Fundraising serves as a vital mechanism to support a 501(c)(3) public charity’s mission. In today’s world where a reputation can be made or broken in a matter of seconds, effective governance lies at the heart of every successful public charity. Board members assume a critical role in this endeavor as they are the guardians of the nonprofit’s reputation, financial health, and commitment to ethical practices.

According to IRS Compliance Guidelines for 501(c)(3) Public Charities, “A governing board should be composed of persons who are informed and active in overseeing a charity’s operations and finances. To guard against insider transactions that could result in misuse of charitable assets, the governing board should include independent members and should not be dominated by employees or others who are not independent because of business or family relationships.”

Board members must grapple with the many perplexing rules and regulations connected to nonprofits that heavily rely on public and governmental support. Failure to comply with these rules may trigger severe repercussions including hefty fines, forfeiture of government grants, or even the loss of their 501(c)(3) status. Ensuring compliance is an essential duty for every board member.

Here are some key insights we share with our clients to ensure adherence to 501(c)(3) fundraising regulations.

Understand Form 990

More than just a tax document, Form 990 is vital tool for nonprofit organizations. It showcases a nonprofit’s financial information, mission, and governance practices to both the public and the IRS. It sheds light into how donations and funds are utilized.

According to the IRS, “While 501(c)(3) public charities are exempt from federal income tax, most of these organizations have information reporting obligations under the IRC to ensure that they continue to be recognized as tax-exempt. In addition, they may also be liable for employment taxes, unrelated business income tax, excise taxes and certain state and local taxes.”

Which Form 990 an organization files depends on their financial activity.

• Form 990-N: Gross receipts are $50K or less
• Form 990-EZ: Gross receipts are less than $200K and total assets are less than $500K
• Form 990: Gross receipts are $200K or more or total assets are $500K or more

Failure to file a Form 990 annually with the IRS can come with substantial penalties including steep fines or revocation of tax-exempt status. No matter what the level of activity, some Form 990 must be filed each year. The IRS considers it a best practice for the 990 to be presented to the full board before filing each year.

There are also a number of other federal compliance requirements related to donor acknowledgements and fundraising solicitations. The IRS provides a wealth of information on these requirements on their website www.irs.gov.

Know Your State Filing Requirements

Forty-two require nonprofits to register with the state before soliciting donations. State laws may have additional requirements that also need to be followed like providing donors with a written disclosure statement.

For example, in Florida disclosure requirements must include all of the following at the point of solicitation: (a) The name of the charitable organization or sponsor and state of the principal place of business of the charitable organization or sponsor.; (b) A description of the purpose or purposes for which the solicitation is being made.; (c) Upon request, the name and either the address or telephone number of a representative to whom inquiries may could be addressed.; (d) Upon request, the amount of the contribution which may be deducted as a charitable contribution under federal income tax laws.; (e) Upon request, the source from which a written financial statement may be obtained. Whereas, New York disclosure requirements must include all information specifically required by Exec. Law 172-e(2); AND a copy of the Annual Financial Report(s) encompassing the entire reporting period for which the Funding Disclosure is made, or the most recent Annual Financial Report filed, including all required forms and attachments and the associated Schedule B(s).

As with federal compliance, failure to meet state obligations can result in fines and revocation of nonprofit status. In some states (e.g., California, New York, Massachusetts), board members can be held personally liable for several reasons, including failure to file necessary tax returns. It is imperative for both the nonprofit and its board members to meet their state’s requirements.

The IRS provides state government website links for tax-exempt organizations so you can easily access your state filing requirements.

Don’t be surprised that the requirements in every state are different. It’s important to re-consider every year if your organization is correctly registered in the states where you are soliciting.

Staying Up-to-Date on Compliance Regulations

As fundraising compliance regulations are essential and noncompliance can impact both a nonprofit as well as a board member’s reputation, it’s essential to stay well-informed and up-to-date on the latest regulations. One effective approach is to establish an oversight committee tasked with regularly reviewing, interpreting, and disseminating information regarding evolving compliance standards and legal updates.

