The IRS has published Notice 2011-43, which provides transitional relief for certain small organizations that lost their tax-exempt status because they failed to file an annual electronic notice for three consecutive tax years beginning in 2007.  Qualifying organizations will be able to file for reinstatement of their tax-exempt status, retroactive to the date the status was lost, and pay a reduced filing fee of $100.

The relief applies to organizations that lost their exempt status because of their failure to comply with Sections 6033(i) and (j) of the Internal Revenue Code, which were added by the Pension Protection Act of 2006.  Section 6033(i) applies to organizations that are exempt from filing annual information returns on Form 990 or 990 EZ because their gross receipts that are normally less than $25,000 (increased to $50,000 for the 2010 tax year).   These organizations are required submit an annual electronic filing on Form 990-N, also called the e-postcard. Section 6033(j) provides that an organization’s exempt status will be revoked if it fails to file the 990-N or other required annual information return for three consecutive tax years. An organization’s annual gross receipts are “normally not more than” $25,000 or $50,000 in a taxable year if its average annual gross receipts for that taxable year and the two taxable years immediately preceding it are not more than $25,000 or $50,000, respectively.

An organization that had its tax-exempt status revoked under section 6033(j) must apply for reinstatement with the IRS, even if it was not originally required to file an application for recognition of exempt status (Form 1023).  If the organization applying for reinstatement of tax-exempt status can show reasonable cause for its failure to file, its tax-exempt status may be reinstated retroactive to the date of the automatic revocation.  Reinstatement is at the Secretary of the Treasury’s discretion, however, the IRS has set a very low bar for determining whether a small organization has established reasonable cause for its failure to file.

The IRS will treat an organization as having established reasonable cause if it meets each of the following criteria:

• The organization was not required to file Form 990 or Form 990-EZ for the taxable years beginning before 2007.

• The organization was eligible to file a Form 990-N in each of its taxable years beginning in 2007.  Organizations (other than private foundations and       most section 509(a)(3) supporting organizations) with annual gross receipts that were normally not more than $25,000 would generally have been eligible to file the Form 990-N.

• The organization submits its application for reinstatement to the IRS on or before December 31, 2012.

An organization must apply for reinstatement on the form used to apply for recognition of exempt status, even if it was not originally required to file. Thus, an organization seeking reinstatement under section 501(c)(3) would file Form 1023, and an organization seeking reinstatement under section 501(c)(4) would file Form 1024.  The organization must write “Notice 2011-43” on the top of the form and on the envelope in which it is mailed.  The organization must also attach the following statement to its application:

[Name of Organization] was not required to file annual information returns for taxable years beginning before 2007; was eligible in each of its taxable years beginning in 2007, 2008 and 2009 to file a Form 990-N e-Postcard; and had annual gross receipts of normally not more than $25,000 in each of its taxable years beginning in 2007, 2008 and 2009.

Organizations that had their exempt status revoked for failure to file under Section 6033(j), but do not qualify for the relief described above, must also file the application for recognition of tax exempt status and pay the normal user fee.  The application must include a request for retroactive reinstatement that conforms to requirements set out in IRS Notice 2011-44.

The committee’s letter states, “As currently drafted, the Bill includes among the permitted special purposes those charitable and public purpose activities that may be carried out by a nonprofit public benefit corporation. It does not include reference to religious purpose activities that may be carried out by religious corporations. Although the California Corporations Code has separated nonprofit public benefit and religious corporations into parallel statutory schemes, the purposes of religious corporations are traditional charitable purposes just as much as those public and charitable purposes of public benefit corporations. Religious purposes encompass activities which may even be identical to those conducted under charitable purposes. There are a significant number of social welfare type of organizations that are incorporated as religious organizations. By leaving out the reference to purposes of religious corporations, the Bill excludes the activities of a large segment of the social welfare and charitable community and unnecessarily restricts the special purposes which could be included for this type of organization.”

In contrast, the California Association of Nonprofits, along with California Church Impact, California Society of Association Executives, and the Blood Centers of California, have written a letter opposing the bill.  They express the following concerns (quoted from their letter):

• What are the consequences for the quality of social, environmental, cultural, and educational services used and needed by California residents if for-profits are provided with enhanced capacity to compete with nonprofits for government grants and contracts, financial and human capital and the definition of the form and scope of practices for delivering social benefits?

