California’s Dangerous Nonprofit Warning Label Bill – AB 2855 – Will Not Advance

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5/28/16 Update: Costly bill that would have required charities in California to post a “warning label” on their websites and fundraising documents was held in committee and will not advance.

AB 2855 was a dangerous bill that threatened nonprofits raising funds in California and reflected the lack of understanding of its author/sponsor, California Assemblymember Jim Frazier (D –Oakley), of the nonprofit sector’s work, influence, and scope. Had this bill passed, it would have ranked among the worst laws in the country in its characterization and treatment of nonprofits. The bill was considered by the Assembly’s Appropriations Committee on May 11. Thanks to the strong advocacy efforts of over 700 nonprofits led by CalNonprofits and to members of the Appropriations Committee and its Chair Lorena Gonzalez (D-San Diego), AB 2855 was held in committee on May 27 and will not advance.

For more information about the dangers of bills like AB 2855, read our Senior Counsel Erin Bradrick‘s article The Ongoing Overhead Myth and the Dangers of Overly Zealous State Legislators in The Nonprofit Quarterly (4/14/16).

Our original analysis of AB 2855 (before it was shelved)

Background of the Bill – Mandated Overhead Disclosures

AB 2855 originally was drafted to require charities operating or engaging in charitable solicitations in California to post their administrative overhead expenses or a link to such information on each and every one of their web pages and on the first page of each and every fundraising document.

Requirements of the ‘Warning Label’ Bill

Likely because of Constitutional issues related to compelling such speech, AB 2855 was amended to delete the overhead disclosure requirement and replace it with a requirement for charities to include what CalNonprofits terms a warning label, more specifically:

  1. a required prominent link on charities’ websites to “the Attorney General’s Internet Web site which contains information about consumer rights and protections and charity research resources”; and
  2. the Web site address of such Attorney General’s Internet Web site on all charities’ fundraising documents (including old ones) used to solicit in California.

AB 2855 would require hundreds of thousands of charities operating or engaging in charitable solicitations in California (regardless of what state in which they are based) to put a link to a California Attorney General website with unknown content that would also be freely available to the public without such link. And it would require those charities to put the Attorney General website address on tens of millions of fundraising documents that are distributed within California.

First Amendment Issues

A general principle of the First Amendment requires a court to review any government regulation of the content of a person’s or organization’s speech with strict scrutiny. Generally, this involves asking two questions:

  1. Does the regulation further a compelling governmental interest?
  2. Are the means used narrowly tailored to accomplish that governmental interest?

The government’s interest, according to the Legislative Analysis, is “to give consumers more information about how to research a charity before making a gift ….” The additional substantive information would be required of, and provided by, the Office of the Attorney General. Such information would be accessible to the general public without requiring charities to add any information to their communications. But advocates of the bill appear to be making an argument that giving consumers an easier time to find such information on a government web address is the compelling government interest requiring the consumer protection ‘warning label’ on what would amount to tens of millions of documents.

Requiring hundreds of thousands of charities fundraising in California to include such website addresses and links on all of their websites and fundraising documents will require much work. It’s difficult to see how proponents of the bill will claim that the bill is narrowly tailored particularly in relation to the rather narrow goal of making information on the Attorney General’s website easier for the general public to find. It would be the first law of such nature governing charities in the country and a strong signal of the state government’s distrust of the charitable sector based on a minuscule fraction of charities involved in scandals picked up by the media. It essentially would put charities in the same category as tobacco companies that are required to put a warning label on their products. And it would undermine the incredibly valuable work of the charitable sector, the sector most trusted by the public.

The U.S. Supreme Court dealt with content-based regulation of speech in a charitable solicitation context in Riley v. National Federation of the Blind, 487 U.S. 781 (1988). In Riley, the Court held that the North Carolina Charitable Solicitations Act was unconstitutional content-based regulation of speech. Members of the Assembly Committee should be fully aware of this case and how the Supreme Court protects free speech before voting on compelling the speech of nonprofits in the manner described by AB 2855.

Imagine if all states had the same requirements. Every charity raising funds in all states would have 50 links to include on their website and on all of their national fundraising documents.


See CalNonprofits letter to Assemblymember Lorena Gonzalez, Chair, Appropriations Committee:

The impact of AB 2855 – and thus any effort to ensure compliance with its requirements – would be far-reaching. AB 2855 would require every charity to include what feels to nonprofits like a “warning label” on their website in a “prominent” location and also requires nearly every document they produce to direct donors and others to the state’s top law enforcement’s website. Mandating content in the ways proposed by AB 2855 would be expensive and burdensome, and would detrimentally interfere with nonprofits’ ability to communicate with their constituents and the public. AB 2855 arguably compels speech in an unconstitutional manner by dictating specific content to be included on nonprofit websites and documents and seems ripe for challenge on this basis.

See CalNonprofits revised letter to the Honorable Ed Chau, Chair, Assembly Privacy and Consumer Protection Committee:

The AG’s office is already communicating this information to the public – their web site is the first listing in a Google search for “California charities.” Burdening nonprofits in and beyond California with required speech on “any document” which seeks donor support to simply advertise what the public can easily find is unnecessarily punitive without serving any compelling public interest. Imagine all the “documents” that non-profit organizations create to solicit funds to support their mission-based work: signs on coin collection jars, private letters to individual donors, billboards and other large-scale outdoor advertisements, flyers posted in laundromats, neighborhood association newsletters, to name just a few. And AB 2855’s provisions would apply to any charity – regardless of where they are based – that solicits donations from Californians. So, every inbound piece of mail from any charity in the world would have to include this unnecessary disclosure. The additional cost of including this provision on “any document” would be extraordinary.

Also see the Opinion piece by Tim Delaney, chief executive of the National Council of Nonprofits, in The Chronicle of Philanthropy:

The bill, as amended late last week, would force every nonprofit in the country that seeks funds in California to put a link on its home page – plus a disclosure on all other solicitation materials directing potential supporters to  the California Attorney General’s Office.  That office is instructed to provide “information about charities, informational materials containing consumer rights and protections and charity research resources to allow donors to become informed about a charity before making a decision to give.” Such legislative  language puts nonprofits at the mercy of an elected partisan’s changing views on what’s “appropriate” on such things as overhead, compensation, and advocacy – as well as which charitable causes are worthy. It probably will prompt copycat legislation in other states, transforming nonprofit website homepages into huge advertisements for the offices of state charity regulators, rather than the mission of the actual nonprofit.

Burdens and Costs to the State Government

AB 2855 will create substantial burdens for the State’s Office of the Attorney General in developing a website with appropriate information on how to research a charity (a very complex matter approached in myriad ways by grantmakers), developing regulations related to the law (including determining the minimum contacts required to fall within AB 2855 – e.g., a “donate” button on a passive website clicked by 5 California residents?), educating the public about the law and its associated regulations, re-designing registration and registration renewal forms, enforcing the law in audits, defending litigation on the constitutionality of the law (which would be expected in light of the almost universal opposition by the nonprofit sector).

You can access the May 11, 2016 Bill Analysis for the Appropriations Committee (which includes the comment “unduly onerous”) here.

Foreign Corporations and the Application of California Nonprofit Laws

Map of CaliforniaA foreign corporation, a corporation formed under the laws of another state, that conducts business in California may be subject to more of California’s laws and jurisdiction than one might think. Generally, activities occurring in California are regulated by California laws (e.g., employment, health and safety, revenue and taxation). California’s Nonprofit Integrity Act of 2004, for example, applies to foreign nonprofit corporations doing business or holding property in California for charitable purposes (Government Code Section 12582.1) and imposes audit and reporting requirements on such organizations.

