Many NIL collectives have been structured as nonprofit entities which have sought and obtained 501(c)(3) public charity status from the IRS.  These collectives usually partner with other charities to establish NIL opportunities for student-athletes.  Under these arrangements, the nonprofit collective typically pays the athlete in exchange for his or her promotion of the partner charity through personal appearances, speaking engagements and social media, or through participation in sports clinics for community youth and the like.

This past year, the IRS announced that many NIL collectives structured as nonprofit organizations fail to qualify as tax-exempt entities.  According to a generic legal advice memorandum (GLAM), many of these entities operate primarily for the private benefit of student-athletes, and thereby fail the “operational test” under Section 501(c)(3) of the Internal Revenue Code (the “Code” or “IRC”), which requires that tax-exempt organizations operate primarily for exempt purposes.  As a result of the perspective shared in this GLAM, the IRS has begun denying NIL collective applications for tax-exemption, as reflected in two recently released IRS Private Letter rulings (the “Rulings”) (Private Letter Ruling 202414007 and Private Letter Ruling 202416015).  

According to the IRS, the nonprofit NIL collectives described in these Rulings and in the GLAM further the following stated purposes: (i) providing opportunities for student-athletes to be paid for the use of their NIL, and (ii) contributing “to the greater good of the community” by raising awareness and support of their partner charities’ missions.  This article includes further discussion of the regulatory obstacles these nonprofit NIL collectives are facing, and the implications for collectives operating with similar missions.

IRS Rules Governing Tax-Exempt NIL Collectives

In order to obtain and maintain tax-exemption under IRC Section 501(c)(3), an entity must be organized and operated exclusively for one or more of the exempt purposes set forth in IRC Section 501(c)(3), which may be charitable, educational or scientific in nature (Treasury Regulation Section 1.501(c)(3)-1(a)(1)).

As discussed above, to be regarded as “operated exclusively” for exempt purposes, an organization must be engaged “primarily” in activities which accomplish exempt purposes (Treas. Reg. Section 1.501(c)(3)-1(c)(1)).  The presence of “a single nonexempt purpose, if substantial in nature, will preclude exemption regardless of the number or importance of truly exempt purposes” (GLAM, citing Better Business Bureau of Washington, D.C., Inc. v. United States, 326 U.S. 279 (1945)).

In addition, to be regarded as organized and operated exclusively for exempt purposes, an organization must serve a public rather than a private interest (Treas. Reg. Section 1.501(c)(3)-1(d)(1)(ii)).  To meet this requirement, an organization must establish that it is not organized or operated for the benefit of private interests, including for example, designated individuals, the founders of the organization or their family, or persons controlled, directly or indirectly, by such private interests.

That said, private benefit will not prevent an organization from obtaining exemption if the private benefit is incidental in both a “qualitative” and “quantitative” sense.   

The IRS has stated that to be “qualitatively incidental,” the private benefit must be a “byproduct” of the exempt activity or a “necessary concomitant” to the “accomplishment of the exempt purpose” (GLAM).   A private benefit that is a “direct or intentional” benefit to designated or identifiable individuals would not be “qualitatively incidental” (GLAM).  

To be “quantitatively incidental,” the private benefit “must be insubstantial in amount when compared to the overall public benefit conferred by the activity” (GLAM).

IRS’ Analysis and Conclusion Regarding Nonprofit NIL Collectives

According to the IRS, the nonprofit NIL collectives described in the Rulings and the GLAM operate primarily for the private benefit of student-athletes, in violation of the “operational test” under IRC Section 501(c)(3).  The following are key factors that went into its determination.  The IRS concluded that:

1. Providing paid opportunities for student-athletes is a primary purpose of the nonprofit NIL collectives’ activities — which means these collectives serve a private, rather than a public interest.

