If your nonproft is setting up a exempt ends or purposes promoted by the hospital or medical care facility, including a group with which you are connected. medical research facility (see the defnitions Line 16. See the instructions before answer- in the 1023 instructions), answer “Yes” and ing this question. A cooperative hospital service complete Schedule C. (See “Filling Out organization is a very special type of organi zation the Schedules,” below, for instructions on that is tax-exempt under section 501(e) of the completing Schedule C.) Internal Revenue Code, which like a 501(c)(3) Line 21. If you are forming a low-income group uses the 1023 application to apply for housing facility or housing for the elderly or its tax exemption. You will need expert help handicapped (see the 1023 instructions for completing your tax exemption application if defnitions of these terms), check “Yes” and you answer “Yes” here. complete Schedule F. Line 17. See the instructions before answer ing Line 22. Refer to the 1023 instructions for this question. A cooperative service organi- defnitions of terms before answering this za tion of operating educational organizations question. If your nonproft, whether it is a is another special type of organization that school or otherwise, will provide scholarships or is tax-exempt under Section 501(f) of the other education or educational-related fnancial Internal Revenue Code. Like a 501(c)(3) group, aid or assistance to individuals, check “Yes” and it also uses the 1023 application to apply for fll in Schedule H. its tax exemption. You will need expert help 208 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Part IX: Financial Data For more information, go to the IRS website All groups should complete the fnancial data (www.irs.gov) and type “Elimination of the tables in Section A (Statement of Revenues and Advance Ruling Process” in the search box. Expenses) and Section B (Balance Sheet) of this Tis will display links to IRS information on Part IX. Start by reading the 1023 instructions the new rules. for this part. Statement of Revenues and Expenses We have replaced the ofcial instructions to UIFGPSNXJUIVQEBUFEJOTUSVDUJPOTUIBUSFìFDU Te fnancial data listed here includes your new rules adopted by the IRS (and summarized group’s past and current receipts and expenses at the beginning of the 1023 Form in Notice (many groups will need to show proposed receipts 1382). Remember to check the IRS website to and expenses as explained below). Te IRS will see whether an updated Form 1023 is available. use this fnancial data to make sure that: Under the latest regulations, there is no advance tZPVSHSPVQTBDUVBMBOEPSQSPQPTFESFDFJQUT ruling period. If a new nonproft shows in the and expenses correspond to the exempt- fnancial information provided in its 1023 purpose activities and operational information application that it can reasonably expect to you describe in your application receive qualifying public support during its frst tZPVEPOPUQMBOUPFOHBHFTVCTUBOUJBMMZJO fve years, it will be granted a defnitive ruling unrelated business activities, and as a public charity for the frst fve years. If it tZPVEPPSNPTUMJLFMZXJMMNFFUUIFBQQSP can’t do this, it will be classifed as a private priate 501(c)(3) public charity support test foundation. Te initial fve-year defnitive public (see our instructions to Part X, below). charity status, if granted, is uncontestable—the Te number of columns you use in Section A nonproft will retain this status during those fve will depend on the number of full and partial years regardless of its actual sources of support tax years your group has been in existence. during this period. In other words, even if it Most nonprofts will have a tax year that goes guessed wrong in its 1023 exemption application from January 1 to December 31, but some will QSPKFDUJPOT JUXJMMLFFQJUTQVCMJDDIBSJUZTUBUVT have a tax year that ends on the last day of After the fve-year period, however, the IRS will another month—see your response to Part 1, look at current and past-year annual Form 990 line 5, above. or 990-EZ returns to see if the group continues New groups without prior tax years. If your to qualify as a public charity. (See Chapter 10 nonproft is newly formed, it probably has for more on Form 990s.) not been in existence for a full tax year. Put JOQSPKFDUFEOVNCFSTGPSUIFDVSSFOUZFBSJO EXAMPLE: Te Free Food Program gets its DPMVNO B BOEQSPKFDUJPOTGPSUIFOFYUUXP 501(c)(3) tax exemption and public charity years in columns (b) and (c), and one for a total tax status starting in 2010. FFP will be of the three years. treated as a public charity for the fve-year period from 2010 to and through 2014. EXAMPLE: You are a new nonproft formed At the end of 2015, the IRS will look at on February 15 of the current year, with the group’s 2011 through 2015 Form 990 a tax year that goes from January 1 to returns to see if it qualifes as a public charity December 31, and you are applying for your for the year 2015. tax exemption in June of the corporation’s CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 209

frst tax year. Te beginning “from” date of side of column (e) for your ffth-year data). the period shown at the top of column (a) is Te current year, column (a), will be your last the date you fled your articles—February completed tax year, not the partially completed 15 of the current year. Te “to” date for this current tax year. You will be supplying fgures period should be December 31, the end of GPSëWFDPNQMFUFEUBYZFBST BOEOPQSPKFDUFE the current tax year. Use columns (b) and (c) information. UPTIPXQSPKFDUFEëHVSFTGPSZPVSOFYUUXP Alternatively, if your nonproft has been in tax years, going from January 1 to December existence more than one full tax year, but less 31 of each of the next two years. Many new UIBOëWFUBYZFBST ZPVNVTUTIPXQSPKFDUFE groups will repeat much of the information fnancial information for your current tax year from their frst tax year for the next three in column (a), then show fgures for your prior proposed tax years, unless they anticipate completed tax year(s) in the other column or BNBKPSDIBOHFJOPQFSBUJPOTPSTPVSDFTPG columns. You will have to add a new column support. Use column (e) to show the total (e) for your fourth prior tax year (see the use for columns (a) through (c). instructions above). You also may need to show QSPKFDUFESFWFOVFBOEFYQFOTFJOGPSNBUJPO Don’t expect to fll in all the items. Te IRS in one of the columns for a future tax year LOPXTZPVWFKVTUDPNNFODFEPQFSBUJPOTBOE depending on how many years you have been in that you are estimating possible sources of reve- existence. Here is how it works: nue and items of expense, and it expects to see If your group has been existence one full a few blank lines. Also realize that some of your QSJPSUBYZFBS TIPXQSPKFDUFEëHVSFTGPSUIF QSPKFDUFESFWFOVFTBOEFYQFOTFTNBZOPUOFBUMZ full current tax year in column (a), and your ft the categories shown in the printed revenue prior completed tax year in column (b). Ten and expense table. You can use revenue item 7 TIPXQSPKFDUFEëHVSFTGPSUIFOFYUUXPZFBST (other income) and expense item 23 (other revenues and expenses (the next two tax years expenses) to list totals for these items, and after the current tax year) in columns (c) and attach a list that itemizes these additional items (d). Tis information represents four full tax of revenue and expense on an attachment page. years worth of information—one completed tax Te IRS does not like to see large lump sum ZFBSBOEUISFFQSPKFDUFEUBYZFBST amounts, so break down these additional items If your group has been in existence two full of revenue and expense as much as possible. QSJPSUBYZFBST TIPXQSPKFDUFEëHVSFTGPSUIFGVMM Groups with prior tax years. If your nonproft current tax year in column (a), your most recent has been in existence for fve or more prior completed tax year in column (b), and your frst tax years, show actual revenue and expense completed tax year in column (c). Ten show amounts for your last fve completed tax years QSPKFDUFEëHVSFTGPSUIFOFYUZFBST UIFZFBS in columns (a) through (d). You will have to after the current year) revenues and expenses in add a column between (d) and (e) for your column (d). Tis information represents four full ffth year—column (e) is for totals for all fve tax years worth of information—two completed years. You can provide this extra column of UBYZFBSTBOEUXPQSPKFDUFEUBYZFBST6TF information on an attachment page (or you column (e) for totals of the other columns. can split column (e) in half and use the left 210 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Line 12 of the revenue and expense statement qualifes under the technical public charity asks you to list any “unusual grant” revenue. support test rules (see Part X, below). Tis term is explained in the instructions for this line in the 1023 instructions, and we explain it Balance Sheet in more detail in Chapter 4, in “Public Support Prepare the balance sheet to show assets and Test” (see the discussion under “Exceptions to liabilities of your corporation as of your last the 2% Limit Rule”) and “Exempt Activities completed tax year, if any, or the current tax year Support Test” (see the discussion under “Unusual if you have not yet completed one full tax year. Grants Drop Out of the Computation”). Also see the specifc rules on unusual grants contained in EXAMPLE: You have organized a new IRS Publication 557. nonproft corpo ration, formed on April 1. Basically, unusual grants are permitted grants You are preparing your 1023 application that can throw a kink in your public charity in November of the same year. Your tax support computations because they come from year goes from January 1 to December one source, as opposed to several smaller grants 31. Te current tax year period covered by from diferent sources. Remember, 501(c)(3) column (a) of your Statement of Revenue public support revenue is supposed to be spread and Expenses is from April 1 to December out and come from a number of public sources, 31. Your balance sheet ending date will OPUKVTUPOFPSUXP*UJTVOMJLFMZUIBUZPV be the same ending date, December 31, expect to receive an unusual grant this early in the eventual ending date of your frst tax your nonproft life—unusual grants normally year. Tis date should appear as the “year- happen only as a result of a sustained and end” date in the blank at the top right of successful outreach program that attracts one the balance sheet page. Even though this or two large grants that surprise the modest is a future end date, you should base your expectations of a small nonproft. In efect, statement of assets and liabilities on current an unusual grant represents both good and information—that is on your organization’s bad news. Te good news is the unusually current assets and liabilities at the time large amount of the grant; the bad news is its of the preparation of your exemption potential damage to the group’s ability to meet application. the technical public support requirements It’s not uncommon for a small starting non- that apply to 501(c)(3) public charities. If you proft without liabilities and accounts receiv- have received or expect to receive one or more able to simply show a little cash as its only unusual grants, insert the total number here on reportable balance sheet item. Other common line 12 in the appropriate column (past, present, items reported are line 8 depreciable assets— or future tax year), and list on an attachment equipment owned by the corporation and used page a description of each grant (what the grant to conduct its exempt activities. was for, whether it was restricted to a specifc Line 17 of the balance sheet asks for fund use, and other terms of the grant), together balances or net asset information. Typically, with the donor’s name, date, and amount of this is the amount by which your assets exceed each unusual grant. If a large grant qualifes as your liabilities—in other words, the net value of an unusual grant, it will be disregarded by the your assets. If you have difculty preparing the IRS when it computes whether your support CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 211

fnancial information under this part, get the (1) Automatic Public Charity Status—groups help of a tax or legal adviser. that are set up for specifc purposes or special Line 19 asks if there have been substantial functions, such as churches, schools, hospitals, changes in your assets or liabilities since the and public safety organizations, qualify as year-end date for your balance sheet. Tis public charities (we say they automatically question should be answered “No” by most qualify because these groups, unlike the other groups. However, if your nonproft is sub- two types of public charities listed below, do mit ting a balance sheet for a prior completed not have to meet public support tests). period and your assets and liabilities have (2) Public Support Test Groups—these are under gone signifcant change—as a result, groups that are supported by contributions perhaps of a sale or purchase of assets, a and grants and that meet the one-third or one- SFëOBODJOHPGEFCU PSPUIFSNBKPSTUSVDUVSBM tenth public support tests, described in “Public change—answer “Yes” and provide an explana- Support Test,” in Chapter 4. tion on an attachment page. (3) Exempt Activities Support Test Groups— these are groups that obtain support through Part X: Public Charity Status the performance of their exempt purposes, You should be familiar with the material in such as admissions, tuition, seminar fees, Chapter 4 to answer the questions in this and receipts from goods and services related part of the form. Tis is where terms such as to the group’s exempt purposes. We assume public charity and private foundation become your nonproft will be setting up either one of important. We will refer to earlier explanations the special public charities that automatically as we go along, but you may want to look qualify under (1) above, or a nonproft that has over Chapter 4 now before you proceed. Te or can reasonably expect to receive the type of questions in this part relate to whether you are support listed in (2), above. seeking to be classifed as a 501(c)(3) public Line 1(a). Check “Yes” or “No” on line 1(a) charity or as a 501(c)(3) private foundation. to indicate whether or not you are a private As you know by now, we assume you want foundation. Again, we assume you expect to your nonproft to qualify as a 501(c)(3) public qualify as a public charity and will mark “No” charity, not as a 501(c)(3) private foundation. to this question. If your response is “No,” go on Line 1(a) and (b). In Chapter 4, we discussed to line 5. If you are forming a 501(c)(3) private the distinction between the public charity foundation, check “Yes” and go on to line 1(b). and private foundation classifcations and Line 1(b). Tis line only applies if you answered the reasons that you should try to meet one “Yes” to line 1(a). Line 1(b) asks you to check the of the three primary tests for being classifed box as a reminder that your private foundation as a public charity. Te 1023 instructions requires special provisions in your articles or provide a list of groups that qualify for public reliance on special provisions of state law. Tis charity status, which lumps all publicly book and its forms do not address these extra supported groups together (“groups that have requirements, and you will need the help of a broad fnancial support”). We use a diferent nonproft adviser to form your 501(c)(3) private classifcation scheme in Chapter 4 that puts foundation and prepare your articles properly. public charities into one of three categories: 212 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Lines 2–4. As with line 1(b), above, these Let’s look a little more closely at each of the lines only apply if you answered “Yes” to line lettered boxes in line 5: 1(a) indicating that you are applying for a tax Line 5(a). If you seek to qualify automatically exemp tion for a 501(c)(3) private foun dation. for public charity status as a church, see the Tese questions ask even more specifc questions 1023 instructions to this item. You will need to to help pigeonhole the private foundation into complete Schedule A and include it with your special subcategories—private operating and 1023 application. (See “Filling Out the Sched- private nonoperating foundation categories. We ules,” below, for instructions on completing assume you will get the help of an experienced Schedule A.) legal or tax person who works with private Line 5(b). Check this box if your primary foundations before answering these questions. purpose is to set up and operate a formal After answering these questions, groups that are school. If you check this box, make sure you preparing their 1023 application for a private have completed Schedule B. See the separate foundation skip the remaining lines in this part 1023 instructions to Schedule B in “Automatic of the form and go on to Part XI. Public Charity Status,” in Chapter 4 (see the All private foundations go on to Part XI, section “Schools”), and our instructions for “User Fee Information.” flling out Schedule B, below. Line 5. Check the box (letters (a)–(i)) that If you will set up and operate a school, but corresponds to the basis of your claim to public operating the school is not your primary charity status. First, absorb what you can of purpose, do not check this box—you will need the technical material given in the 1023 line 5 to qualify as a public charity by checking one instructions. Ten reread “How to Qualify for of the other line 5 boxes. However, you must Public Charity Status,” in Chapter 4—this complete Schedule B and attach it to your section provides the names of these public exemption application if you plan to operate a charity organizations, the requirements they school, even if operating the school is not your must meet, and the Internal Revenue Code primary purpose and the basis for your claim sections that apply to them. Note that letter (i) to public charity status—see the instruction to is a special case that allows certain groups to line 5(b) in the 1023 instructions. have the IRS determine which public charity Lines 5(c)–5(f). Read the instructions for these support test best suits their activities and lines in the 1023 instructions. Few groups sources of revenue. We cover this special choice will choose one of these boxes—each applies in more detail in line (i), below. to a special type of organization such as a Te following chart shows how the diferent hospital, supporting organization, public safety types of groups listed in this part of the applic- organization, or government agency. ation ft within the three diferent categories Line 5(c) hospitals and medical research of public charity status discussed in “How groups will need to complete Schedule C—you to Qualify for Public Charity Status” in should refer to the 1023 instructions for this Chapter 4. If you concentrate on our basic schedule in “Automatic Public Charity Status,” division of these diferent groups into the three in Chapter 4 (see the section “Hospitals and public charity categories, rather than focusing Medical Research Organizations”), and our on the individual Internal Revenue Code instructions for flling out Schedule C, below. sections, this part will go more smoothly. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 213

Line 5(d) supporting organizations are a discussed in Chapter 4. If you believe this is the special type of nonproft set up to support other public charity best suited to your organization’s public charities. Tey are operated solely for sources of support, check the box on this line. If the beneft of, or in connection with, any of you are unsure whether this is the best support the other public charity organizations (except test to use for your group (that is, if you think one testing for public safety). A supporting that the exempt activities support test in line 5(h) organization must complete Schedule D. Tis also may apply to your organization), you may information helps the IRS determine whether wish to let the IRS make this decision for you as this type of organization supports other explained in the line 5(i) instructions, below. qualifed public charities. As discussed in “Public Support Test,” in Chapter 4, many groups will not want to fall TIP under this public charity test because it does Get help when applying for an exemption not allow your receipts from the performance for a special type of nonproﬁt. If you check one of of services related to the corporation’s exempt the 5(c) through 5(f) boxes, the lawyer, accountant, purposes to be included as “qualifed public or other adviser who is helping you organize one of support.” these special corporations should help you with your Groups checking line 5(g) go on to Part X, application and any additional schedules you have to line 6. prepare and include with your application. Line 5(h). Start by reading the 1023 instruc tions for this line. Tis box is for organizations that Line 5(g). First read the 1023 instructions normally receive one-third of their support from for this line. Tis box is for organizations contributions, membership fees, and gross receipts that receive a substantial part of their support from activities related to the exempt functions of from government agencies or from the general UIFPSHBOJ[BUJPO TVCKFDUUPDFSUBJOFYDFQUJPOT public. Tese are the public support test groups but not more than one-third from unrelated

IRS Line 5 Public Charities Covered in Chapter 4

Line 5(a) churches Chapter 4, “Automatic Public Charity Status” Line 5(b) schools Chapter 4, “Automatic Public Charity Status” Line 5(c) hospitals or medical research Chapter 4, “Automatic Public Charity Status” Line 5(d) supporting organizations Chapter 4, “Automatic Public Charity Status” Line 5(e) public safety organizations Chapter 4, “Automatic Public Charity Status” Line 5(f) government organizations supporting colleges Chapter 4, “Automatic Public Charity Status” Line 5(g) public support test groups Chapter 4, “Public Support Test” Line 5(h) exempt activities support test groups Chapter 4, “Exempt Activities Support Test” Line 5(i) either public support or exempt activities Chapter 4, “Public Support Test” and support test groups “Exempt Activities Support Test” 214 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

trades and businesses or gross investment t&WFSZCPEZT%BODF4UVEJPBOE%JOOFS income. Tis exempt activities support test Teater—a group that expects to derive is discussed in Chapter 4. Tis is the most most of its operating revenue from student common and often the easiest way to qualify a tuitions, special workshops, and ticket new nonproft organization as a public charity. sales (as well as from other exempt-purpose So reread the requirements of this test and the activities)—selects line 5(h) to be classifed defnition of terms associated with it, in Chapter as a group that meets the exempt activities 4. If you believe this public charity test best support test, discussed in Chapter 4. suits your expected sources of support, check tɨF4DIPPMGPS"MUFSOBUJWF4PDJBM4UVEJFT this box. If you are unsure, see the instructions an accredited private postgraduate school UPMJOF J KVTUCFMPX with a formal curriculum, full-time faculty, Groups checking line 5(h), go on to Part X, and regularly enrolled student body— line 6. checks line 5(b) to request automatic public Line 5(i). If you feel that your group may charity status as a formal private school. qualify as a public charity either under line 5(g) tɨF&MEFS$JUJ[FOT$PMMFDUJWFBOE*OGPSNB or 5(h) but aren’t sure which to choose, you tion Exchange, which plans to derive can check this box. Te IRS will decide which support from contributions and grants as of these two public charity classifcations best well as sub scrip tions to its weekly newsletter suits your organization based upon the fnancial (and other exempt-purpose services and data and other fnancial support information products made available to members and included in your 1023 application. For many the public at large), checks line 5(i) to have new groups, line 5(i) is the best way to go. the IRS decide whether line 5(g) or 5(h) is Rather than working through the math and the the appropriate public charity classifcation. technical defnitions necessary to approximate Line 6. Only groups that have checked line whether you will qualify as a public charity 5(g), 5(h), or 5(i)—groups that are seeking under line 5(g) or 5(h), by checking this box to be classifed as a publicly supported public you let the IRS do the hard work for you. charity—should look at line 6. To start with, Groups checking line 5(i), go on to Part X, all of these groups should ignore line 6(a) and line 6. the following blank lines that appear under Here are some sample responses to line 5 by the Consent portion of this part of the form. some typical, hypothetical nonproft groups: Line 6(a) and the Consent portion used to tɨF'JSTU'FMMPXTIJQ$IVSDI BSFMJHJPVT apply if a publicly supported group wanted to organization that plans to maintain a space or was required to seek an advance ruling as to provide weekly religious services to its to its public charity status. Since the federal congregation, checks line 5(a) to request tax regulations have eliminated the advance automatic public charity status as a church. ruling period for all groups, line 6(a) no longer tɨF8PSLTIPQGPS4PDJBM$IBOHF BO applies. Ignore it! educa tional group that plans to receive If you checked line 5(g), 5(h), or 5(i), but support from public and private grant your nonproft has not been in existence for fve funds and from individual and corporate or more completed tax years, you also should contributions, checks line 5(g) to request ignore lines 6(b) and 7, and you should go on to public charity status as a publicly supported Part XI. organization. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 215

If you checked 5(g), 5(h), or 5(i) and your 6(b)(ii)(a) and 6(b)(ii)(b). Tese questions nonproft has been in existence for fve or more require you to disclose sources of support that completed tax years, you should complete line the IRS does not consider qualifed public 6(b) and Line 7 of Part X. Te IRS will use support for groups that are seeking public charity this additional information to determine if status under the exempt activities support test your nonproft qualifes as a publicly supported (the groups covered in Chapter 4 that rely on public charity. support received primarily from their exempt- Line 6(b). If you checked line 5(g), 5(h), or 5(i) purpose activities). We’re talking here about and your nonproft has completed fve or more contributions from disquali fed persons or gross tax years (ignore the requirements for completing receipts from other indiv iduals that exceed the line 6(b) on the June 2006 form—these larger of 1% of the organization’s total support or requirements are based on the old law), check $5,000 in any tax year. the line 6(b) box and answer the remaining 6(b)(ii)(a). For a defnition of disqualifed line 6(b) questions, as explained in the next persons, including a “substantial contributor,” several paragraphs. First read the ofcial 1023 see the ofcial instructions to the form. We instructions to these additional line 6(b) items provide a somewhat friendlier set of defnitions before following our instructions below. of these terms in “Who Are Disqualifed 6(b)(i)(a). Enter 2% (0.02) of the amount Persons?” below. If a disqualifed person pro- shown in Part IX-A (Revenues and Expenses), vided gifts, grants, or contributions, mem ber- line 8, column (e)—this is 2% of your organi za- ship fees, or payments for admissions, or other tion’s total public support received over the tax exempt-purpose services or products (these are years shown in Part IX-A. Te IRS will use this the categories listed in lines 1, 2, and 9 of Part number in computing whether your group meets IX-A, Revenues and Expenses) during any tax the appropriate public charity support test. year shown in Part IX-A, list the disqualifed 6(b)(i)(b). If any individual, organization, persons and amounts contributed or paid on an or company has contributed more than the attachment page. If no disqualifed person paid 2% amount shown in 6(b)(i)(a) during the or contributed any of these amounts, check the prior tax years covered in Part IX-A (Revenues box to the right. and Expenses) of your application, supply 6(b)(ii)(b). If any person (other than a dis- the name(s) of the contributor(s) and the qual ifed person) has paid more than the larger amount(s) contributed on an attachment page. of either $5,000 or 1% of the amount shown Conversely, if no individual, organization, in line 9 of Part IX, Revenues and Expenses, or company contributes more than this 2% (admissions or other exempt-purpose services or amount, check the box at the right. Why products) during any completed tax year shown does the IRS want this information? For line in Part IX-A, provide the name of the person 5(g) public support test charities, the IRS or organization who made the payment and generally does not count amounts that exceed the amount of each payment on an attachment 2% of the group’s total support as qualifed page. Your list should be broken down year-by- public support (for more on the 2% rule and year. If no individual (other than a disqualifed its exceptions, see “Public Support Test,” in person) made such a payment for any of the Chapter 4, and IRS Publication 557, “Support completed tax years shown in Part IX-A, check From the General Public”). the box to the right of this item. 216 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Who Are Disqualiﬁed Persons?