However, the California Attorney General (the “AG”) asserts that foreign nonprofit corporations transacting business in California are subject to provisions of the California Nonprofit Corporation Law, which includes laws relating to standards of conduct, investments, and examination by the AG. It’s not precisely clear how much business in California would trigger application of the Nonprofit Corporation Law, but the AG has informally stated that a foreign nonprofit corporation operating substantially all of its activities in California will be subject to the Nonprofit Corporation Law, including on any statutory restrictions on how the corporation’s board is composed.

Internal Affairs Doctrine

In general, the internal affairs of a corporation are governed by the laws of the state of incorporation. (Edgar v. MITE Corp. (1982) 457 U.S. 624, 645.) This principle, known as the Internal Affairs Doctrine, applies primarily to issues related to the corporation’s structure or internal administration, such as, the steps required to incorporate, adopt bylaws, elect officers and directors, hold meetings, and take board or membership actions. Thus, a not-for-profit corporation formed under New York’s Not-for-Profit Corporation Law should refer to such law when drafting its bylaws.

However, when a foreign corporation enters California, it is also required to comply with state laws in the conduct of its business. (Black v. Vermont Marble Co. (1905) 1 Cal. App. 718, 720.) California courts may apply its laws to a foreign nonprofit corporation doing business in California, maintaining an office in California, or holding property in California for charitable purposes. “Doing business” can mean a number of activities including, soliciting donations in California by mail or advertisements, having directors or officers perform work in California, or conducting any charitable programs in California.

Courts may be particularly interested in applying local laws to a foreign nonprofit corporation when an important public policy is at issue, such as the protection of donors, members, or residents. In addition, the Internal Affairs Doctrine described above does not generally apply to situations where torts, transfer of assets, or contract disputes are involved. California courts have, in the past, extended the reach of California laws to apply when corporate actions involve California citizens and residents, and impacts the sale or disposition or transfer of shares of stock. (Western Air Lines, Inc. v. Sobieski (1961) 191 Cal. App. 2d 399). According to the California AG, the trend here is that California courts are less likely to apply the Internal Affairs Doctrine when important state interests are at stake.

Furthermore, the less contact the organization has with its state of incorporation, the less likely the courts will apply the laws of that state of incorporation. If the organization formed in New York has little to no contact with New York while maintaining its only office and conducting all of its charitable work in California, the courts are more likely to apply California law to disputes that arise.

Authority Asserted by the California Attorney General

The California AG cites to California Corporations Code Section 6910 to assert authority over foreign corporations transacting business in California. The AG interprets Section 6910 to mean that foreign nonprofit corporations transacting business in California are subject to all of California Nonprofit Public Benefit Corporation Law, which may, in many cases, be different than, and in conflict with, the laws of the state of incorporation.

However, Section 6910 does not make it clear when the California Nonprofit Public Benefit Corporation Law applies. Section 6910 provides as follows:

Foreign corporations transacting intrastate business shall comply with Chapter 21 (commencing with Section 2100) of Division 1, except as to matters specifically otherwise provided for in this part and except that Section 2115 shall not be applicable.

Note that the “Chapter 21” reference is to the Corporations Code provisions otherwise applicable to for-profit corporations, which generally deal with matters such as obtaining a certificate of qualification to do business in California with the Secretary of State, maintaining a resident agent for service of process, filing an annual statement of information, and making unauthorized distributions. The remaining part of Section 6910 provides “except as to matters … provided for in” the Nonprofit Public Benefit Corporation Law. The AG reads Section 6910 as an authorizing statute providing that the Nonprofit Public Benefit Corporation Law applies. A plausible alternative is that it only conditions where Chapter 21 doesn’t apply.

Specific California laws that the AG has asserted against foreign corporations include:

  • 49% Limitation on Interested Directors (Corp. Code §5227) – In California, not more than 49% of the board of a nonprofit public benefit corporation may be “interested persons,” which includes any person receiving compensation from the nonprofit for services rendered within in the past 12 months and anyone related to the compensated person.
  • Self-Dealing (Corp. Code §5233) – Under California law, a director of a nonprofit public benefit corporation cannot engage in a self-dealing transaction (a transaction in which he or she has a material financial interest) with the nonprofit except under certain conditions and pursuant to certain procedures. The transaction must be fair and reasonable and a majority of the directors (not including the vote of the interested director) must approve such transaction after disclosure of the director’s interest. In addition, either (1) the board must have considered and in good faith determined after reasonable investigation under the circumstances that the corporation could not have obtained a more advantageous arrangement with reasonable effort under the circumstances or (2) it must be shown that the corporation in fact could not have obtained a more advantageous arrangement with reasonable effort under the circumstances. More information here.

It is still not clear under what specific circumstances the courts will agree with the AG and apply California Nonprofit Public Benefit Corporation Law over the corporate laws of the foreign state. In the past, a California court opined, “actions taken in California concerning the administration of [a] charity should not escape the scrutiny of California law, merely because the founders chose to incorporate elsewhere.” (American Center for Education, Inc. v. Cavnar (1978) 80 Cal. App. 3d 476).

How to Start a 501(c)(4) California Nonprofit Step by Step

Business strategy plan over ladder leading to success

You’ve got an idea for making the world a better place, and you want to start a 501(c)(4) nonprofit social welfare organization as the means to do so. In contrast to a 501(c)(3) charitable organization, a 501(c)(4) organization may engage in unlimited lobbying in furtherance of its social welfare purpose and some political campaign intervention activities (e.g., endorsing political candidates) so long as it is not primarily engaged in such intervention. But, generally, a 501(c)(4) organization is not qualified to receive charitable contributions deductible to its donors.

It’s easy to start a nonprofit, but just because you can, doesn’t mean you should. Even the best intentions can lead to bad results when supported by a poor strategy. Before starting a nonprofit social welfare organization, founders should invest meaningful time and thought in determining whether they can actually create a sustainable nonprofit that will effectively and efficiently bring value to the public. This means founders should create a basic business plan that (1) describes the organization’s mission and its core activities, (2) identifies the resources required to carry out those activities, and (3) details reasonable strategies for acquiring those resources. It also requires founders to realistically assess whether they can recruit strong leaders and key supporters and undertake homework for becoming knowledgeable about the basic laws governing nonprofit and 501(c)(4) organizations, the duties and responsibilities of board members and officers, and the market in which they will operate and compete. The advice of experts can also be valuable in determining whether the plan is viable and what changes need to be made, if any.

Before you get started, you’ll also want to consider whether 501(c)(4) is the right type of exemption for your plan and whether you should (1) apply for IRS recognition of 501(c)(4) federal tax-exempt status using Form 1024 (which we generally recommend) or (2) self-declare the organization’s 501(c)(4) status and ensure that the organization complies with all the associated requirements.

11 steps for starting a California nonprofit public benefit corporation exempt under 501(c)(4):

  1. Determine the name of the corporation.  A nonprofit is typically formed as a corporation and its name can be a valuable asset. In California, a corporation name may be adopted if the name is not the same as or too similar to an existing name in the records of the California Secretary of State, or if the name is not misleading to the public. You can check the current database of existing names on the business search page of the Secretary of State website. You can also reserve a name for 60 days by mailing in a Name Reservation Request. You must also make sure the name does not infringe on another person’s trademark rights. This is not always easy to determine, but a good start includes running a trademark search on the U.S. Patent and Trademark Office database and a simple Google search. For some founders, it may also be important to confer with intellectual property counsel to help ensure they are not infringing on another’s rights and to protect their name from being used by other parties.
  1. Draft and file the articles of incorporation.  A corporation is legally created with the filing of the articles of incorporation. Articles of incorporation typically identify:
    • The organization’s name;
    • Purpose or purposes of the nonprofit;
    • Agent for service of process — that is, a person whose name and address are identified and who can receive lawsuits and other official correspondence; and
    • Any limitations on corporate powers.