Engaging in continuous education and training programs focused on compliance issues is also extremely beneficial for board members. Our nonprofit experts at HBK can help ensure your organization stays up-to-date and informed on all fundraising compliance issues.

Is donor information disclosure required?

It’s important to know if your organization might need to disclose donor information. Some organizations are required to file a Schedule B with their Form 990, 990 EZ, or 990PF, including:

Organizations described under Section 501(c)(3). Some common examples are religious organizations; scientific and literary organizations; public charities; educational organizations; safety department organizations; organizations involved in the prevention of cruelty to children, women, or animals; and international amateur sports competitions and amateur athletic organizations.

Political organizations described under Section 527.

Nonexempt charitable trusts under Section 4947(a)(1) that aren’t treated as a private foundation.

Any organization filing Form 990 and answers “Yes” in Part IV, Checklist of Required Schedules, line 2.

In general, a tax-exempt organization is not required to publicly disclose on Form 990 Schedule B the names or address of its contributors. Key to note here is that “publicly” refers to anyone other than the IRS. All other information reported on Schedule B, including the amount of contributions, the description of noncash contributions, and any other required information, must be made available for public inspection unless it clearly identifies the contributor. Regulations specifically exclude the name and address of any contributor to the organization from disclosable documents. The exclusion does not apply to private foundations or 527 political organizations.

What does the regulation really mean? First, if a Schedule B is required when filing a 990, a complete filing for IRS purposes includes a Schedule B showing donor names, addresses, amounts given, and various other data. For many organizations, total annual donations from a single donor will be disclosed over $5,000. Larger organizations can elect to only disclose donors over a 2 percent threshold calculated each year. In the end—that is, the complete Form 990—donor information is provided only to the IRS and not to the general public or any other reporting entity, except for private foundations and 527 organizations.

The history and the debate

Anonymous giving has a long history. Philosophical thinking on anonymous giving goes back at least as far as the first century with the Roman philosopher Seneca, who wrote that anonymous gifts allow a person to avoid both praise and blame for the gift.

The freedom to keep philanthropic contributions anonymous is not just about the religious, cultural, or practical reasons that motivate many donors’ desires to keep their giving private. The rights to associate privately and contribute to organizations anonymously are also intrinsic to effective exercise of the First Amendment. Based on this premise, the U.S. Supreme Court has long recognized that compelled disclosure of the identities of people who give to charity as well as many other organizations and causes is unconstitutional.

The debate to disclose or not disclose donor information continues to this day. Various states have attempted to circumvent federal rules by passing state regulations. In 2023 alone, 24 states have donor disclosure and privacy bills under consideration.

Gather but do not disclose

Whether the organization is required to disclose or not and no matter what side of the political debate you take, organizations are required to gather and maintain donor data. An organization must keep its donors’ names and addresses in its records and make them available to the IRS in the event of an examination.

Beyond IRS examination, some reasons for maintaining donor data are driven by specific requirements:

To process a donation (e.g. a credit card transaction)

To issue a tax receipt

To recognize contributions

To meet requirements imposed by law

Other reasons are more about relationship building:

To establish a relationship and communicate with a donor

To understand who the donors are and how to improve services to meet donor preferences and expectations

One of the common failures by many organizations is that they do not correctly identify the actual donor. I often ask, “Where did the funds come from?” Historical data is often incomplete and incorrect. Here are a couple of examples.

Organization A is actively engaging a potential donor for a gift. Success: a check arrives! Mr. and Mrs. Y are happy to contribute but the check comes from their family foundation. Correct donor data should show the foundation name and address as the donor, not Mr and Mrs. Y.

Banker C is a board member and promises to contribute. Success: two checks arrive, one paid by the board member’s bank and one paid by Banker C. Correct donor data should show two unique donors.