• Some SB 201 proponents maintain that the capital pool for existing nonprofits and Flexible Benefit Corporations are mutually exclusive. What is the evidence to substantiate that claim? How can we be sure that investments in FPCs are not being made in lieu of charitable contributions?

• Although the single largest source of revenue for nonprofits is earned income, nonprofits are likely to find themselves at a competitive disadvantage with FPCs with access to capital simply unavailable to governmental and charitable entities. What are the likely outcomes of that situation?

• By all accounts, public benefit is difficult to evaluate and measure. How will nonprofits and investors be protected from misrepresentations by management and directors accountable only to their shareholders and not to standards established in many areas of nonprofit practice by existing nonprofit professional associations?

• There may be lessons to be learned from the UK, where there is a highly developed system for assessing public benefit outcomes of Community Interest Companies, a hybrid similar to that proposed in SB 201 and in existence since 2005. In the legislation, this core principle is achieved through the “community interest test.” A company satisfies the community interest test if a reasonable person might consider that its activities (or proposed activities) are carried on for the benefit of the community. Many community interest companies use independent social auditors, whose audits provide the basis for evaluations by social audit panels.  Through this audit system, the UK approach requires accountability not only to the shareholders but also to the stakeholders, such as recipients of social services, who are the purported beneficiaries of the companies’ activities.

• To the limited extent that they are regulated, what’s to prevent a Flexible Purpose Corporation from enjoying the same “light touch” from regulators received by their UK counterpart, the Community Interest Company, as reported in a recent article “Wrong Way Corrigan and Recent Developments in the Nonprofit Landscape: A Need for New Legal Approaches,” by James J. Fishman Pace, University School of Law?

• Given that they are engaging in “charitable and public purpose activities that could be carried out by a nonprofit public benefit corporation,” should FPCs be subject to some specific form or degree of oversight or accountability similar to the requirements for nonprofits from the California Attorney General, Internal Revenue Service, Franchise Tax Board, Board of Equalization, and Secretary of State?

• What assurances do we have that FPCs will continue to provide needed services when the economy is faltering when there are decisions to be made about shareholder returns? Nonprofits must maintain their vision and mission regardless and face scrutiny by taxing authorities and the California Attorney General.

• What is likely to be the impact of FPCs and similar measures on service and volunteerism, which up to now have been key component of our way of life in both California and the nation? Will the mixing of for-profit with charitable motives send a message that undermines the efforts of religion, nonprofits and government to encourage individuals, families and communities to unselfishly “take action that changes the world,” in the words of the mission statement of the Points of Light Foundation.

• In addition the proposals already pending in the Legislature, there are other available methods, some that have been in place for decades, to blend public and private purposes in single or related corporations. What are the relative merits of each type from the perspectives of potential abuse, impact on nonprofits, and impact on existing businesses? Will they erode or enhance the capacity of existing nonprofit entities under current law and in which both the public and private sectors have invested immense amounts of time and dollars?

For tax years beginning on or after January 1, 2010, California tax-exempt organizations with gross receipts normally equal to or less than $25,000 (except churches) are now required to electronically file FTB 199N, California e-Postcard (available January 3, 2011).

1.     If your organization’s gross receipts are normally $50,000 or less, you can file a Form 990-N – a simple filing (this threshold has been increased from $25,000 – thank you IRS!)

2.     If your organization’s gross receipts are greater than $50,000 but less than $200,000 (and total assets not more than $500,000), you can file a 990-EZ (which is not necessarily easy, but it is easier than the Form 990)

3.     All others must file Form 990

Click here for more information.

The deadline looms.  Small nonprofit organizations that failed to file the 990-N or 990-EZ for 2007, 2008 and 2009 will lose their tax-exempt status if they fail to file by October 15^th.  (See earlier post IRS Announces One-Time Relief for Non-filing Organizations.)

