Two Lawline CLE Programs for Attorneys Helping California Nonprofits

We are presenting two Continuing Legal Education (CLE) programs for Lawline on Friday, January 13, 2016 that we hope California attorneys will find helpful in their representation of nonprofits:

 Forming a California Nonprofit (Erin)

This program will discuss the process of forming a California nonprofit entity, going through the legal considerations involved in each step in detail. We will start with a discussion of some of the appropriate things to consider before beginning the formation process and then turn to the mechanics of formation, including drafting Articles of Incorporation, Bylaws, and a Conflict of Interest Policy. We will also cover other legal considerations that apply to California nonprofits, including registration requirements at the state level.

Most nonprofits are required to separately seek recognition of tax-exemption at the state and federal levels, so we will take a close look at the requirements for exemption and the application process, focusing primarily on 501(c)(3) organizations. Finally, we’ll briefly touch on some alternatives to forming a California nonprofit that may be attractive in certain circumstances.

Throughout the session, Erin Bradrick, Senior Counsel at NEO Law Group, will illustrate concepts through examples and will provide information on how to access additional resources.

Earned Income Issues and Guidance for California Nonprofits (Gene)

Many people are surprised to learn that over 70% of the revenues from reporting public charities comes from the sale of goods and services. And charities are increasingly engaging in earned income (and social enterprise) ventures as they face the simultaneous challenges of uncertainty in public fundraising and the tax benefits associated with charitable giving, undependable philanthropic funding, and increased competition for limited resources. But earned income is an area wrought with misconceptions and misunderstandings.

The rules governing unrelated business taxable income (UBTI) are complex. As a result, many non-profits simply fail to properly report and pay taxes on their UBTI or preclude themselves from starting an earned income venture. As the differences in the activities of non-profit and for-profit organizations continue to blur with the increasing commercialization of charities and the growth of socially-purposed taxable entities (like the benefit corporation), the associated tax issues will only get more complicated. Subsidiaries, joint ventures, and commercial co-ventures may be useful options for some non-profits if entered into with sufficient knowledge and consideration.

This audio-only course, taught by Gene Takagi, the managing attorney of NEO Law Group, a firm specializing in non-profit law, reviews the legal issues that should be considered when reviewing a non-profit’s earned income venture and offers practical guidance on best practices for both in-house and outside counsel.

When Should a 501(c)(3) Consider Creating an Affiliated 501(c)(4)?

Closeup of businessman making decision whether to accept or deny a suggestion or employee.

501(c)(3) organizations have numerous tools at their disposal for achieving their charitable purposes, and also have the distinct advantage of being able to receive contributions that are generally tax-deductible for donors.  However, in exchange for tax-exemption and the ability to receive deductible charitable contributions, the law places some limitations on the permissible advocacy-related activities of 501(c)(3) organizations.  These limitations have led some 501(c)(3) organizations to make use of affiliated 501(c)(4) social welfare organizations, which are generally subject to fewer limitations and restrictions, to best further their common primary mission.

The limitations associated with 501(c)(3) exempt status include a complete prohibition on engaging in any activities that constitute intervention in a political campaign and a requirement that no more than an insubstantial amount of a 501(c)(3)’s activities constitute lobbying.  While we unfortunately do not have a clear definition of “insubstantial” in this context, as we’ve previously written about on this blog, many 501(c)(3) organizations have the option of making the election under IRC Section 501(h) to have their lobbying activities measured based solely on expenditures.  Section 501(h) also offers fairly generous thresholds for permissible lobbying expenditures by an electing organization.

Nonetheless, some 501(c)(3)s find that they could more effectively pursue their missions through lobbying or election-related activities beyond those permissible for 501(c)(3)s.  In that case, forming an affiliated 501(c)(4) organization may be an attractive option.

Unlike 501(c)(3)s, 501(c)(4) organizations are permitted to engage in an unlimited amount of lobbying activities, provided such activities are in furtherance of the organization’s social welfare purposes.  They may also engage in a limited amount of political campaign intervention activities, so long as such activities are secondary to their general social welfare activities.  Because of the greater flexibility that 501(c)(4)s have in these areas, they can be a great tool for effectively furthering a social welfare mission.