People who are disqualified in the eyes of the substantial contributor if that person makes no IRS are not necessarily prohibited from partici- contribution to the organization for ten years. pating in the operation of the 501(c)(3) nonprofit 2. All foundation managers. Directors, trust- corporation. Instead, their contributions to ees, and officers (or people with similar powers the nonprofit may not count when figuring or responsibilities), or any employee with final the public support received by public charities. authority or responsibility to act on the matter in (Note that the defini tions of disqualified persons question, are disqualified as “foundation manag- discussed here are different from the definitions ers”—this is a buzzword that means the bigwigs of disqualified persons under IRC Section in a nonprofit who exercise executive control. 4958 —see the instructions to Part V above for Officers include persons specifically designated as informa tion on these separate set of definitions.) “officers” in the articles, bylaws, or minutes, and If the corpo ration is classified as a 501(c)(3) persons who regularly make administrative and private foundation (we assume yours won’t be), policy decisions. Officers do not include indepen- the corporation and the disqualified individual dent contractors, such as accountants, lawyers, can be held liable for certain private foundation financial and investment advisers, and managers. excise taxes. Disqualified persons for purposes of Generally, any person who simply recommends meeting the public charity support tests include: action but cannot implement these recommen- 1. Substantial contributors. Tese are donors dations will not qualify as an officer. who give more than $5,000, if the amount 3. Owners and substantial players in entities they contributed is more than 2% of the total that contribute. An owner of more than 20% contributions and bequests received by the of the total combined voting power of a corpo- organization. For example, suppose Ms. X makes ration, the profits of a partnership, or the a gift of $20,000 to your nonprofit corporation. bene ficial interest of a trust or unincorporated If this gift exceeds 2% of all contributions and enter prise are all disqualified, if any of these bequests made to your organization from the entities is a substantial contributor. time it was created until the end of the corporate 4. Family members. A member of the family tax year in which Ms. X made the contribution, —including ancestors, spouse, and lineal descen- Ms. X is a substantial contributor. dants, such as children and grandchildren but not To determine whether a sub stan tial donor is brothers and sisters—of any of the individuals a disqualified person, gifts and bequests made described in 1, 2, or 3 above, is disqualified. by that individual include all contri butions and 5. Other business entities. Corporations, bequests made by the individual’s spouse. Once partnerships, trusts, and so on in which the a person is classified as a substantial contributor, persons described in 1 through 4 above have at he or she generally remains classified as one least a 35% ownership interest. (regardless of future contributions made, or For further information on disqualified persons, not made, by the individual, or future support type “Private Foundation” and “disqualified received by the organization). However, if other person” in the search box of the IRS website at conditions are met, a person will no longer be a www.irs.gov. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 217

Line 7. As with line 6(b), line 7 applies only the amounts listed in Part XI of the 2006 form. to groups that checked line 5(g), 5(h), or 5(i), We have included the latest amounts but check and have completed fve or more tax years. that they are still current at the time you file your To answer this question, frst refer to our application. instructions to Part IX-A, above (Statement of Revenue and Expenses). If you have listed any Line 1. Groups that qualify for a reduced unusual grants on line 12 of the Statement of user fee of $400—the new increased fee— Revenue and Expenses in any of the columns, check “Yes.” Your organization qualifes for check “Yes” and list them on an attachment this reduced fee if it is submitting its initial page along with the donor’s name, date, and exemption application and: amount and the nature of the grant (what the tJUJTBOFXPSHBOJ[BUJPO JOPQFSBUJPOGPS grant was for, whether it was restricted to a less than four years) that anticipates annual specifc use, and other terms of the grant). If gross receipts averaging not more than you provided this information in an attachment $10,000 during its frst four tax years, or to Part IX-A, you can refer to your earlier tJUIBTCFFOJOPQFSBUJPOGPSGPVSUBYZFBST response. For further explanation of what or more and has had annual gross receipts constitutes unusual grants, see “Unusual averaging not more than $10,000 during Grants,” below. If you have not listed any the preceding four years. unusual grants in the Part IX-A Revenue and Line 2. If you checked “Yes” in line 1, also Expense statement, check the “No” box. check the line 2 box. Cross out $300 and insert $400 (the current reduced fee). If you did not Part XI: User Fee Information check “Yes” to line 1, do not check box 2. Check the IRS website to see if the “Cyber You must pay a user fee when you submit your Assistant” online program with reduced fling 1023 tax exemption application. Te fee is fees is available. Te IRS has planned to launch determined according to the amount of gross this program for several years but it has been receipts your group has or expects to receive delayed indefnitely. annually (averaged over a four-year period). See Line 3. If you did not check “Yes” to line 1, the 1023 instructions to this part frst before check the line 3 box and include a user fee reading our instructions below. check for $750. If you checked the line 1 box, do not check this box. CAUTION Always check that the fee amount is TIP current. Your user fee check should be made payable to the “United States Treasury,” and show “User What happens if you guess incorrectly? fee Form 1023 [name of your group]” on the check You may be concerned about what will happen if memo line. Before writing your check, go to the IRS you estimate that your gross receipts will average no website at www.irs.gov to make sure you have the more than $10,000 during your first four tax years, current fee amounts. Type “Exempt Organization but your actual gross receipts exceed this amount User Fee” in the keyword box to find fee amounts. in one or more years. We don’t know for sure, but if Alternatively, call the IRS Exempt Organization you make more than this threshold amount, it seems Customer Service telephone number at 877-829- reasonable to assume that the IRS would monitor 5500 to ask for current 1023 user fee amounts. Ignore your annual information returns and ask you to pay 218 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

the remaining balance later. Of course, if the financial Write a check payable to the United States information you submit with your 1023 exemption Treasury for the amount of the user fee. Do application shows that your group has, or expects to not staple or otherwise attach your check to have, average gross receipts exceeding $10,000 for its your application. You will simply place your first four years and you check the wrong box here, check at the top of your assembled exemption expect the IRS to return your exemption application application package, as explained in the next due to insufficient payment or to send out a request section. Te check does not have to be an for an additional payment before it continues organizational check. Te person preparing processing your application. the application or any other incorporator may write a personal check. Te user fee is kept by the IRS in almost all circumstances, even if Unusual Grants your application is denied. Te only time it is refunded is if the IRS decides that it cannot Unusual grants are contributions, bequests, issue a determination as to your exempt or grants that your organization receives status one way or the other—because it has because it is publicly supported but that are insufcient information or cannot resolve some so large that they could jeopardize your ability of the issues associated with your tax exemption to meet your public support test. Te benefit request. By the way, this rarely happens. For of having a large grant qualify as an unusual example, if you don’t respond to any follow- grant is that it does not jeopardize the group’s up questions that the IRS may ask in response public charity status (as do other large sums to your application, it normally denies your received from a single source). It is unlikely that exemption (and keeps the check). your beginning nonprofit has received sums 8IFX:PVSFKVTUBCPVUEPOF'PMMPXUIF that should be classified as unusual grants. For instructions below for assembling your entire further information on this technical area, see federal exemption package. the 1023 instructions to line 7 of Part X, the discussion and examples of unusual grants in “What Is Public Support?” in Chapter 4, (see Filling Out the Schedules “Money From Unusual Grants” and “Unusual Grants Drop Out of the Computation”), and the Certain groups must complete and submit specific rules on unusual grants contained in IRS schedules with their Form 1023 application. In Publication 557. the line-by-line instructions to the 1023 form, above, we let you know when you are required to complete a schedule. For example, in Part Signature, Name, Title, and Date Lines. Have VII, line 1, of the application, we tell you that one of your initial directors or ofcers sign, type if you answered “Yes” to that item, you must his or her name and title (director, president, complete Schedule G. chief operations ofcer, or the like), and insert the date on the lines provided at the bottom of SKIP AHEAD Part XI. If you do not need to submit any schedules with your Form 1023, then you can skip this section. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 219

Schedule A—Churches tXIFUIFSUIFIPTQJUBMPSNFEJDBMSFTFBSDI organization qualifes for automatic public See the separate instructions to Schedule A charity status (see the Schedule C instruc- included in the last portion of the ofcial 1023 tions in the ofcial 1023 instructions and instructions for help in flling out this schedule. IRS Publication 557, “Hospitals and Medi- We’ve discussed the requirements for churches cal Research Organizations”). in “Automatic Public Charity Status,” in A 501(c)(3) charitable hospital normally has Chapter 4. Te questions here seek to determine many of the following characteristics: whether your organization possesses conventional, tTUBêEPDUPSTTFMFDUFEGSPNUIFDPNNVOJUZ institutional church attributes—the more the at large better as far as the IRS is concerned. Some also tBDPNNVOJUZPSJFOUFECPBSEPGEJSFDUPST relate to whether your organization unduly (directors come from the community served benefts, or was created to serve the personal by the hospital) needs of, your pastor or the pastor’s family and tFNFSHFODZSPPNGBDJMJUJFTPQFOUPUIFQVCMJD relatives. Obviously, doing so is an IRS no-no. tBQPMJDZPGBMMPXJOHBUMFBTUTPNFQBUJFOUT Schedule B—Schools, to be treated without charge (on a charity basis) Colleges, and Universities tBOPOEJTDSJNJOBUJPOQPMJDZXJUISFTQFDU See the ofcial 1023 instructions to Schedule B to patient admissions (it doesn’t pick for help in completing this schedule. Your and choose its patient population) and responses to this schedule should show that particularly does not discriminate against your operations are nondiscriminatory and in Medicare or Medicaid patients, and accordance with a nondiscrimination statement tBNFEJDBMUSBJOJOHBOESFTFBSDIQSPHSBN included in your bylaws and published in the that benefts the community. community in which you serve (you must Hospitals need to be careful when it comes to attach this bylaw resolution to Schedule B). renting space to physicians who are members For information on drafting and publishing of the board—and carrying out a private this statement of nondiscrimination, see practice that’s unrelated to the community “Educational Purposes,” in Chapter 3. Also see service programs of the hospital. Te IRS will IRS Publication 557, “Private Schools.” be particularly suspicious if such physicians are prior tenants and their rent is below fair market Schedule C—Hospitals and value. Section 1, question 7, of Schedule C Medical Research Organizations addresses this issue. )PTQJUBMTTIPVMEBEPQUBTVJUBCMFDPOìJDU Make sure to check the appropriate boxes at the of-interest policy in their bylaws (see Schedule top of the schedule and fll out the appropriate C, Section 1, line 14). Article 9 of the bylaws section of the form. Generally this schedule included with this book contains most of the seeks to determine two things: QSPWJTJPOTJOUIFTBNQMFDPOìJDUPGJOUFSFTU tXIFUIFSUIFIPTQJUBMJTDIBSJUBCMFJOOBUVSF policy provided in Appendix A of the ofcial and qualifes for 501(c)(3) tax-exempt 1023 instructions. However, it does not include status, and the special bracketed provisions that apply 220 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

specifcally to hospitals. Make sure you insert If you decide that you fall within one of these additional bracketed provisions. Tere these exceptions (after reading any additional are two, which are clearly marked in Appendix instructions for the line below), check the “Yes” A of the 1023 instructions with the words box or boxes on the appropriate line (either line “[Hospital Insert — for hospitals that complete 1, 2, or 3) and go on to Part VIII of the 1023 Schedule C...]” to the provisions in Article 9 of form. You do not need to complete the rest of the bylaws included with this book. Schedule E. If the IRS agrees that you qualify Te Afordable Care Act added new require- as one of these three special groups, your federal ments for charitable hospitals. (See Notice exemption will be efective retroactively from 2010-39 and Notice 2011-52 and ask your tax the date of your incorporation, even though adviser for more information.) you fled your exemption application late (after more than 27 months from the end of the Schedule D—Section 509(a)(3) month when you fled your articles). Supporting Organizations If you fall within one of the three groups, you are fling an exemption application even Refer to the 1023 instructions for this schedule, though you believe you are not required to do in “Automatic Public Charity Status” in so and even though you are fling more than Chapter 4 (see “Supporting Organizations”), 27 months after your nonproft corporation and Publication 557, “Section 509(a)(3) was formed. As we said above, we agree that Organizations.” Tis is a complicated schedule this is the best way to go, since by submitting —you must meet a number of technical tests. your exemption application you are making Your nonproft legal or tax adviser can help you sure the IRS agrees that your group is entitled qualify for this special type of public charity to a tax exemption in one of these three special classifcation. 501(c)(3) categories. Line 2(a) and 2(b). Schedule E—Organizations Te 2(a) exception is often applicable to new nonprofts. Your group Not Filing Form 1023 Within qualifes if: 27 Months of Formation tJUJTBQVCMJDDIBSJUZSBUIFSUIBOBQSJWBUF Before flling in Schedule E, read the ofcial foundation (because one of the purposes IRS 1023 instructions to Schedule E, which of completing your 1023 application is to are contained in the instructions for separate establish that you are eligible for public schedules at the end of the 1023 instructions. charity status, we assume that you meet this Tis material will give you some basic defni- requirement), and tions and information that will help you work tJUiOPSNBMMZwIBTHSPTTSFDFJQUTPGOPUNPSF your way through the schedule. than $5,000 in each tax year. Lines 1–3. Tree groups are not required to Groups that have been in existence for two fle Form 1023: churches; public charities that tax years qualify if they had total gross receipts normally have gross receipts of not more than of $12,000 or less during the frst two years. $5,000 in each year (see the extra instructions We assume your group has been in existence for line 2(b) below); and subordinate organiza- for at least two years because it is fling more tions exempt under a group exemption letter than 27 months after it was formed. If you have (see “Do You Need to File Form 1023?” above). CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 221

been in existence for three or more tax years, Line 4. Here is where you end up if your group your gross receipts over the three years must is fling the 1023 application more than 27 be $15,000 or less to qualify for the “normally months from the date of your incorporation $5,000” exception. Many new groups without and you don’t meet one of the three exceptions outside sources of support can meet this listed in lines 1 through 3 of this part. Groups gross receipts test during their beginning tax formed on or before October 9, 1969 get a years. And, if you can’t check “Yes” to line special break. Of course, we assume you were 2(a), there’s a technical loophole in line 2(b): formed recently, and will check “No” and move It says that groups that are fling their 1023 on to line 5. application within 90 days after the end of the tax year when they qualifed for the “normally If You End Up on Schedule E, Line 5, Should $5,000 gross receipts” test, also can fle their You Ask for an Extension? application late. Most groups will not end up on Schedule E, EXAMPLE: You form a new nonproft line 5—they will submit their 1023 application corporation in January 2009 and fle your within 27 months from the date of their incor- tax exemption application more than four poration. If your group does end up here, you years later—in February 2013. Your group may decide not to bother seeking an extension had gross receipts of less than $5,000 for and simply check “No” on line 5. Tis means 2009 through 2011, but 2012 was a really that your 501(c)(3) exemption, if granted, good year so the total gross receipts for your will be effective only from the application’s organization over the three-tax-year period post mark date, not from the date of your from January 2010 through December 2012 incor poration. Is this so terrible? Often, it isn’t. was $25,000. Tis is well over the three- Here’s why. Many nonprofits will not have any year $15,000 cumulative total maximum taxable income or contributions from donors amount. If you submit your 1023 application during these early start-up months (the 27-plus in February 2013, which is within 90 days months of operation prior to filing their 1023 of the end of 2012, you can check box 2(b) application). Consequently, obtaining a tax and have the tax exemption extend all the exemption for these early months will not way back to the date of incorporation, since provide a tax benefit. However, if your group it meets this special line 2(b) exception. is facing tax liability for early operations, the Obviously, this 2(b) exception is intended need to provide donors with tax deductions for groups that fle quickly after determining for gifts contributed during the first 27-plus that their past three-year cumulative gross months, or the need to obtain 501(c)(3) tax- receipts put them over the $15,000 mark. exempt status from the date of its creation Once they go over this mark, they become for some other pressing reason, then it makes a group that is required to fle a 1023 sense to prepare a special statement under line application—the IRS will let them have 5 as explained in the text. If you are unsure, their tax exemption for all prior years, even check with your tax adviser. though the last three-year cumulative total exceeded the $15,000 threshold, as long as the group fles the 1023 within 90 days of the end of the high-receipts tax year. 222 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Line 5. Since your group is not one of the explained in more detail in Chapter 4. So check special groups listed in the previous lines on “Yes” to 6(a) and move on to 6(b). Schedule E, your group can only qualify for Even though the 1023 instructions say that an exemption that extends back to its date checking “Yes” to 6(a) means that you will of formation if it asks the IRS to qualify for have to request an advance ruling period for late fling. To do this, check “Yes” and attach a your public charity status, (by completing Part statement giving the reasons why you failed to X, 6(c)), this is no longer true. As mentioned complete the 1023 application process within earlier, advance rulings have been eliminated the 27-month period after your incorporation. and you should ignore Part X, line 6(a)—see our Federal rules, contained in Treasury Regulations instructions to Part X earlier in this chapter. 301.9100-1 and 301.9100-3, also include a list Line 6(b). Most groups that are applying late of the acceptable reasons for late fling, as well for their tax exemption are not planning to as those that aren’t. For example, acceptable substantially change how they get fnancial reasons include the following: you relied on support, so they will check “No” to 6(b), and the advice of a lawyer, accountant, or an IRS ignore the table in line 7—they will move on to employee, and received inaccurate information line 8 of Schedule E. However, some groups that or were not informed of the deadline. Tese are applying late realize that their past operations acceptable reasons are summarized in the and sources of fnancial support may or do not 1023 instructions for this line. After attaching qualify them to meet one of the public charity your statement, perhaps with the help of your support tests (as more fully explained in our tax adviser, go on to Part VIII of the 1023 instructions to Part X), and will want to change application—you should not complete the rest their plans for fnancial support now. If this is of Schedule E. the case for your late-fling nonproft, mark “Yes” If you don’t think you can qualify for an UP C UIFOëMMJOUIFQSPKFDUFESFWFOVFUBCMFJO extension (or if you decide not to bother—see line 7 to show your expected sources of future “If You End Up on Schedule E, Line 5, Should fnancial support. You Ask for an Extension?” above), check “No” Line 7. If you marked “Yes” to line 6(b), fll and go on to line 6. JOQSPKFDUFETPVSDFTPGëOBODJBMTVQQPSUGPS Line 6 (a). If you checked “No” on line 5 (you the next two full years following the current don’t want to qualify for an extension of time to tax year. For example, if you are applying for fle), you should check “Yes” to 6(a). Tis means your tax exemption late in July of 2013, and that you agree that your 501(c)(3) exemption your nonproft’s tax year goes from January to can be recognized only from its postmark date, December (the typical case), supply fnancial not retroactively to the date of your incorpo- fgures for the period from January 2014 to ration. By the way, if you check “No” to 6(a), December 2016 in the table. You don’t have you are saying that you are applying for a tax to fll in items for all rows, but you should be exemption as a 501(c)(3) private foundation, able to supply fgures that show that you expect not a public charity—this is something you your nonproft to obtain support from sources defnitely will not want to do. We assume all that qualify it for public charity status under readers will want to form a 501(c)(3) public one of the two basic fnancial support categories charity, as mentioned earlier in this chapter and discussed in Part X. CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 223