Identifying the actual donor is vital, particularly for determining when Schedule B disclosure is required. In our second example, if the bank contributed $3,000 and the individual banker contributed $2,500, these amounts would not be combined—and neither meets the $5,000 disclosure threshold.

One challenge is that organizations need to maintain data over many years; best-practice document retention guidelines dictate at least seven years. For 501(c)(3) public charities, donor records must be kept for a minimum of five years in order to calculate the required public support test on IRS Form 990. There are many effective donor management systems available no matter the organization’s budget.

Managing donor expectations

Donors are more informed than ever about the organizations they support. One of the premier policies organizations should adopt concerns the collection, management, and use of confidential donor data. Best practices indicate policies should include:

Who is responsible in the organization, top to bottom, for confidential data

How donor names may be published

How are memorial/in-honor-of gifts handled

Will anonymous donations be accepted

How donor data will be used and by whom

What donor information is maintained and how secure the data is.

The watchdog groups are watching! In order to meet CharityWatch’s informational Privacy Policy benchmark, a charity must have a privacy policy (or policies) that apply to the collection of donor information both online and offline, and the charity must post the policy on its public website. As part of a charity’s Governance & Transparency benchmarks on charitywatch.org, CharityWatch also reports on the type of donor privacy policy a charity maintains, either “no sharing,” “opt-in,” or “opt-out,” all of which are driven by the donor and not the organization. Charities whose privacy policies lack clear information about how donors can opt-in or opt-out of personal data sharing will not satisfy CharityWatch’s Privacy Policy benchmark.

Challenging Times

Nonprofits face many challenges around donor data management and donor privacy. Here are just a few:

Be wary of all documents prepared by the organization from inception. The original application for exempt status is a public document, so contributor information typically held as confidential should not be included in this filing.

When applying for grants, nonprofits are often asked for their complete form 990 or a list of supporters. First and foremost, the complete 990 with a complete Schedule B should be given to no one other than the IRS. Any supporter list that is made public should follow the organization’s donor privacy policy discussed above.

Inadvertent disclosure of donor information does happen. Copies of form 990 are often provided to state regulators or grantors. The correct practice is to provide a “Public Disclosure Copy” of the form 990, with the Schedule B redacted. The organization needs to control who can access and/or release this type of information.

Donor education is needed for political giving as compared to charitable giving.

Some donors want to remain anonymous, especially for larger donations. This takes some donor education and again should be spelled out in the donor management policy. Executive and development staff should engage with these donors as there are organized ways to give anonymously.

The most complex recent challenge is the use of online giving platforms. Many donors see these as an easy way to give, but don’t completely understand exactly how these platforms work. Some platforms take fees off the top. Many are actually managed by donor-advised funds, which many donors misunderstand. Many provide limited donor data to the recipient nonprofit—and some are scams. Savvy donors need to investigate the platform before parting with a donation.

Conclusion

Contributions are the primary source of funding for many exempt organizations. Gone are the days when all the organization had to do was say “thank you.” The management of donors and their data is a big responsibility for all organizations.

Welcome to the March 2023 issue of Insights, a newsletter from HBK Nonprofit Solutions designed to help you navigate the financial challenges of operating a nonprofit organization.

In this issue, learn about:

• Using key person insurance to protect against the loss of your most valuable asset
• New rules from the SECURE Acts regarding including long-term part-time employees in employer-sponsored retirement plans
• The public support test on Schedule A and how passing it is essential to operating as a public charity
• The importance of financial transparency, the basics and initiatives
• How Western Pennsylvania’s Keystone Adolescent Center has been serving local communities since 1993 by helping at-risk kids 

Read about the best practices of highly effective nonprofit organizations in the latest issue of Insights, a publication of HBK Nonprofit Solutions. We hope you find Insights as interesting as it is informative, and we welcome your thoughts and input via the author contact information provided with each article. 

Read the Latest Issue.