Once you’ve decided to form an affiliated 501(c)(4), you may find our post on the step by step process for creating a 501(c)(4) helpful.  However, before launching into forming a new entity, here are a few things to consider:

  • Capacity – In creating a separate 501(c)(4), you are creating a separate legal entity with its own filing, registration, and compliance obligations, and operational needs. The 501(c)(3) should carefully assess whether it has access to the additional capacity necessary to create and run a separate entity.
  • Funding – While 501(c)(4)s are exempt from federal income taxes, donations to them are typically not deductible for donors. Accordingly, finding funding for a 501(c)(4)’s activities can be challenging.  Before beginning the process of forming an affiliated 501(c)(4), it would be wise for a 501(c)(3) to ensure that the 501(c)(4) will be able to attract sufficient funding to set it up for success, and that the pursuit of such funding will not negatively impact the 501(c)(3)’s ability to fundraise from common donors.
  • Affiliation Structure – Because nonprofits do not have any owners, it is not possible to a create a 501(c)(4) “subsidiary” of a 501(c)(3). However, if close affiliation between the two organizations is desired, there are a few options for structuring such affiliation.  These structures are usually created in the 501(c)(4)’s Bylaws, which will be subject to the laws of the state in which the entity was incorporated.  In California, one option may be to create a voting membership structure with the 501(c)(3) as the sole voting member of the 501(c)(4).  Alternatively, the 501(c)(3) could be given the right to designate some or all of the Directors of the 501(c)(4).  However, in setting up such an affiliation, the 501(c)(3) will need to be mindful of the need to maintain appropriate separation between the entities, for the purposes of both ascending liabilities and to ensure it does not jeopardize its own tax-exempt status.
  • Exemption/Registration – Another distinction between 501(c)(4) and most 501(c)(3) organizations is that 501(c)(4)s may self-declare as exempt from federal income taxes without needing to file an application with the IRS. Many 501(c)(4)s nonetheless choose to file a Form 1024 and obtain recognition of tax-exemption in order to have the assurance that comes with such recognition.  In addition, as of mid-2016, organizations intended to operate as exempt under Section 501(c)(4) must file IRS Form 8976 with the IRS no later than 60 days after the organization is formed (see our earlier blog post on this requirement here).
  • Maintain Appropriate Separation – Because 501(c)(4)s can engage in activities that 501(c)(3)s may not, it is important that appropriate separation between two such affiliated organization be maintained and that the 501(c)(3) not allow its assets to be used to subsidize the activities of the 501(c)(4) that are prohibited for the 501(c)(3). For example, if the 501(c)(3) wishes to make a grant to an affiliated 501(c)(4), it should be made pursuant to a written grant agreement that clearly requires the funds to be used solely for 501(c)(3)-consistent purposes.  Accordingly, a general operating grant from a 501(c)(3) to a 501(c)(4) would not be permissible, even for startup costs, as such a grant could serve to further activities not permissible for the 501(c)(3).  A grant made for the stated purpose of supporting the 501(c)(4)’s lobbying activities must be accounted for as a lobbying activity and/or expenditure of the 501(c)(3), and a grant that does prohibit its use for lobbying may also be attributed as a lobbying expenditure by the 501(c)(3).  If the two entities will share resources, such as staff or facilities, such sharing should be pursuant to a resource sharing agreement that ensures that the 501(c)(4) pays at least its fair share for the costs of the day-to-day operations of the 501(c)(4).
  • Political/Election Laws – Finally, if a 501(c)(4) does engage in lobbying or election-related work, it may be subject to additional election and political laws beyond the tax laws generally discussed in this post. A 501(c)(4) will need to be aware of any such applicable laws in advance of engaging in lobbying or election-related activities in order to ensure compliance.  Note that a 501(c)(3) may also be subject to some political and election laws if it engages in certain activities, particularly permissible nonpartisan election-related activities.

In summary, in many instances, creating an affiliated 501(c)(4) can be a highly effective means of furthering an organization’s mission.  However, it is important to think through the various considerations in advance to ensure that such an affiliation is proper under the particular circumstances, and will be set up for success.

Starting a Nonprofit: Environmental as a 501(c)(3) Charitable Purpose

Green Globe On Moss - Environmental Concept

An environmental purpose is not one of the seven exempt purposes specified in Section 501(c)(3) of the Internal Revenue Code (the “Code”). However, many environmental organizations qualify for exemption under 501(c)(3) because their activities further charitable, educational, and/or scientific purposes.

Although there is no explicit mention of environmental purposes in the statutes or regulations defining what is charitable under Section 501(c)(3) of the Code, the IRS has said that efforts to preserve and protect the environment for the benefit of the public serve a charitable purpose. However, not every activity directed at advancing environmental benefits is recognized as charitable. Additional factors may be required to show that the environmental activities are “lessening the burdens of government” and/or “combating community deterioration.” (See Starting a Nonprofit: What is “Charitable” under 501(c)(3)).