Line 8. If you are fling your 1023 application 501(c)(4) Organizations late and checked “Yes” to line 6(a) on Schedule E, you should complete line 8 of the Schedule, Internal Revenue Code Section 501(c)(4) pro- regardless of how you responded to 6(b). If you vides a federal corporate income tax exemp- end up here, your application for 501(c)(3) tion for nonprofit social welfare groups and status will be considered only from the date of civic leagues (see “Special Nonprofit Tax- its postmark. If you check “Yes” to line 8, you Exempt Organizations,” in Appendix B). Since are asking the IRS to grant your group tax- the promotion of public welfare is defined as exempt status as a 501(c)(4) organization—a “promoting the common good and general social welfare group or a civic league—during welfare of the people of the community,” many your late fling period (the 27-month-plus 501(c)(3) nonprofits also qualify as 501(c)(4) period from the date your articles were fled up social welfare organizations. Although 501(c)(4) to the date your 1023 application postmark). nonprofits are exempt from federal corporate What does this do for you? If your request for income taxation, they are not eligible to receive 501(c)(4) status is approved, your organization tax-deductible contributions from donors. Tey will be exempt from paying federal corporate also do not enjoy many of the other advantages income taxes as a 501(c)(4) organization from associated with 501(c)(3) tax-exempt status, the date of its formation until the date of such as eligibility to receive public and private approval of your 501(c)(3) tax-exempt status grant funds, participate in local, state, and (the 1023 postmark date). For most newly federal nonprofit programs, obtain county real formed groups without taxable income during and personal property tax exemptions, and this initial period, obtaining this extra tax other benefits. exemption will not be necessary and you can But 501(c)(4) organizations do enjoy one ignore this box. advantage not available to 501(c)(3) groups: However, if you or your tax adviser deter- Tey may engage in substantial legislative NJOFTUIBUZPVSPSHBOJ[BUJPOJTTVCKFDUUP activities and may support or oppose candi- tax liability for this initial period, check this dates to public office. For further information box and call 800-TAX-FORM to order IRS on 501(c)(4) tax-exempt status, see IRS Publication 1024 (or go to www.irs.gov). Fill Publication 557. in the page 1 of Form 1024 and submit it with your exemption application. If you qualify as a 501(c)(4) social welfare group (as many 501(c)(3)s do—see “501(c)(4) Organizations,” Schedule F—Homes for the below), your 501(c)(3) tax determination letter Elderly or Handicapped and will indicate that you qualify as a 501(c)(4) Low-Income Housing organization during your initial late fling (your See the 1023 instructions for help in flling out pre-501(c)(3) period). this schedule. In part, this schedule attempts to determine whether elderly or handicapped housing facilities are made available to members of the public or the particular community at reasonable rates, whether provision is made 224 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

for indigent residents, whether health care serve the private interests of the people asso- arrangements are adequate, and whether ciated with the predecessor organization. If facilities are adequate to house a sufcient assets were transferred from the prior nonproft number of residents. association to the new nonproft corporation, you are asked to provide a sales or transfer Schedule G—Successors agreement (Schedule G, line 6(c)). If you have to Other Organizations prepared this formal paperwork, attach a copy to your application. If you haven’t (this Line 1(a). We assume your nonproft is not a is normally the case for a small nonprofts successor to a prior proft-making company, that are formally converting a prior nonproft which is one such as a sole proprietorship, association to a nonproft corporation), you partnership, limited liability company, or a should prepare (perhaps with help from business corporation that allows its owners someone with fnancial savvy associated with to have a proprietary (fnancial) interest in your nonproft) and put together a simple its assets. In the unlikely case that you check term sheet that lists the assets and liabilities “Yes” to line 1(a) because you are a successor to transferred to the new nonproft and the terms a proft organization, we think you will need of the transfer. Tis simple agreement should be help from a nonproft expert when flling out signed by ofcers of the prior association and Schedule G and the rest of your tax exemption directors or ofcers of your new nonproft, and application to explain to the IRS why you attached to Schedule G. decided to convert a prior proft-making activity If your nonproft corporation will lease to nonproft corporate status, and why the new property or equipment previously owned or nonproft is entitled to its tax exemption. used by the predecessor organization or will Successor groups that check “No” to line 1(a) lease property from people associated with the will have to check “Yes” to line 2(a) to indicate prior group, include an explanation and copies that they are successors to a nonproft groups of any leases as requested in line 8. Te IRS (remember, a successor group is one that meets will scrutinize a lease to make sure that it does one of the successor tests listed above—if not provide for excessive rent payments to the you are not a successor group, you shouldn’t people associated with the former organization. be flling in Schedule G). Even these groups If a nonproft corporation is a successor to a may need help responding to Schedule G. For prior nonproft association, it’s usually best, example, it asks for the prior tax status and if possible, for the prior association simply to EIN of your predecessor group, and whether it assign any leases to the nonproft corporation has previously applied for a tax exemption. If without payment (or for a $1 consideration the predecessor group was required to fle tax to keep things legal) or have the corporation returns and/or pay taxes but did not, expect the renegotiate the leases with the landlord. Tat IRS to ask for these returns (and late fling and way, the successor nonproft corporation can late payment penalties too). If the prior group deal with the landlord directly rather than was denied a tax exemption, you will need to have people from the former organization clearly explain what has changed that makes retain the lease and require rent payments from you believe you qualify for an exemption now. the successor nonproft corporation. (For an Te schedule also attempts to determine if the new nonproft has been set up to beneft or CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 225 example of an assignment of lease form, see Assemble and Mail Your “Prepare Assignments of Leases and Deeds,” in Chapter 9.) If your successor nonproft will Application to the IRS lease property back to the people associated You’ve accomplished the most difcult part of with the prior group, line 9 also asks for a copy your paperwork. Te only task left is to gather of the lease agreement. Obviously, a leaseback up your application forms and papers and send of property will be strictly scrutinized by the them of to the IRS. Follow these steps: IRS to see if the payments are reasonable—the tComplete the checklist. Te IRS wants you IRS also will wonder why the new nonproft to complete and include the checklist with transferred the assets in the frst place, since your mailed materials. Te checklist is after the transfer it decided to lease them back included as the last two pages of the 1023 to the people associated with the prior group. application form. To complete the checklist, Leaseback deals like this look fne in the normal check each box to show you completed business world, but raise IRS examiner eyebrows all the checklist tasks. If you followed the when they are disclosed on tax-exemption previous steps in this chapter, you should be applications. able to check each box and complete each checklist task as follows: Schedule H—Organizations tAssemble your application materials in order. Providing Scholarships, Educational Put your materials together in the order Loans, or Other Educational Grants shown in the checklist. Note that Forms Schedule H is used by the IRS to determine 2848 and 8821, as well as amendments to whether your nonproft will provide fnancial articles of incorporation, nondiscriminatory aid on a nondiscriminatory basis. Te IRS school statement, and Form 5768, will not wants to know that fnancial aid funds will not apply to most groups. User fee. be set aside specifcally to help put family and t Place your user fee check at the top friends of people associated with your nonproft of your materials. Do not staple it to your through school and that the providing of application papers. EIN. funds in general will promote your group’s t Make sure you have obtained an tax-exempt public purposes, which typically Employer Identifcation Number (it will be charitable and/or educational. For should be stated in Part I, line 4, of your further information on IRS guidelines, see application). Completed Parts I through XI of your IRS Publication 557, “Charitable Organization t application. Supporting Education” and “Organization We assume you can check this Providing Loans.” Section II of this schedule checklist box to show you have completed can be used to get IRS approval of your all parts of the 1023 form. Schedules. organization’s grant-making procedures if your t Check “Yes” or “No” to show organization is classifed as a private foundation which, if any, schedules you have completed (in the event your request for public charity and included with your application. Many classifcation under Part X is denied). If you groups will mark “No” to all schedules. wish to plan for this contingency, consult your Only submit schedules with your applica- tax adviser to help you select the appropriate tion that you have completed—do not IRC section on line 1(b) of Section II. include blank schedules. 226 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tArticles. We assume you have included to send your application papers to the IRS a fle-stamped or certifed copy of your via an express mail service (see the approved articles in response to Part II, line 1, of the list of private delivery services in the 1023 application. Fill in the two blanks here to instructions, “Private Delivery Services”). Te show (1) your purpose clause (repeat the express mail address currently shown on the reference to your articles you inserted in 1023 checklist is: response to Part III, line 1) and (2) your Internal Revenue Service dissolution clause (repeat the reference to 201 West Rivercenter Boulevard your articles you inserted in response to Attn: Extracting Stop 312 Part III, line 2(b)—we assume you did not Covington, KY 41011 refer to a state law provision in line 2(c); see our instructions to Part II, above). Your next step is to wait. Although the IRS tSignature. Make sure a director or ofcer turnaround time to respond to your application has signed, flled in the name and title lines, is usually about three months, you may have to and dated the form at the bottom of Part wait three to six months or more for a response XI (and, if applicable, completed and signed to your exemption application. To see the the Consent lines in Part X, line 6a—see timetables for the review process, go to the IRS our instructions to this line, above). website at www.irs.gov and type in the search tName of organization. Te name you insert box “Where is My Exemption Application?” in Part 1, line 1, of the 1023 applica- You can request expedited fling of your 1023 tion must be the same as the name of application by submitting a written request your corpo ration in your articles of along with your exemption application. Te incorporation. IRS may approve the request and speed up the Make copies. After completing the checklist processing of your application if your reason and including it as the frst page of your exemp- for the request is an impending grant deadline, tion materials, make at least one photocopy of your nonproft provides disaster relief, or the all pages and attachments to your application IRS has already delayed a prior application or and fle them in your corporate records book. response to a previous application by the group. Mail your application. Mail your package to See “Expedite request,” in the 1023 instructions the IRS address listed in the checklist. You for more information. may want to send it certifed mail, return receipt requested, to obtain proof of mailing CAUTION and/or of receipt by the IRS. At this writing, You must ﬁle annual federal and state the address is: information returns for your organization while Internal Revenue Service your federal tax exemption application is pending (see “Annual Filing Requirements,” in the 1023 P.O. Box 12192 instructions and in Chapter 10). Indicate on your Covington, KY 41012-0192 annual returns that your federal 1023 application is You can check for the current mailing pending approval by the IRS. address on the IRS website at www.irs.gov. As an alternative to regular mail, you may want CHAPTER 8 | APPLY FOR YOUR FEDERAL 501C3 TAX EXEMPTION | 227

What to Expect From the IRS CAUTION If your determination letter tells you that After reviewing your application, the IRS will you are exempt as a private foundation, see a tax do one of three things: or legal adviser immediately. Most nonprofits will tHSBOUZPVSGFEFSBMUBYFYFNQUJPO not want to maintain a nonprofit private foundation, tSFRVFTUGVSUIFSJOGPSNBUJPO PS and often either contest the determination or decide tJTTVFBQSPQPTFEBEWFSTFEFUFSNJOBUJPO to dissolve their nonprofit corpo ration immediately. (a denial of tax exemption that becomes efective 30 days from the date of issuance). Resist the natural temptation to fle the letter If the IRS asks for more information and without reading past the frst sentences. In you are not sure what they want from you—or fact, the letter contains important information ZPVKVTUGFFMUIBUZPVBSFJOPWFSZPVSIFBE regarding the basis for your exemption and the consult a nonproft attorney or tax adviser. If requirements for maintaining it. Here’s what to you receive a proposed denial and you wish to look for: appeal, see a lawyer immediately. For further tAre you properly classified? Check to make information on appeal procedures, see IRS sure that the public charity section listed by Publication 557, Tax-Exempt Status for your the IRS corresponds to the kind of public Organization, and type “Appeal Procedures” charity status you asked for. Some groups in the Search box on the IRS website at www. that used the 1023 Form will have checked irs.gov for links to other appeals procedure Part X, line 5(i), to let the IRS determine information. the proper public charity support test category support test for the organization. tMust you file a federal tax return? Te Te Federal determination letter will tell you whether Determination Letter you must fle a federal annual information return, IRS Form 990 or Form 990-EZ. Te fortunate among you—and we trust it will Most 501(c)(3) groups must fle a 990 be most of you—will get good news from the return (it’s explained in Chapter 10). IRS. It will come in the form of a favor able tAre you liable for excise taxes? Te deter- determination letter, telling you that you are mination letter also should state that you exempt from federal corporate income taxes are not liable for excise taxes under Chapter under Section 501(c)(3) of the Internal Revenue 42 of the Internal Revenue Code. Tese are Code, as a public charity. Unless you fled the taxes applicable to private foundations. your application late and were not entitled to Te letter will also refer to other excise an extension, your tax exemption and public taxes for which you may be liable. Tese charity status will be efective retroactively to are the regular excise taxes applicable to all the date when your articles were fled with the businesses that engage in certain activities, secretary of state. such as the sale of liquor, the manufacturing of certain products, and so on. For further information, see IRS Publication 510, Excise Taxes. 228 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tInformation on deductions for donors. $POHSBUVMBUJPOT:PVWFKVTUëOJTIFEUIF Your letter will include information on the most complicated, and indeed most crucial, deductibility of charitable contributions part of your nonproft incorporation process. made to your organization, and will refer to Te remaining formal incorporation steps are Internal Revenue Code sections that cover explained in the next chapter. ● the deductibility of such donations. tMust you pay FUTA taxes? Most groups will be told in their letter that they are exempt from federal unemployment (FUTA) UBYFT:PVBSF IPXFWFS TVCKFDUUPëMJOH nonproft unrelated business income tax returns (Form 990-T). Nonprofts and their FNQMPZFFT IPXFWFS BSFTVCKFDUUP4PDJBM Security (FICA) taxes—see “Federal and State Corporate Employment Taxes,” in Chapter 10. CHAPTER

Final Steps in Organizing Your Nonproﬁt 9

Obtain Your State Tax Exemption ...... 230 Set Up a Corporate Records Book ...... 230 Corporate Records Book ...... 230 Corporate Kits ...... 231 Corporate Seals ...... 231 Corporate Membership Certificates ...... 231 Prepare Offer to Transfer Assets From an Existing Business or Organization to Your Nonprofit ...... 231 Transfers From a For-Profit Business...... 232 Transfers From an Informal Nonprofit Group ...... 233 Prepare Your Offer to Transfer Form ...... 233 Prepare Minutes of Your First Board of Directors’ Meeting ...... 237 Instructions for Preparing Minutes ...... 237 Place Your Minutes and Attachments in a Corporate Records Book ...... 245 Complying With the Bulk Sales Law ...... 246 Prepare a Bill of Sale for Assets ...... 247 Prepare Assignments of Leases and Deeds ...... 249 File Final Papers for the Prior Organization ...... 250 Notify Others of Your Incorporation ...... 250 Apply for a Mailing Permit ...... 250 Apply for Your Property Tax Exemption ...... 251 Timing Your Application ...... 251 Applying for an Exemption ...... 251 File a Domestic Corporation Statement ...... 253 File an Initial Report With the Attorney General ...... 253 Issue Membership Certificates ...... 254 File Your Articles With the County Recorder ...... 254 Register With the Fair Political Practices Commission ...... 255 230 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

ost of the hard work is over, but there Te FTB will send your nonproft an are still a few important details to acknowl edgment letter, which indicates the Mattend to. Don’t be overwhelmed by efective date of your organization’s California the number of steps that follow—many will not corpo rate tax exemption under Section apply to your nonproft corporation and others 23701(d) of the California Revenue and are very simple. Taxation Code—the section of state law that To chart your way through the tasks that parallels the federal 501(c)(3) tax exemption. follow, we recommend you use the Incorpo- Te efective date of your state exemption ration Checklist included with this book. should be the same as the efective date of your federal 501(c)(3) corporate income tax exemp tion. If you have any questions about the Obtain Your State California exemption acknowledgment process, Tax Exemption see the Franchise Tax Board website. Tis new California acknowledgment Te California Franchise Tax Board grants a procedure for obtaining state tax exemption state tax exemption from corporate franchise can only be used by nonprofts that the IRS has taxes to 501(c)(3) groups that have received determined are exempt under Section 501(c)(3) their federal exemption determination letter of the Internal Revenue Code. All other entities from the IRS. Te state tax exemption for seeking a California state tax exemption should religious, charitable, scientifc, literary, and fle form FTB 3500, Exemption Application, educational nonprofts parallels the federal with the California Franchise Tax Board. Much 501(c)(3) tax exemption. Once you obtain your of the information you prepared for your federal state tax exemption, your nonproft corporation tax exemption form (discussed in Chapter 8) is exempt from paying the annual California can be used to fll in the FTB 3500 form. franchise tax, including the minimum annual franchise tax payment of $800. To obtain your California corporate tax Set Up a Corporate exemption, mail a copy of your IRS determi- Records Book nation letter with a completed FTB 3500A, Submission of Exemption Request, to the Cali- Now take a few minutes to set up or order a fornia Franchise Tax Board. You can fll in the corporate records book—this is an important form online at the Franchise Tax Board website part of your incorporation process. (www.ftb.ca.gov); then print and mail it to the Franchise Tax Board at the address provided on Corporate Records Book the application. You will need a corporate records book to keep Te FTB 3500A form asks for basic infor- all your papers in an orderly fashion. Tese mation about the nonproft organization’s documents include articles of incorporation, identity and purpose. Te instructions to the bylaws, minutes of your frst board meeting and form explain how to fll it out, attach your ongoing director and shareholder meetings, tax federal determination letter to it, and mail the exemption application and determination letter, packet to the Franchise Tax Board. membership certifcates (for those nonprofts with formal members), and any other related CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 231 documents. You should keep your corporate Corporate Membership Certiﬁcates records book at the principal ofce of your If you have decided to adopt a formal member- corporation at all times to make sure you ship structure with members entitled to vote always know where to fnd it. for the board of directors, you may want to use To set up a corporate records book, you can membership certifcates. Ten tear-out certi- simply place all your incorporation documents fcates are included in Appendix B. Unlike in a three-ring binder. If you prefer, you can stock certifcates used in proft corporations, order a custom-designed corporate records book membership certifcates in nonproft 501(c)(3) through a legal stationery store. corporations do not represent an ownership interest in the assets of the corporation. Tey Corporate Kits serve only as a formal reminder of membership You order a nonproft corporate kit through a status. legal stationery store. Tese nonproft corporate Each certifcate that you issue should be kits typically include: numbered sequentially. Type the certifcate tBDPSQPSBUFSFDPSETCPPLXJUINJOVUFQBQFS number at the top of the form. Type the and index dividers for charter (articles name of the corporation in the heading and of incorporation), bylaws, minutes, and the name of the member in the blank in the membership certifcates frst paragraph. Have the certifcate signed by tBNFUBMDPSQPSBUFTFBM BDJSDVMBSTUBNQ your president and secretary, then place an with the name of your corporation, the impression of the seal of the corporation at state’s name, and year of incorporation), the bottom. You should also record the name which you can use on important corporate and address of the member and the number documents, and of the issued membership certifcate in the tNFNCFSTIJQDFSUJëDBUFT QSJOUFEXJUIUIF membership list in your corporate records. name of your corporation.

Corporate Seals Prepare Oﬀer to Transfer Placing a corporate seal on a document is a Assets From an Existing formal way of showing that the document is the Business or Organization authorized act of the corporation. Nonprofts don’t normally use a seal on everyday business to Your Nonproﬁt papers (such as invoices and purchase orders), If you are incorporating an existing organiza- but they do use them for more formal docu- tion, you may want to prepare an ofer to ments, such as leases, membership certifcates, transfer assets—this document provides a deeds of trust, and certifcations of board formal record of the transfer and its terms. resolutions. A corporation is not legally required Your ofer to transfer assets is a preliminary to have or use a corporate seal, but many fnd it agreement. It will be accepted by the board of convenient to do so. directors at the frst meeting of the board and A metal seal is usually included in the corpo- then formalized by a bill of sale. Tere are two rate kits or you can get a customized seal from a basic types of ofers, as we describe below. legal stationer for about $25 to $50. 232 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Transfers From a For-Profit Business Lots to Consider When If you are incorporating a preexisting for- Transferring Assets proft business, you may want to prepare an ofer to transfer the assets and liabilities of the Many practical and legal issues arise in a transfer predecessor organization to your nonproft (to of assets and liabilities from a prior busi ness take efect after the corporation has obtained to a nonprofit. We suggest you consult an accountant to make sure you have considered: its federal tax exemption). An ofer to transfer t UIFCFTUUSBOTGFSNFUIPEUPBTTVSFUIFCFTU formalizes the transfer of assets and liabilities treatment of the prior business to your nonproft and t XIFUIFSUIFQSFFYJTUJOHCVTJOFTTIBTSFUBJOFE provides documentation of the transfer. sufficient assets to pay liabilities not assumed by the nonprofit CAUTION t XIFUIFSSFBMQSPQFSUZTIPVMECFLFQUCZUIF Tere can be significant federal and state prior business owners and leased to the non- income tax consequences when the assets and profit liabilities of a prior business or organization are t UIBUQBZNFOUCZUIFQSJPSCVTJOFTTPXOFSTPG transferred to a new nonprofit corporation. For an liabilities not assumed by the nonprofit allows overview, see the author’s blog article, “Converting them a current, and sometimes necessary, tax an LLC to a Corporation—It’s Not as Simple as It deduction for the prior business, and Seems,” at the LLC & Corporation Small Talk blog, at t UIBUUIFUSBOTGFSTIPVMECFNBEFPOUIFEBUF www.llccorporationblog.com. Although it discusses (the closing date referred to below) most issues relating to converting a co-owned profitmaking advantageous for the prior owners of the business to a corporation, the tax issues can have profit business. applicability to nonprofit corporations as well. Make Te new nonprofit corporation is not usually sure to check with a knowledgeable tax adviser before liable for the debts or liabilities of the prior transferring the assets and liabilities of a business or business unless it assumes the debt or the trans- organization to your new nonprofit corporation or action was fraudulent (with intent to frustrate using the offer and bill of sale in this book. and deceive the prior business creditors). In rare cases, the transfer must also comply with the When the people connected with the Bulk Sales Law (the Bulk Sales Law is explained preexisting business and the newly formed below, in “Complying With the Bulk Sales Law”). nonproft corporation are one and the same, the Te former business owners remain personally liable for debts or liabilities of the prior business assets are usually transferred without payment. incurred prior to the transfer of assets to the However, when the nonproft acquires assets corporation (even if they are assumed by the from a pre existing proft-making business run corporation). Tey may also be held personally by people diferent from those starting up liable for debts incurred after the transfer, the nonproft, the nonproft may agree to buy if credit is extended to the corporation by a the assets. In either case, the ofer will record creditor who believes and relies on the fact that the terms of the transfer (donation or sale of she is still dealing with the prior profit business assets). You can prepare this ofer (as we’ve and hasn’t been notified of the incorporation explained in Chapter 9) when completing (see “Notify Others of Your Incorporation,” Schedule G, which you included with your below, for notification procedures). federal tax exemption application. Refer to CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 233

special instruction ➑, in “Prepare Your Ofer Each circled number in the sample form (they to Transfer Form,” below. look like this: ➊) refers to an instruction that helps you complete an item. Transfers From an ➊ Attach a copy of an assets and liabilities Informal Nonproﬁt Group statement (Balance Sheet) that is current as of the date that is one business day before the date If you are incorporating a preexisting nonproft of sale. Insert this Balance Sheet date in the association or another less formal type of non- blank—it represents the “closing date of the proft group, you might want to prepare a ofer,” a date that is referred to throughout the transfer form to document the details of the remainder of the ofer. As explained earlier, this transfer of any assets and liabilities. Docu- date should be as advantageous as possible, tax- mentation of this type (who is transferring or wise, to the prior business owners or organization contributing what to the new nonproft) can (consult with your accountant). If you prepare avoid disputes or misunderstandings later on. In this ofer at the same time that you prepare your this case, you will need to modify the form to federal exemption application, keep in mind the show that it is prepared by the trustees, ofcers, three- to six-month time lag that usually occurs members, or organizers of the preexisting non- before the IRS approves your exemption. Tis proft organization or group. means that you may want to hold of making the ofer until you hear from the IRS that your Prepare Your Oﬀer to Transfer Form federal tax exemption has been approved. Tis To transfer assets from a prior proft-making ofer states that it is contingent upon your business or a nonproft association to your nonproft corporation obtaining its federal and nonproft corporation, you can use the Ofer state tax exemption (see instruction ➐, below). to Transfer Assets form. Refer to the sample Also, in the unlikely event that the Bulk Sales form as you follow the instructions below. Law applies to you, make sure this date allows Te sample form below is written to apply to you enough time to comply with the appropriate the transfer of a proft-making business to a presale notice requirements. nonproft. We have included options in brackets For an example, see the general format of for you to select either the word “business” the Balance Sheet provided in Part IX(b) or “organization” when preparing the form. of your federal exemption application. Te Simply delete the inapplicable word as you bookkeeper or accountant of the prior business prepare the ofer with your word processor. or organization can help you prepare this tɨFQBSFOUIFUJDBMCMBOLT i(______),” in statement. the sample form indicate information that ➋ If the nonproft corporation will not assume you must supply. any debts or liabilities of the preexisting business t0QUJPOBMJOGPSNBUJPOJTFODMPTFEJO or organization, include these bracketed provisions brackets, like this: “[optional information].” in paragraph 3(b) and omit the bracketed t3FQMBDFUIFCMBOLTJOUIFPOMJOFGPSN FBDI provisions of paragraph 4(a). series of underlined characters) with the ➌ If the corporation is going to assume information indicated in the blanks in the the debts and liabilities of the business or sample form below. organization, include the bracketed provisions 234 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Oﬀer to Transfer Assets