The articles of incorporation are typically signed by an “incorporator,” which can be just one person but may also be signed by the initial board of directors if they are named in the articles.

The sample articles for California nonprofit public benefit corporations found on the Secretary of State’s website are specific to those seeking exemption under 501(c)(3) and not 501(c)(4). In our opinion, form documents from governmental agencies generally meet minimal requirements but do not provide guidance on several important considerations. For example, sample articles may provides little guidance on specific purpose statements.

A word on specific purpose statements: A broad specific purpose statement provides room for the organization’s mission to evolve without requiring an amendment to the articles of incorporation. It may also make it easier to comply with charitable trust laws that require charitable funds be used consistent with the specific purpose of the organization at the time such funds were originally acquired. If, instead, you adopt a narrow purpose statement such as “to advocate for legislation and regulations to improve the environment in San Francisco County,” you can’t use funds to advocate for environmental improvements in other counties, but the statement would provide a stronger mission anchor to help ensure that your organization stays on a specific course after the founders have left.

For additional information on this issue, read Starting a Nonprofit: Articles of Incorporation and Specific Purpose Statements.

More about the agent for service of process: It is also important to understand that the agent is responsible for receiving lawsuits and possibly other important legal documents on behalf of the organization and making sure those documents reach the President or other authorized officer in a timely manner. If the agent fails to do so (e.g., fails to have his or her mail checked regularly while away for an extended period) the organization could face negative consequences such as losing a default judgment for not showing up to defend a lawsuit. An organization can identify an individual as agent or may elect to pay for a corporate agent, which may be preferred if there is no person willing to accept this responsibility or if privacy concerns are an issue (the agent’s street address will be a matter of public record).

  1. Appoint the board of directors.  If the initial directors are not named in the articles of incorporation, the incorporator can and should appoint the board through a written action. Recruiting and appointing the initial board of directors may well be the founders’ most important startup task. A new nonprofit has a significantly better chance at long-term viability and impact when the right people are at the wheel. These individuals should share your organizational vision and core values but should also bring other skills, perspectives, and networks to the table.

Under California law, a nonprofit board may be composed of as few as one director, but it is generally recommended to have at least 3. California law also requires that not more than 49% of the current directors be “interested persons” as defined in Corporations Code section 5227, which includes any person receiving compensation from the nonprofit for services rendered within in the past 12 months and anyone related to the compensated person.

These directors should understand their duties and responsibilities to act with reasonable care and in the best interests of the organization while providing direction and oversight over the organization’s activities, finances, officers, and legal compliance. BoardSource offers valuable resources on nonprofit corporate governance, including these Ten Basic Responsibilities of Nonprofit Boards.

  1. Draft the bylaws and conflict of interest policy.  A corporation’s bylaws typically address, at a minimum, fundamental provisions related to the management of the activities and affairs of the corporation. Bylaws should provide guidance to the board and reassurance of sound governance practices to government authorities, funders, and other interested stakeholders.

Bylaws typically contain specific provisions detailing:

    • The purpose or mission of the nonprofit;
    • How directors are elected or otherwise selected (e.g., by majority vote of directors at the annual board meeting);
    • How the board may take an action (e.g., by majority vote of directors);
    • How board meetings are called and noticed (e.g., six times per year with 14 days advance notice by email);
    • How board meetings are conducted (e.g., the chair of the board presides);
    • The officers of the corporation (a president or chair of the board, secretary, and treasurer or chief financial officer are required by California law);
    • The duties and responsibilities of each officer;
    • The authorization of board and non-board committees (e.g., committees tasked to act with the authority of the board versus committees that can only make recommendations);
    • The level of indemnification provided by the corporation to protect its directors, officers and other agents; and
    • The reports due to directors (e.g., financial reports).

If the nonprofit has voting members, the bylaws will also need to contain additional provisions regarding member rights and processes. Nonprofits considering a voting membership structure may want to first discuss such structure with a lawyer, particularly if they do not expect their members to actively participate in meetings and regularly exercise their voting rights. Public Counsel provides an Annotated Form of Bylaws for a California Nonprofit Public Benefit Corporation on its website.

  1. Take the initial board actions at a board meeting or by unanimous written consent of the directors.  The board should take the following actions:
    • Adopt the bylaws and conflict of interest policy;
    • Elect officers;
    • Adopt a fiscal year (such as a year ending December 31 or June 30);
    • Approve establishing a bank account;
    • Approve applying for federal and state tax-exempt status;
    • Approve reimbursement of startup expenses (if applicable); and
    • Approve the compensation of the executive director (CEO) or the treasurer (CFO) (if applicable).
  1. Obtain an employer identification number (EIN).  An officer or authorized third party designee may apply for and obtain an EIN online.
  1. Notify the Internal Revenue Service (IRS) of intent to operate as a social welfare organization.  Social welfare organizations will soon be required to notify the IRS within 60 days after the organization is established of its intent operate, as established by section 405 of the Protecting Americans from Tax Hikes Act of 2015 (the PATH Act). The IRS issued Notice 2016-09 on January 19, 2016 stating that he Treasury Department and the IRS intend to issue temporary regulations prescribing the manner in which social welfare organization will provide the notification (which the IRS hopes but has not promised will be electronic). Even organizations that seek IRS recognition of tax-exempt status using Form 1024 will need to provide this new notification.
  1. File the initial registration form (Form CT-1) with the California Attorney General’s Registry of Charitable Trusts.  This annual registration is required for the majority of nonprofit public benefit corporations and must be filed within 30 days after receipt of assets. The Form and Instructions are available online. The corporation’s articles of incorporation and bylaws should be included in the initial filing. The Form 1024 application and federal determination letter (Step 9) should be submitted upon receipt of the determination letter to complete the filing.
  1. File the Statement of Information (Form SI-100) with the Secretary of State.
    The Statement must initially be filed within 90 days of the date of incorporation. This biennial filing requirement, which identifies the organization’s address, principal officers, and agent for service of process, can be filed online or by mail.
  1. Make the decision whether to apply for federal tax exemption with the IRS and receive a determination letter from the IRS.  Organizations that believe they are properly classified as a 501(c)(4) organization may self-declare their tax exempt status and begin filing Form 990s, without submitting a Form 1024 to the IRS. However, it is generally recommended to complete the Form 1024 application for exempt status under Internal Revenue Code (IRC) Section 501(c)(4), in order to have some assurance that your plan is consistent with the requirements of 501(c)(4). Form 1024 requires a comprehensive reporting of all activities carried on by the organization. A critical section for careful completion is Part II, Activities and Operational Information, which asks:

For each past, present, or planned activity, include information such as:

    • A detailed description of each activity including its purpose and how each activity furthers your exempt purpose;
    • When the activity was or will be initiated; and
    • Where and by whom the activity will be conducted.

Form 1024 also requires information regarding (a) annual compensation of any officers, directors, or trustees; (b) membership qualifications, classes, and voting rights, if any; and (c) actual and/or projected statement of revenues and expenses (which should be consistent with any identified activities).

Form 8718, User Fee for Exempt Organization Determination Letter Request, must be attached to Form 1024 for filing. Currently, the user fee for a new organization that anticipates gross receipts averaging more than $10,000 during its first 4 years is $850. Smaller organizations may be eligible for the $400 user fee.

The IRS may typically take 4-6 months to process a Form 1024 application for exempt status. However, the waiting period may be much longer if the application contains errors, omissions, or other information that require additional development by a special IRS department. The IRS application process is further explained on the IRS’s Where Is My Exemption Application webpage.