While most nonprofits are required to file at least one of two IRS annual information returns, small tax-exempt organizations may fall under an exception and be eligible to file an annual electronic notice Form 990-N, otherwise known as an “e-Postcard.”

Typically, if your nonprofit has annual gross receipts of $50,000 or less, it will fall under the annual information return exception and be eligible to file Form 990-N. If you choose, you could file the full Form 990 or the Form 990-EZ short form return, but if you are eligible and decide to file the Form 990-N, here are a few things you need to know:

• As the name suggests, e-Postcard must be filed online; there is no paper form that can be mailed to the IRS when remitting a Form 990-N.
• Form 990-N can be filed using the IRS filing system located on the IRS Charities and Nonprofits page or can be filed with an approved e-file service provider.
• You will need assistance from the IRS to set up an account online if you use the IRS filing system.
• Late Form 990-N submissions can only be submitted using an approved e-file service provider. There is no penalty when filing a late Form 990-N, however, an organization that does not file its 990-N for three consecutive years will have its tax-exempt status automatically revoked.
• Form 990-N can be filed as soon as the day after your organization’s year-end, but is due by the 15th day of the fifth month following your organization’s year-end. There is no extension allowed when electing to file Form 990-N.

Gross receipts and filing eligibility

The IRS defines gross receipts as all amounts received without subtracting costs or expenses. However, a nonprofit can have in excess of $50,000 in gross receipts for a given year but still be eligible to file a Form 990-N if one of the following scenarios exists:

• The newly formed organization has received or donors have pledged to give $75,000 or less during its first tax year.
• The organization has been operating less than three years and averaged $60,000 or less in gross receipts during each of its first two tax years.
• The organization has been operating for at least three years and averaged $50,000 or less in gross receipts for the prior three tax years.

Signing in to the IRS filing system

As of August 2022, the sign-in process has changed for accessing the IRS filing system. New users must create an account with ID.me, the new IRS credential service provider. Existing users are able to sign in with their previous IRS login or they can create a new account on the ID.me platform. As an extra layer of security, ID.me requires multifactor authentication in order to access their filing system. The previous filing process is still in place once you have accessed the filing system.

Organizations will need the following information to complete the Form 990-N:

1. Name and address of the organization


2. Employer Identification Number


3. Name and address of the organization’s principal officer


4. Website, if applicable


5. Tax year period


6. Confirmation that the organization’s gross receipts are normally $50,000 or less


7. Confirmation if the organization has terminated or is terminating

Once you have submitted the filing, you will be able to print a confirmation page of your submission and pending status to maintain for your organization’s records. Your submission will update once the filing has been accepted or rejected.

Please reach out to the Nonprofit Solutions Group for information, or if you would like more information on how HBK can help you comply with your IRS filing requirements.

Nonprofit organizations are required to disclose substantial amounts of information regarding their activities on their annual Form 990. Some of the required information is intuitive; some of it requires understanding certain rules and definitions. Reporting of transactions with interested persons, otherwise known as Schedule L, is one such schedule that requires basic knowledge and understanding of what types of transactions are to be considered and the classes of individuals and entities that are to be included when determining what must be disclosed.

Excess Benefit Transactions

Excess Benefit Transactions is one of the more complex types of transactions to be disclosed on Schedule L. They are reported on Part I of Schedule L and exist where an economic benefit is provided, either directly or indirectly, to or for the use of a disqualified person where the consideration received in return is less than the economic benefit. These transactions are reportable for 501(c)(3), (c)(4), and (c)(29) organizations. All excess benefit transactions, regardless of amount, need to be reported on the annual return to meet 990 reporting requirements.

For purposes of these transactions, a disqualified person is an individual who has substantial influence over the organization’s affairs. This would include an organization’s top-level management,
voting members of the governing board, and anyone who has responsibility for managing the organization’s finances.

