M. Jude Egan Stephenson Disaster Management Institute, Louisiana State University

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1 White Paper State VOAD and 501(c)(3) status. 1 M. Jude Egan Stephenson Disaster Management Institute, Louisiana State University I. Introduction: This white paper is written in two sections. The first section provides an overview of the process of forming a 501(c)3 entity. I try to keep that section relatively brief because my sense is that it is likely to be either a refresher of what is already known or a rehashing of what can be found readily on the IRS website. The second section addresses some potential organizational concerns and some of the pitfalls of either filing for tax-exempt status or not filing. This white paper is a work in progress thus, if the issues addressed either are off-the-mark or are underinclusive, please feel free to contact me at the above address so that I can provide further analysis. The goal of the white paper is to help NVOAD and state VOADs determine the benefits and challenges of seeking 501(c)(3) status. Process and Benefits information is taken from Internal Revenue Service (IRS) documents available online at: This is written as a white paper rather than a legal memorandum. Though I am qualified to practice law in California, this white paper is not meant to provide legal advice as state laws in various jurisdictions may differ or require a different analysis. Many law firms have a commitment to pro bono service for worthwhile charities, and they should be contacted for actual legal advice and services. Tax advice is a specialized field of law and should be given either by an attorney with specialized experience in federal and state tax law or by a licensed tax professional. As such, this white paper specifically does not purport to be tax advice. II. The Process of filing for 501(c)(3) or Tax-Exempt Status: a. Benefits Benefits of having 501(c)(3) status include: Exemption from federal income tax Eligibility to receive tax-deductible charitable contributions. Some organizations may be exempt from certain employment taxes. Recognition of exemption under section 501(c)(3) of the IRC assures foundations and other grant-making institutions that they are issuing grants or sponsorships to permitted beneficiaries. 1 This white paper is written as a part of the LSU/Stephenson Disaster Management Institute consulting agreement with the National Voluntary Organizations Active in Disaster. Funds have been generously provided by the Stephenson Disaster Management Institute as part of its ongoing applied research initiative in facilitating disaster relief and response. The opinions are the author s own and do not in any way constitute legal advice. 1 P a g e

2 State officials may grant exemption from state income, sales, and property taxes; and U.S. Postal Service offers reduced postal rates to certain organizations Some limitation on liability for negligent acts of officers and directors Some limitation on liability for negligent acts of volunteers. b. Components Required for 501(c)(3)Status For an organization to be exempt from federal income tax under section 501(c)(3) of the IRC, a not-for-profit (i.e., nonprofit) organization must be organized and operated exclusively for one or more exempt purposes. Organized: A 501(c)(3) organization must be organized as a corporation, trust, or unincorporated association. Organization generally requires filing organizing documents with the state in California this is done with the Secretary of State but it may be different in different jurisdictions. Organizing documents include: articles of incorporation, trust documents, or articles of association. Articles of incorporation usually follow state law provisions, which usually include: name, type of organization, board members, officers and directors, and contact information for the organization, including where service of process is to be sent and who is qualified to receive it on behalf of the organization. Federal law does not require by-laws to be filed for tax-exempt status, but many states do. By-laws are the internal operating rules for an organization and usually include: election of directors, voting rights, how and when meetings are conducted and minutes taken, description of officers duties and the process of amending rules and procedures. To qualify for 501(c)(3) status, organizing documents must: limit the organization s purposes to those described in section 501(c)(3) of the IRC; not expressly permit activities that do not further its exempt purpose(s), i.e., unrelated activities; and permanently dedicate its assets to exempt purposes. 2 2 From the IRS website: A charity's organizing document must limit the organization's purposes to one or more of the exempt purposes set forth in section 501(c)(3) and must not expressly empower it to engage, other than as an insubstantial part of its activities, in activities that are not in furtherance of one or more of those purposes. This requirement may be met if the purposes stated in the organizing document are limited in some way by reference to section 501(c)(3). In addition, assets of an organization must be permanently dedicated to an exempt purpose. This means that should an organization dissolve, its assets must be distributed for an exempt purpose described in section 501(c)(3), or to the federal government or to a state or local government for a public purpose. To establish that an organization's assets will be permanently dedicated to an exempt purpose, the organizing document should contain a provision insuring their distribution for an exempt purpose in the event of dissolution. Although reliance may be placed upon state law to establish permanent dedication of assets for exempt purposes, an organization's application can be processed by the IRS more rapidly if its organizing document includes a provision insuring permanent dedication of assets for exempt purposes. Available at: 2 P a g e