  1. Apply for California tax exemption with the California Franchise Tax Board (FTB) and receive an affirmation of exemption letter from the FTB.  Organizations with a 501(c)(4) federal determination letter can request California affirmation of tax exemption under California Revenue & Taxation Code section 23701f from the FTB by filing Form 3500A along with a copy of the IRS determination letter. The FTB will recognize the organization’s exemption from state income taxes as of the federal effective date. You can find a downloadable form here.

If the organization chose to self-declare its federal tax exempt status, it will need to file the long Form 3500 to apply for state income tax exemption in California.

Should You Start a Nonprofit?

Now that you know how to start a California nonprofit, you should thoughtfully consider whether this is the right choice for your ideas and for the public benefit. There may be other ways to carry out your dreams, including working within or supporting an existing nonprofit. See Alternatives to Forming a Charitable Nonprofit published by the American Bar Association. One often overlooked alternative is fiscal sponsorship, a relationship that may allow a group to house a charitable project within an existing nonprofit with the ability to spin it off at a later date. Note, however, that finding a 501(c)(4) fiscal sponsor may be much more difficult than finding a 501(c)(3) fiscal sponsor. For more information on fiscal sponsorship, see Fiscal Sponsorship: A Balanced Overview published by The Nonprofit Quarterly.

Commercial Fundraiser – A Revised Definition

Commercial Fundraiser

Beginning on January 1, 2016, a “commercial fundraiser” in California is defined as any individual, corporation, unincorporated association, or other legal entity who for compensation does any of the following:

  1. Solicits funds, assets, or property in this state for charitable purposes.
  2. As a result of a solicitation of funds, assets, or property in this state for charitable purposes, receives or controls the funds, assets, or property solicited for charitable purposes.
  3. Employs, procures, or engages any compensated person to solicit, receive, or control funds, assets, or property for charitable purposes.
  4. Plans, manages, advises, counsels, consults, or prepares material for, or with respect to, the solicitation in this state of funds, assets, or property for charitable purposes, but is disqualified as a fundraising counsel for charitable purposes pursuant to subdivision (a) of Section 12599.1.

It’s the fourth activity (described in red font above) that newly creates another category of commercial fundraiser. Planning, managing, advising, counseling, consulting or preparing materials for, or with respect to, charitable solicitations, in and of themselves, are activities that are generally associated with another regulated fundraising position known as fundraising counsel. But such activities can lead a professional fundraiser to fall within the definition of a commercial fundraiser if:

  • the professional fundraiser is compensated as a percentage of the funds, assets, or property received as a result of a solicitation campaign rather than as a flat fee; or
  • the professional fundraiser receives or controls the funds, assets, or property received as a result of a solicitation campaign, including indirectly by:
    • the right to approve or veto any payment from an escrow account to which such funds are subject;
    • maintenance of an interest in an account into which solicited funds are deposited;
    • the right to access such funds, assets, or property held by a caging company (a business that receives contributions, processes donor mail, and deposits all contributions to an account under the sole control of the charitable organization);
    • any ownership or management interest in any other entity that receives or controls the funds, assets, or property solicited for charitable purposes, including, but not limited to, an escrow agent or caging company, but not including any federally insured financial institution; and
    • receipt of any financial benefit, directly or indirectly, from any other individual or entity that receives or controls the funds, assets, or property solicited for charitable purposes, other than the trustee or charitable corporation soliciting the funds, assets, or property for charitable purposes.

The purpose behind this change in the definition (as part of AB 556) is to close a loophole that some professional fundraisers used to avoid the more rigorous disclosure requirements to which commercial fundraisers are subject:

  1. Commercial fundraisers must disclose to donors that the solicitation is being conducted by a commercial fundraiser and must identify themselves by the name under which they are registered with the Attorney General.
  2. Commercial fundraisers must disclose the percentage of total fundraising expenses of the fundraiser (the ratio of the total expenses of the fundraiser to the total revenue received by the fundraiser for the charitable purpose for which funds are being solicited) upon receiving a written or oral request from a person solicited.

Principal Registration and Reporting Requirements

Commercial fundraisers in California are also subject to several registration and reporting requirements, including:

Form CT-1CF (Annual Registration Form)
For use by commercial fundraisers prior to soliciting any funds in California for charitable purposes.

Form CT-2CF (Annual Financial Report – Commercial Fundraisers)
Disclosure reporting form for use by every commercial fundraiser to report funds or assets received as a result of a solicitation for charitable purposes.

Form CT-10CF Form (Notice of Intent To Solicit For Charitable Purposes – Commercial Fundraiser)
For use by commercial fundraisers for charitable purposes to provide 10 working days’ notice prior to the commencement of each solicitation campaign, event, or service, in accordance with Govt. Code sec. 12599(h).

See Office of the Attorney General site for Forms and Instructions.

Not Commercial Fundraisers

The following persons or entities are explicitly not commercial fundraisers:

  • any trustee holding property in trust pursuant to any charitable trust, or any of such trustee’s employees;
  • any charitable nonprofit corporation or any employee of such nonprofit corporation;
  • any employee of a commercial fundraiser;
  • any federally insured financial institution that holds, as a depository, funds received as a result of a solicitation for charitable purposes; or
  • any escrow agent or caging company that receives or controls funds received as a result of a solicitation for charitable purposes.

Characterization by the Office of the Attorney General

Presumably, in large part due to the efforts of some commercial fundraisers to hide or misrepresent the amounts they raise that ultimately go to the targeted charities, the Office of the Attorney General has included some cautionary statements on its webpage describing commercial fundraisers:

Historically, use of a commercial fundraiser has meant higher costs for a charity. Most of the charities registered with the Registry of Charitable Trusts do not employ commercial fundraisers to solicit donations on their behalf. Historical figures show that a campaign conducted by a commercial fundraiser returns to charity, on average, less than 50 percent of the contributions it raises on a charity’s behalf. The remainder is retained by the commercial fundraiser as a fundraising fee and for reimbursement of expenses.

Legal Compliance

With the heightened scrutiny of commercial fundraising practices, it is more important then ever for commercial fundraisers to operate in full compliance with applicable laws. Here are a few tips for commercial fundraisers beyond the registration and reporting requirements:

  • It must enter into a written contract with a charity for each solicitation campaign, event, or service. Such contract must be available for inspection by the Attorney General and contain all of the provisions required under Gov. Code Sec. 12599(i).
  • It must provide to the charity the right to cancel the contract without cost, penalty, or liability for a period  of 10 days following the date on which the contract is executed, and the right to terminate the contract at any time with or without cause upon 30 days’ written notice.
  • It must only contract with a charity that is actively registered with the Attorney General’s Registry of Charitable Trusts or agrees to register prior to the commencement of any solicitation.
  • It must provide to the Registry of Charitable Trusts with each application for registration and registration renewal a cash deposit or bond in the amount of $25,000 for the benefit of any person damaged as a result of malfeasance or misfeasance in the conduct of the commercial fundraiser regulated activities.
  • It shall not misrepresent (including through the failure to disclose a material fact) the purpose of the charity or the nature or purpose or beneficiary of a solicitation.
  • It shall ensure that charity knows that the charity must establish and exercise control over its fundraising activities conducted for its benefit, including approval of all written contracts and agreements, and must ensure that fundraising activities are conducted without coercion.

New California Regulation Poses Threat to Nonprofits Not Properly Registered

venus flytrap - dionaea muscipula with a trapped fly

Effective as of January 1, 2016, new regulations related to administrative enforcement of violations of the Supervision of Trustees and Fundraisers for Charitable Purposes Act go into effect. We wrote about the regulations when they were first proposed (see our post explaining our opposition to the regulations here).