IRS rulings reveal that the IRS looks for activities that have a “significant” and “direct” impact on the environment when determining if an activity qualifies as charitable. In addition, the charitable aspects of the activity must outweigh any commercial or private benefits. Any private benefit conferred upon individuals or for-profit businesses that is more than incidental, quantitatively and qualitatively, to the environmental preservation activities will defeat the exemption. Some rulings suggest that credible studies and research should be provided to the IRS to demonstrate the direct and significant impact of the proposed activities.

Examples of environmental organizations that served charitable purposes according to the IRS include:

  • an organization that planted trees in public areas when the city did not have sufficient funds to do so, thus lessening the burdens of government and combating community deterioration (Rev. Rul. 68-14, 1968-1 C.B. 243);
  • an organization that acquired and maintained ecologically significant land, the IRS noting that the benefit to the public was guaranteeing “future generations … the ability to enjoy the natural environment” (Rev. Rul. 76-204, 1976-1 C.B. 152).

Examples of organizations that did not qualify for exemption because the impact on the environment was determined to be too indirect or resulting in too much private benefit, include:

  • an organization that provided particular solar panels to low and middle class income households, where the impact on the environment was “indirect and tangential” and the benefits flowed to a select group of homeowners rather than the general community (Priv. Ltr. Rul. 201210044 (2012);
  • an organization whose primary activity was beta testing green residential housing products to make those products market-ready, because the direct and primary beneficiaries were the private business manufacturing the products (Priv. Ltr. Rul. 201149045 (2011).

In Example 12 of IRS’s final regulations for program related investment (PRIs), effective April 2016, the IRS illustrates another instance where furthering an environmental interest is recognized as charitable so long as the private benefit is only incidental to the overall charitable nature of the activity. In the example, a private foundation is permitted to make an investment in a new business enterprise in a developing country whose only activity would be to collect recyclable solid waste and deliver those materials to recycling centers. Although the investment was benefiting a private business, the primary purpose for making it was to combat environmental deterioration, in furtherance of the foundation’s exempt purposes. The facts show that the business was unable to attract other funding because the expected rate of return was low, and thus, the IRS reasons, the foundation would not have made the investment but for its charitable purpose.

As more nonprofits are created to address new and continuing environmental concerns, it will be interesting to see how such activities are characterized as charitable or not by the IRS. Alternative energy, segments of the sharing economy, and eco-friendly products all pose several questions for the future.

Lorman Webinar: Complexities of Starting a Nonprofit in California

Erin is presenting a live webinar titled, Complexities of Starting a Nonprofit in California, for Lorman on October 13 at 10:00 a.m. – 11:30 a.m. PST. Here is the description of the program:

This topic will cover the process of forming a California nonprofit entity, going through the legal considerations involved in each step in detail. We will also cover some additional California law considerations that apply to nonprofit, as well as considerations for organizations seeking recognition of exemption under Internal Revenue Code Section 501(c)(3). Concepts will be illustrated through examples and information on how to access additional resources will be provided. By the end, you will have a better understanding of the process of forming a California nonprofit entity, obtaining federal and state tax-exemption, and complying with some common ongoing legal requirements.


Learning Objectives:

  • You will be able to describe the formation process.
  • You will be able to recognize the organizational mission and developing business plan.
  • You will be able to discuss alternatives to forming a nonprofit.
  • You will be able to review California law considerations.

Attendees of this webinar can earn CLE, CAC, or CPE credit, and can get 50% off of the webinar price using this link. For more information about the agenda, click here.

Starting a Nonprofit: Form 1023 or Form 1023-EZ?

Young business woman writing easy and hard compare on balance bar. Blue background.

Most new charitable nonprofits other than churches will seek 501(c)(3) recognition from the IRS. Since July 2014, qualifying nonprofits have been able to apply for recognition of 501(c)(3) tax-exempt status using either Form 1023 or the much simpler Form 1023-EZ. While Form 1023-EZ has since become the more popular application form, it may not always be the most beneficial to a nonprofit.

Who Qualifies to File the Form 1023-EZ

The Instructions for Form 1023-EZ provide an eligibility worksheet starting on page 11. Among the 26 qualifications necessary to use Form 1023-EZ:

  • Projected annual gross receipts must not exceed $50,000 in any of the next 3 years
  • Actual annual gross receipts must not have exceeded $50,000 in any of the past 3 years
  • Total assets must not exceed $250,000
  • The organization must not be a foreign organization, LLC, successor to a for-profit entity, church, school, or hospital
  • The organization must not request classification as a supporting organization or a private operating foundation
  • The organization must not maintain or plan to maintain one or more donor-advised funds

How are Forms 1023 and 1023-EZ different?