3 Operated: Certain organizational activities are prohibited or restricted for 501(c)(3) organizations including, but not limited to, the following activities. A 501(c)(3) organization: must absolutely refrain from participating in the political campaigns of candidates for local, state, or federal office must restrict its lobbying activities to an insubstantial part of its total activities must ensure that its earnings do not inure to the benefit of any private shareholder or individual must not operate for the benefit of private interests such as those of its founder, the founder s family, its shareholders or persons controlled by such interests must not operate for the primary purpose of conducting a trade or business that is not related to its exempt purpose, such as a school s operation of a factory may not have purposes or activities that are illegal or violate fundamental public policy Exempt Purpose: To be tax exempt, an organization must have one or more exempt purposes, stated in its organizing document. Acceptable organizational purposes under IRC section 501(c)(3) include: organizations that are organized and operated exclusively for: religious 3, charitable 4, educational purposes 5, or for the prevention of cruelty to children or animals. 6 Thus, state-filed organizing documents should clearly state that the organizational purpose is limited to one or more of these purposes. While probably not necessary, the organizing documents may reference specific activities listed in the footnotes, though if the organization will do more than those activities alone, the organizing documents should make clear that specific activities are only a partial list of organizational activities to further the organization s tax-exempt purposes. The organizing documents do not need to expressly state that activities that 3 The term church includes synagogues, temples, mosques, and similar types of organizations Although the IRC excludes these organizations from the requirement to file an application for exemption, many churches voluntarily file applications for exemption Such recognition by the IRS assures church leaders, members, and contributors that the church is tax exempt under section 501(c)(3) of the IRC and qualifies for related tax benefits Other religious organizations that do not carry out the functions of a church, such as mission organizations, speakers organizations, nondenominational ministries, ecumenical organizations, or faith-based social agencies, may qualify for exemption These organizations must apply for exemption from the IRS See Publication 1828, Tax Guide for Churches and Religious Organizations, for more details. 4 Charitable organizations conduct activities that promote: relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erection or maintenance of public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency. 5 Educational organizations include: schools such as a primary or secondary school, a college, or a professional or trade school; organizations that conduct public discussion groups, forums, panels, lectures, or similar programs; organizations that present a course of instruction by means of correspondence or through the use of television or radio. 6 This is a partial list, but includes the most relevant purposes for State VOADs. 3 P a g e

4 do not further its exempt purposes are barred, but they cannot expressly permit other non-exempt activities. The activities of State VOADs almost assuredly meet at least one, if not all three, of these purposes and will most likely not include non-exempt purposes, so this should not pose a major challenge to getting 501(c)(3) status. Public Charities: Most, if not all, State VOADs will qualify as public charities under IRC section 509(a) because they will receive a substantial part of their support in the form of contributions from publicly supported organizations, governmental units, and/or from the general public and because they support other public charities. 509(a) status generally allows for fewer restrictions on charitable contributions than if the organization is considered a private foundation. Public charities must show continued commitment to seeking significant, diversified public support throughout their lifetime. Employer ID Number: All organizations must have an EIN whether they have employees or not. This can be done on-line or over the telephone. This is not the tax-exempt number. Charitable Solicitation: This is governed by state law. 501(c)(3) Application Checklist: 1. File organizing documents with the state. a. Articles of Incorporation or Charter b. By-Laws (if required) 2. File for EIN 3. Follow state charitable solicitation rules 4. File IRS Form 1023 and all supporting documents and application fee. III. Issues for State VOAD 501(c)(3) Status: a. Lawsuits and Liability Some State VOAD representatives in Salt Lake City voiced concerns that if the VOAD is a separate legal entity for tax purposes, it will also be a separate legal entity for tort and contract liability, i.e., if the organization incorporates, it can get sued. While this is true, that is most likely a preferable outcome to the alternative. This section covers some of the landscape of tort liability for voluntary nonprofit associations, for 501(c)(3) organizations and the Volunteer Protection Act of An informal voluntary nonprofit association (the term used when the organization has not filed organizing documents with the state and the IRS) has no separate identity from its members making each personally liable for their own, and in some instances others, actions. 7 When an organization incorporates, it has a legal identity separate from the identities of its members and 7 For example, in North Carolina: The law surrounding nonprofit unincorporated associations is vague and uncertain. The members of such associations generally have equal rights and responsibilities, and all members of such associations generally face unlimited personal liability. 4 P a g e