Also read Erin Bradrick’s article in the Nonprofit Quarterly:

California’s New Regulations: The Start of a New Problematic Trend in State Charity Oversight?

Now that regulations are set to become law, all nonprofits operating and/or raising charitable funds in California must be prepared to comply and stay in compliance with the registration requirements. Failure to comply can result in suspension or revocation of a nonprofit’s registration status, and operating while suspended or revoked can potentially result in dire consequences, including, in worst case scenarios, personal liability of board members and forced distribution of the nonprofit’s assets to another nonprofit.

Registration and Annual Reporting Requirements

The California Office of the Attorney General (“AG”) describes the registration and reporting requirements (applicable to most 501(c)(3) and 501(c)(4) organizations except religious organizations, educational institutions, and hospitals) as follows:

The Supervision of Trustees and Fundraisers for Charitable Purposes Act (Government Code sections 12580-12599.8) requires registration and annual reporting by all charitable nonprofit corporations, unincorporated associations, trustees, and other legal entities holding assets for charitable purposes. The law’s application is not limited to entities that are tax exempt under section 501(c)(3) of the Internal Revenue Code. With very limited exception, the Supervision of Trustees and Fundraisers for Charitable Purposes Act applies to any person/entity holding money or property for charitable purposes, including entities that are tax exempt under other subsections of 501(c), entities that are not tax exempt, and for-profit entities that hold assets for charitable purposes. … Nonprofit religious organizations, educational institutions, and hospitals are exempt from the registration and reporting requirements.

Suspension or Revocation by the AG

Registration status refused, suspended, or revoked for:

  • Misuse of charitable assets
  • False or misleading statements and/or conduct in connection with a solicitation for charitable purposes
  • False or misleading statements in a requiring filing with a government agency, including the AG, IRS, and Franchise Tax Board (FTB) – Note that the omission of material information in a required filing, like a redacted schedule of contributors (Schedule B, Form 990) filed with the AG, constitutes a false or misleading statement.
  • Failure to comply with statutory Standards of Conduct applicable to directors and managers

Registration automatically suspended for:

  • Nonprofit’s tax-exempt status is suspended (which can happen with missing a single filing) or revoked (which will happen automatically with missing required filings for 3 consecutive years) by the IRS or FTB
  • Nonprofit fails to file with the AG an annual registration renewal (Form RRF-1) together with a copy of its Form 990 for 3 consecutive years
  • Nonprofit corporate status is suspended or revoked by the California Secretary of State (which can happen with missing a single filing of a Statement of Information)

Prior to suspending an organization, the AG will first mail a notice to the registrant identifying what is needed to resolve the suspension. If the AG does not receive the information needed to resolve the suspension within 30 days of the issuance of the notice, the registration is suspended. This notice will only be helpful if the AG has the current address of the organization on its records.

Registration automatically revoked (without further action by the AG) if:

  • Nonprofit has been suspended for one year.

Potential Penalties for Operating While Suspended or Revoked

As a result of operating while suspended or revoked, directors may be held personally liable and the AG may direct the nonprofit’s funds be distributed to another nonprofit. While the AG has informally told us that it would not take such actions except in egregious cases, it has the authority to use its discretion without any further evidence of misconduct. When you factor in that more than 100,000 nonprofits operating in California are not in compliance with the registration requirements and the AG is now going to make a push at compliance, it’s now critical for nonprofits to comply with all of the registration and reporting requirements with the AG, the California Secretary of State, and the FTB. As Erin writes in the Nonprofit Quarterly article:

Section 999.9.3 of the regulations provides that, if an entity that is required to register with the California Attorney General’s Registry of Charitable Trusts has had its registration suspended or revoked, “[m]embers of the board of directors or any person directly involved in distributing or expending charitable assets [while the organization is suspended or revoked without the written approval of the Attorney General] may be held personally liable” for the amounts of such expenditures. The same Section goes on to provide that “[t]he Attorney General may direct a registrant whose registration has been suspended or revoked to distribute some or all of its charitable assets…to another charitable organization or into a blocked bank account.”

Make sure you file:

California Nonprofits

  • Form CT-1 (initial registration) or Form RRF-1 (registration renewal) together with a Form 990 with the AG every year
  • Form CT-694 (annual solicitation financial report) with the AG for each year in which more than $1 million was collected in contributions from donors in California
  • Form 199 or 199-N with the FTB every year
  • Statement of Information (Form SI-100) with the Secretary of State every two years (or earlier if updating certain information)

Out-of-State Nonprofits Operating in California

  • Form CT-1 (initial registration) or Form RRF-1 (registration renewal) together with a Form 990 with the AG every year\
  • Form CT-694 (annual solicitation financial report) with the AG for each year in which more than $1 million was collected in contributions from donors in California
  • Form 199 or 199-N (if the nonprofit is recognized by the FTB as tax-exempt) or Form 100 (if the nonprofit is taxable) with the FTB every year
  • Statement of Information (Form SI-350) with the Secretary of State every year (or earlier if updating certain information)

Out-of-State Nonprofits Fundraising Residents of California

  • Form CT-1 (initial registration) or Form RRF-1 (registration renewal) together with a Form 990 with the AG every year
  • Form CT-694 (annual solicitation financial report) with the AG for each year in which more than $1 million was collected in contributions from donors in California

California Governor Signs Administrative Dissolution Bill Into Law

Close up view - The end - written on an old typewriter


On September 30, 2015, Governor Brown signed into law Assembly Bill No. 557, making amendments to the laws governing dissolution of California nonprofits. The amendments, which will become effective on January 1, 2016, essentially create two new sets of dissolution procedures for California nonprofits: an automatic dissolution process and a streamlined dissolution process.

Automatic Dissolution Procedures

Under the automatic dissolution procedures of AB 557, provisions are to be added to the California Corporations Code sections applicable to nonprofit public benefit, mutual benefit, and religious corporations, as well as to foreign nonprofit corporations qualified to do business in California, providing for the automatic dissolution or surrender of such corporations under certain circumstances. The bill provides that a nonprofit corporation whose powers have been suspended or forfeited by the Franchise Tax Board for 48 consecutive months or more shall be subject to administrative dissolution or surrender.

Prior to such automatic dissolution, the Franchise Tax Board will mail a notice of the impending dissolution to the nonprofit’s last known address and will also send the name of any nonprofit subject to such dissolution to the Secretary of State and the Attorney General’s Registry of Charitable Trusts. The Secretary of State is then required to provide notice of the planned dissolution of such entities on its website for at least 60 days, as well as instructions for how a nonprofit may submit a written objection to the dissolution. If no written objection is received by the Franchise Tax Board within the 60-day notice period, the nonprofit will be dissolved. If a written objection is received, the nonprofit will have an additional 90 days from the date of the objection to cure any outstanding defects with the Franchise Tax Board. The Franchise Tax Board has the authority to extend this cure period for one additional 90-day period, but no longer.

If a nonprofit is automatically dissolved pursuant to these procedures, the liabilities owed to any creditors of the nonprofit and any liabilities of its Directors will remain in place, and the dissolution will not impact the ability of the Attorney General to enforce any liabilities with respect to the corporation or its Directors as provided by law (e.g., for the diversion or misuse of charitable assets). However, the law does provide a process by which a nonprofit’s liabilities for qualified taxes, interest, and penalties owed to the Franchise Tax Board may be abated upon its automatic dissolution.