When determining whether an excess benefit transaction has occurred, all transactions between the organization and the disqualified person need to be considered as well as the factors that contribute to them being treated as a disqualified person. There are certain indicators to look for when determining whether an individual can be considered a disqualified person:

1. The individual is the organization’s founder or a substantial contributor (donated more than $5,000 in a given year, if that amount also exceeds 2 percent of the total contributions received by the organization in that year).

2. The individual receives compensation that is determined based on the revenues of organizational activities.

3. The individual has the authority to control the organization’s budget, capital expenditures, or employee compensation.

4. The individual owns a controlling interest in a trust, partnership, or corporation that is considered a substantial contributor.

Examples of Excess Benefit Transactions include payment of unreasonable compensation, sale of property to the organization by a disqualified person in excess of fair market value, payment of personal expenses, and embezzlement.

An excise tax is assessed on Excess Benefit Transactions, equal to 25 percent of the excess benefit received. The organization will be given a timeframe within which the transaction is required to be corrected, and the recipient of the excess benefit is liable for the tax. Suppose the organization fails to remedy the excess benefit transaction. In that case, an excise tax equal to 200 percent of the excess benefit may be assessed for the recipient, and the organization could have its tax-exempt status revoked.

Other required disclosures

Loans to or from interested persons should also be disclosed on Schedule L, Part II. These transactions are reportable for all organizations. For purposes of completing this portion of Schedule L, an interested person is defined as any trustee, director, officer, key employee, organization founder, substantial contributor, or family member of any interested person.

Only outstanding loans at the organization’s year-end should be disclosed. Loans can include salary advances, unsecured or secured loans, split-dollar life insurance arrangement payments that are treated as a loan, and any other receivables or advances reported on Form 990, Part X, lines 5, 6, or 22.

Loans to or from the organization to a member of the governing body that are outstanding at year-end will impair those individuals’ independence, even if those loans are made during the ordinary course of business and are done in arms-length transactions. The disclosure of these loans, in conjunction with the other disclosures made throughout the return, allows the users of Form 990 to draw their own conclusions about the organization’s activities and gives a full picture of the organization’s business dealings.

Grants or assistance provided to interested persons are required to be disclosed in Part III of Schedule L. An organization is required to disclose a grant or other assistance provided to an interested person at any time during its tax year, regardless of the amount. Examples include grants, scholarships, and discounted goods or services, including the use of facilities, fellowships, internships, prizes, and awards.

An interested person for this section of Schedule L is deemed to be those considered for Part II loans plus members of the grant selection committee and their families and employees of substantial contributors. However, grants made to a substantial contributor’s employees are not
reportable if the grants were awarded on a nondiscriminatory, predetermined set of criteria reviewed by an independent selection committee.

Grants or assistance to an interested person who is also a member of the charitable class the organization serves in carrying out its exempt purpose are also not required to be reported as long as similar grants or assistance is given to other members of the same charitable class. Part III of Schedule L intends to disclose those grants or assistance given to interested persons and their family members that were made outside of the organization’s exempt purpose and in a biased way.

The last type of transaction reported on Schedule L are business transactions involving interested persons, and these are reported in Part IV. For this section of Schedule L, the definition of an interested person is the same as for Part II.

Business transactions include joint ventures, sales, leases, licenses, insurance, and performance of services. It should be noted that business transactions that benefit the organization should not be reported unless they are between the organization and an interested person.

There are reporting thresholds for these types of transactions, unlike the other types of transactions reported on Schedule L. The minimum thresholds are:

1. The total of all payments made during the year related to one transaction is the greater of $10,000 or 1 percent of the organization’s total revenue for the year.

2. The total payments (regardless of the number of individual transactions) exceed $100,000.

3. Compensation paid to a family member of a current or former trustee, director, officer, or
key employee exceeds $10,000.

4. If entered into a joint venture with an interested person, the organization has invested $10,000 or more, and the combined profits or capital interest of the organization and the interested person in the joint venture exceeds 10 percent.