5 thus limits their personal liability for negligent actions committed by officers, directors and employees. There are a number of corporate forms, such as the corporation, the limited liability company (LLC), and limited liability partnership (LLP) that serve to provide personal liability protection for members against their own or other members negligent actions. The result of this formality is that when a third party is injured by the negligent act of one of the members, the corporation gets sued and is liable for the resulting damages, but the personal property of the members remains protected against any judgments. b. Voluntary Nonprofit Association Liability In most states, two or more people engaged in a for-profit undertaking are said to be in a general partnership whether they intended to form such a partnership or not. Lawyers generally advise against general partnerships because, though they are among the most flexible of organizational forms, they expose each member to personal liability (that is, their own personal property is at risk) to judgments resulting from the actions of all of the other general partners. Many, but not all, states have laws that limit such exposure in the case of voluntary nonprofit associations. At the outset, it is worth finding out the liability rules in the state in which the state VOAD exists as a voluntary association. As noted above, even if the state makes an exception for general liability to all members of voluntary nonprofit association, each individual member will be personally liable for all negligent acts undertaken in furtherance of the organizational mission. Thus, the negligent act of an officer or director, or an occasional employee (volunteer-basis or otherwise) will expose the individual to personal liability to the injured third party. Many personal liability insurance policies will not cover negligent actions on behalf of a such an association; again, this can be determined by examining personal insurance policies. c. Corporate Liability The corporate form creates an individual entity (a legal person ) separate from members. This means that where individual members commit negligent acts while working on behalf of the corporation, the corporation alone is liable for the damages caused by those negligent acts. Again, state laws vary in terms of whether this protection is extended to wrongful acts that go beyond mere negligence, such as gross negligence, recklessness, intentionality and wrongful acts committed while under the influence of alcohol or drugs. The main advantage of the corporate form is the protection of employees personal property from judgments. Further, the corporate form, so long as all formalities are kept, also largely insulates employees from their own negligent acts. d. Corporate Form plus 501(c)(3) Status 5 P a g e

6 As noted in the previous section, the corporate form insulates employees from personal liability for negligent actions taken by them or other members of the organization. It alone does not, however, insulate volunteers from personal liability. One advantage of the tax-exempt or 501(c)(3) status is that volunteers receive some shielding from personal liability for negligent acts committed while volunteering for the organization from the federal Volunteer Protection Act (VPA) so long as certain conditions are met (more below). Further, some states, such as Massachusetts, provide tort immunity to recognized charitable nonprofit organizations, while others limit liability in the form of damage caps. This is not the rule in all states and state organizations should check with legal counsel or read state law on the subject to be sure. i. Volunteer Protection Act: Volunteer Tort Immunity The Volunteer Protection Act (VPA) was adopted in 1997 to provide immunity from lawsuits filed against a nonprofit's volunteer where the claim is that they carelessly, or negligently, injured another in the course of helping the nonprofit. The Act does not provide immunity to the organization itself. Prior to the adoption of the Act, under the law of most states, a volunteer who negligently hurt someone would be personally liable. Now the Act preempts all such laws and the volunteer is immune from suit so long as: The Volunteer is uncompensated The Volunteer is working on behalf of a 501(c)(3) or 501(c)(4) nonprofit organization. The immunity is a qualified immunity and protects the volunteer only against claims of negligence. It carves out exceptions to immunity for claims of gross negligence, willful or criminal misconduct, reckless misconduct, or conscious, flagrant indifference to the rights or safety of the individual harmed by the volunteer. Another exception to the immunity for volunteers comes when a negligent act is committed while operating a motor vehicle, which accounts for a large number of claims filed against volunteers. 8 The VPA requires as a condition of this immunity that the 501(c)(3) or (c)(4) organization must "provide a financially secure source of recovery for individuals who suffer harm as a result of actions taken by a volunteer in behalf of the organization," such as a general liability policy with adequate limits. Conditions for volunteer immunity include: The nonprofit purchases general liability insurance of with adequate limits and/or selfinsures with adequate reserves. The nonprofit amend its articles of incorporation or bylaws to specifically indemnify volunteers. Certain volunteers receive training from the nonprofit. 8 The difference between negligence and gross negligence is one of degree: gross negligence involves a greater degree of carelessness than negligence. In practice, this means that lawsuits for injuries suffered at the hands of a volunteer will be brought alleging gross negligence on the part of the volunteer, meaning that cases cannot be won on the relatively less-resource intensive basis of summary judgment.nonprofit Risk Management Center (202) P a g e