TO: (name of corporation) , a California nonprofit (public benefit [or] religious) corporation. 1. Te undersigned is [are] the sole proprietor [partners] known as “(name of prior business)” , located at (street address) , (city) , (county) , California. 2. A true and correct statement of the assets and liabilities of this business as of the close of business on (date of statement) , _____, is attached to this offer.➊ 3. On the terms and conditions herein set forth, I [we] offer to sell and transfer to you at the close of business on (closing date) , ____,➊ subject to such changes as may occur therein in the ordinary course of business between the date of this offer and the close of business on (closing date) , ____:➊ (a) All stock in trade, merchandise, fixtures, equipment, and other tangible assets of the business as shown on the financial statement attached to this offer [except … (indicate here any exceptions, e.g., real property to be leased to the corporation, retained cash, etc.) ;] (b) Te trade, business, name, goodwill, and other intangible assets of the business [free and clear of all debts and liabilities of the business as shown on the financial statement attached to this offer, and all such additional liabilities as may be incurred by me (us) between the date of the financial statement and the close of business on the (closing date) , ____].➋ 4. As consideration for the sale and transfer, you agree: [(a) To assume and pay all debts and liabilities of the business as shown on the financial statement attached to this offer, and all such additional liabilities as may be reasonably incurred by me (us) between the date of the financial statement and the close of business on (closing date) , ____, except ... (indicate any unassumed debts or liabilities).]➌ (b) To pay an amount of $ ____ [which represents the fair market value of the business as transferred to the above Corporation per the terms prescribed above], to be paid as follows: (state terms of payment) .➍ [or] CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 235

(b) To execute a note in the amount of $______, [which amount represents the fair market value of the business as transferred to the above Corporation], incorporating the following provisions regarding payment under the note: (state terms of loan) .➎ 5. If this offer is accepted by you and upon payment of $______, per the terms of paragraph 4(b), above [or “upon execution of a note per the terms of paragraph 4(b), above”],➏ I [we] shall: (a) Deliver possession of the business and assets described in paragraph 3 of this offer to you at the close of business on (closing date) , ______. (b) Execute and deliver to you such instruments of transfer and other documents as may be required to fully perform my [our] obligations hereunder or as may be required for the convenient operation of said business thereafter by you. [NOTE: It is clearly understood that this offer is contingent upon the above nonprofit corporation obtaining tax-exempt status with the IRS under Section 501(c)(3) of the Internal Revenue Code and with the State of California under Section 23701(d) of the California Revenue and Taxation Code, and that failure to obtain either or both of these exemptions within (number) months shall allow me (us) to rescind this offer at any time thereafter, notwithstanding any of the other provisions of this offer contained above.]➐

Dated: ______, _____ ➑ (signature of prior business owner[s]) [Te blanks below are to be filled in later, after the first board meeting:]. Te above Offer was accepted by the board of directors on (date of board meeting) , ____, on behalf of (name of corporation) , a California nonprofit (public benefit [or] religious) corporation.

By: ______, President ______, Secretary [When you have completed the form, you will wish to make several attachments as indicated in special instruction ➒.] 236 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

of paragraph 4(a) and omit the bracketed Te terms of the loan should be commercially provisions in paragraph 3(b), as explained reasonable—a defnite payback period and above. If the corporation is to assume some, schedule, and a commercially reasonable rate but not all, debts and liabilities, indicate of interest. Tis will help avoid a determination any exceptions in paragraph 4(a). If you are by the IRS that the prior business owners preparing the ofer at the time of applying for (who perhaps now are directors or ofcers of your federal tax exemption, you should return the nonproft corporation) or organization are to this section of your ofer in your response to receiving some monetary advantage from the Schedule 6, question 7. corporation, such as an above-market value ➍ Use paragraph 4(b) if you are transferring payment or an excessive rate of interest paid by the business for a lump sum of cash to be the nonproft. Conversely, the more generous paid by the corporation. If the assets will be the terms to the nonproft corporation, the donated, state $1 as the amount. Tis silly less likely are your chances of having your amount satisfes an age-old legal rule, namely, exemption application denied or having that there must be some consideration (money) problems with the IRS later upon an audit of for a contract to be valid, although the actual your organization. amount usually doesn’t matter. ➏ Use the unbracketed sentence of para- If you are transferring the business for its graph 5 if the corporation will pay the full sum fair market value, write the dollar amount of money when the business is transferred to and include the language in brackets. If you the corporation. Use the bracketed phrase if the are transferring the assets of a proft-making amount will be paid of over time per the terms business, and you had an appraisal done (see of a loan note. Schedule G, question 6(a), of the federal exemp- ➐ Include this bracketed NOTE paragraph tion application), you can use the appraisal if you are drafting the ofer while preparing fgure determined by the qualifed expert in your federal exemption application. State how response to question 4(b) of Schedule I of your much time the corporation has to obtain its federal tax exemption application, unless this exemption before the prior business owner(s) fgure has changed. State the terms of the cash can cancel the ofer. payment at the end of this paragraph (such as ➑ Print the form and have the prior busi- the date of payment). ness owner(s) or one or more authorized ➎ Use this paragraph 4(b) instead of the mana gers or ofcers of the unincorporated preceding paragraph 4(b) if the corporation will organi zation sign and date the ofer. If the not immediately pay cash for the assets, but ofer is prepared for the transfer of assets of a will instead sign a loan note and pay the amount prior nonproft organization, we assume the in specifed installments. Te discussion above transfer was properly approved by the prior concerning fair market value applies here as well. nonproft organization according to its charter Specify the terms of the loan—the amount and or bylaws—see “Preparing Articles for an date of installment payments, the rate of interest, Unincorporated Association,” in Chapter 6. and maturity date, whether it’s an interest-only Don’t fll in the blanks at the bottom of the loan with the principal amount paid at some ofer yet—do so after the frst meeting of your future date, a noninterest note for the principal board of directors. If you are preparing the ofer amount only, or payable on demand. for submission with your federal exemption application in response to Schedule G, CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 237

question 6(b), your response to this item on any other steps you’ll need to take to get your an attachment page can state: “Te ofer is nonproft corporation of the ground. Our contingent upon the nonproft corporation minutes form assumes that your directors really obtaining its federal tax exemption, at which EJENFFUBOEBQQSPWFEUIFEFDJTJPOTSFìFDUFE time the ofer will be submitted to the board in the minutes. of directors and, upon approval by the board, will be signed by the appropriate ofcers of the Instructions for Preparing Minutes corporation.” Preparing minutes for your frst meeting is ➒ Attach a copy of the prepared fnancial not hard. Use the form included with this statement to the ofer and a copy of an book (Minutes of First Meeting of Board of appraisal, if applicable. Directors) and consult the sample form below If you are submitting this ofer with your BTZPVGPMMPXPVSJOTUSVDUJPOT8FIBWFìBHHFE federal exemption application, make a copy optional resolutions on the sample form and in of the form and all attachments, and submit the instructions. If an optional resolution does these copies with your federal application (see not apply to you, do not include it in your fnal Schedule G, question 6(c)). Place the originals minutes. of these papers in your corporate records book. tɨFQBSFOUIFUJDBMCMBOLT i(______),” in the sample form indicate information that Prepare Minutes of Your First you must complete on the form. t3FQMBDFUIFCMBOLTJOUIFPOMJOFGPSNXJUI Board of Directors’ Meeting the information shown in the blanks in the sample form. Now that you’ve prepared your articles and t&BDIDJSDMFEOVNCFSJOUIFPOMJOFGPSN ➊) bylaws, fled your articles with the secretary refers to an instruction to help you complete of state, and obtained your federal and state an item. tax exemption (and possibly prepared an ➊ Normally, you must follow formal notice ofer to transfer assets of a prior business or rules when holding special meetings (the frst organization to your nonproft corporation), meeting of the board is a special meeting). Tis your next step is to prepare minutes of your Waiver of Notice form allows you to dispense frst board of directors’ meeting. Te purpose with that notice. Fill in this form as indicated, of this meeting is to transact the initial giving the time, date, and place of the meeting. business of the corporation (elect ofcers, Have all the directors sign the form and type fx the legal address of the corporation, and the directors’ names under their signature lines. so on) and to authorize the newly elected It may be signed and dated before the actual ofcers to take actions necessary to get your meeting of the board. nonproft corporation going (such as setting ➋ Tis is the frst page of your minutes form. up bank accounts and admitting members, if Fill in the blanks as indicated, entering the appropriate). Although this meeting sometimes names of directors present and listing those, if is a “paper meeting” (where the directors any, who are absent (a quorum of the board, JOGPSNBMMZBHSFFUPUIFEFDJTJPOTSFìFDUFEJOUIF as specifed in the bylaws, must be shown in minutes without actually sitting down together attendance). Name one of the directors chair- and talking business), we suggest that you take person, and another as secretary of the meeting. this opportunity to meet in person and discuss 238 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Minutes of First Meeting of Board of Directors of (name of corporation) WAIVER OF NOTICE AND CONSENT TO HOLDING ➊ OF FIRST MEETING OF BOARD OF DIRECTORS OF NAME OF CORPORATION

A CALIFORNIA NONPROFIT PUBLIC BENEFIT OR RELIGIOUS CORPORATION We, the undersigned, being all the directors of (name of corporation) , a California nonprofit (public benefit [or] religious) corporation, hereby waive notice of the first meeting of the board of directors of the corporation and consent to the holding of said meeting at (principal place of business) , California, on (date) , ____, at (time) _M., and consent to the transaction of any and all business by the directors at the meeting, including, without limitation, the adoption of bylaws, the election of officers, and the selection of the place where the corporation’s bank account will be maintained. Date: ______

(signatures of director(s) listed in Article FIVE) (typed name) , Director ______, Director ______, Director ______, Director ______, Director CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 239

MINUTES OF FIRST MEETING OF BOARD OF DIRECTORS ➋ OF NAME OF CORPORATION A CALIFORNIA NONPROFIT PUBLIC BENEFIT OR RELIGIOUS CORPORATION Te board of directors of (name of corporation) held its ﬁrst meeting on (date) , ____ at (principal oﬃce address) , California. Written waiver of notice was signed by all of the directors. Te following directors, constituting a quorum of the full board, were present at the meeting: (names of directors present at meeting) ______Tere were absent: (names of absent directors, if any) ______On motion and by unanimous vote, (name of director) was elected temporary chairperson and then presided over the meeting. (name of director) was elected temporary secretary of the meeting.

Te chairperson announced that the meeting was held pursuant to written waiver of notice signed by each of the directors. Upon a motion duly made, seconded, and unanimously carried, the waiver was made a part of the records of the meeting; it now precedes the minutes of this meeting in the corporate records book.

BYLAWS ➌ Tere was then presented to the meeting for adoption a proposed set of bylaws of the corporation. Te bylaws were considered and discussed and, on motion duly made and seconded, it was unanimously:

RESOLVED, that the bylaws presented to this meeting be and hereby are adopted as the bylaws of the corporation;

RESOLVED FURTHER, that the secretary insert a copy of the bylaws in the corporate records book, and see that a copy of the bylaws is kept at the corporation’s principal oﬃce, as required by law. 240 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

FEDERAL AND CALIFORNIA TAX EXEMPTIONS ➍ Te chairperson announced that, upon application previously submitted to the Internal Revenue Service, the corporation was determined to be exempt from payment of federal corporate income taxes as a/n (501(c)(3) tax-exempt classification, e.g., “educational,” “charitable,” “religious,” etc.) organization under Section 501(c)(3) of the Internal Revenue Code per Internal Revenue Service determination letter dated (date of federal determination letter) and, further, that the corporation has been classified as a public charity under Section (IRC section or sections under which the corporation qualifies as a public charity) of the Internal Revenue Code. Te effective date of the organization’s 501(c)(3) tax exemption is (effective date of federal tax exemption). Te chairperson also announced that the California Franchise Tax Board acknowledged the corporation’s federal tax exemption and its classification as exempt from payment of state corporate franchise taxes under Section 23701(d) of the California Revenue and Taxation Code per Franchise Tax Board acknowledgment letter dated (date of state acknowledgment letter). Te effective date of the corporation’s 23701(d) tax exemption is (effective date of state tax exemption). Te chairperson then presented copies of the IRS tax-exemption determination letter and the California Franchise Tax Board acknowledgment letter, and the secretary was instructed to insert these letters in the corporate records book.

ELECTION OF OFFICERS ➎ Te chairperson then announced that the next item of business was the election of officers. Upon motion, the following persons were unanimously elected to the offices shown after their names: (names of officers) President ______Vice President ______Secretary ______Treasurer

COMPENSATION OF OFFICERS ➏ Tere followed a discussion concerning the compensation to be paid by the corporation to its oﬃcers. Upon motion duly made and seconded, it was unanimously: RESOLVED, that the following annual salaries be paid to the oﬃcers of this corporation: President $______Vice President $______Secretary $______Treasurer $______CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 241

CORPORATE SEAL ➐ Te secretary presented to the meeting for adoption a proposed form of seal of the corporation. Upon motion duly made and seconded, it was:

RESOLVED, that the form of corporate seal presented to this meeting be and hereby is adopted as the seal of this corporation, and the secretary of the corporation is directed to place an impression thereof in the space next to this resolution.

(Impress seal here)

PRINCIPAL OFFICE ➑ After discussion as to the exact location of the corporation’s principal oﬃce for the transaction of business in the county named in the bylaws, upon motion duly made and seconded, it was:

RESOLVED, that the principal oﬃce for the transaction of business of the corporation shall be at (street address) , in (city) , California.

BANK ACCOUNT ➒ Upon motion duly made and seconded, it was:

RESOLVED, that the funds of this corporation shall be deposited with (name of bank) .

RESOLVED FURTHER, that the treasurer of this corporation be and hereby is authorized and directed to establish an account with said bank and to deposit the funds of this corporation therein.

RESOLVED FURTHER, that any oﬃcer, employee, or agent of this corporation be and is authorized to endorse checks, drafts, or other evidences of indebtedness made payable to this corporation, but only for the purpose of deposit.

RESOLVED FURTHER, that all checks, drafts, and other instruments obligating this corporation to pay money shall be signed on behalf of this corporation by any (number) of the following: (names of directors, oﬃcers, and/or staﬀ) ______

RESOLVED FURTHER, that said bank be and hereby is authorized to honor and pay all checks and drafts of this corporation signed as provided herein. 242 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

RESOLVED FURTHER, that the authority hereby conferred shall remain in force until revoked by the board of directors of this corporation and until written notice of such revocation shall have been received by said bank.

RESOLVED FURTHER, that the secretary of this corporation be and hereby is authorized to certify as to the continuing authority of these resolutions, the persons authorized to sign on behalf of this corporation, and the adoption of said bank’s standard form of resolution, provided that said form does not vary materially from the terms of the foregoing resolutions.

CORPORATE CERTIFICATES (Optional) ➓ Te secretary then presented to the meeting proposed director, sponsor, membership, or other forms of corporate certiﬁcates for approval by the board. Upon motion duly made and seconded, it was:

RESOLVED, that the form of certiﬁcates presented to this meeting are hereby adopted for use by this corporation and the secretary is directed to attach a copy of each form of certiﬁcate to the minutes of this meeting.

ISSUANCE OF MEMBERSHIPS (Optional) ⓫

Te board next took up the matter of issuance of memberships in the corporation.

Upon motion duly made and seconded, it was unanimously:

RESOLVED, that upon [“making application therefor in writing” (or state other procedure as speciﬁed in the membership provisions in your bylaws)] [“and upon payment of an application fee” (and/or) “ﬁrst annual dues in the amount(s) of $ ,”] members shall be admitted to the corporation and shall be entitled to all rights and privileges and subject to all the obligations, restrictions, and limitations applicable to such membership in the corporation as set forth in the articles of incorporation and by-laws of the corporation and subsequent amendments and changes thereto, and subject to any further limitations as resolved from time to time by the board of directors.

RESOLVED FURTHER, that the secretary of the corporation shall record the name and address of each member in the membership book of the corporation and, upon the termination of any membership in accordance with the termination procedures speciﬁed in the bylaws of the corporation, the secretary shall record the date of termination of such membership in the membership book. CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 243

[RESOLVED FURTHER, that each person admitted to membership in the corporation shall be given a membership certiﬁcate, signed by the president and secretary of the corporation, and the secretary shall record the date of issuance of said certiﬁcate in the corporate membership book.]

ACCEPTANCE OF OFFER TO TRANSFER ASSETS AND ⓬ LIABILITIES OF PREDECESSOR ORGANIZATION (Optional) Upon motion duly made and seconded, it was unanimously: RESOLVED, that the corporation accept the written oﬀer dated ______, ____, to transfer the assets and liabilities of the predecessor organization, (name of predecessor organization) , in accordance with the terms of said oﬀer, a copy of which precedes the minutes of this meeting in the corporate records book.