The IRS has made two types of relief available under a one-time reprieve.  Small organizations required to file Form 990-N, also known as the e-Postcard, simply need to go to the IRS website, www.irs.gov, and electronically file the brief form by Oct. 15.  Organizations eligible to file Form 990-EZ must file their delinquent annual information returns by Oct. 15 and pay a compliance fee under the Voluntary Compliance Program.  The relief is not available to larger organizations required to file the Form 990 or to private foundations that file the Form 990-PF.

The IRS has posted on its websites the names and last-known addresses of at-risk organizations, but has cautioned that the list may not be complete.

If an organization loses its exemption, it will have to reapply with the IRS to regain its tax-exempt status. Any income received between the revocation date and renewed exemption may be taxable.

I. State statutes governing contests in general

State laws regulating contests are found in Bus. & Prof. Code § 17539 et seq.  Section 17539.3 grants an exemption to some tax-exempt nonprofits. However, it is recommended that a nonprofit use these rules as a guideline when designing and publicizing a contest to help avoid violating false advertising and unfair trade practices laws.

The following summary is adapted from the CA Department of Consumer Affairs: Rules for Operation of Contests and Sweepstakes, available at: http://www.dca.ca.gov/publications/legal_guides/u-3.shtml

Generally, rules governing contests are found in CA. Bus. & Prof. Code 17539-17539.3, 17539.35.

A “contest” is any game, puzzle, scheme, or plan which offers prospective participants the opportunity to receive or compete for gifts or prizes on the basis of skill and/or chance, and which is conditioned on some payment of value.

The law requires every person who conducts a contest to disclose on each entry blank the submission deadline.

All contest and promotional puzzles and games must clearly and conspicuously include the following:

•           Contest description, number of anticipated contestants, and the nature and value of the prizes.

•           All the rules, regulations, terms and conditions of the contest.

•           The maximum number of puzzles or games which may be necessary to complete the contest and determine winners.

•           The maximum amount of money, including postage and handling fees, which a participant may be asked to pay to win each of the prizes offered.

•           The date(s) upon which the contest will terminate, and upon which all prizes will be awarded.

•           Whether future contests or tie-breakers, if any, will be significantly more difficult than the initial contest, and the method of determining prize-winners if a tie remains after completion of the last tie-breaker.

Misrepresenting in any manner the odds of winning any prize is prohibited. All prizes of the value and type represented must be awarded and distributed. The opportunity to win a prize cannot be conditioned on a minimum number of entries or contest participants.

Also, the contest sponsor must retain for at least two years following the completion of a contest the following information:

(1) Copies of all contest solicitations and puzzles.

(2) All puzzles and correspondence sent by a contestant or copies or records disclosing details thereof and records of replies thereto.

(3) Adequate records which disclose the names and addresses of all contestants, the approximate date each contestant was sent each puzzle or game, the number of prizes awarded, the method of selecting winners, the names and addresses of the winners, and facts upon which all representations or disclosures made in connection with the contest are based and from which the validity of the representations or disclosures can be determined.

II. Deceptive Mail Prevention and Enforcement Act (39 U.S.C. 3001 et seq)

•   Federal statute that regulates advertisements sent through U.S., including contest materials.

•   Requires the contest sponsors to disclose in a clear and conspicuous way:

•           the terms, rules and conditions of the contest.

•           how many rounds of the contest you must achieve to win the grand prize.

•           the time frame for the winner to be determined.

•           the name of the contest’s sponsor.

•           an address where you can reach the sponsor to request that your name be removed from the mailing list.

•           Mailings for skill contests or promotions must:

1.        State all terms and conditions, including rules and entry procedures in language that is easy to find, read and understand and;

2.        Provide a name and the business address where the sponsor can be contacted.

•           Skill contest mailings must disclose:

3.        The number of rounds or levels of the contest and the cost to enter each level;

4.        Whether subsequent rounds will be more difficult to solve;

5.        The maximum cost to enter all rounds;

6.        The estimated number or percentage of entrants who may win, or have won the sponsor’s last three contests;

7.        Qualifications of the judges if the contest is not judged by the sponsor;

8.        The method used in judging and;

9.        The date prizes will be awarded, how many, the nature and estimated value of each prize, and the payment schedule.