Form 1023

Form 1023 is 12 pages long, not including 8 possible schedules, some of which may or may not need to be completed depending on the type of organization and its circumstances. The schedules are for (A) churches; (B) schools, colleges, and universities; (C) hospitals and medical research organizations; (D) supporting organizations; (E) organizations not filing Form 1023 within 27 months of formation; (F) homes for the elderly or handicapped and low-income housing; (G) successors to other organizations; and (H) organizations providing scholarships, fellowships, educational loans, or educational grants to individuals and private foundations requesting advance approval of individual grant procedures.

There are many questions on Form 1023 that require fairly detailed narrative answers regarding:

  • Past, present, and planned activities
  • Compensation of directors, officers, trustees, and certain highly paid employees and contractors (“Close Personnel”)
  • Compensation of Close Personnel from related organizations
  • Sales and/or contracts between the organization and any Close Personnel (including any organizations they have certain affiliations with)
  • Family and business relationships among directors, officers, and trustees
  • Goods, services, and/or funds (grants) provided to individuals or organizations
  • Fundraising programs

In addition, the Form 1023 requires:

  • Articles of incorporation
  • Bylaws
  • Conflict of interest policy or explanation of how the organization manages conflicts of interest
  • Financials (actual and/or projected) for 3 or 4 years

If you submitted an application on Form 1023, … you can expect to be contacted within 180 days from the date you submitted the application.  After 180 days, if you haven’t been contacted, you can call the toll-free Customer Account Services number, Monday through Friday, 8 a.m. – 5 p.m. (local time), at 877-829-5500 to check on the status. – IRS

Form 1023-EZ

Form 1023-EZ (sample) is an online form that is 3 pages long. It requires no narrative responses and consists of mostly check box attestations. By checking just one box, the applicant is attesting that it will do all of the following:

  • Refrain from supporting or opposing candidates in political campaigns in any way. 
  • Ensure that its net earnings do not inure in whole or in part to the benefit of private shareholders or individuals (that is, board members, officers, key management employees, or other insiders).
  • Not further non-exempt purposes (such as purposes that benefit private interests) more than insubstantially.
  • Not be organized or operated for the primary purpose of conducting a trade or business that is not related to its exempt purpose(s).
  • Not devote more than an insubstantial part of its activities attempting to influence legislation or, if the organization made a section 501(h) election, not normally make expenditures in excess of expenditure limitations outlined in section 501(h).
  • Not provide commercial-type insurance as a substantial part of your activities.

If you submitted a Form 1023-EZ application, you can expect to be contacted within 90 days from the date you submitted the application.  After 90 days, if you haven’t been contacted, you can call the toll-free Customer Account Services number, Monday through Friday, 8 a.m. – 5 p.m. (local time), at 877-829-5500 to check on the status. – IRS

Filing the Form 1023-EZ


  1. It’s much easier to prepare; and
  2. It’s typically processed in less than half the time it takes to process Form 1023 (the IRS has reportedly processed the Form 1023-EZ in as few as two weeks).


  1. It doesn’t provide sufficient guidance to the organization or the IRS about whether the organization is actually organized to meet the requirements of 501(c)(3). According to the National Taxpayer Advocate, in a blistering criticism of Form 1023-EZ, 37 percent of a representative sample of Form 1023-EZ applicants whose applications were approved by the IRS were not, as a matter of law, 501(c)(3) organizations (i.e., they didn’t qualify and could run into major problems if they ever get audited). We’ve even seen a for-profit corporation granted 501(c)(3) status because the IRS never reviewed its articles of incorporation (it’s not required with a 1023-EZ application) and the applicant checked the wrong box.
  2. It doesn’t require the organization to develop a business plan consistent with 501(c)(3) before obtaining 501(c)(3) status, which is very likely to cause greater compliance problems. While the Instructions to Form 1023-EZ provide some information about what is necessary to operate consistent with 501(c)(3), the organization is never required to identify specifics about its operations (apart from checking a few boxes) to be vetted by the IRS. It’s become so easy for a startup to receive 501(c)(3) status (95% approval rate) that an IRS determination letter is becoming almost meaningless with respect to evidencing that an organization is actually operating consistent with 501(c)(3).
  3. It will produce an IRS determination letter, assuming it’s not rejected, that will reveal to knowledgeable funders that Form 1023-EZ was used to obtain tax-exemption. This may make the organization a less attractive grantee because its governance structures, insider compensation and transactions, and planned activities were never vetted by the IRS unlike with organizations that received tax-exempt status by filing Form 1023.