RESOLVED FURTHER, that the appropriate oﬃcers of this corporation are authorized and directed to take such actions and execute such documents as they deem necessary or appropriate to eﬀect the transfer of said business to this corporation. Since there was no further business to come before the meeting, on motion duly made and seconded, the meeting was adjourned. Dated:______⓭ , Secretary 244 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

➌ Tis resolution shows acceptance of the CAUTION contents of the bylaws by your directors. A majority of the directors of a California ➍ Tis resolution recites the particulars of public beneﬁt corporation cannot be paid your federal and state tax exemptions. Fill in (other than as directors of the corporation). See the blanks as indicated, using information “Directors,” in Chapter 2, for further information contained in your federal tax exemption on this disinterested director rule for public beneﬁt determination letter and Franchise Tax Board corporations. tax exemption acknowledgment letter. Indicate your tax-exempt classifcation with the IRS— Article 9, Section 5, of the bylaws included for example, educational, religious, charitable— with this book contains compensation approval and the date of your federal determination procedures that help your nonproft meet the letter. Ten show the code section or sections excess beneft avoidance rules under federal tax under which you have obtained federal public law (see “Limitation on Profts and Benefts,” charity status, as shown in your IRS exemption in Chapter 3, for more on these rules). Tese letter (for example, “a publicly supported bylaw provisions require disinterested members organization of the type described in Section of your board or a com mittee of the board 509(a)(2)”). Next, insert the efective date of (such as a compensation committee) to approve your federal tax exemption. ofcer salaries, after obtaining comparable Fill in the remaining blanks to show the date fgures for compensation paid to similar ofcers of your letter from the Franchise Tax Board in similar organizations. A safe harbor rule at acknowledging your federal tax exemption and the end of Article 9, Section 5c, allows smaller recognizing your state tax exemption under nonprofts to approve ofcer salaries if they Section 23701(d) of the California Revenue and have comparability data from three similar Taxation Code. Finally, show the efective date organizations showing that their ofcer salary of your state tax exemption, which should be levels are comparable to those organizations. the same as the efective date of your federal tax Complying with this bylaw provision also exemption. should help you meet the special requirements ➎ Type the names of the persons you elect under the California Nonproft Integrity Act of as ofcers of your corporation. Remember, 2004 for approving salaries paid to your chief directors may be ofcers and any one person executive ofcer (president) and chief fnancial may hold more than one ofcer position with ofcer (treasurer). (See “Compensation of the exception that the person(s) who serve(s) as Ofcers,” in Chapter 2.) the secretary and/or treasurer cannot also serve If you fll in any of the ofcer salaries in this as the president (or chairperson of the board). resolution, we suggest you add a paragraph to ➏ If you decide to provide for ofcers’ the resolution stating that you approved the salaries, indicate each ofcer’s salary in the salaries in compliance with Article 9, Section 5, blanks in this resolution. Of course, you of your bylaws, and that you docu ment each of may decide to omit one or more ofcer the applicable facts or items listed in Article 9, salaries here—if so, simply type a zero in the Section 5d, of the bylaws. For example, appropriate blank. your additional language should include the following information: CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 245

tUIFOBNFPGUIFCPBSEDPNNJUUFFUIBU director, or sponsor certifcates from a legal approved the salary and the members of the stationer), include this page in your minutes. committee. Tis listing should show that Attach to your printed minutes a sample of any only disinterested (unpaid) members voted certifcates you plan to issue. for ofcer compensation ⓫ Tis resolution is for membership corpo- tUIFOBNFTBOEWPUFTPGFBDICPBSEPS rations, that must include it. State your committee member procedure for admitting members in the frst tUIFDPNQBSBCJMJUZEBUBUIBUKVTUJëFEUIF bracketed phrase, according to the membership approval of the salary. Attach any written provisions in your bylaws. If you have provided data to the minutes. Te data should for application fees and/or annual dues in show specifc salary levels paid by other your bylaws, use the second bracketed phrase organizations in your geographical and to describe the amount of such fees and/ program area for similar ofcer positions, and or dues provided for in your bylaws. If your tUIFTLJMMT FYQFSJFODF FEVDBUJPO BOEPUIFS membership corporation has no qualifcation qualifcations of all the ofcers that help requirements, annual fees, or dues, you can KVTUJGZFBDITBMBSZBTSFBTPOBCMF TJNQMZDSPTTPVUUIFXPSEiVQPOwKVTUCFGPSFUIF ➐ If you’ve ordered a corporate seal, impress blank and leave the blank empty without flling your corporate seal in the space indicated on in the blanks, or retype this paragraph to read: the printed form. “RESOLVED that members shall be admitted ➑ So far, your formal documents have to the corporation and shall be entitled to indicated only the county of the principal BMMSJHIUTBOEQSJWJMFHFTBOETVCKFDUUPBMMUIF place of business of your corporation. Here you obligations…” If you plan to issue membership should provide the street address and city of certifcates, add the bracketed paragraph shown this ofce. Do not use a post ofce box. on the sample form at the end of the resolution. ➒ It is important to keep corporate funds ⓬ Tis is an optional resolution. If you separate from any personal funds by depositing have incorporated a preexisting proft-making corporate funds into, and writing corporate business or other organization and have checks out of, at least one corporate checking prepared an Ofer to Transfer Assets, include account. List the bank and branch ofce where this resolution in your fnal minutes, indicating you will maintain corporate accounts. In the the date of the ofer and the name of the ffth paragraph, say how many people must predecessor business or organization. cosign corporate checks, giving the names ⓭ After printing your minutes, your secretary of individuals allowed to cosign checks on should date and sign the form at the bottom of the lines below this paragraph. As a minimal the last page. measure of fscal control, specify the signature of two persons here. Many nonprofts list the Place Your Minutes and Attachments president and treasurer, or the names of other in a Corporate Records Book supervisory ofcers who can be trusted with You are now through preparing your minutes. check-writing authority. Place your minutes and all attachments in your ➓ Tis is an optional resolution for member- corporate records book. Your attachments may ship nonprofts. If you plan to use the tear- include the following forms or documents: out membership certifcates included with this book (or if you will order membership, 246 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tXBJWFSPGOPUJDFBOEDPOTFOUUPIPMEJOHPG selling inventory from stock (such as a retail the frst meeting or wholesale business, including a business tXSJUUFOPêFS ëMMJOUIFCMBOLTBUUIFFOE that manufactures what it sells). of the form and have your nonproft corpo- t:PVBSFUSBOTGFSSJOHNPSFUIBOIBMGUIF ration president and secretary sign the ofer) value of the old business’s inventory and tDFSUJëFEDPQZPGZPVSBSUJDMFT equipment to your new corporation. tDPQZPGZPVSCZMBXT DFSUJëFECZUIF tɨFWBMVFPGUIFCVTJOFTTBTTFUTCFJOHUSBOT secretary of the corporation ferred is $10,000 or more (an exemption tGFEFSBMUBYFYFNQUJPOEFUFSNJOBUJPOMFUUFS from the provisions of the bulk sales law and state exemption acknowledgment also applies if the value of the assets being letter, and transferred is more than $5 million). tDPQZPGBOZNFNCFSTIJQ EJSFDUPS BOEPS If, as is true for most nonprofts, these three sponsor certifcate that you plan to issue, conditions do not apply to your incorporation, certifcate marked as a “Sample.” you can skip the rest of this section. For those To certify your bylaws, have the corporate of you who do, however, meet the test, take secretary date and sign the certifcate section at heart. Even if you are incorporating the type the end of all copies of your bylaws. of business covered by this law, you may still Remember, you should continue to place be eligible for an exemption from most of the an original or copy of all formal corporate provisions of this law if your corporation: documents in your corporate records book tBTTVNFTUIFEFCUTPGUIFVOJODPSQPSBUFE and keep this book at your principal ofce. business For example, if you have prepared or ordered tJTOPUJOTPMWFOUBGUFSUIFBTTVNQUJPOPG membership certifcates, place any unissued these debts, and certifcates in the membership certifcate tQVCMJTIFTBOEëMFTBOPUJDFUPDSFEJUPST section of your records book. within 30 days of the transfer of assets. To comply with this exemption, call a local legal newspaper. Te paper should be able to Complying With the send you the proper form (see “Notify Others Bulk Sales Law of Your Incorporation,” below) to prepare and will publish and fle this form with the A few nonprofts that have incorporated county recorder’s and tax collector’s ofces for a existing businesses may have to comply with small fee. California’s Bulk Sales Law (Division 6 of the Tere are various notice forms that ft California Commercial Code, starting with specifc provisions of the bulk sales law. To Section 6101). You might have to comply, for rely on the exemption above, prepare and example, if you have taken a preexisting retail have the newspaper publish and fle a Notice or wholesale business, such as a charitable thrift to Creditors under Section 6013(c)(10) of the shop, and incorporated it to obtain nonproft California Commercial Code. Tis notice will corporate status. But compliance is required usually include a heading indicating that it only if all of the following are true: is a Bulk Sale and Assumption form. In any tɨFCVTJOFTTCFJOHJODPSQPSBUFEJTBSFTUBV case, it must include a clause stating that the rant or one whose principal business is buyer has assumed or will assume in full the CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 247

debts that were incurred in the seller’s business appropriate, include the language that states before the date of the bulk sale (you may see that this amount represents the fair market slightly diferent wording, but the sense should value of the business or organization (if the be the same). BTTFUTXFSFEPOBUFE ZPVXJMMKVTUTIPXBT For other exemptions from the Bulk Sales the amount of payment without the statement Law, see Division 6 of the California Com- concerning fair market value). mercial Code. ➋ Include this second bracketed phrase (instead of the frst bracketed phrase referred to above) if the business or organization will Prepare a Bill of Sale for Assets be transferred in return for a promissory note. If you have incorporated a preexisting business A sample promissory note is shown below. You or organization, you may want to prepare a bill may need to modify its terms to conform to of sale to formally transfer the assets for the the terms contained in your ofer. In all cases, organization to the nonproft corporation. Tis your note should state the date and place of its should be done according to the terms of the execution, the due date, amount to be paid, and written ofer, if you prepared one in “Prepare rate of interest, if any. ➌ Ofer to Transfer Assets From an Existing Attach an inventory to the ofer, showing Business or Organization to Your Nonproft.” all tangible assets of the business—this can be It should have been accepted by the board at copied from the schedule of assets and liabilities the frst meeting and signed by the ofcers on you’ve attached to your written ofer. Add, in behalf of the corporation after the meeting. the blank provided, any nontransferred assets Before using this bill of sale, see the caution according to the terms of your ofer. ➍ relating to tax consequences in “Transfers From Include this paragraph if the corporation a For-Proft Business,” earlier in this chapter. will assume liabilities of the prior business or Prepare the bill of sale by completing the form organization, noting any exceptions. ➎ that is included with this book, following the Include this paragraph if the business’s sample form and special instructions below. or organization’s accounts receivable will be tɨFQBSFOUIFUJDBMCMBOLT i(______),” in transferred to the corporation, indicating any the sample form below indicate information exceptions. ➏ that you must complete on the online form. Fill in the bottom portion of the bill t0QUJPOBMJOGPSNBUJPOJTFODMPTFE of sale and print the form. Have the form in brackets, for example, “[optional signed by the prior business owners or the information].” authorized manager(s) or ofcer(s) of the t3FQMBDFUIFCMBOLTJOUIFPOMJOFGPSNXJUI prior organization (the “trans ferors”) and the the information indicated in the blanks in president and secretary of the corporation. the sample form below. Place the completed form, together with the t&BDIDJSDMFEOVNCFSJOUIFTBNQMFGPSN attachments (inventory and promissory note), in refers to a special instruction that will help your corporate records book. Give copies to the you complete an item. prior business owners or representatives of the ➊ Include this frst bracketed phrase if your prior nonproft organization. Te business or written ofer specifed an amount of money to organization is now ofcially transferred. be paid upon the transfer of the business. If 248 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Bill of Sale

Tis is an agreement by (names of prior business owners) , herein called “transferor(s),” and (name of corporation) , herein called “the corporation.” 1. In return for [“payment of $______which represents the fair market value of the business transferred” (or state other amount to be paid per the terms of the written oﬀer)] ➊ (or) [“execution of a promissory note in the principal amount of $______, with the terms as contained in said note, a copy of which is attached to this agreement”] ➋ by (name of corporation) , a California nonproﬁt corporation, I [we] hereby sell, assign, and transfer to the corporation all my [our] right, title, and interest in the following property: All the tangible assets listed on the inventory attached to this bill of sale, and all stock in trade, trade, goodwill, leasehold interests, trade names, and other intangible assets [“except … (show nontransferred assets) of (name of prior business) , located at (street address) , (city) , (county) , California”]. ➌ 2. [In return for the transfer of the above property to it, the corporation hereby agrees to assume, pay, and discharge all debts, duties, and obligations that appear on the date of this agreement, on the books and owed on account of said business [“except … (list any unassumed debts or liabilities) ”]. Te corporation agrees to indemnify and hold the transferor(s) of said business and their property free from any liability for any such debt, duty, or obligation and from any suits, actions, or legal proceedings brought to enforce or collect any such debt, duty, or obligation.] ➍ 3. [Te transferor(s) hereby appoint(s) the corporation as his (her, their) representative to demand, receive, and collect for itself, all debts and obligations now owing to said business [“except (list any exceptions) ”]. Te transferor(s) further authorize(s) the corporation to do all things allowed by law to recover and collect such debts and obligations and to use the transferor’s(s’) name(s) in such manner as it considers necessary for the collection and recovery of such debts and obligations, provided, however, without cost, expense, or damage to the transferor(s). ] ➎ Dated:______, ______➏ , Transferor ______, Transferor (name of corporation) By: ______, President ______, Secretary CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 249

Promissory Note For value received, the undersigned California nonprofit corporation promises to pay to (names of prior business owners or name of prior unincorporated nonprofit association) the principal amount of $______, together with interest at the rate of __% per annum with a total amount due under this note of $ (principal + interest) , to be paid in full by (due date) , with payment to be made in (number) equal monthly installments of $_____ each payable on the ____ day of each month, with the first installment being due on (date) [or state other provisions per the terms of the written Offer regarding rate of interest, if any, due date, and manner of payment]. Executed this _____ day of ______, ____, at ______, ______, County of ______, California. (name of corporation)

By: ______, President ______, Secretary

Prepare Assignments If you prepare an assignment, the terms of the lease itself will normally require you to of Leases and Deeds get the landlord’s consent. It is particularly If you have transferred a prior business or important to communicate with the landlord organization to your corporation, the prior if the nonproft corporation expects to obtain owners or nonproft organization may want to an exemption from local real property taxes on prepare assignments of leases or deeds if they the leased premises from the county tax assessor are transferring real property interests to the (see “Apply for Your Property Tax Exemption,” corporation. Under an assignment, you step below). Nonproft groups that obtain the into the shoes of the old tenant—the terms and exemption will want a clause in their new lease conditions of the lease don’t change. that gives them a credit against rent payments for the amount of any decrease in the landlord’s TIP property tax bill. A real estate broker can help you obtain and To avoid going through a reassignment, prepare forms to transfer property in which the ask the landlord to terminate the old lease and renegotiate a new lease between the landlord and prior owners have an ownership interest. If a your new corporation. Use this approach if you mortgage or deed of trust is involved, you may think you can hammer out a better deal than the old well need the permission of the lender, too. lease gave the old tenants. 250 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

File Final Papers for the the U.S. Post Ofce. Tis permit entitles you to lower rates on mailings, an important Prior Organization advantage for many groups since the nonproft If you have incorporated a prior business or rate is considerably lower than the regular other organization, you may need to fle fnal third-class rate. sales tax and other returns for the preexisting To obtain your permit, bring to your local or organization. You will also want to cancel any main post ofce branch: permits or licenses issued to the prior business or tBëMFTUBNQFEPSDFSUJëFEDPQZPGZPVS its principals. If you need new licenses, get them articles in the name of the new nonproft corporation. tBDPQZPGZPVSCZMBXT tBDPQZPGZPVSGFEFSBMBOETUBUFUBY exemption determination letters, and Notify Others of Your tDPQJFTPGQSPHSBNMJUFSBUVSF OFXTMFUUFST Incorporation bulletins, and any other promotional materials. If a preexisting group has been incorporated, Te post ofce clerk will ask you to fll out a notify creditors and other interested parties, in short application and take your papers. If your writing, of the termination and dissolution of local post ofce branch doesn’t handle this, the prior organization and its transfer to the the clerk will send you to a classifcations ofce new corporation. Tis is advisable as a legal at the main post ofce. You’ll pay a one-time precaution and as a courtesy to those who have fee and an annual permit fee. Te clerk will dealt with the prior organization. forward your papers to the classifcation ofce To notify past creditors, suppliers, organi- at the regional post ofce for a determination. zations, and businesses of your incorporation, In a week or so, you will receive notice of the send a friendly letter that shows the date of your post ofce’s determination. incorporation, your corporate name, and its You can download the application, Form principal ofce address. Make a copy of each 3624, online from www.usps.com. Fill it in letter and put it in your corporate records book. and prepare the supporting documentation If the prior group was organized as a partner- before you go to the post ofce (district ofces ship, have a local legal newspaper publish a Notice that handle the mailing permit applications are of Dissolution of Partnership in the county where listed online at the USPS website). the partnership ofce or property was located. Once you have your permit, you can mail Ten fle the form with the local county clerk’s letters and parcels at the reduced rate by ofce according to the instructions on the form, afxing stamps to your mail; by taking the or pay the newspaper to fle it for you. mail to your post ofce and flling out a special mailing form; or by using the simpler methods of either stamping your mail with an imprint Apply for a Mailing Permit stamp (made by a stampmaker) or leasing Most 501(c)(3) tax-exempt nonproft corpo- a mail-stamping machine that shows your rations will qualify for and want to obtain imprint information. Ask the classifcations a third-class nonproft mailing permit from clerk for further information. CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 251

Apply for Your Property acquire during the fscal year after you submit the copies of your state and federal exemption Tax Exemption letters to complete your welfare exemption As a nonproft corporation, you can obtain an application information. exemption from local (county) property taxes In your application, explain how far along you on the corporation’s personal and real property, are in your incorporation process. For example, whether it’s owned or leased. Reread “California you might write, “nonproft corporation, pre- Welfare Exemption,” in Chapter 5, which explains par ing to apply for federal and state corporate the welfare exemption, before deciding whether tax exemp tions”; or “proposed nonproft corpo- to apply for it. Most groups that meet the ration to be exempt from corporate taxation requirements will want it. under Section 23701(d) of the California Reve- If you lease from an organization that, itself, nue and Taxation Code and Section 501(c)(3) of is exempt under the welfare exemption, you the Internal Revenue Code” in the appro priate should prepare and submit the application to blanks. Answer the questions on the appli cation be exempt from personal property taxes and and provide attachments as best you can (for to reduce your rent payments to your landlord instance, you can attach fled or unfled articles once you qualify for a real property tax or proposed fnancial statements). Note on the exemption on the portion of the premises that form that you will supply addi tional appropriate you rent (you should agree with your landlord documents (such as fled articles, exemption to reduce your rent once you qualify for the letters, fnancial data, and descriptions of real welfare exemption on the leased premises). Both and/or personal property) during the fscal year, the nonproft tenant and the nonproft owner when available. of the property must apply for and obtain the If you are seeking an exemption for real welfare exemption to qualify for a real property property owned by the nonproft corporation, welfare tax exemption on the leased premises. the grant deed for the property should be fled in the county recorder’s ofce before March 1 Timing Your Application (15 days before you fle your claim). If you are seeking an exemption on leased property, your You need not have your federal and state tax lease or assignment of lease should be dated exemption to apply for the welfare exemption. before March 1. Even if you have not yet fled your articles with the secretary of state (but are sure that you will Applying for an Exemption do so), go ahead and fle if the February 15 property tax assessment deadline is approaching. Applying for the welfare exemption isn’t It’s a good idea to fle for this exemption early, difcult. Follow these steps: before you’ve even obtained your state and t(PPOMJOFUPUIF#PBSEPG&RVBMJ[BUJPO federal tax exemptions. When you do become website at www.boe.ca.gov or call the a tax-exempt nonproft corporation, you will be local county assessor’s ofce and request a able to obtain a complete, partial, or prorated welfare exemption claim form. If you go refund on any applicable real or personal online, type “boe-267” in the site search property taxes associated with real property box to locate the downloadable form. you buy or rent or personal property you A list of county assessors with contact information is provided on the State Board 252 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

of Equal ization’s website at www.boe.ca.gov/ Te assessor will go out and inspect your proptaxes/assessors.htm. When you contact property, to determine if the uses to which it is the county assessor, ask for the welfare being put meet the requirements of the welfare exemption form for frst-time flers, Form exemption. Te inspector will prepare a feld BOE-267, Welfare Exemption (First Filing). inspection report and send it, together with Complete the claim form, using the one copy of your claim and attachments, to accompanying instruction sheet. Fill in all of the State Board of Equalization in Sacramento. the blanks on the form. If a particular item Te Board will review the documents and doesn’t apply, mark it as “Not Applicable.” make a decision, sending a copy of the decision t"TTFNCMFDPQJFTPGZPVSDFSUJëFEBSUJDMFT to you and one copy to the local assessor. If federal and state exemption letters (if you you’ve been granted the exemption, the local have obtained them), and the requested assessment roll will be updated and a tax “bill” fnancial statements. Tese statements showing your exemption will be sent to you. If are your operating statement and balance you are renting, the updated tax bill will go to sheet—you should be able to use the your landlord. fnancial information submitted with your federal exemption application. Include any TIP other appropriate attachments (such as a Religious corporations may be able to copy of a lease). avail themselves of the streamlined application t"TTFNCMFBMMUIFQBQFSTUPHFUIFSUIF and renewal procedures of the religious exemption completed claim form and all documents. under Section 207 of the Revenue and Taxation Tey do not need to be stapled or fastened Code—call your local county tax assessor’s oﬃce together. Make two copies of all the papers. (Exemption Division) or go online to the Board of t'JMFUXP EVQMJDBUF TFUTPGZPVSDMBJNGPSN Equalization website for more information. and attachments with the county assessor. Keep one copy to place in your corporate RESOURCE records book. File your papers before February 15 of the fscal year for which you For more information on the welfare exemption and how to apply for it, consult the are seeking the exemption (the property Assessors’ Handbook—Welfare Exemption, publi- tax fscal year goes from July 1 to June 30). cation number AH-267, a pamphlet for local tax If you submit it after this date and before assessors written by the Board of Equalization. January 1 of the following year, you will Te handbook is included on Nolo’s website (see only be allowed a 90% exemption if your Appendix A for the link). If you want to check if a claim is approved. If you fle even later newer edition has come out since the publication than this during the fscal year, you will be of this book, go to the California State Board of allowed an 85% exemption, except that the Equalization website at www.boe.ca.gov and search maximum amount in taxes you will have to for the “Assessors’ Handbook,” then select “AH-267- pay is $250. Welfare, Church and Religious Exemptions.” CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 253