If a business transaction is required to be disclosed, the transaction should have board approval prior to being entered into.

Importance of identifying disclosures

It is important for an organization to be able to identify the types of transactions required to be disclosed, and it’s also important to know how to mitigate or remedy transactions that may impact the organization negatively. Having members of the board, management, and key employees complete an annual conflict-of-interest statement or questionnaire would assist in identifying potential transactions before they become reportable. Also, having a separate, independent compensation committee would ensure that employees and organization directors are compensated reasonably. An organization’s ability to remain transparent about its transactions with disqualified persons and other interested parties is imperative to remain compliant with the Form
990 reporting.

To satisfy the IRS requirements for identifying and reporting transactions with interested persons, an organization must display reasonable effort in its process. An annual inquiry with suspected interested parties to disclose transactions is a sufficient way for an organization to apply reasonable effort in obtaining information to report on their Form 990. If the organization cannot
obtain satisfactory information from a potentially interested party about a reportable transaction, the organization is not required to provide information about that transaction.

Read the full Summer issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

A private foundation is an organization that is exempt under IRC § 501(c) (3), but does not meet the requirements to be considered a public charity. This is generally because the private foundation is either not operating an activity that would qualify as a private charity, or the source of funds is limited to a family group, and therefore the organization is unable to show sufficient support from the general public. When an organization is classified as a private foundation, it must comply with several complicated rules governing its assets and activities. This article addresses one of the most important of those rules: the requirement to make annual qualifying distributions to avoid significant excise taxes.

Overview

In general, a private foundation is required to distribute annually an amount equal to the foundation’s “minimum investment return” in order to avoid the excise tax for a failure to distribute income. The minimum investment return generally calculates to 5 percent of the net fair market value of the foundation’s assets, with some exceptions. Only distributions that meet the definition of a “qualifying distribution” will count toward the requirement. However, if a foundation qualifies as a “private operating foundation,” it is not subject to this distribution requirement.

Minimum Investment Return

A private foundation’s minimum investment return is generally defined under IRC § 4942(e)(1) as 5 percent of the net value of the foundation’s income producing assets. Assets used directly by the foundation in carrying out its exempt purpose are not included in the net value. Whether or not an asset is used to carry out the foundation’s exempt purpose depends on the facts and circumstances, and generally requires that the foundation have a charitable activity.

For example, a private foundation that purchases a building to carry out its future plans of operating a museum should be able to exclude the value of the building from the foundation’s minimum investment return calculation. However, if the private foundation does not have plans in place to create a museum, or purchased the building solely for the purpose of generating rental income, the value of the building should not be excluded.

There may be instances where assets are used for both direct charitable and non-charitable purposes. In those instances only a portion of the asset value will be included in the minimum investment return calculation. When at least 95 percent are used in direct charitable activities, assets can generally be fully excluded from the calculation.

The timing of the value is also important when calculating the minimum investment return. Cash accounts will generally be valued as a monthly average balance, whereas other assets may be valued on any day of the year, assuming the same day is used consistently each year. Real property may qualify for a special rule that allows the private foundation to obtain an appraisal every five years.

Private foundations should look at valuations carefully to ensure they are accurate. While an excise tax may apply if the valuations used are later determined to be too low, IRC § 4942(a) (2) prevents the imposition of this excise tax, provided the foundation did not act willfully and made a good faith effort to ascertain accurate values.

What Are Qualifying Distributions?