Criticisms of Form 1023-EZ

We were among the many critics of the Form 1023-EZ when it was first proposed (Proposed Form 1023-EZ). Nevertheless, a revised version was released by the IRS on July 1, 2014, lowering the annual gross receipts threshold from $200,000 to $50,000 (Form 1023-EZ Streamlined 501(c)(3) Exemption Application). The criticisms have continued and may eventually cause the IRS to implement some changes.

The Tax Exempt and Government Entities Exempt Organizations function approved Form 1023-EZ applications much less frequently — 77 percent of the time, compared to 95 percent of the time — when it requested documents or basic information from the applicants, rather than relying on the attestations contained in the form. – National Taxpayer Advocate

National Taxpayer Advocate’s Recommended Changes to the Form 1023-EZ

  1. Revise Form 1023-EZ to require applicants, other than corporations in states that make articles of incorporation publicly available online at no cost, to submit their organizing documents.
  2. Revise Form 1023-EZ to require applicants to provide a description of their actual or planned activities and submit summary financial information such as past and projected revenues and expenses.
  3. Make a determination only after reviewing the Form 1023-EZ application, the applicant’s organiz- ing documents, its description of actual or planned activities, and its financial information.
  4. Where there is a deficiency in an organizing document, require an applicant to submit a copy of an amendment to its organizing document that corrects the deficiency and has been approved by the state, even where the documents are available online at no cost, before conferring exempt status.

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.

MyLawCLE: Forming a Nonprofit & Applying for Exemption


Erin is presenting Nonprofit 101: Forming a Nonprofit & Applying for Tax Exemption Under IRS Code Section 501 (c)(3) for MyLawCLE in Miami on August 20, 2015. You can attend the live broadcast or on-demand. Here’s the description from MyLawCLE:

In this Level 101 session, we’ll be discussing the basic legal considerations applicable to nonprofits. We’ll start with a discussion of the current environment for nonprofits, as well as the process for forming a nonprofit and applying for tax exemption under Internal Revenue Code Section 501(c)(3). We’ll cover the fundamentals of nonprofit governance and the duties that directors of a nonprofit owe to the organization. We’ll also discuss some of the other rules applicable to Section 501(c)(3) exempt organizations, including those pertaining to earned income and the unrelated business income tax (UBIT), executive compensation, and lobbying and advocacy activities. Finally, we’ll briefly cover a few alternatives to forming a nonprofit that may be used to achieve an individual’s charitable goals.

This will be a great program for attorneys who occasionally represent nonprofits or who serve on nonprofit boards.

Live Broadcast | August 20, 2015
Eastern 3:00 pm – 5:00 pm
Central 2:00 pm – 4:00 pm
Mountain 1:00 pm – 3:00 pm
Pacific 12:00 pm – 2:00 pm

The Avengers, a Nonprofit Corporation



In Avengers: Age of Ultron, Captain America made reference to bylaws in stating that there were no restrictions against relationships between members. This of course proves that The Avengers are not only a superhero team that saves the world on a regular basis but also a nonprofit corporation. Here is the way the startup process must have played out:


A group of individuals that will engage in activities may form a corporation to mitigate the risks of personal liability. Without forming a corporation, a group might be characterized as an unincorporated association or partnership. While Thor may be judgment-proof (he could simply fly off to Asgard where our courts have no jurisdiction) and could probably care less, Tony Stark (Ironman) has significant personal assets and would not have let The Avengers operate without the limited liability protection offered by a corporation. Cap might have argued about some ethical obligation to pay for any of the corporation’s liabilities, but he would have been outvoted.


A nonprofit corporation, unlike a for-profit corporation, has no owners and does not make distributions of its net income to any shareholders. Cap’s insistence that the corporation be a nonprofit would have carried the day despite Stark’s preference for the flexibility of a for-profit form like the benefit corporation. These two heroes have been on a collision course from the start … stay tuned.


A nonprofit may be tax-exempt under Internal Revenue Code Section 501(c)(3) if it has a charitable purpose or under Section 501(c)(4) if it has a social welfare purpose. Generally, only a 501(c)(3) provides the benefit of being able to receive deductible charitable contributions, but in return, it’s subject to certain limitations on lobbying and gives up the right to engage in political campaign intervention activities. Because Stark is providing substantial funding, he would have insisted on forming an exempt organization under 501(c)(3) to benefit from the charitable deduction. Cap would have also favored the 501(c)(3) option because it signals that The Avengers exist for charitable purposes, including lessening the burdens of government and relief of the distressed (which includes all of us when the bad guys/robots/aliens threaten to destroy the world).