File a Domestic Some California nonproft corporations, however, are exempt from registration and Corporation Statement reporting requirements—these include Shortly after you fle your articles of incor- California religious nonproft corporations and poration, you will receive a Statement of Infor- California public beneft nonprofts organized mation for a Domestic Nonproft Corporation as hospitals or schools. All other 501(c)(3) (Form SI-100) from the secretary of state’s California nonproft corporations must fle an ofce. Tis form requests basic organizational initial and annual reports with the Attorney information (which will be a matter of public General’s Charitable Trusts Section. When a record and can be obtained by anyone for public beneft corporation fles its articles, the a small fee), including the address of your secretary of state forwards a copy of the articles principal ofce, the names and addresses of to the attorney general. Te attorney general your ofcers, and your agent for service of will send nonexempt groups an initial report process. (Your initial agent is designated in form (Form CT-1) to complete and fle, and your articles of incorporation and is the person an annual reporting form (RRF-1) to complete authorized to receive legal documents on behalf and fle for the second and subsequent years of of your corporation.) Tis form must be flled the corporation. For more information on fling out and sent back to the secretary of state initial and annual reports, see “Attorney General within 90 days of the date your articles are Annual Periodic Report,” in Chapter 10. fled. You may want to retain some anonymity As noted above, in addition to religious for your ofcers by listing the principal ofce of groups, the following types of 501(c)(3) non- the corporation as their business address. profts should be exempt from initial and Every two years, the secretary of state will send annual reporting with the attorney general. If you a new statement to prepare and fle. Failure you think you ft in one of these categories but to fle this statement when required can result in have received a CT-1 form, call the attorney penalties and can, eventually, lead to suspension general’s ofce in Sacramento to see if you can of corporate powers by the secretary of state. establish your attorney general exemption. Te California Secretary of State’s website tSchools. Educational organizations set up allows you to fll in and fle the domestic corpo- as formal schools with the institutional ration statement online from your browser—if attributes (such as a regular faculty and you use this online form preparation and fling curriculum, enrolled body of students, method, you do not need to mail in your initial and established place of instruction) don’t or biennial statements. Go to the state site to have to fle form CT-1 with the attorney prepare and fle this form online. general. Notice that this defnition is more restrictive than the one used for qualifying for your federal tax exemption, and is File an Initial Report With basically the same as that which applies to the Attorney General schools for purposes of obtaining public charity status. Most California public beneft corporations tHospitals. Te attorney general has a must register by fling an initial report and restrictive defnition of hospitals. In thereafter fle annual reports with the California addition to being the kind of charitable Attorney General, Charitable Trusts Section. hospital that made it eligible for the federal 254 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tax exemption and public charity status, If you have ordered membership materials as the hospital must be operated on a 24-hour- part of a corporate kit, record each member’s a-day basis and have a round-the-clock name and address, together with the number of medical staf. Day or outpatient clinics or the certifcate, in the membership roll in your those that don’t have licensed practitioners corporate records book. regularly working at the clinic will not, in If you are using the tear-out membership most cases, qualify for the exemption. certifcate included in Appendix B, complete each certifcate by typing the number of the RESOURCE certifcate, the name of the corporation, and the Te California Attorney General’s Guide for name of the member on the certifcate. Ten Charities is a helpful guide for California nonprofits, execute the certifcate by flling in the date and as well as a source of information on the attorney having the president and secretary sign at the general’s reporting and filing requirements. It bottom (if you have a seal, impress it at the also contains excellent summaries of the legal bottom of each certifcate). Give the certifcate responsibilities and liabilities of nonprofit directors to the member, then record the member’s name, under California law, as well as practical information address, certifcate number, and date of issuance on fundraising, fiscal management, and other on a separate page in your corporate records important nonprofit issues. We recommend all book. Te information on these pages, kept California nonprofits obtain a copy of this valuable in the corporate records book, constitutes the sourcebook. Tis guide is available for viewing and membership book of the corporation. downloading from the Attorney General’s Division of Charitable Trusts website, located at http://oag. ca.gov/charities/publications. Te site also contains other informative publications of the Attorney File Your Articles With General’s Office, including the Attorney General’s the County Recorder Guide to Charitable Solicitations plus the initial (CT-1) and ongoing (RRF-1) registration and reporting forms 6OJODPSQPSBUFEBTTPDJBUJPOTUIBUIBWFKVTU required to be filed with the Attorney General’s incorporated (see “Preparing Articles for an office. Te guide is also available on the Nolo website. Unincorporated Association,” in Chapter 6) and that owned real property prior to incorporating should fle a certifed copy of their articles of incorporation with the county Issue Membership Certificates recorder of the county or counties in which If you have set up a membership corporation the previous unincorporated association owned and have membership certifcates, you will property. Tis will show legal ownership by the want to issue them to members after they have new nonproft corporation of the preexisting applied for membership in the corporation unincorporated association’s real property. and paid any fees required by the membership When fling these copies of your articles, send provisions in your bylaws. Te corporate presi- the county recorder two copies, together with dent and secretary should sign each certifcate the required fee. Request that one copy be fle- before giving it to the member. stamped by the county recorder and returned to you. Place this copy in the articles section of your corporate records book. CHAPTER 9 | FINAL STEPS IN ORGANIZING YOUR NONPROFIT | 255

Register With the Fair Political Check State and Local Solicitation Practices Commission Requirements If your nonproft corporation plans to lobby If you plan to solicit contributions directly for legislation, hire a lobbyist, or otherwise be (by mail, the Internet, or door-to-door) or politically active (for example, by supporting through paid fundraisers or consultants, make or opposing state, county, or city measures to sure your organization and the people it hires be voted on by the public), you must comply comply with state and local solicitation laws, with registration and reporting requirements regulations, and ordinances. For tips on how for lobbying activity administered by the to learn about state laws that may apply to California Fair Political Practices Commission. your organization and its fundraisers and Go online to www.fppc.ca.gov or call the consultants, see “State Solicitation Laws and ofce in Sacramento for further information Requirements,” in Chapter 5. if you think these registration and reporting requirements apply to the activities of your ● nonproft corporation. (Read Lobbying Disclosure Infor mation Manual online or call the California Fair Political Pratices Commission to request a copy.)

CHAPTER

After Your Corporation Is Organized 10

Piercing the Corporate Veil—If You Want to Be Treated Like a Corporation, It’s Best to Act Like One ...... 258 Federal Corporate Tax Returns ...... 259 Public Charities: Annual Exempt Organization Return ...... 259 Private Foundations: Annual Exempt Organization Return ...... 260 Unrelated Business Income: Annual Exempt Organization Tax Return ...... 261 California Corporate Tax Returns and Reports ...... 261 Public Charities: Annual Exempt Organization Return ...... 261 Private Foundations: Annual Exempt Organization Return ...... 262 Unrelated Business Income Tax Return and Quarterly Estimated Tax Payments...... 262 Attorney General Annual Periodic Report ...... 263 Public Beneﬁt Corporations’ Annual Corporate Report ...... 263 Federal and State Corporate Employment Taxes ...... 263 Federal Employment Taxes and Forms ...... 264 State Employment Taxes and Forms ...... 265 Sales Tax Forms and Exemption From Sales Tax ...... 266 Sales Tax ...... 267 Groups Exempt From Collecting and Submitting Sales Tax ...... 267 Licenses and Permits ...... 268 Workers’ Compensation ...... 269 Private Insurance Coverage ...... 269 Dissolving a Nonproﬁt Corporation...... 269 Voluntary Dissolution ...... 269 Involuntary Dissolution ...... 270 Religious Corporations ...... 271 Winding Up Corporate Business and Distribution of Assets ...... 271 258 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

ou have now incorporated your non- insulates the people behind the corporation proft and have handled many initial from taxes and lawsuits. Y organizational details. But before you Courts and the IRS do, on occasion, scruti- DMPTFUIJTCPPL SFBEKVTUBMJUUMFNPSF"GUFS nize the organization and operation of a incorporating, you need to become familiar corpo ration, particularly if it is directed and with the formalities of corporate life, such as operated by a small number of people who fling tax returns, paying employment taxes, wear more than one hat (such as those who fll and preparing minutes of formal corporate both director and ofcer positions). If you don’t meetings. In this chapter, we look at some tax take care to treat your corporation as a separate and other routine flings required by federal, legal entity, a court may decide to disregard the state, and local governmental agencies. At the corporation and hold the principals (directors end, we give you an overview of what’s involved and ofcers) personally liable for corporate in dissolving a nonproft corporation. debts. Tis might happen if the corporation Te information presented here won’t tell you doesn’t have adequate money to start with, everything you will need to know about these making it likely that creditors or people who TVCKFDUT CVUXJMMQSPWJEFTPNFPGUIFCBTJDTBOE have claims against the corporation won’t be JOEJDBUFTPNFPGUIFNBKPSBSFBTUIBUZPV PSZPVS able to be paid; if corporate and personal funds tax adviser) will need to go over in more detail. are commingled; if the corporation doesn’t keep adequate corporate records (such as minutes of meetings); or generally doesn’t pay much Piercing the Corporate attention to the theory and practice of corporate Veil—If You Want to Be life. Also, the IRS may assess taxes and penalties personally against those connected Treated Like a Corporation, with managing the afairs of the corporation if It’s Best to Act Like One it concludes that the corporation is not a valid MFHBMPSUBYFOUJUZ*OMFHBMKBSHPO IPMEJOH After you’ve set up a corporation of any kind, individuals responsible for corporate deeds or your organization should act like one. Although misdeeds is called “piercing the corporate veil.” fling your articles of incorporation with the To avoid problems of this type, be careful secretary of state brings the corporation into to operate your corporation as a separate legal existence as a legal entity, this is not enough entity. Hold regular and special meetings of to ensure that a court or the IRS will treat your board and membership as required by your your organization as a corporation. What we bylaws and as necessary to take formal corporate are referring to here is not simply maintaining action. It is critical that you docu ment formal your various tax exemptions or even your corporate meetings with neat and thorough nonproft status with the state—we are talking minutes. Also, it is wise to have enough money about being treated as a valid corporate entity in your corporate account to pay foreseeable in court and for tax purposes. Remember, it debts and liabilities that may arise in the course is your legal corporate status that allows your of carrying out your activities—even nonprofts organization to be treated as an entity apart should start with a small cash reserve. Above all, from its directors, ofcers, and employees and keep corporate funds separate from the personal allows it to be taxed (or not taxed), sue, or be funds of the individuals who manage or work for sued, on its own. It is the corporate entity that the corporation. CHAPTER 10 | AFTER YOUR CORPORATION IS ORGANIZED | 259

Federal Corporate See the instructions to these 990 forms on the IRS website, www.irs.gov, for more Tax Returns information. Section 501(c)(3) public charities *OUIJTTFDUJPO XFMJTUBOECSJFìZEJTDVTTUIF that fle Form 990 or 990-EZ must also main IRS tax paperwork you can expect to face complete and submit Form 990, Schedule A as a 501(c)(3) nonproft corporation. (with additional schedules if required), to their Your 990 and 990-T (unrelated business return. Tis form is used to test whether the income return) forms must be made available publicly supported charity meets the applicable for public inspection (see the IRS website at support test for the year (see Chapter 4). www.irs.gov for more information). CAUTION CAUTION Watch out for short deadlines. Your first IRS forms, instructions, fees, and 990 return deadline may come up on you sooner penalties are subject to constant change. Make sure than you expect if your first tax year is a short to get the most current information (on return dead- year—a tax year of less than 12 months. lines, tax rates, penalties, and so on) when you file. You can download the federal tax forms discussed in EXAMPLE: If your accounting period as this section from the IRS website, at www.irs.gov. Go specifed in your bylaws runs from January 1 to “Forms & Pubs” on the IRS website, then “Current to December 31 and your articles were fled Forms & Pubs,” and type in the form number. on December 1, your frst tax year consists of one month, from December 1 to December 31. In this situation, your frst Form 990 Public Charities: Annual would have to be fled within four and a half Exempt Organization Return months of December 31 (by May 15 of the following year), only fve and a half months Nonproft corporations exempt from federal after your articles were fled. It is likely corporate income tax under Section 501(c)(3) that your federal tax exemption application and treated or classifed as public charities must would still be pending at this time. fle IRS Form 990, Return of Organization Exempt From Income Tax (together with Form Your federal exemption determination letter 990, Schedule A). Te fling deadline is on or should state whether you must fle Form 990. before the 15th day of the ffth month (within If your nonproft corporation makes the four and a half months) following the close of political expenditures election by fling Federal their accounting period (tax year). You should Election Form 5768 (discussed in “Limitation fle this even if your 1023 federal application for on Political Activities,” in Chapter 3), indicate exemption is still pending. on Form 990, Schedule A, that you made Depending on their annual gross receipts this election and fll in the appropriate part and total assets, some groups may be eligible of the schedule showing your actual lobbying to fle a simplifed IRS Form 990-EZ or a expenditures during the year. 990-N (postcard) instead of Form 990. Also, some types of nonprofts, such as churches, are exempt from annual 990 fling requirements. 260 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

TIP Te foundation manager(s) must publish 990 returns as financial disclosure. Most a notice telling the public that they may see California public benefit corporations must report the annual report. Do so in a local county annually to the California Attorney General. A copy newspaper before the fling deadline for the of the nonprofit’s federal Form 990 must be included 990-PF. Te notice must state that the annual with the attorney general annual report form. report is available for public inspection, at the principal ofce of the corporation, within 180 days after the publication of the inspection CAUTION notice. A copy of the published notice must be IRS e-Postcard, Form 990-N, annual filing attached to the 990-PF. require ment for small nonprofits. Small tax-exempt organizations that are not required to file 990 returns File Your Returns on Time with the IRS are required to file an annual electronic notice with the IRS—Form 990-N, Electronic Notice Te IRS and the state are notoriously efficient (e-Postcard) for Tax-Exempt Organizations not in assessing and collecting late filing and other Required To File Form 990 or 990-EZ. Organizations penalties. So, while it’s generally true that your that do not file the e-Postcard or an information nonprofit corporation does not have to worry return Form 990 or 990-EZ for three consecutive about paying taxes, you should worry a bit years will have their tax-exempt status revoked. about filing your annual information returns on time (including your employment tax returns For more information and to fle a 990-N and payments). Too many nonprofit corpo- online, go to the IRS website (type “990-N” in rations have had to liquidate when forced to the search box). pay late filing penalties for a few years’ worth of Private Foundations: Annual simple informational returns that they inadver- tently forgot to file. Exempt Organization Return Another important aspect of late filing Very few 501(c)(3) nonprofts will be classifed penalties and delinquent employment taxes is as private foundations. If you are one, however, that the IRS (and state) can, and often do, try you must fle a Return of Private Foundation, to collect these often substantial amounts from Form 990-PF, within four and one-half months individuals associated with the corporation if of the close of your tax year. You fle this Form the corporation doesn’t have sufficient cash to 990-PF instead of Form 990, discussed above. pay them. Remember, one of the exceptions You’ll provide information on receipts and to the concept of limited liability is liability expenditures, assets and liabilities, and other for unpaid taxes and tax penalties. Te IRS information that will help the IRS determine and state can go after the person (or persons) whether you are liable for private foundation associated with the corporation who are excise taxes. You should receive the form and determined to be responsible for reporting and/ separate instructions for completing it close or paying taxes. to the end of your accounting period. Again, watch out for a short frst year and an early deadline for fling your Form 990-PF. CHAPTER 10 | AFTER YOUR CORPORATION IS ORGANIZED | 261

year from an unrelated trade or business More Information on Taxes must fle an Exempt Organization Business We suggest all nonprofits obtain IRS Publication Income Tax Return (Form 990-T). Te form 509, Tax Calendars, prior to the beginning of is due within two and a half months after the each year. Tis pamphlet contains tax calendars close of their tax year. For a defnition and showing the dates for corporate and employer discussion of unrelated trades and businesses, filings during the year. see “Federal Unrelated Business Income Tax,” Information on withholding, depositing, in Chapter 5, and obtain Federal Publication reporting, and paying federal employment taxes 598, Tax on Unrelated Business Income of can be found in IRS Publication 15, Circular E, Exempt Organizations. Use booklet 598 and the Employer’s Tax Guide, and the Publication 15-A separate instructions to Form 990-T to prepare and 15-B Supplements. this form. Other helpful IRS publications are Publication Te taxes imposed on unrelated business 542, Corporations, and Publication 334, Tax income are the same rates applied to normal Guide for Small Business. federal corporate income. Remember that too Helpful information on accounting methods much unrelated business income may indicate and bookkeeping procedures is contained to the IRS that you are engaging in nonexempt in IRS Publication 538, Accounting Periods activities to a substantial degree and may and Methods, and Publication 583, Starting a KFPQBSEJ[FZPVSUBYFYFNQUJPO Business and Keeping Records. You can get IRS publications online at www .irs.gov. You can also pick them up at your local California Corporate Tax IRS office (or order them by phone—call your Returns and Reports local IRS office or try the toll-free IRS forms In this section, we list some of the California and publications request telephone number, tax reporting forms and paperwork you will 800-TAX-FORM). California tax forms and need to tackle as a tax-exempt nonproft information are available at www.ftb.ca.gov. corporation. Tax forms, instructions, and rates California employment tax information can be frequently change. Go to the Franchise Tax downloaded from www.edd.ca.gov. Board website at www.ftb.ca.gov for the latest For information on withholding, contributing, information and forms. paying, and reporting California employment, unemployment, and disability taxes, get the Public Charities: Annual California Employer’s Guide (Publication DE 44), available online at www.edd.ca.gov. Exempt Organization Return Nonproft corporations exempt from tax under 23701(d) of the California Revenue and Taxation Unrelated Business Income: Annual Code (the state parallel exemption to the federal 501(c)(3) exemption) and classifed by the IRS Exempt Organization Tax Return as public charities must fle a California Exempt With a few minor exceptions, Section 501(c) Organization Annual Information Return, Form (3) federal tax-exempt corporations that have 199. Te form is due within fve-and-a-half gross incomes of $1,000 or more during the months of the close of their tax year. Depending 262 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

on their annual gross receipts, some groups the year from an unrelated trade or business is may be eligible to fle a 199N (e-postcard) $1,000 or more. Tey’ll pay an 8.84% state tax instead of Form 199. Te state exemptions (the normal corporate tax rate) on their taxable from the 199 fling requirements are similar to unrelated business income. the IRS exemptions from fling Form 990. A Tis return must be fled within four-and-a- failure to make timely 199 flings can result in half months of the end of the tax year. Paying a suspension of corporate rights, powers, and the tax, unlike paying the federal unrelated privileges; or a revocation of the corporation’s business income tax, is done periodically during state tax exemption. the year for which the tax is due, by estimating If you’ve made a political expenditures election your expected income from unrelated trade with the state (by submitting a copy of your or business activities during the current year. federal 5768 election form to the Franchise Tax Twenty-fve percent of the estimated tax must Board within the year), attach Form FTB3509, be paid within three-and-a-half months of Political or Legislative Activities by Section the beginning of the tax year. Te balance of 23701(d) Organizations, to your annual 199 fling. the tax is payable in three equal installments on or before the 15th day of the sixth, ninth, Private Foundations: Annual and twelfth months of the tax year. If you’ve Exempt Organization Return underestimated, at the end of the year you’ll pay any additional amount with your annual return. California corporations exempt under Section Te state doesn’t usually send you forms and 23701(d) of the Revenue and Taxation Code instructions for paying this tax during your frst and classifed as private foundations must fle year. You won’t receive it for later years, either, Form 199. Private foundations must provide unless a prior annual information return shows some additional information not required of that the corporation is likely to have unrelated public charities that fle the same form. Instead business income. If the state does send you a of flling out Part II of this form, you can (and form, it will be Form 100-ES. should, to avoid extra paperwork) provide a copy Form 100-ES is the same form that regular of your annual report to the attorney general proft corporations use. Te normal minimum (Form RRF-1—see “Attorney General Annual franchise tax that proft corporations must pay Periodic Report,” below), or furnish a copy of with their frst annual estimated tax payment IRS Form 990-PF and its schedules instead. does not apply to tax-exempt nonprofts. Unrelated Business Income Nonprofts pay a simple 8.84% rate on their estimated taxable unrelated business income. Tax Return and Quarterly Because you must make estimated unrelated Estimated Tax Payments business tax payments if this tax applies to All corporations that are exempt from state you (whether or not the Franchise Tax Board corporate franchise taxes under Section sends you the forms), make sure you pay 23701(d) (except those formed to carry out a attention to this often overlooked aspect of state function) must fle an annual California nonproft corporate taxation. Penalties apply to Exempt Organization Business Income Tax underpayment of this estimated tax and to late Return, Form 109, if their gross income during fling of the return referred to above. CHAPTER 10 | AFTER YOUR CORPORATION IS ORGANIZED | 263

Attorney General Annual report. Te corporation will have already Periodic Report prepared most of the information needed in order to comply with the state and federal 4VCKFDUUPBGFXFYDFQUJPOT D BOE annual tax return requirements discussed above. 23701(d) tax-exempt public beneft nonproft Keep in mind that this annual report to insiders corporations must fle an annual report with must be furnished within approximately four the California Attorney General (Form RRF-1). months—120 days—after the close of the However, religious organizations, nonproft fscal year. Tis is a little sooner than most of schools, and hospitals are exempt from the the annual state and federal tax returns, which annual RRF-1 fling requirement (see the must be submitted within four-and-one-half instructions to the RRF-1 form). Te attorney months of the close of the tax year. general should mail the Form RRF-1 to you, along with a Form 990. Groups with total assets or gross receipts over $25,000 must also Federal and State Corporate fle a federal 990 or 990-PF annually with the attorney general (with the required schedules Employment Taxes and attachments). Failure to make these You must pay employment taxes on behalf required annual flings on time can result in of the people who work for your nonproft late fling penalties. Groups with total assets or corporation. Directors, with certain exceptions, gross receipts of $100,000 or more must pay a are not considered employees if they are paid Form RRF-1 fling fee. only for attending board meetings. However, if they are paid for other services or are salaried Public Beneﬁt Corporations’ employees of the corporation, they will Annual Corporate Report be considered employees whose wages are Nonmembership public beneft corporations TVCKFDUUPUIFFNQMPZNFOUUBYFT/POQSPëU must furnish all directors with an annual report tax-exempt corporations are often exempt containing fnancial information, including from having to pay certain employment taxes a statement of assets, liabilities, receipts, and for their employees (for example, federal expenditures. Te report is due within 120 days unemployment insurance). after the close of the fscal year. (See Article Independent contractors (such as consultants) 7, Section 6, of the public beneft corpo ration XIPBSFOPUTVCKFDUUPUIFGVMMDPOUSPMPGUIF bylaws.) Membership public beneft corpo- corporation (for example, how the work is to rations must also submit this annual report be performed) are generally not considered within the same time period to any member employees. Wages paid to these outsiders are not who requests it. Te annual report (or a separate TVCKFDUUPUIFFNQMPZNFOUUBYFTEJTDVTTFECFMPX state ment sent to all directors and members) Of course, it goes without saying that corpo- must also disclose the details of certain rate directors, ofcers, and other compensated indemni fcation or self-dealing transactions (see corporate personnel must report employment “Direc tors,” in Chapter 2, and Article 7, Section compensation on their individual annual 7, of the public beneft corporation bylaws). federal and state income tax returns (IRS Form It should not be very difcult to compile the 1040; California Form 540). fnancial information required for this annual 264 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