7 Volunteers receive prior written authorization in order to act. The conditions are consistent with the federal law s intent: to ensure that the nonprofit, not the volunteer serving the nonprofit, is financially responsible for negligent acts or omissions committed by an uncompensated volunteer. If the organization does not meet these conditions, its volunteers and the organization itself will then be liable if a volunteer carelessly injures someone while volunteering on behalf of the organization. In practice, the organization is liable in either event, but the failure to meet the above conditions also spreads risk of tort suits to volunteers. 9 In practice, the insurance requirement often means that volunteers serving the smallest and least organized nonprofits those with only meager resources often don t enjoy any protection under the state volunteer protection law, while those volunteering for larger organizations, which can afford liability insurance, will enjoy protection. Volunteers who are serving smaller, more informal organizations are at greatest risk, because the lack of sophistication and resources of the nonprofits they serve removes the protection the volunteers would otherwise enjoy under the state volunteer protection law. Some states, such as Massachusetts, give personal injury immunity to nonprofit organizations and others place caps on damage awards, so these are issues that should be considered with the advice of legal counsel in the home jurisdiction. However, personal injury award limits and immunities seem to be the exception and not the rule. A major advantage of adopting the corporate form and seeking tax-exempt status is to take advantage of liability protection for directors, officers, employees and volunteers. Unfortunately, at least from a charity s standpoint, the Volunteer Protection Act only addresses the volunteer's liability. It provides absolutely no protection for the charity. If the volunteer was acting on behalf of the charity as its agent, then the charity is legally responsible for the volunteer s acts under the respondent superior doctrine. Some will ask about charitable immunity. With the exception of a very few states, that legal doctrine has largely disappeared from the legal landscape. The charity must answer for the acts of the volunteer; as noted above, this is likely to be true whether the organization has insurance or not. Further, there are open questions about whether the negligent act of a volunteer could expose not only the charity itself to liability but also the parent organization. Corporate formalities are often created to insulate parent organizations from liability. For example, a large parent organization with substantial resources may spin off subsidiary corporations with less substantial resources to perform specific tasks or undertake specific business activities. If all of the corporate formalities are kept, the parent organization is insulated from liability for the subsidiaries activities. Tort plaintiffs may attempt to pierce the corporate veil to get to the deep pockets of the parent organization. To do this they will have to show that the subsidiary did not keep its corporate formalities, had inadequate resources and was set up solely to shield the parent from liability. Piercing the veil is difficult in practice, but it is a costly maneuver from a legal standpoint. In the case of a charitable organization spun off from a church with 9 Whether state or national reps are uncompensated volunteers for purposes of the VPA is an open question that should be resolved by legal counsel providing legal advice. It is possible that senior personnel would be treated like officers and directors rather than volunteers and thus enjoy liability limitations from the corporate form alone. It is also possible that they would be treated like uncompensated volunteers by the VPA and thus liable for injuries caused by negligent decision-making. 7 P a g e