The automatic dissolution procedures are intended to assist the Franchise Tax Board in clearing its records of nonprofits that are no longer operating, but have not gone through the formal legal process of dissolving. There is some minimal risk that nonprofits not intending to dissolve may be caught up in these automatic dissolution procedures. However, given that a nonprofit must have been suspended by the Franchise Tax Board for at least 4 consecutive years for the procedures to apply, this risk is likely very low. And it is likely even lower since a California nonprofit that failed to file a required return with the Franchise Tax Board for three consecutive years will have had its California tax-exempt status automatically revoked on the date that its third missed return was due (similar to the procedures for automatic revocation of federal tax exemption).



The Franchise Tax Board provides on its site:

We will administratively dissolve or surrender a corporation that:

  • We suspended or forfeited for more than 48 continuous months.
  • Is no longer in business.
  • Has not filed returns for 4 or more years.
  • Has not filed a Statement of Information with California Secretary of State (SOS) for 4 or more years.

Administrative dissolution process

  • We send a notice to the nonprofit corporation’s last known address. If we do not have a valid address, we deem that posting on the SOS nonprofit corporation’s website that the nonprofit corporation is administratively dissolved or surrendered is sufficient notification.
  • We send the SOS and the Office of the Attorney General, Registry of Charitable Trusts (AG), the pending administratively dissolved or surrendered nonprofit corporations’ names and SOS file numbers.
  • The SOS provides a 60-calendar day notice of the pending administrative dissolution or surrender on their website. They list the corporation name and the SOS file number.
  • If we receive no written objection before the 60 day period expires, the nonprofit corporation is administratively dissolved or surrendered.
  • We abate qualified tax, interest, and penalty liabilities upon administrative dissolution or surrender.
  • Liabilities to creditors do not discharge. Liabilities of the director or persons related to the administratively dissolved or surrendered nonprofit corporation do not discharge. A nonprofit corporation’s administrative dissolution or surrender shall not diminish or adversely affect the AG’s ability to enforce liabilities.

Streamlined Dissolution Procedures

Given the complexity and expense that can be associated with the current process for dissolving a California nonprofit corporation, a streamlined dissolution process is certainly a welcome development. Unfortunately, however, the procedures set forth in AB 557 are available to only a narrow class of nonprofits and are unlikely to change the dissolution process for the vast majority of California nonprofits seeking to legally dissolve.

The streamlined dissolution procedures set forth in AB 557 provide that a nonprofit corporation that has not issued any memberships may dissolve by having a majority of its Directors sign and verify a certificate of dissolution. Once the certificate of dissolution is filed with the Secretary of State, the corporation is dissolved and it is the responsibility of the Secretary of State to notify the Attorney General’s Registry of Charitable Trusts and the Franchise Tax Board of the corporation’s dissolution.

This is certainly a much simpler dissolution process than is currently available to nonprofits. However, this streamlined process may only be used if the Directors are able to state and verify all of the following:

  • The certificate of dissolution is being filed within 24 months after the corporation’s articles of incorporation were filed;
  • The corporation does not have any outstanding debts or other liabilities, other than tax liabilities, and all existing tax liabilities will be satisfied or be assumed by another individual or entity;
  • A final franchise tax return has been or will be filed with the Franchise Tax Board;
  • The known assets of the corporation remaining after paying any known debts or liabilities have been distributed as required by law; and
  • The corporation was created in error.

These limitations on which corporations may use the streamlined dissolution procedures raise a few questions. For example, what does it mean to certify that a corporation was “created in error”? Is it sufficient that, in retrospect, the Directors feel that incorporating was a mistake, or is this requirement intended to apply only to corporations that were truly mistakenly formed (assuming it is even possible to mistakenly file articles of incorporation)? Also, if a nonprofit corporation is required to distribute all of its assets prior to taking advantage of the streamlined dissolution process, is it required to provide notice to the Attorney General in advance of such distribution of all or substantially all of its assets? If so, this largely defeats any procedural benefits of a streamlined dissolution process and, if not, will there be any oversight to ensure that any assets held by such nonprofits are appropriately distributed to be used in furtherance of permissible exempt purposes? The fact that the streamlined dissolution process is only available to corporations that were formed within the two years prior to their planned dissolution will also make it unavailable to the great majority of California nonprofits seeking to dissolve.

In short, while the automatic and streamlined dissolution procedures set forth in AB 557 are a step in the right direction in terms of dissolving inactive nonprofit corporations and easing the procedural burdens of dissolution, they unfortunately will have little impact on the voluntary dissolution procedures applicable to most California nonprofit corporations.

See the FTB Notice regarding AB 557 here.



The California Secretary of State has now made available on its website a Domestic Nonprofit Corporation Short Form Certificate of Dissolution form that may be used by nonprofits that are eligible to use the streamlined dissolution procedures outlined above.  The new form may be filed with the Secretary of State beginning on January 1, 2016.


California Social Purpose Corporation: An Overview

The social purpose corporation is one of two “hybrid” corporate forms in California that provide alternative business entity options to entrepreneurs who want to combine profitability with broader social and environmental objectives (the other is the benefit corporation). Formerly known as the flexible purpose corporation, the social purpose corporation requires directors to consider socially responsible purposes, in addition to shareholder interests, when making business decisions.

Special Purposes

In addition to engaging in any lawful business purpose, the social purpose corporation must set out one of the following special purposes in its articles of incorporation:

  • One or more charitable or public purpose activities that a nonprofit public benefit corporation is authorized to carry out.
  • The purpose of promoting positive effects of, or minimizing adverse effects of, the social purpose corporation’s activities upon any of the following, provided that the corporation consider the purpose in addition to or together with the financial interests of the shareholders and compliance with legal obligations, and take action consistent with that purpose:
    • The social purpose corporation’s employees, suppliers, customers, and creditors.
    • The community and society.
    • The environment.

Fiduciary Duties

While directors of any corporation must fulfill their fiduciary duties of care and loyalty to the corporation, directors of the social purpose corporation must also consider and give weight to additional factors, as they deem relevant, including the overall prospects of the corporation, the best interests of the corporation and its shareholders, and the purposes of the corporation, as set forth in its articles of incorporation.


Annual Report – The board must produce and send to its shareholders an annual report, containing a management discussion and analysis (the “special purpose MD&A”), along with standard corporate financial statements. The special purpose MD&A must, among other things, identify and discuss (1) material actions taken to achieve the corporation’s special purpose throughout the fiscal year, (2) the impact of such actions, including the causal relationships between the actions and the reported outcomes, and (3) the extent to which those actions achieved the special purpose objectives for the fiscal year. It must be made publicly available on the corporation’s website.

Current Report – In addition to the annual report with the special purpose MD&A, shareholders of a social purpose corporation must receive a special purpose current report within 45 days of any (1) significant expenditure in furtherance of the corporation’s special purposes, (2) withholding of expenditures in furtherance of the corporation’s special purposes, or (3) a determination that a special purpose has been satisfied or should no longer be pursued. Such reports must also be made publicly available on the corporation’s website.

Major Changes

Amendment to Articles– Any amendment that changes the special purposes of the corporation can only be approved with an affirmative vote of at least two-thirds of the outstanding shares of each class, or a greater vote if required by the articles.

Conversion/Merger– Similar to the requirements for an amendment, any reorganization that materially alters or eliminates the corporation’s special purposes requires the vote of at least two thirds of each class of outstanding shares, or more if required by the articles. These supermajority voting rights function as substantial control for even minority shareholder groups.

Derivative Actions – Any shareholders of the social purpose corporation may maintain a derivative lawsuit to enforce the duties required of the directors of the corporation.

Why Would You Form a Social Purpose Corporation?