In addition to reading this material, we number of allowances claimed by the employee, recommend you get the publications listed and is used in determining the amount of income in “More Information on Taxes,” above. Tis taxes withheld from the employee’s wages. will give you more detailed and the most current information to help you compute Income Tax Withholding your withholding and employer contribution Te corporation must withhold federal income payments. Also, check with the IRS and your tax from wages paid to employees based upon local state employment tax district ofce if you the wage level, marital status, and number of need more information. allowances claimed on the employee’s W-4. Tese, as well as other employment taxes, CAUTION are withheld and reported on a calendar year Be careful when classifying people as basis (January 1 to December 30), regardless independent contractors. Te law in this area of the tax year of the corporation. You’ll is fuzzy, and the IRS (as well as the California submit returns on a quarterly basis and Employment Development Department, which deposit withheld tax in an authorized bank oversees state unemployment taxes) is obstinate on a quarterly (or more frequent) basis; or you about trying to prove that outsiders really work for can pay with the quarterly return—see IRS the corporation (and must be covered by payroll Publication 15. taxes). For more information, see IRS Publication 937. An excellent legal guide to the ins and outs of Social Security Tax Withholding independent contractor status is Working for Yourself: Law & Taxes for Independent Contractors, Freelancers Employees who work in a 501(c)(3) nonproft & Consultants, by Stephen Fishman (Nolo). DPSQPSBUJPOBSFTVCKFDUUP4PDJBM4FDVSJUZ (FICA) tax withholding. Employers withhold FICA taxes from the employee’s wages, and Federal Employment must match the tax, too. Te combined amount Taxes and Forms is reported quarterly and paid either with the Tis section summarizes the federal payroll quarterly return or deposited in an authorized tax paperwork and payment obligations that bank. See the next section below and IRS will apply to your 501(c)(3) nonproft. It’s not Publication 15 for specifcs. NFBOUUPHJWFZPVBMMUIFEFUBJMT KVTUBIFBETVQ so you can go online and fgure out more for Quarterly Withholding Returns and Deposits yourself. (See the online payroll tax resources On or before the last day of the month imme- listed above, in “More Information on Taxes.”) di ately following the end of each calendar quarter, the corporation must fle an Employer’s Employee’s Withholding Certiﬁcate Quarterly Federal Tax Return, Form 941. Tis is Each employee of the corporation must fll a consolidated return, including both withheld out and give the corporation an Employee’s income taxes and Social Security taxes, and has Withholding Allowance Certifcate (IRS Form specifc payment and deposit rules. W-4), on or before commencing employment. Deposits of income and Social Security taxes Tis form indicates the marital status and must be made on a quarterly, monthly, or more CHAPTER 10 | AFTER YOUR CORPORATION IS ORGANIZED | 265 frequent basis. You will want to pay careful Employer Registration Form attention to withholding, depositing, paying, and Nonproft corporations with employees must reporting these taxes to avoid costly penalties. register with the California Employment Again, consult IRS Publication 15 for details. Develop ment Department within 15 days PGCFDPNJOHTVCKFDUUPFJUIFSUIF$BMJGPSOJB Federal Unemployment Tax Unemployment Insurance Code or to Your 501(c)(3) tax-exempt nonproft corpor a tion California personal income tax withholding should be exempt from federal unemploy ment provisions. Because this usually happens once (FUTA) taxes. Your federal exemption letter wages in excess of $100 in a calendar quarter should tell you that you are exempt from these are paid, you should register right away if taxes. you plan to have any employees. Do this by preparing and submitting Registration Form for Annual Wage and Tax Statement Commercial Employers, DE-1, available online Your nonproft corporation must furnish two at www.edd.ca.gov or from a local Employment copies of the Wage and Tax Statement (IRS Tax District ofce. If you plan to apply for a Form W-2) to each employee from whom sales tax permit, your permit application can income tax has been withheld (or would have also serve as your employer registration form. been withheld if the employee had claimed no more than one withholding allowance on his Personal Income Tax Withholding W-4). Tis form must show total wages paid Te corporation must withhold California and amounts deducted for income and Social personal income taxes from employees’ wages Security taxes. A special six-part W-2 should according to the tax tables in Publication be used in California to show state income DE-44. Te tables take into account the marital tax and disability insurance contributions, in status, claimed allowances, and wage level addition to the required federal withholding of the employee. Tese tables automatically information. Give W-2s to employees no later allow for applicable exemptions and the state’s than January 21. standard deduction. Te corporation must submit each employee’s previous year’s W-2 form and an annual California Unemployment and Transmittal of Wage and Tax Statements (Form Disability Insurance W-3) to the Social Security Administration on Most nonproft 501(c)(3) tax-exempt corpo- or before the last day of February. SBUJPOTBSFTVCKFDUUP$BMJGPSOJBVOFNQMPZNFOU and disability insurance tax contributions and State Employment Taxes and Forms withholding. Certain churches or religious non- Tis section summarizes the state payroll tax proft corporations and schools that are a part requirements that will apply to your 501(c)(3) of a church or religious nonproft corporation nonproft. Again, see “More Information on BSFOPUTVCKFDUUPVOFNQMPZNFOUBOEEJTBCJMJUZ Taxes,” above, to obtain more information insurance taxes. Rates change constantly. online and forms. For further information, consult the DE-44 publication listed in “More Information on 266 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Taxes,” above. If you have any questions, call Te corporation must fle a quarterly return, your local employment tax ofce. reporting the employment taxes mentioned Also, certain types of services performed for above for the previous quarter and pay any 501(c)(3) tax-exempt nonproft groups are not balance not already paid with monthly returns. TVCKFDUUPTUBUFVOFNQMPZNFOUBOEEJTBCJMJUZ For specifcs, consult the DE-44 pamphlet. coverage unless elected (the criterion here is the type of services, not the type of nonproft). Te CAUTION California Employment Development Depart- Officers can be personally liable. Under ment should mail Form DE-1-NP, which lists Section 1735 of the California Unemployment these excluded services and allows you to elect Insurance Code, officers and other persons in charge coverage for any which apply to you. of corporate affairs are personally liable for taxes, California unemployment insurance can be interest, and penalties owed by the corporation. paid by 501(c)(3) groups in one of two ways: (1) the regular contribution rate method, or (2) a Annual Wage and Tax Statement prorated cost of benefts paid. Form DE-1-NP, Te corporation should prepare a six-part referred to above, allows you to select which combined federal/state Wage and Tax Statement, payment method you want to use. IRS Form W-2. Tis form indicates total Under the regular contribution rate method, annual state personal income tax and state unemployment insurance contributions are paid disability insurance withholding. Copies of this by the corporation at its “employer contri bution form should be provided to the employee. rate” shown on the Quarterly Contribution Return and Report of Wages (DE-9). Annual Reconciliation of Under the prorated cost of benefts method, Income Tax Withholding Form the corporation pays the actual amount Te corporation must prepare and fle a of unemploy ment benefts received by ex- completed Annual Reconciliation Statement, employees who receive such benefts, to the (DE-7), with the Employment Development extent that such benefts are attributable to base Department annually, before February 28, period wages paid by the corporation to the ex- attaching one copy of each employee’s W-2 employee. Ask the local employment tax ofce and a totaled listing of the California personal for Form DE-1378-F, which contains examples income tax amounts withheld as shown on the of your potential liability under this method. attached W-2s. Disability insurance contributions are paid by the employee and withheld, reported, and submitted to the state by the corporation. Again, Sales Tax Forms and rates change—check your DE-44 pamphlet. Exemption From Sales Tax Withholding Returns Many nonprofts sell goods to the public and A corporation is required in most cases to fle UIFSFGPSFBSFTVCKFDUUPDPMMFDUJOH EFQPTJUJOH monthly returns with the state, reporting and and reporting sales tax. We cover some of the paying personal income tax withholding and basic rules and exceptions in this section. For disability and unemployment tax contributions more information on the sales tax and forms, go for each employee. online to the main sales tax page on the State Board of Equalization’s website. CHAPTER 10 | AFTER YOUR CORPORATION IS ORGANIZED | 267

Sales Tax Sellers must fle periodic sales and use tax returns, reporting and paying sales tax collected 4VCKFDUUPBGFXFYDFQUJPOT BTOPUFEJO from customers. A seller must keep complete “Exempt Transactions” below, every nonproft records of all business transactions, including cor po ration that has gross receipts from the sales, purchases, and other expenditures; and sale of tangible personal property in California have them available for inspection by the Board (for example, merchandise sold to customers) of Equalization at any time. must apply for a sales tax seller’s permit. You can fle the application (Form BOE-400-SPA) with the nearest ofce of the California Board Exempt Transactions of Equalization. Te form is available online, at Certain transactions entered into by any www.boe.ca.gov. Te BOE should soon allow kind of organization (profit or nonprofit) online applications and return flings—check are not subject to the collection of sales tax. the website for more information. Even groups Examples are sales of personal property shipped exempt from collecting sales tax, as described out of state, certain sales incidental to the below, must obtain a seller’s permit. Tis appli- performance of services, and purchases of cation can also serve as an employer registration art that will be loaned by certain nonprofits. form with the Employment Devel opment Call a Board of Equalization office for further Department. information. Tere’s no fee for applying for or obtaining a sales tax (seller’s) permit. Some applicants, however, may be required to post a bond or other security for payment of future sales taxes. Groups Exempt From Collecting A separate permit is required for each place of and Submitting Sales Tax business at which transactions relating to sales A few tax-exempt nonproft corporations are tax are customarily entered into with customers. exempt from collecting sales tax and preparing Sales tax is added to the price of certain goods the quarterly report. To be eligible for the and is collected from the purchaser. exemption, a nonproft corporation must meet Wholesalers, as well as retailers, must obtain all of the following stringent requirements: a permit. A wholesaler, however, is not required tɨFPSHBOJ[BUJPONVTUCFGPSNFEBOE to collect sales tax from a retailer who holds operated for charitable purposes, and must a valid seller’s permit and who buys items qualify for the welfare exemption from for resale to customers, provided a resale property taxation provided by Section 214 certifcate is completed in connection with the of the California Revenue and Taxation transaction. Code. If the corporation owns the retail location, it must have obtained the welfare EXAMPLE: If your nonproft sells supplies exemption for the real property at this to another nonproft with its own seller’s location. If it leases the premises, it must permit, you are exempt from collecting sales have obtained the welfare exemption on the tax on the transaction—the nonproft buyer personal property (such as inventory and will collect the sales tax on the supplies when furnishings) at this location. it sells them to the public. 268 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

tɨFPSHBOJ[BUJPONVTUCFFOHBHFEJOUIF Licenses and Permits relief of poverty and distress and the sales must be made principally as a matter of Many businesses, whether operating as proft assistance to purchasers in a distressed or nonproft corporations, partnerships, limited fnancial condition. Tese conditions are liability companies, or sole proprietorships, fulflled if the corporation sells its goods at must obtain state licenses and permits before reduced prices so as “to be of real assistance commencing business. While you may not be to purchasers.” Incidental sales to persons TVCKFDUUPUIFVTVBMLJOEPGSFEUBQFBQQMJDBCMF other than low-income consumers will not to strictly proft-making enterprises (for prevent the organization from obtaining the example, contractors and real estate brokers), sales tax exemption. you should check with your local department tɨFQSPQFSUZTPMENVTUIBWFCFFONBEF of consumer afairs ofce for information prepared, assembled, or manufactured concerning any state licensing requirements for by the organization. Tis condition will your activities or type of organization. If one be satisfed when the property is picked of the boards does not regulate your activities, up at various locations and assembled they may be able to refer you to the particular at one or more locations for purposes of state agency that oversees your operations. sale, even though nothing other than Many nonproft institutions (for example, assembling needs to be done to place it in schools or hospitals) will, of course, need to salable condition. Property is considered comply with a number of registration and prepared when it is made ready for sale by reporting requirements administered by the such processes as cleaning, repairing, or state and, possibly, the federal government. A reconditioning. local business license or permit may also be A nonproft corporation seeking to obtain required for your activities. Check with your this exemption from sales tax collection and city business license department. reporting must, as we’ve said, still apply for a Newly incorporated groups that have held seller’s permit by fling Form BOE-400-SPA, licenses or permits for previous activities attaching to it a Certifcate of Exemption— or operations should check to see if special Charitable Organizations, Form BT-719, corporate licensing requirements apply to their available at the nearest board of equalization activities. In some cases, a separate corporate ofce. Appli cants should also request an license must be taken out in the corporate name; information sheet relating to the exemption, in others a corporate license must be obtained in Form BT-719-A. the name of supervisory corporate personnel. Other sales tax exemptions exist for special You should also check to see if the city and nonproft groups (for example, certain non proft county where your principal place of business cooperative nursery schools are exempt). is located (and other places where you plan to conduct activities) require you to obtain a permit for soliciting funds for charitable purposes. Many cities and counties have enacted permit (or other) requirements of this type. CHAPTER 10 | AFTER YOUR CORPORATION IS ORGANIZED | 269

Workers’ Compensation Dissolving a Nonproﬁt With some exceptions, employees of a nonproft Corporation corporation, whether ofcers or otherwise, We’ll end our discussion of the housekeeping must be covered by workers’ compensation details afecting California nonproft corpo- insurance. Rates vary depending on the salary rations with a short summary of the Nonproft MFWFMBOESJTLBTTPDJBUFEXJUIBOFNQMPZFFTKPC Corporation Law provisions related to dissol- If directors are paid only for travel expenses ving (ending) the corporation. Te primary for attending meetings, they may be exempt point to keep in mind here is that a California GSPNDPWFSBHF BMUIPVHIìBUQFSNFFUJOH nonproft corporation may be dissolved by QBZNFOUTXJMMHFOFSBMMZNBLFUIFNTVCKFDUUP mutual consent (in a voluntary dissolution) coverage). Tis is a blurry area, so check with with a minimum of formality. Te forms your insurance agent or broker (or your local and instructions you’ll need to dissolve a State Compensation Insurance Commission) nonproft voluntarily are available online from for names of carriers, rates, and the extent of the Secretary of State’s Business Programs required coverage. Division website. (See Appendix B for more For online information, go to the California information.) You can download Certifcate of Department of Insurance website at www Election to Wind Up and Dissolve and Certifcate .insurance.ca.gov and enter “Workers’ Com- of Dissolution forms for nonproft corporations pensation” in the search box. from the website. Don’t let our discussion of dissolution, court Private Insurance Coverage flings, and attorney general supervision scare you into thinking that this will be your fate. In Nonproft corporations, like other organi za- GBDU UIFHSFBUNBKPSJUZPGTNBMM TFOTJCMZSVO tions, should carry the usual kinds of commer- OPOQSPëUDPSQPSBUJPOTXJMMOFWFSGBDFBOZNBKPS cial insurance to help protect against losses problems. Of course, you should use good in the event of an accident, fre, theft, and so KVEHNFOUBTUPXIFOBOEXIZUPQBZBëOBODJBM on. Remember, although being incorporated or legal adviser to answer important questions can help insulate directors, ofcers, and others related to your individual problems. Te fact from personal liability and loss, it won’t protect that you can competently do many things on against losses to corporate assets. Look into your own doesn’t mean that you will never need coverage for general liability, product liability, to see an accountant or lawyer. and fre and theft. You should also consider liability insurance for directors and ofcers, Voluntary Dissolution particularly if your nonproft corporation wants Any nonproft corporation may, on its own and to reassure any passive directors that they will out of court, decide to voluntarily wind up and be protected from personal liability in the event dissolve, for any reason. In a nonmembership of a lawsuit (see “Directors,” in Chapter 2). To corporation, you’ll need the board’s approval; take advantage of California’s volunteer director in a membership corporation, the approval of a and ofcer immunity provisions, adequate NBKPSJUZPGUIFNFNCFSTJTOFFEFE director and ofcer liability insurance must be Te board of directors of a public beneft obtained (or be proven to be unobtainable)— corporation may elect to dissolve the corporation, see “Directors,” in Chapter 2. 270 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

without membership approval, if any of the afairs, so that the corporation’s business following conditions apply (the rules are cannot be conducted to advantage, or so essentially the same for religious corporations): that there is danger that its property and tUIFDPSQPSBUJPOIBTOPNFNCFST business (exempt-purpose activities) will be tUIFDPSQPSBUJPOIBTOPUDPNNFODFECVTJOFTT impaired and lost, and the members are so and has not issued any memberships divided into factions that they cannot elect tUIFDPSQPSBUJPOIBTCFFOBEKVEHFECBOLSVQU an odd-numbered board. tUIFDPSQPSBUJPOIBTEJTQPTFEPGBMMJUTBTTFUT tɨFNFNCFSTIBWFCFFOVOBCMF BUUXP and hasn’t conducted any activity for the consecutive meetings (or in two written past fve years, or ballots), where full voting power has been tBTVCTJEJBSZDPSQPSBUJPONVTUEJTTPMWF exercised, or during a four-year period, because its charter from a head organization whichever period is shorter, to elect succes- has been revoked. sors to directors whose term has expired or Occasionally, the court will supervise a would have expired upon election of their corporation’s voluntary dissolution. Tis can successors. happen upon the request of the corporation tɨFSFJTJOUFSOBMEJTTFOTJPOBOEUXPPSNPSF itself, or by request of 5% or more of the factions of members are so deadlocked that members or three or more creditors. the corporation’s activities can no longer be conducted to advantage. Involuntary Dissolution tɨPTFJODPOUSPMPGUIFOPOQSPëUDPSQPSB An involuntary dissolution is one that happens tion (the directors) have been guilty of or in court against the wishes of the nonproft knowingly allowed persistent and pervasive board. One-third of the membership votes of a fraud, mismanagement, or abuse of nonproft corporation, one-half of the directors, authority, or the corporation’s property is or the attorney general can force a dissolution as being misapplied or wasted by its directors explained below. Te attorney general can also or ofcers. trigger a dissolution for the separate reasons t-JRVJEBUJPOJTSFBTPOBCMZOFDFTTBSZ discussed below. Te petition for dissolution because the corporation is failing and must be fled in the superior court of the has continuously failed to carry out its county of the corporation’s principal ofce. purposes. tɨFMJNJUFEQFSJPE JGUIJTBQQMJFT GPSXIJDI Dissolution Triggered by Directors, the corporation was formed has terminated Members, or Attorney General without extension of such period (one member alone can fle a court petition for One-third of the members, one-half of the involuntary dissolution on this basis). direc tors, or the attorney general can force an t*OUIFDBTFPGBTVCPSEJOBUFDPSQPSBUJPO involun tary dissolution by fling a court petition created under the authority of a head based on one or more of the following grounds: organization, the articles of incorporation tɨFOPOQSPëUDPSQPSBUJPOIBTBCBOEPOFEJUT of the subordinate corporation require it activities for more than one year. to dissolve because its charter has been tɨFOPOQSPëUDPSQPSBUJPOIBTBOFWFO surrendered to, taken away, or revoked by number of directors who are equally divided the head organization. and cannot agree to the management of its CHAPTER 10 | AFTER YOUR CORPORATION IS ORGANIZED | 271

Additional Grounds for Dissolution in Winding Up Corporate Business Actions Brought by Attorney General and Distribution of Assets In addition to the grounds mentioned above, Once a voluntary or involuntary dissolution the attorney general can bring an action for process begins (by vote of the board and/or involuntary dissolution of the corporation based members to start a voluntary winding up or on its own information or upon another party’s upon the fling of an involuntary dissolution complaint, for any of the following reasons: court petition), the corporation must stop doing tɨFDPSQPSBUJPOIBTTFSJPVTMZWJPMBUFE business, except to the extent necessary to wind any provision of the statutes regulating up its afairs pending a distribution of its assets. corporations or charitable organizations. All corporate debts and liabilities must be paid tɨFDPSQPSBUJPOIBTGSBVEVMFOUMZBCVTFEPS or provided for (to the extent that corporate usurped corporate privileges or powers. assets can do so). If any corporate assets remain tɨFDPSQPSBUJPOIBT CZBDUJPOPSEFGBVMU after paying corporate debts, a 501(c)(3) tax- violated any provision of law that authorizes exempt nonproft corporation must distribute the forfeiture of corporate existence for them to another 501(c)(3) group as required noncompliance. by the “irrevocable dedi cation” clause in the tɨFDPSQPSBUJPOIBTGBJMFEGPSëWFZFBSTUP corporation’s articles. pay to the California Franchise Tax Board If your involuntary or voluntary dissolution any tax for which it is liable. JTTVCKFDUUPTVQFSJPSDPVSUTVQFSWJTJPO ZPVMM In certain situations, the corporation may take have to publish a notice to creditors of the corrective action to avoid a dissolution initiated corporation (a standard formality handled by by the attorney general. newspapers that publish legal notices). Creditors who don’t fle claims within a specifed period Religious Corporations of time after you’ve published your notice will Te California Nonproft Corporation Law be barred from participating in any distribution doesn’t directly provide for the involuntary of the corpor ation’s assets. ● winding up of a religious corporation. However, the attorney general may go to court and, following Section 9230 of the Religious Corporation Law and the procedures of Section PGUIF$PEFPG$JWJM1SPDFEVSF BTLBKVEHF to rule on whether the corporation is properly qualifed or classifed as a religious corporation. *GUIFKVEHFEFDJEFTUIBUUIFDPSQPSBUJPOJT improperly qualifed, the attorney general can ask the Franchise Tax Board and IRS to revoke the corporation’s religious tax exemptions.