8 substantial resources this is a particular problem and should be addressed by church counsel. Similarly, NVOAD and its state VOAD members may want to address similar concerns with their own legal counsel because failure to maintain corporate formalities at the state level could potentially expose NVOAD to liability for the negligent acts of volunteers at the state level. Boards should be concerned that their organizations have adequately addressed vicarious liability through risk management policies and insurance coverage. In large part, that means that a charity should have an insurance policy that clearly covers its employees, volunteers, and agents when they are acting on behalf of the charity. The policy should cover the delivery situation, but it should also cover rental cars. This requires that the charity have a competent insurance agent to help it obtain the appropriate coverage. The charity should also be asking its volunteers and other agents who drive on its behalf to provide adequate proof that they have required insurance in place. Of course, we can expect the two insurance companies to argue over which policy is the first responder or primarily responsible.[t]he organization also needs to focus on who might be considered to be its volunteer. This will not be a problem for the many charities with clearly-defined operations. But as the Milwaukee Archdiocese case points out, when related charities are using volunteers, it may not be entirely clear whether the volunteer is acting on behalf of one charity or another. This can be particularly problematic when one charity with a large facility permits other charities to use that facility. If the other charities have missions that in anyway further the mission of the charity with the large facility, that charity may find itself responsible for the acts of the volunteers that it never viewed as its agents. The legal problem can be exacerbated when the other charities are unincorporated groups A charity with a facility used by other charities should take steps to make sure the legal relationships between it and the other charities are clear before there is an incident. This may mean requiring incorporation of the other organizations or groups, indemnity agreements, and written contracts (leases) that clearly spell out the relationships between the parties. A clever plaintiff s lawyer may still be able to overcome these hurdles, but his or her burden will be higher. 10 Insurance is thus an open issue, though I think it merits consideration by state and national VOAD. Insurance would protect both organizational assets and employees and volunteers of the organization. It would also be a major step toward standardization of the VOAD form. e. Charitable Contributions State VOADs getting nonprofit status may find themselves in the difficult position of either directly competing or seeming like they are directly competing with local, state and national organizations for charitable contributions from the general public and private foundations. Several State VOAD representatives at the NVOAD meeting in Salt Lake City noted that this is an issue that has them concerned. This is an issue that should probably be decided at the national level. 10 This statement is taken directly from the Charity Governance website: The site includes a specific disclaimer that this is not legal advice. That disclaimer also applies to its placement in this white paper. These are important issues to discuss with legal counsel and are far beyond the scope of this white paper. 8 P a g e

9 A potential solution to this would be to have State VOADs accept only small donations up to a certain target amount, enough, for example to cover insurance and membership costs to the organization, accounting and legal costs, and any training and supply activities. Additional contributions could then be disbursed to member organizations or otherwise not allowed. f. Corporate Formalities and Record Keeping Incorporating, even as a nonprofit organization, will require that certain corporate formalities be observed. These formalities are required by state law but usually include at least one meeting a year, with minutes taken, a vote every couple of years on board membership and officers and directors and financial record-keeping. The IRS will also require yearly financial record-keeping for the purposes of tax-exemption. This will come with increased accounting costs and requirements for formal procedures to keep the corporate form active and avoid piercing the corporate veil. These formalities are important and the practices should be stated in the corporate origination and followed by the organization. g. Structure At least in theory, state VOADs could be structured as subsidiaries of the National VOAD. The advantage of this would be that they could take advantage of the NVOAD taxexempt status (assuming such status already exists) and could probably reduce the waiting period for tax-exempt status and the record-keeping costs. Again, this is an issue that should be decided by and between organizations. FEMA and DHS are in the process of standardization of response and decision-making, so increasing formality in the NVOAD and State VOADs may serve to facilitate relationships with those organizations by showing them that the VOADs are serious about conducting their affairs. IV. Conclusions There are a number of important reasons for state VOADs to file corporate origination documents and seek tax-exempt status. The decision should be made in careful deliberation with the board and legal counsel to ensure adequate attention to state and federal laws and to weigh the benefits and pitfalls in the specific and particular case of the individual organization and the national organization. This document is still in draft form and is thus not an exhaustive account of all of the possible benefits and pitfalls of seeking 501(c)(3) status. As such, the document may be expanded to include other areas of specific concern to VOAD members as they raise them so long as the concerns do not raise specific state or federal legal questions that would or could be considered legal advice, which is not only, in 49 states beyond my bar qualifications, but is also beyond the scope of work for the LSU/NVOAD agreement. Please address correspondence to the author at: jegan@lsu.edu and I will be happy to address concerns and/or expand this document as called for. 9 P a g e