Qualifying distributions are generally administrative expenses, payments to other exempt organizations, or amounts set aside for a specific project that has a charitable purpose:

• Administrative expenses tend to be expenses that are reasonable and necessary to accomplish the exempt purpose of the foundation. Legal and accounting fees generally qualify, as do state registration fees, trustee fees, and banking fees. To the extent any of the administrative expenses of the foundation are incurred partly for the foundation’s charitable purposes and partly for other purposes, the foundation will need to allocate the expenses between purposes. Allocation is done on Page 1 of Form 990-PF. There is no defined method for allocation, though allocations should be reasonable and consistently applied each year. We recommend looking at each administrative expense separately to determine the most accurate method of allocation. For instance, trustee fees may be allocated based on hours spent reading grant applications versus monitoring investments. In contrast, legal fee allocations may be based on the specific matter they pertain to—for example, drafting internal governance documents or giving an opinion on whether an investment strategy is aligned with the foundation’s charitable purpose.

• Payments to other exempt organizations may be qualifying distributions as long as the designated organization is not controlled directly or indirectly by the foundation or its disqualified persons, with some exceptions. In addition, payments to other private foundations will generally not qualify unless the foundation receiving the payment is a private operating foundation. Interestingly, payments made to foreign organizations may be considered qualifying distributions if the foundation has made a good faith determination that the foreign organization is not considered a private foundation.

• Amounts set aside for a specific charitable project can be a qualifying distribution when the amount set aside will be used on the project within five years. In addition, the foundation must either show that the project is better accomplished by setting aside funds instead of making immediate payments during the term of the project, or meet a mechanically defined cash distribution test that generally principally applies to foundations applying the setaside rule shortly after organizing as a private foundation.

Ordering of Qualifying Distributions

Qualifying distributions made during a current year will first reduce any undistributed income—that is, of the minimum investment return—from the immediately preceding year if the private foundation was subject to the income distribution requirements for that year. To the extent that there are excess qualifying distributions for the current year, the private foundation can elect to apply the excess to undistributed income from years prior to the immediately preceding year. If the election is not made, or there is no undistributed income for prior years, the current year qualifying distributions will reduce distributable income for the current year. Any excess qualifying distributions are deemed “distributions of corpus,” which may reduce distributable income in future years.

IRC § 4942 Excise Taxes

If a private foundation does not make sufficient qualifying distributions to distribute the entire minimum investment return for the year, the undistributed amount carries forward to the following year. The private foundation must then make sufficient qualifying distributions to cover the undistributed amount from the prior year, or a 30 percent excise tax will be imposed on the amount that remains undistributed as of the first day of the third taxable year after the amount was required to be distributed. The excise tax will continue to apply each year until qualifying distributions are sufficient to offset the undistributed amount subject to the excise tax. (See example below.)

IRC § 4942 Excise Taxes:an Example

The Smith Family Foundation calculates a minimum investment return of $10,000 during tax year 2019, but does not make any qualifying distributions. The minimum investment return for tax year 2020 calculates to $12,000, and the foundation makes qualifying distributions of $5,000 by the end of tax year 2020. The qualifying distributions of $5,000 first offset the distributable amount from tax year 2019, leaving a balance of $5,000, against which the 30 percent excise tax is assessed in tax year 2021. The foundation will need to make qualifying distributions of at least $17,000 during tax year 2021, and apply excess qualifying distributions to undistributed income from 2019 in order to avoid the excise tax in tax year 2022.

Conclusion

Private foundations need to be aware of their distribution requirements and the excise tax that could be assessed if the qualifying distributions they make are insufficient to meet those requirements. HBK Nonprofit Solutions is well versed in those requirements and regularly consults with nonprofits on adhering to qualifying distribution rules. To discuss the rules, or for a better understanding of how they could impact your private foundation, we encourage you to reach out to HBK Nonprofit Solutions.

Read the full Spring issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.