2. The private benefit to student-athletes is not “qualitatively incidental” to the collectives’ exempt purposes.  This benefit is not a “necessary concomitant” to accomplishing their exempt purpose of supporting partner charities.  According to the IRS, there “are alternative means by which you could promote local charities without conferring a substantial private benefit on these student athletes, such as by encouraging volunteerism” (Private Letter Ruling 202414007).

3. The private benefit to student-athletes is not “quantitively incidental” when compared to the overall public benefit conferred by the collectives’ activities.  In the GLAM, the IRS noted that many collectives pay 80 to 100 percent of all donations to student athletes.  The IRS said, “for payouts anywhere within this range, the benefit to private interests is substantial by any measure and cannot be dismissed as merely incidental to [their] other purposes and activities” (GLAM).

4. Student-athletes being paid by nonprofit NIL collectives are not themselves a recognized charitable class.  The IRS noted in the GLAM that “absent a finding that NIL collectives select student athletes for participation based on need, such that their activities could be considered” as being “conducted for the relief of the poor or distressed, …payments to the student-athletes are properly regarded as serving private rather than public interests.”

The Future of Nonprofit NIL Collectives

As discussed herein, the IRS has begun denying tax-exempt status to some nonprofit NIL collectives for the reasons discussed above.  For similar reasons, the IRS has indicated that it may reconsider the exempt status of nonprofit NIL collectives that have already been granted exemption (GLAM).¹  These actions also have implications for donors, who cannot take a charitable deduction for contributions to nonprofit collectives whose exemption has been denied or revoked.

With the above in mind, it is critical for nonprofit NIL collectives to review the Rulings and the GLAM with counsel and ensure that their purposes and activities do not confer impermissible private benefits to student-athletes.  Nonprofit NIL collectives should also consult with counsel on the pros and cons of converting to a more flexible legal form, including, for example, a for-profit limited liability company structure, which is not subject to limitations on the type of activities it facilitates.

1 However, the IRS has also noted that in reconsidering the exempt status of such collectives, it may be appropriate to grant relief under IRC 7805(b) to limit the retroactive effect of any such revocations.

The post Nonprofit NIL Collectives Are Facing Obstacles in Obtaining Tax Exemption appeared first on Perlman & Perlman.

While “pay-for-play” is still prohibited by the NCAA,² these new rules have opened the door for college athletes to explore a new world of sponsorships, endorsements and compensation.  For example, college athletes can now earn money for commercials, appearances, speeches, social media posts, hosting sports camps, giving lessons, writing books and more — all without violating NCAA rules.

“NIL collectives” have emerged as the chief brokers of these opportunities.  This article discusses what NIL collectives are, their legal forms of organization, and the regulatory framework that governs them.

How are NIL Collectives Structured?
NIL collectives are entities that are structurally independent of a school, yet fund NIL opportunities for the school’s student-athletes. They are typically founded by well-known alumni and supporters of the school.  Collectives generate and pool revenue raised through contributions from a wide variety of sources, including boosters, businesses, fans and more.  They use these funds to create opportunities for student-athletes to leverage their NIL in exchange for compensation.

While a number of NIL collectives have been formed as for-profit entities,³ in a growing number of cases, they have been formed as nonprofits. Numerous nonprofit collectives have, in turn, sought and obtained 501(c)(3) public charity status from the IRS, which potentially allows donors to receive a tax-deduction for their contribution to the collective.⁴

Tax-exempt collectives typically use student-athletes as independent contractors to help further their charitable mission.  For example, some provide in-kind contributions of a student-athlete’s services to other charities, including speaking, appearances and other public relations services that help expand the charities’ reach and visibility in their communities.  The student-athlete is paid by the tax-exempt collective to provide the services, while the other charities receive these services on a pro bono basis.

Special Rules Governing Tax-Exempt NIL Collectives
Collectives that obtain tax-exemption should be mindful of special rules that apply to tax-exempt entities.  These rules are enforced not only by the IRS, but also by State Attorneys General, whose responsibility is to ensure that charitable funds are used for charitable purposes. These rules require that tax-exempt cooperatives operate differently from the typical NIL collective.