Instead of a Nonprofit Corporation – If you are seeking investors and equity capital and/or have a plan that is inconsistent with tax exemption under IRC Section 501(c)(3).  In order to establish and maintain tax exemption under 501(c)(3), a nonprofit corporation must be primarily operated for a  charitable or other exempt purpose. If an organization plans to engage in activities that are in direct competition with for-profits, or operate in a manner that is too commercial with respect to pricing, marketing methods, sources of revenue, staffing, and use of surpluses, then a social purpose corporation may be a better choice of form. Additionally, in contrast to a nonprofit corporation, a social purpose corporation is not subject to prohibitions on private inurement or private benefit; self-dealing rules; restrictions on lobbying or political campaign activities; or 501(c)(3)-like public disclosure requirements.

Instead of a Regular (For-profit) Corporation – If you want to market the corporation’s goods and services as a social business, attract capital from social investors (including foundations), and anchor your social mission even after you exit from the ownership. For-profit corporations traditionally are organized to pursue the interests of their shareholders above all other interests. While the business judgment rule may provide broad flexibility for board members to consider other interests, this may not be true in the event of a sale of the corporation. In such event, the Revlon Rule generally provides that the board must approve a sale to the highest bidder without consideration of other factors.

Instead of a Benefit Corporation – If you want more flexibility than is provided by a California benefit corporation. A benefit corporation’s directors must advance a “general public benefit,” and must also consider a number of stakeholders, including shareholders, employees, subsidiaries, suppliers, customers, and the community, as well as the local and global environment. A social purpose corporation must only take into account its shareholders and its special purposes, as stated in its articles of incorporation. Accordingly, board members of a social purpose corporation may have fewer considerations when making decisions and less risk of liability for failure to consider required factors.

Concluding Thoughts

Although the social purpose corporation may be an attractive option for entrepreneurs who want to emphasize social impact as one of the core missions of their business, the adoption rate of the social purpose corporation has been slow. According to the California Secretary of State’s Office, since its introduction in 2012, there have been only 68 flexible purpose corporations and 9 social purpose corporations formed (as of 10/16/15).


Executive Compensation – The Legal Issues

Determining the appropriate amount of compensation to pay an executive is one of the most important decisions a board is asked to make. Board members must balance budgetary concerns with the need to find a qualified candidate. Traditionally, it was not uncommon for nonprofits to expect executives to work for significantly less than they might earn elsewhere because of their passion for the organization’s mission. However, that’s a poor business strategy to rely on for recruiting or retaining the right person for the most pivotal position to the organization’s success.

While, ideally, nonprofit executives should be sufficiently compensated for their valuable work, many nonprofits still tend to be very conservative with paying reasonable compensation to their executives. This may be due in part to limited funds. But for some organizations, lower compensation rates may also be linked to board members’ concerns about staying compliant with tax and charitable trust laws that can impose penalties for approving excessive compensation. In extreme cases, excessive compensation can be held to be a form of private inurement, which can result in revocation of the organization’s tax-exempt status. In other cases, it can be a form of private benefit or excess benefit transaction, which may result in the required return of the excessive amount and penalty taxes imposed on the executive as well as the board members who approved the transaction knowing the compensation to be excessive. Moreover, if the organization is a private foundation, it can be an act of self-dealing, which can also subject the organization to penalty taxes.

Both federal and California law have aimed to regulate nonprofit executive compensation. Under the California Nonprofit Integrity Act of 2004, charitable corporations and unincorporated associations must have their governing board of directors or authorized board committee review and approve the compensation, including any bonuses, of the (1) CEO or President, and (2) the CFO or Treasurer, to ensure that the payment is “just and reasonable.”

Under federal law, the overall compensation to any employee “may not exceed what is reasonable under all the circumstances.” Treas. Reg. 1.162-7(b)(3). Note that compensation includes salary and benefits, such as insurance, a car, housing allowance, or other fringe benefits that should be included in the calculation of total annual compensation. The following steps should be considered when approving executive compensation:

Create an Independent Committee

An independent body charged with approving compensation may be made up of the full board of directors or a smaller authorized board committee, so long as all members of the body do not have a conflict of interest with respect to the compensation arrangement. This means that no person voting on the compensation may be:

  • a member of the director or employee’s family,
  • in a position to benefit financially if the transaction is approved or disapproved,
  • an employee of the nonprofit who works under the executive’s direction,
  • an employee of the nonprofit whose compensation is subject to approval by the executive, or
  • involved in any financial transaction with the nonprofit that has been, or will be, subject to the executive’s approval.

If the independent body is a board committee, such committee should be delegated with appropriate authority by the board and operate in accordance with the corporation’s bylaws.

Approve Compensation Arrangements as Required

The California Nonprofit Integrity Act requires that the board or an authorized board committee review and approve the compensation arrangement (1) initially upon the hiring of the position; (2) whenever the term of employment, if any, of the officer is renewed or extended; and (3) whenever the officer’s compensation is modified (unless the same modification applies to substantially all employees as may be the case with a cost-of-living increase). California nonprofits should be careful to approve the executive’s compensation as required, including generally whenever a bonus may be awarded.

Use Appropriate Comparability Data

The recommended process for determining the appropriate compensation package for an executive is to conduct a review of what similarly-sized organizations, in the same geographic area, offer their executives (of comparable level). Such comparability data may include, but is not limited to:

  • compensation levels paid by similarly organizations, both taxable and tax-exempt, for equivalent positions in the same community or geographic area;
  • the availability of similar services in the geographic area of the applicable tax-exempt organization;
  • current compensation surveys compiled by independent firms; and
  • actual written offers from similar institutions competing for the services of the executive.

Organizations should make sure that the data they rely on is detailed enough to be an adequate comparison. For example, a national survey of compensation for university presidents that does not delineate criteria such as the number of students served, academic ranking, geographic location, or annual revenues, would not be sufficient data as to the comparability of what a local university should pay its president. However, specific information obtained from a customized compensation survey commissioned from an independent firm, or even a written summary of a telephone survey of three or more unrelated local universities of similar size and ranking, are both appropriate examples of data to rely on as to comparability.

Keep Adequate Documentation

Simply stating that your organization approved a compensation arrangement is not the same as being able to prove it.  The documentation should be in writing and include the following information:

  • the terms of the transaction and the date it was approved;
  • the members of the independent committee who were present when the transaction was debated;
  • the comparability data obtained and relied on by the independent committee and how the data was obtained; and
  • any actions taken by a regular member of the independent committee who had a conflict of interest with respect to the transaction (e.g., abstention).

The documentation should also be timely and accurate. For a decision to be documented properly, records must be prepared before the board or committee’s next meeting or 60 days after the board or committee’s final actions are taken, whichever is later. Records must be reviewed and approved by the independent body as reasonable, accurate, and complete within a reasonable time period. Additionally, nonprofits filing IRS Form 990 must be able to describe the process they use to approve executive compensation arrangements.

Understand the Rebuttable Presumption of Reasonableness Procedures

Generally, if the IRS penalizes a disqualified person (DQP) under the excess benefit transaction rules, such individual bears the burden to prove that the compensation arrangement was reasonable. A DQP may be a director, officer, substantial contributor, family members, or a 35% controlled entity. However, if the organization follows the Rebuttable Presumption of Reasonableness procedures described below with respect to the compensation package, the burden of proof shifts to the IRS to show that the compensation arrangement was excessive. Using the rebuttable presumption of reasonableness procedures to approve compensation arrangements can help a nonprofit ensure that it is paying appropriate compensation to its key employees and mitigate the risks of an IRS charge of excessive compensation and the associated penalty taxes.