Many nonprofit organizations engage in some type of gaming activity on a regular basis, whether it’s through annual fundraising events or social events for their members. The main purpose behind these types of activities is to raise funds that are then used to further the organization’s exempt purpose (see Insights volume 1, issue 3 “Understanding a Charitable Organization’s Exempt Purpose” for discussion of “exempt purpose”). It’s important to note that gaming activities in and of themselves do not further the exempt purpose of most organizations, and therefore could be treated as taxable unrelated business income. Gaming Activities Examples of gaming activities include, but are not limited to, raffles, bingo, casino, and card games, scratch-offs, slot machines, and other games of chance. Although the IRS does not define all gaming activities, it does generally distinguish between games of chance and games of skill:

• Raffles are games of chance where the participant is required to give something of value in order to participate: cash or a required purchase of goods or services. Raffles are also referred to as lotteries.
• Contests are games of skill, where chance doesn’t determine a winner. Generally, contests aren’t considered gaming activities, even if those who participate are required to pay to play.
• Sweepstakes are games of chance where a participant isn’t required to give anything of value in order to participate (i.e., no purchase necessary) and are generally not considered gaming activities.

In all cases, wagers and similar payments aren’t considered to be charitable contributions, regardless of whether the participant wins or not. The entire purchase price of the raffle ticket or wager placed is deemed to be payment for goods and services. Not all states define gaming the same. Before engaging in any activity you believe could be considered gaming, be sure to check how the state where you’re holding the activity defines gaming and whether special licenses or permits are required to conduct gaming activities. As well, avoid online gaming activities if at all possible, as they can easily be considered interstate gambling activity, which is a violation of both federal and state gaming laws. 501(c)(3) Organizations and Gaming To qualify as a 501(c)(3) organization, the nonprofit has to operate exclusively for religious, charitable, scientific, literary, or educational purposes. Gaming activities are commonly thought of as charitable if run by a nonprofit organization. The proceeds from those activities may be used to cover expenses related to its charitable programs, but gaming activities themselves do not further any charitable purpose, and therefore must be an insubstantial part of a 501(c)(3) organization’s operations. There are no specific quantitative factors explicitly stated by the IRS to determine whether an activity is substantial or not, but all aspects of the activity will be taken into consideration when evaluating it: amounts raised, expenses paid, time spent, resources devoted. Section 501(c)(3) public charities must also be cognizant of their public support test and how their gaming and unrelated business activities might negatively impact their public support percentage. Funds raised from unrelated business income like gaming are not considered part of the “public” portion of the support test. If a public charity receives too much of their financial support from these non-public sources, they risk failing their public support test and could be classified as a private foundation. Private foundations also cannot have substantial financial support from activities classified as unrelated trade or business. Gaming activities could also be subject to unrelated business income tax, and the organization would need to report the unrelated business income from gaming activities on Form 990-T. Sections 501(c)(3) organizations also must not be organized or operated for the benefit of private interests or inure profits for the benefit of any private shareholder or individual. Any profits received from gaming activities must support the organization. Other Organizations and Gaming Social clubs and fraternal organizations classified as 501(c)(7), 501(c)(8), or 501(c)(10), as well as 501(c)(19) veterans’ organizations are exempt as providers of social and recreational activities for members and their guests. Those organizations are permitted to engage in gaming activities that involve only their members without risking their tax-exempt status. If such an organization opens its activities to the public, then its tax-exempt status would be at risk, and the income generated from those public gaming activities could also be subject to the unrelated business income tax. Social welfare organizations classified as 501(c) (4), and 501(c)(5) and 501(c)(6) labor and agriculture organizations and business leagues are treated similarly to 501(c)(3) organizations in that gaming activity cannot be a substantial portion of the organization’s activities, or it will jeopardize its tax-exempt status. Unrelated Business Income Tax As a general rule, gaming is considered unrelated to an organization’s exempt purpose and, therefore, should be subject to unrelated business income tax. There are exceptions and exclusions for certain types of gaming activities conducted by certain types of tax-exempt organizations, as outlined above. Three conditions must be met before an activity is classified as an unrelated trade or business activity: 1. The activity must be considered a trade or business. 2. The activity must be regularly carried on. 3. The activity must not be substantially related to the organization’s exempt purpose. Read the full Winter issue of Insights, the HBK Nonprofit Solutions quarterly newsletter.