•           Ads for sweepstakes, skill contests, and facsimile checks that appear in magazines, newspapers and other periodicals can be mailed as long as the advertisements are not personalized and do not offer a way to make a payment or order a product or service.

About a quarter of the non-profit sector just got another chance.   The IRS is providing one-time relief that will allow small exempt organizations to come back into compliance and retain their tax-exempt status even though they failed to make required annual filings for three consecutive years.   This one-time relief benefits Form 990-N (e-Postcard) and Form 990-EZ filers only.

When a tax-exempt organization that is required to file an annual return (e.g., Form 990) or submit an annual electronic notice to the IRS does not do so for three consecutive years, the organization automatically loses its federal tax exemption.  On April 22, the New York Times reported that as many as 25% of existing tax-exempt organizations were at risk of losing their exempt status because they had failed to make their annual filing.  This situation apparently developed because many managers of small organizations overlooked a change in the law.   In the past, organizations with gross annual revenues under $25,000 were exempt from annual filing requirements. The Pension Protection Act of 2006 imposed a new requirement that they make a brief electronic annual filing on From 990-N, also called the e-postcard.  http://www.irs.gov/charities/article/0,,id=169250,00.html

The IRS website has a list of organizations at risk of losing their tax-exempt status because, according to IRS records, they have not filed for 2007, 2008 and 2009. The list contains the name of the organization and its last-known address. Check this list to see whether your organization is at risk of automatic revocation and can avoid this consequence by following IRS guidance.  If an organization loses its exemption, it will have to reapply to regain its tax-exempt status. Any income received between the revocation date and renewed exemption may be taxable.

Note: The IRS website warns that the list may be incomplete, and the list may include organizations that were required to file Form 990 or Form 990-PF and are not eligible for the relief program.

Although raffles can be a great fundraising opportunity for some nonprofits, most states consider raffles to be a type of illegal gambling. Many states, including California, carve out an exception for nonprofits. The following is a brief summary of the California exception.

Charitable Raffles in California

California Penal Code section 320.5 carves out an exception to the general prohibition against gambling in California. This exception allows “eligible organizations” to “conduct raffles for the purpose of directly supporting beneficial or charitable purposes or financially supporting another private, nonprofit, eligible organization that performs beneficial or charitable purposes if the raffle is conducted in accordance with this section.”

Definition of an eligible organization

Generally, an eligible organization is a private nonprofit organization that is exempt from California income tax and has been qualified to conduct business in California for at least one year prior to conducting a raffle.

Definition of a raffle

A raffle is a scheme to distribute prize(s) by chance among people who purchase paper tickets that provide the opportunity to win the prize(s). The paper tickets must have a detachable stub/coupon. Each paper ticket and its corresponding stub/coupon must have a unique and matching identifier. The prizes are awarded by a random drawing from all the purchased tickets; the drawing must be conducted under the supervision of a natural person who is at least 18 years old.

Note: California law prohibits raffles from being operated or conducted over the Internet, although the organization conducting the raffle may advertise the raffle over the Internet. Also, federal law prohibits multi-state raffles, so a nonprofit should only sell tickets inside California.

The 90/10 rule

At least 90 percent of the gross revenue from the sale of raffle tickets must be used to benefit or provide support for beneficial or charitable purposes. “Beneficial purposes” excludes purposes that are intended to benefit officers, directors, or members of the eligible organization. The funds may not be used to fund any beneficial, charitable, or other purpose outside of California.

Registration and reporting requirements

Unless specifically exempted, nonprofits that want to conduct raffles must register with the California Department of Justice. They also have to comply with annual reporting requirements to disclose information such as gross raffle ticket sales, expenses, and how the revenue was spent. Registration and reporting forms are available at http://ag.ca.gov/charities/raffles.php.

Educational institutions, religious institutions, and hospitals are exempt from raffle registration and raffle reporting requirements but must otherwise comply with all the other regulations.

Taxes and withholding

A raffle ticket purchase is not tax-deductible. Prizes are considered taxable income to the winners.