Private foundation

Because Stark and his company Stark Industries are providing substantially all of the funding, The Avengers will not be able to pass either of the applicable public support tests (509(a)(1)/170(b)(1)(A)(vi) or 509(a)(2)) to qualify as a public charity. Accordingly, it would have been recognized as a private foundation subject to the more restrictive laws applicable to private foundations, including those prohibiting self-dealing, excess business holdings, jeopardizing investments, and taxable expenditures (including those on lobbying and grants to individuals). However, because The Avengers will not be a grantmaking entity, it would have been structured to qualify as a private operation foundation, which is not subject to the private foundation tax on failure to distribute income.


A nonprofit corporation is governed by a board of directors. Initially, it may have been desired to make each of the individual Avengers a board member (director). However, that would not have been the best arrangement, particularly because not all of the heroes were keen on meeting their fiduciary duties and director responsibilities, including providing financial and program oversight, planning how to most effectively and efficiently advance The Avengers’ charitable mission in the near and long-term future, and protecting charitable assets. One very important part of meeting a board member’s fiduciary duties is attending meetings. Bruce Banner (The Hulk) would have abstained from serving as a director based on his inconsistent availability and ability to cooperate with others, particularly when angered. Because directors must disclose their names on the IRS annual information return (Form 990), Clint Barton (Hawkeye), whose personal identity was a secret, would have also declined. Individuals from foreign jurisdictions (like Thor) are permitted to serve as directors, but the IRS may give additional scrutiny to any nonprofit whose board was composed of directors who all resided in a foreign country, planet, or dimension.


Generally, a nonprofit corporation requires three officers: a president (or chair of the board), a treasurer, and a secretary. While many state laws and best practices prohibit the president from concurrently serving as treasurer or secretary, most permit one individual to serve as both treasurer and secretary. Cap would have been elected as president in a unanimous vote. While Stark possesses the financial management expertise desired in a treasurer, the board would have recognized his disregard for following rules would make him a poor choice for such position. Though Natasha Romanova (Black Widow) also has a checkered past, she would have convincingly made the case that she would be the best choice for treasurer. Despite his relative inexperience, The Vision would have been elected as Secretary based on his ability to properly maintain copious records and his computer-like attention to detail.

Public Charity: Public Support Tests Part II: 509(a)(2)

Glassy Pie Chart

A 501(c)(3) organization is presumed to be a private foundation unless it qualifies as a pubic charity. Part I of this post discussed how an organization can qualify as a public charity under one of two 509(a)(1) tests, either the one-third support test or the facts and circumstances test. Alternatively, an organization can qualify as a public charity under Section 509(a)(2) if it receives a substantial part of its income from activities related to the performance of the organization’s exempt purpose (i.e., related earned income) rather than from donations or investment income.

In order to qualify as a public charity under Section 509(a)(2), an organization (1) must normally receive more than one-third of its support from any combination of gifts, grants, contributions, membership fees, and gross receipts from certain permitted sources described below, and (2) must not receive more than one-third of its support from gross investment income and unrelated business income less tax. An organization must meet these tests – the One-Third Support Test and Not-More-Than-One-Third Support Test – in the aggregate over a five-year measuring period including the current taxable year and four prior taxable years.

To determine if an organization qualifies under 509(a)(2), three figures must be computed:

  1. Total support;
  2. Percentage of public support, which must exceed 33 1/3 percent of total support; and
  3. Percentage of investment income, which may not exceed 33 1/3 percent of the total.

Total Support

The sum of the following items, for the period in question, is the denominator of the fraction for computing both the percentage of public support and the percentage of investment income, further detailed below:

  •  Gifts, grants, contributions, and membership fees received
  • Gross receipts from admissions, merchandise sold or services performed, furnishing of facilities, or other business activities related to the charity’s exempt purposes
  • Gross investment income
  • Net income from unrelated business activities
  • Excluding: unusual grants

Percentage of Public Support


                        PUBLIC SUPPORT     

                       —————————              =    1/3 OR GREATER

                        TOTAL SUPPORT


An organization will be treated as a public charity under 509(a)(2) for its current year and the next taxable year if, over the five-year measuring period, one-third or more of its total support is public support, which generally includes donations, membership fees, gross receipts from admission, sales, performance of services, or furnishing of facilities related to an activity which is not an unrelated trade or business. There are, however, limitations with respect to what is included as public support. For example:

  • Gifts, grants, bequests, and gross receipts from the performance of exempt functions, if from a disqualified person, should not be included in the numerator. A disqualified person is generally defined to include a director, officer, substantial contributor (whose gifts to the charity exceed the greater of $5,000 or 2% of the total amount of donations received by the charity from its formation through the end of the taxable year in which the gift is made), owner of an entity that is a substantial contributor, and family members and 35% controlled entities of any of the foregoing.
  • Gross receipt amounts from the performance of exempt functions from government units, 509(a)(1) public charities, and individuals/entities that have not become disqualified persons as of the end of the taxable year may only be included in a taxable year up to the greater of $5,000 or 1% of the total support received by the charity in that taxable year.