CHAPTER

Lawyers, Legal Research, and Accountants 11

Lawyers ...... 274 Legal Research ...... 275 Finding the Law You Need...... 275 Annotated Codes ...... 276 Accountants and Tax Advice ...... 276 274 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

hile we believe you can take care patience and persistence (and enough phone of the bulk of the work required calls), this second word-of-mouth approach W to organize and operate your almost always brings positive results. nonproft corporation, you may need to consult Another approach is to locate a local non- a lawyer or accountant on complicated or proft legal referral panel. Local bar associations special issues. It also makes sense to have a or another nonproft organization typically lawyer or accountant experienced in forming run panels of this sort. A referral panel in nonprofts and preparing tax exemption your area may be able to give you the names applications look over your papers. Reviewing of lawyers who are experienced in nonproft your incorporation papers with an attorney or law and practice and who ofer a discount or accountant is a sensible way to ensure that all free consultation as part of the referral panel of your papers are up to date and meet your program. Ask about (and try to avoid) referral needs. Besides, making contact with a legal and services that are operated on a strict rotating tax person early in your corporate life is often basis. With this system, you’ll get the name of a sensible step. As your group grows and its the next lawyer on the list, not necessarily one programs expand, you’ll be able to consult these with nonproft experience. professionals for help with ongoing legal and You can check Nolo’s Lawyer Directory at tax questions. www.nolo.com/lawyers for nonproft lawyers Te professionals you contact should have in your area. Te Nolo Directory ofers experience in nonproft incorporations and tax comprehensive profles of the lawyers who exemption applications. Tey should also be advertise, including each attorney’s education, prepared to help you help yourself—to answer background, areas of expertise, fees, and your questions and review, not rewrite, the practice philosophy. It also states whether the forms you have prepared. lawyer is willing to review documents or coach Te next sections provide a few general clients who are doing their own legal work. suggest ions on how to fnd the right lawyer or When you call a prospective lawyer, speak tax adviser and, if you wish to do your own XJUIUIFMBXZFSQFSTPOBMMZ OPUKVTUUIF legal research, how to fnd the law. reception desk. You can probably get a good idea of how the person operates by paying close attention to the way your call is handled. Is Lawyers the lawyer available, or is your call returned Finding the right lawyer is not always easy. promptly? Is the lawyer willing to spend at least Obviously, the best lawyer to choose is someone a few minutes talking to you to determine if you personally know and trust, who has lots TIFJTSFBMMZUIFCFTUQFSTPOGPSUIFKPC %PFT of experience advising smaller nonprofts. Of the lawyer seem sympathetic to, and compatible course, this may be a tall order. Te next best with, the nonproft goals of your group? Do is a nonproft advisor whom a friend, another you get a good personal feeling from your nonproft incorporator, or someone in your conversation? Oh, and one more thing: Be sure non proft network recommends. A local non- to get the hourly rate the lawyer will charge set proft resource center, for example, may be in advance. If you are using this book, you will able to steer you to one or more lawyers who probably want to eliminate lawyers who charge maintain active nonproft practices. With top-dollar rates per hour to support an ofce on top of the tallest building in town. CHAPTER 11 | LAWYERS, LEGAL RESEARCH, AND ACCOUNTANTS | 275

process. First defne and, if necessary, narrow What About Low-Cost Law Clinics? EPXOUIFTVCKFDUNBUUFSPGZPVSTFBSDIUP Law clinics advertise their services regularly essential key words associated with your area of on TV and radio. Can they help you form a interest. For example, if one of the directors on nonprofit organization? Perhaps, but usually at your board resigns and you want to determine a rate well above their initial low consultation whether there are any statutory rules for rate. Because the lawyer turnover rate at these flling vacancies on the board, you will defne clinics is high and the degree of familiarity with and restrict your search to the key areas of nonprofit legal and tax issues is usually low, we “directors” and “resignation” or “vacancies.” recommend you spend your money more wisely Te laws governing nonprofts in California by finding a reasonably priced nonprofit lawyer (the Nonproft Corporation Law) are contained elsewhere. in Division 2 of the California Corporations Code. If you want information on flling a director vacancy in your nonproft (a public beneft corporation), you would start with Legal Research the Nonproft Corporation Law. Tere is a section in the Nonproft Corporation Law Many incorporators may want to research legal (Part 2) that covers nonproft public beneft information on their own. You can browse corporations. One of the topics in the public the nonproft laws online (go to http://leginfo. beneft corporations section is “Directors and legislature.ca.gov; click on the Corporations Management.” Within that section, there Code—CORP and scroll down to Division 2, is a subsection for “Selection, Removal and Nonproft Corporation Law. Most county law Resignation of Directors,” followed by a range of libraries are open to the public (you need not DPEFTFDUJPOTEFWPUFEUPUIJTTVCKFDUBSFB*GZPV be a lawyer to use them) and are not difcult to read through those code sections, you would use once you understand how the information fnd the information you were looking for. is categorized and stored. Tey are an invaluable Another search strategy is to simply start at source of corporate and general business forms, the beginning of the Nonproft Corporation federal and state corporate tax procedures, and -BXBOEMFBGUISPVHIBMMUIFNBKPSBOENJOPS information. Research librarians will usually IFBEJOHT&WFOUVBMMZVTVBMMZBGUFSKVTUBGFX go out of their way to help you fnd the right minutes or so—you will hit upon your area of statute, form, or background reading on any interest or will satisfy yourself that the area in corporate or tax issue. question is not covered by the corporate statutes. By the way, after going through the nonproft Finding the Law You Need law this way once or twice, you should become Whether you are leafng through your own BDRVBJOUFEXJUINPTUPGJUTNBKPSIFBEJOHTɨJT copy of the nonproft corporation law or XJMMIFMQZPVMPDBUFTQFDJëDOPOQSPëUTVCKFDU browsing corporate statutes online or at your areas and statutes quickly when searching this local county law library, fnding a particular material in the future. corporate provision is usually a straightforward 276 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

RESOURCE Legal Shorthand and Definitions If you are interested in doing your own legal Many rules in the corporate statutes are given research, an excellent source of information is Legal in legal shorthand—short catchwords and Research: How to Find & Understand the Law, by Stephen Elias and the Editors of Nolo (Nolo). phrases that are defined elsewhere in the code. For example, a common requirement in corporate statutes is that a matter or trans action be “approved by the board” or “approved by Accountants and Tax Advice a majority of the board.” But what do these phrases mean—how much approval is enough? As you already know, organizing and operating An alphabetical listing of definitions that a nonproft corporation involves a signifcant apply to California nonprofit corporations is amount of fnancial and tax work. While much contained in California Corporations Code of it is easy, some of it requires a nit-picking §§ 5030–5080. Read this definition section attention to defnitions, cross-references, before you go on to search for a particular rule, formulas, and other elusive or downright so that you’ll understand any legal shorthand boring details, particularly when preparing you might encounter. (By the way, the first the long-form federal 1023 tax exemption phrase usually means approval by a majority application. As we often suggest in the book, of directors present at a meeting at which a you may fnd it sensible to seek advice or help quorum of directors is present; the second from an accountant or other tax adviser when usually means approval by a majority of the organizing your nonproft corporation. full board.) For example, you may need help preparing the income statements, balance sheets, and other fnancial and tax information submitted with Annotated Codes your IRS tax exemption application. Also, if your organization will handle any signi fcant When you look up a nonproft statute, whether amount of money, you will need an accoun- online or in a book, you might want to use tant or book keeper to set up your double- an annotated version of the codes. Annotated entry accounting books (cash receipts and codes include not only the text of the statutes EJTCVSTFNFOUKPVSOBMT HFOFSBMMFEHFS BOETP themselves, but also brief summaries of court on). Double-entry accounting techniques are cases that mention and interpret each statute. particularly important to nonprofts that receive After you fnd a relevant statute, you may want federal or private grant or program funds— to scan these case summaries—and perhaps accounting for these “restricted funds” usually even read some of the cases—to get an idea of requires setting up a separate set of books for how courts have interpreted the language of each fund (and the assistance of a professional). the statute. CHAPTER 11 | LAWYERS, LEGAL RESEARCH, AND ACCOUNTANTS | 277

Nonproft corporation account books should tax publications listed in “More Information on be designed to allow for easy transfer of fnan- Taxes,” in Chapter 10. Tese pamphlets contain cial data to state and federal nonproft corporate essential information on preparing and fling tax returns and disclosure statements. It should IRS corporation and employment tax returns. be easy to use the books to determine, at any When you select an accountant or book- time, whether receipts and expenditures fall keeper, the same considerations apply as into the categories proper for maintaining your when selecting a lawyer. Choose someone 501(c)(3) tax exemption, public charity status, you know or whom a friend or nonproft and grant or program eligibility. You will also contact recommends. Be as specifc as you can want to know whether your operations are regarding the services you want performed. MJLFMZUPTVCKFDUZPVUPBOVOSFMBUFECVTJOFTT Make sure the adviser has had experience income tax under federal and state rules. with nonproft taxation and tax exemption Once your corporation is organized and your applications, as well as regular payroll, tax, books are set up, corporate personnel with and accounting procedures. Many nonproft experience in bookkeeping and nonproft tax bookkeepers work part time for several matters can do the ongoing work of keeping nonproft organizations. Again, calling people the books and fling tax forms. Whatever your in your nonproft network is often the best way arrangement, make sure to at least obtain the to fnd this type of person. ●

APPENDIX

Using the Interactive Forms and Other Online Material A

Editing RTFs ...... 280 List of Corporate, IRS, and other Forms and Publications on the Nolo website ...... 281 280 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

his book comes with interactive fles Editing RTFs that you can access online at T www.nolo.com/back-of-book/NON.html Here are some general instructions about To use the fles, your computer must have editing RTF forms in your word processing specifc software programs installed. Here is a program. Refer to the book's instructions and list of types of fles provided by this book, as sample agreements for help about what should well as the software programs you’ll need to go in each blank. access them: tUnderlines. Underlines indicate where to t 35'You can open, edit, print, and save enter information. After flling in the these form fles with most word processing needed text, delete the underline. In most programs such as Microsoft Word, Windows word processing programs you can do this WordPad, and recent versions of WordPerfect. by highlighting the underlined portion and t 1%'You can view these fles with Adobe typing CTRL-U. Reader, free software from www.adobe. tBracketed and italicized text. Bracketed and com. Government PDFs are sometimes italicized text indicates instructions. Be sure fllable using your computer, but most to remove all instructional text before you PDFs are designed to be printed out and fnalize your document. completed by hand. tSignature lines. Signature lines should appear on a page with at least some text from the TIP document itself. Note to Macintosh Users. Tese forms Every word processing program uses diferent were designed for use with Windows. Tey should commands to open, format, save, and print also work on Macintosh computers; however Nolo documents, so refer to your software's help cannot provide technical support for non-Windows documents for help using your program. Nolo users. cannot provide technical support for questions about how to use your computer or your software.

CAUTION In accordance with U.S. copyright laws, the forms provided by this book are for your personal use only. APPENDIX A | USING THE INTERACTIVE FORMS | 281

List of Corporate, IRS, and other Forms and Publications on the Nolo website Te following fles are in rich text format (RTF), and are available for download at: www.nolo.com/back-of-book/NON.html

Form/Document Title File Name Bill of Sale for Assets BILLSALE.rtf Incorporation Checklist CHECKLST.rtf Cover Letter for Filing Articles COVERLET.rtf Membership Certificate MEMCERT.rtf Incorporator’s Statement INCORPST.rtf Minutes of First Meeting of Board of Directors MINUTES.rtf Offer to Transfer Assets OFFER.rtf Bylaws for Public Benefit Corporation PUBBYLAW.rtf Membership Bylaw Provisions for Public Benefit Corporation PUBMEM.rtf Special Articles Provisions for an Unincorporated Association UNINC.rtf Bylaws for Religious Corporation RELBYLAW.rtf Membership Bylaw Provisions for Religious Corporation RELMEM.rtf IRS Revenue Procedure 75-50 IRS7550.rtf IRC Section 4958, Taxes on Excess Benefit Transactions IRS4958.rtf IRS Regulations Section 53.4958-0, Table of Contents IRS4958R.rtf Member Register MEMBERREG.rtf

Te following fles are in Adobe Acrobat PDF Format, and are available for download at: www.nolo.com/back-of-book/NON.html

Form/Document Title File Name Pub 557: Tax-Exempt Status for Your Organization p557.pdf Publication 4220: Applying for 501(c)(3) Tax-Exempt Status p4220.pdf Publication 4221-PC: Compliance Guide for 501(c)(3) Public Charities p4221pc.pdf Publication 4221-PF: Compliance Guide for 501(c)(3) Private Foundation p4221pf.pdf Publication 1828: Tax Guide for Churches and Religious Organizations p1828.pdf Attorney General’s Guide for Charities guide_for_charities.pdf Guide to Charitable Solicitation 99char.pdf Public Charity or Private Foundation Status Issues under eotopicb03.pdf IRC §§ 509(a)(1)-(4), 4942(j)(3), and 507 Disclosure, FOIA, and the Privacy Act eotopicc03.pdf Update: Te Final Regulations on the Disclosure Requirements for Annual topico00.pdf Information Returns and Applications for Exemption Education, Propaganda, and the Methodology Test cpe.pdf Election Year Issues eotopici02.pdf 282 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Lobbying Issues topic-p.pdf Private School Update topicn00.pdf UBIT: Current Developments topic-o.pdf Intermediate Sanctions (IRC 4958) Update eotopice03.pdf IRS Revenue Ruling 2007-41: Political Campaign Prohibition Guidance rr-07-41.pdf Internal Revenue Bulletin (IRB 2008-18) with T.D. 9390 Final Regulation irb08-18.pdf changes to Section 4958 regulations Assessors’ Handbook Section 267, Welfare, Church, and Religious ah267.pdf Exemptions ● APPENDIX

Forms B

Incorporation Checklist Special Nonprofit Tax-Exempt Organizations *Name Availability Inquiry Letter *Name Reservation Request Form *California Form 3500A, Submission of Exemption Request *IRS Form 1023-EZ: Streamlined Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code *IRS Package 1023: Application for Recognition of Exemption (With Notice 1382) Member Register Membership Certificates * California Secretary of State forms and filing fees are subject to change. Make sure the form has not changed and the filing fee is still correct by checking the California Secretary of State’s website.

APPENDIX B | FORMS | 285

How to Form a Nonprofit Corporation in California Incorporation Checklist New* Existing** Chapter Page Groups Groups Optional*** Step Name My Group Done 6 105 ✓ ✓ Choose a Corporate Name 6 116 ✓ ✓ Prepare Articles of Incorporation 6 123 ✓ ✓ Prepare Articles for an Unincorporated Association 6 124 ✓ ✓ File Your Articles 6 129 ✓ ✓ Appoint Initial Corporate Directors 7 ✓ ✓ Prepare Bylaws 8 ✓ ✓ Prepare and File Your Federal Tax Exemption Application 9 230 ✓ ✓ Mail IRS Letter and Form 3500A to Franchise Tax Board 9 230 ✓ ✓ Set Up a Corporate Records Book 9 231 ✓ ✓ Prepare Offer to Transfer Assets 9 237 ✓ Prepare Minutes of First Board Meeting 9 245 ✓ ✓ Place Minutes and Attachments in Corporate Records Book 9 246 ✓ ✓ Comply With Bulk Sales Law 9 247 ✓ ✓ Prepare Bill of Sale for Assets 9 249 ✓ ✓ Prepare Assignments of Leases and Deeds 9 250 ✓ ✓ File Final Papers for Prior Organization 9 250 ✓ ✓ Notify Others of Your Incorporation 9 250 ✓ ✓ ✓ Apply for Nonprofit Mailing Permit 9 251 ✓ ✓ ✓ Apply for Property Tax Exemption 9 253 ✓ ✓ File Domestic Corporation Statement 9 253 ✓ ✓ ✓ Register with Attorney General (Public Benefit Corps.) 9 254 ✓ ✓ ✓ Issue Membership Certificates 9 254 ✓ ✓ File Articles With County Recorder 9 255 ✓ ✓ ✓ Register With Fair Political Practices Commission * New = Groups starting operations as newly formed corporations. ** Existing = Groups in operation prior to incorporation. *** Optional = (1) Optional step may be elected by new or existing groups; or (2) Step must be followed by some (but not all) new or existing groups to which step applies.

APPENDIX B | FORMS | 287

Special Nonprofit Tax-Exempt Organizations Application Annual Deductibility of IRC § Organization and Description Form Return Contributions1 501(c)(1) Federal Corporations: corporations organized under an Act No Form None Yes, if made for of Congress as federal corporations specifically declared to be public purposes exempt from payment of federal income taxes. 501(c)(2) Corporations Holding Title to Property for Exempt Orga- 1024 990 No nizations: corporations organized for the exclusive purpose of holding title to property, collecting income from property, and turning over this income, less expenses, to an organization which, itself, is exempt from payment of federal income taxes. 501(c)(4) Civic Leagues, Social Welfare Organizations, or Local 1024 990 Generally, No2 Employee Associations: civic leagues or organizations operated exclusively for the promotion of social welfare, or local associations of employees, the membership of which is limited to the employees of a particular employer within a particular municipality, and whose net earnings are devoted exclusively to charitable, educational, or recreational purposes. Typical examples of groups that fall under this category are volunteer fire companies, homeowners’ or real estate development associations, or employee associations formed to further charitable community service. 501(c)(5) Labor, Agricultural, or Horticultural Organizations: 1024 990 No organizations of workers organized to protect their interests in connection with their employment (e.g., labor unions) or groups organized to promote more efficient techniques in production or the betterment of conditions for workers engaged in agricultural or horticultural employment. 501(c)(6) Business Leagues, Chambers of Commerce, Etc.: business 1024 990 No leagues, chambers of commerce, real estate boards, or boards- of-trade organized for the purpose of improving business conditions in one or more lines of business. 501(c)(7) Social and Recreational Clubs: clubs organized for pleasure, 1024 990 No recreation, and other nonprofit purposes, no part of the net earnings of which inure to the benefit of any member. Examples of such organizations are hobby clubs and other special interest social or recreational membership groups. 501(c)(8) Fraternal Beneficiary Societies: groups that operate under the 1024 990 Yes, if for lodge system for the exclusive benefit of their members, which certain 501(c)(3) provide benefits such as the payment of life, sick, or accident purposes insurance to members. 501(c)(9) Volunteer Employee Beneficiary Associations: associations of 1024 990 No employees that provide benefits to their members, enrollment in which is strictly voluntary and none of the earnings of which inure to the benefit of any individual members except in accordance with the association’s group benefit plan. 501(c)(10) Domestic Fraternal Societies: domestic fraternal organizations 1024 990 Yes, if for operating under the lodge system that devote their net certain 510(c)(3) earnings to religious, charitable, scientific, literary, educational, purposes or fraternal purposes and that do not provide for the payment of insurance or other benefits to members. 288 | HOW TO FORM A NONPROFIT CORPORATION IN CALIFORNIA

Special Nonprofit Tax-Exempt Organizations (continued) Application Annual Deductibility of IRC § Organization and Description Form Return Contributions1 501(c)(11) Local Teacher Retirement Fund Associations: associations No Form3 990 No organized to receive amounts received from public taxation, from assessments on the teaching salaries of members, or from income from investments, to devote solely to providing retirement benefits to its members. 501(c)(12) Benevolent Life Insurance Associations, Mutual Water and 1024 990 No Telephone Companies, Etc.: organizations organized on a mutual or cooperative basis to provide the above and similar services to members, 85% of whose income is collected from members, and whose income is used solely to cover the expenses and losses of the organization. 501(c)(13) Cemetery Companies: companies owned and operated 1024 990 Generally, Yes exclusively for the benefit of members solely to provide cemetery services to their members. 501(c)(14) Credit Unions: credit unions and other mutual financial 1024 990 No organizations organized without capital stock for nonprofit purposes. 501(c)(15) Mutual Insurance Companies: certain mutual insurance 1024 990 No companies whose gross receipts are from specific sources and are within certain statutory limits. 501(c)(16) Farmers’ Cooperatives: associations organized and operated 1024 990 No on a cooperative basis for the purpose of marketing the products of members or other products. 501(c)(19) War Veteran Organizations: posts or organizations whose 1024 990 Generally, No members are war veterans and that are formed to provide benefits to their members. 501(c)(20) Group Legal Service Organizations: organizations created 1024 990 No for the exclusive function of forming a qualified group legal service plan. 510(d) Religious and Apostolic Organizations: religious associations No Form 1065 No or corporations with a common treasury that engage in business for the common benefit of members. Each member’s share of the net income of the corporation is reported on his individual tax return. Tis is a rarely used section of the Code used by religious groups that are ineligible for 501(c)(3) status because they engage in a communal trade or business. 521(a) Farmers’ Cooperative Associations: farmers, fruit growers, 1028 990-C No and like associations organized and operated on a cooperative basis for the purpose of marketing the products of members or other producers, or for the purchase of supplies and equipment for members at cost. For specific information on the requirements of several of these special-purpose tax exemption categories, see IRS Publication 557, Tax- Exempt Status for Your Organization. 1An organization exempt under a subsection of IRC Section 501 other than (c)(3)—the types listed in this table—may establish a fund exclusively for 501(c)(3) purposes, contributions to which are deductible. Section 501(c)(3) tax-exempt status should be obtained for this separate fund of a non-501(c)(3) group. See IRS Publication 557 for further details. 2 Contributions to volunteer fire companies and similar organizations are deductible, but only if made for exclusively public purposes. 3Application is made by letter to the key District Director.

Member Register

Certifcate Date of Issuance Member’s Name and Address Number Month Day Year Member Register

Certifcate Date of Issuance Member’s Name and Address Number Month Day Year Certifcate Number ______Received Certifcate Number ______For one membership MEMBERSHIPS IN THIS For one membership Issued To: NONPROFIT CORPORATION Tis ______day of ______, ______ARE NONTRANSFERABLE ______Date ______, ______SIGNATURE OF MEMBER

Certifcate Number ______

______A C A L I F O R N I A N O N P R O F I T C O R P O R A T I O N

MEMBERSHIP CERTIFICATE

THIS IS TO CERTIFY THAT ______is a member of the above Corporation incorporated under the laws of this state and is entitled to the full rights and privileges of such membership, subject to the duties and restrictions, as more fully set forth in the Corporation’s Articles of Incorporation and Bylaws. IN WITNESS WHEREOF, the Corporation has caused this Certifcate to be executed by its duly authorized ofcers, and its corporate seal to be hereunto afxed.