The Rebuttable Presumption of Reasonableness procedures consist of three steps:

  1. The compensation arrangements are approved in advance by an authorized body of the organization composed entirely of individuals who do not have a conflict of interest with respect to the compensation arrangement (Treas. Reg. 53.4958-6(a)(1));
  2. The authorized body obtained and relied upon appropriate comparability data prior to making its determination (Treas. Reg. 53.4958-6(a)(2)); and
  3. The authorized body adequately documented the basis for its determination concurrently with making that determination (Treas. Reg. 53.4958-6(a)(3)).

Adopt a Robust Conflict of Interest Policy

Adopting and following the procedures of a conflict of interest policy can also help eliminate improper private benefits (e.g., excessive compensation) flowing to interested individuals before they occur. A good policy can help ensure that when actual or potential conflicts of interest arise, the organization has a procedure in place under which the interested individual can advise the board about all the relevant facts concerning the conflict, and the board can appropriately act and determine whether it is necessary to excuse such interested individual from voting. A good policy will also describe the process of recording such discussions in the board or committee minutes so that there is accurate documentation of the proceedings. Note that the IRS Form 990 asks whether the organization has a conflict of interest policy, and also about the procedures used by the organization to handle conflicts.


Overall, nonprofit organizations should not be deterred from considering paying their highly skilled and highly valued executives on the higher end of the salary range for similar positions in similar organizations. However, an organization should be able to justify that the compensation is fair and reasonable under the circumstances, and that the organization adequately documented the approval of such compensation package.

Proposed Regulations Threaten California Nonprofits – Comments due July 13


Your Comment Counts words on a red suggestion box to illustrate the value and importance of feedback, opinions, suggestions and brainstorming ideas


In a previous post, we warned our readers about the initial draft of these proposed regulations from the Office of the Attorney General of the State of California:

The proposed regulations, if adopted, will mean such charities will need to suspend activities and fundraising if they are delinquent in their registration, and if suspended or revoked, their board members will be subject to personal liability and their assets subject to forced divestiture.

A revised version of the proposed regulations dated June 25, 2015 failed to adequately address the three provision we believe threaten California’s nonprofit sector and all individuals served by California nonprofits. You have until 5 p.m. on Monday, July 13, to send your comments to Joseph N. Zimring, Deputy Attorney General at

According to this article by Jeffrey Davine of Mitchell Silberberg & Knupp LLP:

The California Department of Justice, however, estimates that there are 52,000 charities within California that have not complied with these requirements. Moreover, it is estimated that there are at least 130,000 additional non-California charities operating in the State that have not complied with these requirements.

Assuming such statistics are accurate, if the proposed regulations are promulgated, over 180,000 charities in California will be required to stop operation until they have fixed their registration issues (which may take several months). 180,000! What would be the impact on the people relying on the services those charities are providing? What is the likelihood that this rule will most impact those most in need, particularly in rural and poor areas? And what message is the Attorney General sending by stating that if those 180,000 charities don’t stop operating, the Attorney General can hold the board members personally liable and take away all of the charity’s assets?

§ 999.9.3. Disclosure and Restrictions on Use of Charitable Assets After Suspension or Revocation of Registration.

(b) A registrant that has been suspended or revoked may not distribute or expend any charitable assets or assets subject to a charitable trust without the written approval of the Attorney General. Members of the board of directors or any person directly involved in distributing or expending charitable assets may be held personally liable in a civil action brought by the Attorney General for any charitable assets or assets subject to a charitable trust that are distributed or expended in violation of this regulation.

Why It’s a Problem:  A charitable nonprofit that is late filing a single form with a California agency may be suspended. If a nonprofit is suspended (whether it is aware of the suspension or not) but still operates (which generally means it’s expending charitable assets), the Attorney General has the power to sue the board members. This is the true even if the nonprofit is expending funds to pay its employees, live up to its contractual operations, or deliver urgent services to its beneficiaries. This will have a chilling effect on board recruitment and on the desire for nonprofits to operate in California.

(c) The Attorney General may direct a registrant whose registration has been suspended or revoked to distribute some or all of its charitable assets or assets subject to a charitable trust to another charitable organization or into a blocked bank account.

Why It’s a Problem:  If a charitable nonprofit has been suspended (e.g., for one late filing), that fact alone gives the Attorney General power to force the nonprofit to give all of its assets to another nonprofit.

§ 999.9.1. Automatic Suspension.

(d) A registration that has been continuously suspended for one year pursuant to this regulation shall be automatically revoked.

Why It’s a Problem:  A charitable nonprofit that is unaware of its suspended status (possible due to a change in mailing address, a common scenario for all-volunteer organizations) may have its registration revoked. While the revised version of the proposed regulations included a 30-day notice period to allow a noncompliant charity to cure the violation causing an automatic suspension, this notice will not be helpful if the organization’s leaders do not receive it.

Why the AG Wants These Regulations

I get why the Attorney General wants to propose regulations with teeth that forces the tens of thousands of noncompliant charities operating in California to comply with the registration requirements. I agree this is a major problem that needs to be addressed. But the draft regulations provide an inelegant solution, leaving it up to the Office of the Attorney General to pick and choose which charities and board members will be the examples facing the stiff consequences with little guidance. Why not limit the draconian consequences to more specific situations and eliminate the possibility of imposing such consequences upon an organization that missed a single filing resulting in suspension.

You can read more about the proposed regulations on the Wexler Law Group post, Second Bite at the Apple. We encourage you to also check out his very detailed comments.

Endorse Our Letter of Concerns

Please consider adding your endorsements to the Letter to Attorney General detailing our concerns with the proposed regulations. Joining us as signatories to the letter are  Barbara Rosen of Evans Rosen LLP; the California Association of Nonprofits; the National Council of Nonprofits, the Nonprofits Insurance Alliance of California (NIAC) and NIAC’s Founder/President/CEO Pamela E. Davis, and Independent Sector. The letter has also been endorsed by the United Ways of California; the Alliance for Justice; and Anne Wallestad, President & CEO, BoardSource. Even thought the comment period has passed, your endorsements will add weight to our efforts to protect charities operating in California and the millions of people they serve. Please contact us or leave your endorsement in the comments section below. Thank you for your advocacy!


California Charity Registration: Form 990 Schedule B Disclosure

Compliance mind map, business concept

California requires a charity subject to its registration requirements to submit its IRS Form 990 including Schedule B (Schedule of Contributors) with its annual registrations to the Registry of Charitable Trusts. The list of major contributors, which remains confidential pursuant to current policy and proposed regulations*, may not be redacted from the filing.

While the right of the California Attorney General to require the unredacted Schedule of Contributors has been challenged by organizations, last month, the U.S. Court of Appeals for the Ninth Circuit affirmed a lower court’s decision to deny a preliminary injunction against the Attorney General. Notwithstanding this decision, the Ninth Circuit has yet to issue an order to compel the appellate, the Center for Competitive Politics (CCP), to file the unredacted Schedule with the Registry of Charitable Trusts. On May 15, 2015, CCP filed an emergency appeal with the U.S. Supreme Court, but it was denied by Justice Anthony Kennedy. CCP intends to file a full appeal this summer.

* Proposed Regulation 301.1


Donor information treated as confidential by the Internal Revenue Service pursuant to Internal Revenue Code section 6104(d)(3)(A) shall be treated as confidential by the Attorney General and shall not be disclosed except as follows:
1.  In a court or administrative proceeding brought pursuant to the Attorney General’s charitable trust enforcement responsibilities; or
2.  In response to a court order, search warrant, or administrative subpoena.

Read more …

California Attorney General Can Demand Full IRS Forms From Charity – Forbes

Court Affirms California Attorney General’s Demand for Confidential Donor List – Seyfarth Shaw LLP

No protection — yet — for group’s donor privacy – SCOTUSblog