Note that when computing the public support fraction, the entire amount of donations, membership fees, and exempt functions gross receipts for the period in question must be included in the denominator (total support), despite the limitations to such amounts in the numerator (public support). Unusual grants are excluded from this calculation.

It is important to note that the one-third public support test under 509(a)(2) is different from the one-third public support test under 509(a)(1). Both public support and total support are defined differently. In addition, there is no backup facts and circumstances test for organizations that have less than one-third public support under 509(a)(2).

If an organization is going to be making grants, it should understand the difference to its grantees between receiving a grant from a 509(a)(1) and a 509(a)(2) organization with respect to its characterization as public support. Contributions from organizations that qualify under 509(a)(1)/170(b)(1)(A)(vi) may be counted fully as public support, whereas contributions from other sources (including 501(a)(2) charities) are subject to a 2% cap as discussed in Part I.

Percentage of Investment Income


                    INVESTMENT INCOME

                       —————————              =    LESS THAN 1/3

                        TOTAL SUPPORT


Under 509(a)(2), an organization may not receive more than one-third of its total support from gross investment income and unrelated business income activities. Very generally, gross investment income is defined in the Internal Revenue Code as gross amounts of income from interest, dividends, rents, and royalties, excluding capital gains. Unrelated business taxable income includes net income derived from any trade or business which is not substantially related to the organization’s exempt purpose, keeping in mind certain applicable exceptions (e.g., volunteer, convenience, and donated good exceptions).

Therefore, at the end of each measuring period, the charity must compute a fraction with its total support as the denominator, and a numerator of gross amounts of income from interest, dividends, rents, and royalties, excluding capital gains, and any excess amount of unrelated business taxable income over the amount of tax imposed on that income.

Public Charity: Public Support Tests Part I: 509(a)(1)

Percent sign on scale pan

A 501(c)(3) organization is presumed to be a private foundation unless it qualifies as a pubic charity. As discussed in a previous post and on our short YouTube clip, public charity classification is generally far more advantageous due to the burdensome rules and restrictions applicable to private foundations. Most 501(c)(3) organizations qualify as public charities under Section 509(a)(1) of the Internal Revenue Code (IRC). Generally, this group includes certain “per se” charities (churches, schools, hospitals, medical research institutions); governmental units; and organizations that pass either one of two public support tests.

The two public support tests referenced by IRC Sections 509(a)(1) and 170(b)(1)(A)(vi) are commonly referred to as the One-Third Support Test and the Facts and Circumstances Test. Both tests include a mathematical computation of an organization’s public support ratio (i.e., public support/total support) measured over a five-year period ending on the last day of the fiscal year for which the organization is filing its Form 990. An organization’s public support ratio is disclosed each year on its Form 990.

One-Third Support Test


                       PUBLIC SUPPORT     

                       —————————              =    1/3 OR GREATER

                        TOTAL SUPPORT

An organization will be treated as a public charity under 509(a)(1)/170(b)(1)(A)(vi) for its current year and the next taxable year if, over the five-year measuring period, one-third or more of its total support is public support from governmental agencies and qualifying contributions or grants from the general public and other public charities. For example, if at the end of 2014, an organization has a public support ratio of at least 1/3 for the five years from 2010 through 2014, the organization will pass the test for 2014 and 2015 (even if it doesn’t pass the test for years 2011 through 2015).

Understanding what is and is not included in both “public support” and “total support” is critical to reporting and managing the public support ratio.