Mailings and advertisements

The Federal Deceptive Mail Prevention and Enforcement Act prohibits deceptive mailing practices for sweepstakes, contests, and raffles. If the nonprofit plans to use the U.S. Postal Service to mail advertisements or raffle tickets, it must comply with this act, which requires certain disclosures on each mailing. When drafting the raffle rules, it is helpful to include these disclosures in the raffle rules. For more information, see http://www.dmaresponsibility.org/Sweepstakes/.

The recently enacted health insurance reform legislation includes a tax credit that helps many small businesses provide coverage for their employees.  Many tax-exempt non-profit organizations can also receive the health care tax credit, although at a reduced level.

To qualify, small businesses and exempt organizations must:

• Have fewer than  25 full-time equivalent (FTE) employees
• Pay average annual wages below $50,000, and
• Cover at least 50% of their workers’ health insurance premium costs.

Small businesses can receive a credit up to 35% of their 2010 employee premium costs.  This amount increases to 50% in 2014.  The non-profit credit starts at 25% in 2010, increasing to 35% in 2014.

The credit is effective January 1, 2010.  Eligible small businesses can claim the credit as part of the general business credit starting with the 2010 income tax return they file in 2011. For tax-exempt employers, the IRS will provide further information on how to claim the credit.

For more information click here.

In a recent Technical Advice Memorandum (TAM), the IRS determined that a major source of revenue for a 501(c)(6) trade association was unrelated business income and therefore taxable.

The trade association’s purpose was to promote a particular sport within a region.  Individuals can only play the sport at sports facilities that charge a fee to play.  The trade association sold discount coupons for use of such facilities.

In the TAM, the IRS listed the requirements for a Section 501(c)(6) organization:

(1)    It must be an association of persons having a common business interest,

(2)    Its purpose must be to promote that common business interest,

(3)    It must not be organized for profit,

(4)    It should not be engaged in a regular business of a kind ordinarily conducted for a profit,

(5)    Its activities should be directed toward the improvement of business conditions of one or more lines of business as opposed to the performance of particular services for individual persons, and

(6)    Its net earnings, if any, must not inure to the benefit of any private shareholder or individual.

The Internal Revenue Code imposes a tax on income to a nonprofit organization derived from any unrelated trade or business regularly carried on.  An unrelated trade or business is any trade or business which is not substantially related to the organization’s exempt purposes.

The trade association argued that the discount coupon program is substantially related to its exempt purposes because it encourages more people to engage in the sport.

The IRS disagreed.  The question turned on whether the sale of coupons promotes general interest and involvement in the sport or if it constitutes the performance of particular services for individual persons or businesses.  The IRS concluded that the sale of coupons only benefited those facilities that chose to participate and not the sport as a whole and therefore the sale of coupons was basically an advertising service for individual businesses.

The IRS states, “Advertising campaigns . . . that name and promote specific businesses rather than the industry as a whole constitute the performance of particular services for individual persons” which is an unrelated trade or business.

We know of many 501(c)(6) organizations that promote their members by maintaining business directories, spotlighting their members on their web sites, etc.  These organizations need to be careful that their activities don’t start to look like the sale of advertising (or else pay tax on the revenue associated with those activities).  (Note that occasional highlighting of members such as for a special event is not a problem because the tax on unrelated business income only applies to a trade or business that is regularly carried on.)

The following are some examples of activities that have been found to be taxable as unrelated business income to a 501(c)(6):

• Advertising of products and services in an association journal, even if those products and services are related to the purpose of the organizations
• Promotions that mention particular businesses
• Promotion of members to the exclusion of non-members in the same industry when members and non-members meet similar standards
• Fee-based services for members and/or non-members that are similar to what might be provided by a commercial business
• Providing discounted parking for patrons of only certain businesses in a downtown area.

The following are some examples of activities that have been found to be substantially related and therefore not taxable as unrelated business income:

• Publication of educational information that incidentally promotes specific businesses
• Providing discounted parking for all visitors to a downtown area
• Sponsorship of tournaments to promote interest in a sport and sale of broadcasting rights to those tournaments
• Promotion of an entire industry or line of business such as Washington apples or the use of plywood as a building material.

Note that a nonprofit can lose its exempt status if a significant amount of its revenue is derived from and/or a significant amount of its resources is devoted to an unrelated activity.