Total Support consists of:
  • Gifts, grants, contributions and membership fees received*
  • The value of services and facilities furnished by a governmental unit to the organization without charge (except services or facilities generally furnished to the public without charge)**
  • Gross investment income
  • Net income from unrelated business activities
  • All other revenues EXCEPT:
    • Gains from the sale of capital assets
    • Gross receipts from admission, merchandise, or other business activities related to the charity’s exempt purposes
    • Unusual grants

* Partly included in public support, subject to the 2% cap described below

** Fully included in public support

Public Support consists of:
  • Grants from government agencies
  • Contributions from other 509(a)(1)/170(b)(1)(A)(vi) public charities
  • Gifts, grants, contributions, and membership fees from all other sources, subject to a 2% cap (i.e., any such contributions from a single source* count as public support only to the extent they do not cumulatively exceed 2% of total support). For example, if an organization has a total support figure (over the 5-year period) of $1 million, including $200,000 of cumulative contributions from Foundation X, the amount of Foundation X’s contributions that count as public support is limited to 2% of $1 million ($20,000).*
  • The value of any services or facilities furnished by a governmental unit to the organization without charge (except services or facilities generally furnished to the public without charge)
  • Benefits from tax revenues received by the charity

* Note that, when applying the 2% cap, amounts from certain related family members, and from business and their major owners, are combined and treated as coming from one source.

Facts and Circumstances Test

An organization that fails to meet the One-Third Support Test can alternatively qualify as a public charity under 509(a)(1)/170(b)(1)(A)(vi) if (a) it has a public support ratio of 10% or more; (b) the organization is organized and operated so as to attract new and additional public or governmental support; and (c) the facts and circumstances indicate it is a publicly supported organization (see the Five Factor Analysis below).

Attraction of public support. The organization must be organized and operated so as to attract new and additional public or governmental support. This may be shown if the organization maintains a “continuous and bona fide program” for solicitation of funds from the general public, community, or membership group involved, or if it carries on activities designed to attract support from governmental units or other charitable organizations described in Section 509(a)(1).

Five Factor Analysis. The organization must show that it is in the nature of a publicly supported organization, taking into account the following factors:

  • Percentage of Financial Support. The greater the percentage of public support above 10 percent, the lesser the burden of establishing the rest of the factors below. If the percentage is low due to a high percentage of its total support from investment income on its endowment funds, the IRS will also consider whether the endowment came from general public, government sources, or from a limited group of donors.
  • Sources of Support. Here, whether an organization is supported by government units, directly or indirectly from a representative number of persons, or a single family, will be taken into consideration in determining if the organization is publicly supported. Also important is the age and type of organization, and whether it appeals to a limited number of persons or communities.
  • Representative Governing Body. The fact that an organization has a governing body that represents the broad interests of the public rather than the personal or private interest of a limited number of donors will be considered here. An organization’s governing body will generally be considered representative of the public interest if it is composed of: (a) public officials acting in their public capacity; (b) individuals selected by public officials acting in their public capacities; (c) persons having special knowledge or expertise in the particular field or discipline in which the organization is operating; and (d) community leaders, such as elected or appointed officials, members of the clergy, educators, civil leaders, or other such persons representing a broad cross-section of the views and interests of the community. Lastly, in the case of a membership organization, an organization will satisfy this factor if the governing body is comprised of individuals elected according to the organization’s governing instrument or bylaws by a broad based membership.
  • Availability of Public Facilities or Service; Public Participation in Program or Policies. This factor looks for evidence that the organization:
    • Provides facilities or services directly for the benefit of the general public on a continuing basis. Examples include a museum or library that is open to the public, or a conservation organization that provides educational services to the public through the distribution of educational materials.
    • Publishes scholarly studies that are widely available and used by colleges, universities, and members of the general public.
    • Participates in or sponsors programs by members of the public having special knowledge or expertise, public officials, or civil or community leaders.
    • Conducts and maintains programs that focus on charitable work in the community, such as combating community deterioration or developing employment opportunities.
    • Receives a significant part of its funds from a public charity or governmental agency to which it is in some way held accountable as a condition of the grant, contract, or contribution.
  • Additional Factors for Membership Organizations. To determine if a membership organization is publicly supported, examine:
    • Whether the solicitation for dues-paying members is designed to enroll a substantial number of persons in the community or area, or in a particular profession or field of special interest (taking into account the size of the area and the nature of the organization’s activities).
    • Whether membership dues for individual (rather than institutional) members have been fixed at rates designed to make membership available to a broad cross section of the interested public, rather than to restrict membership to a limited number of persons.
    • Whether the activities of the organization will be likely to appeal to persons having some broad common interest or purpose, such as educational activities in the case of alumni associations, musical activities in the case of symphony societies, or civil affairs in the case of parent-teacher associations.

If an organization is unable to satisfy both the One-Third Support Test and the Facts and Circumstances Test, there are alternative ways for an organization to become a public charity, including passing a public support test under IRC Section 509(a)(2) and meeting the requirements of a supporting organization under IRC Section 509(a)(3). Stay tuned for our next post, Public Support Tests Part II: 509(a)(2).