For example, NIL collectives commonly facilitate endorsement, merchandising and marketing deals that allow for-profit companies to promote their products and services using a student-athlete’s NIL, which helps these for-profit companies increase business and revenues.  Many NIL collectives have the flexibility to promote such commercial interests due to their structure as for-profit (and therefore, taxable) entities.

However, facilitating commercial deals does not constitute a permissible purpose for a charitable, tax-exempt organization.  Therefore, if a tax-exempt NIL collective engages in such activity, revenues from this activity could be taxed by the IRS as unrelated business income – i.e., income from a trade or business, regularly carried on, that is not substantially related to the collective’s charitable mission.

Also, if the IRS finds that these commercial activities constitute a primary or substantial non-exempt purpose of the organization, the IRS could revoke its tax-exempt status.⁵ State Attorneys General could bring enforcement actions for similar reasons.  Therefore, if a tax-exempt collective facilitates marketing or similar NIL arrangements, it should generally avoid arrangements promoting goods and services of for-profit companies.  However, it could use the NIL of student-athletes to help promote and amplify the charitable missions of nonprofits serving communities.⁶

NIL collectives are also becoming well-known for offering lucrative compensation to student-athletes in connection with promotional deals.  For many collectives, their status as for-profit entities give them the flexibility to do so.

But, in the context of a tax-exempt collective, these payments must be reviewed carefully to ensure they do not constitute “excessive compensation” for federal tax law purposes.  NIL collectives should therefore carefully structure athletes’ compensation in accordance with IRS rules to ensure it does not exceed fair market value.  Failure to do so could put the collective at risk of losing its tax-exemption, and lead to potential enforcement actions by State Attorneys General.

However, it should be noted that even if such compensation is determined to be reasonable, a tax-exempt NIL collective could nevertheless lose its exemption if the IRS determines that its primary or substantial purpose is to pay or recruit student-athletes.  For this reason, it’s important that tax-exempt collectives work closely with legal counsel to ensure they have well-constructed charitable programs.

Given the risks outlined above, an NIL collective seeking tax-exempt status should carefully consider whether any of its time and resources will be spent on pursuing commercial (non-exempt) activities.  Collectives considering such activities should consult with counsel to reconsider its structural options, and discuss whether it would be advisable to create a for-profit subsidiary to house any commercial activity.

NCAA Interim Rules
Aside from understanding the regulatory framework discussed above, NIL collectives (no matter their legal form) should have an understanding of the NCAA rules which, as of the time of this writing, consist of interim rules adopted in July 2021.  These interim rules will remain in effect until federal legislation creates a national standard (which is what the NCAA is calling for), or until new NCAA rules are adopted.  While the purpose of the interim rules is to suspend NCAA restrictions on athletes’ profiting off their NIL, the rules maintain certain guardrails to prevent “pay-for-play” and similar arrangements.  Subject to state law, the following is prohibited under the interim rules:

• NIL opportunities cannot be used as a recruiting tool for prospective student athletes.  Such an action is considered an “improper recruiting inducement.”  Therefore, NIL collectives should refrain from making offers of NIL opportunities contingent upon a student-athlete’s enrollment at a particular school.
• As discussed above, NIL arrangements that constitute “pay-for-play” are also prohibited.   This rule prohibits any kind of arrangement that constitutes compensation in exchange for a student-athlete’s participation or performance in college athletics.
• NIL agreements should be specific about the NIL work being performed by the athlete in exchange for compensation, and such compensation should be paid only for work performed.  Such compensation must be determined through an independent analysis, based upon the facts of each specific case and the value each athlete offers to an NIL arrangement.
• The NCAA interim rules prohibit compensation from any school in exchange for the use of a student athlete’s name, image or likeness.  In addition, schools may not direct how student-athletes use NIL compensation.  (For example, schools may not require a student-athlete to use NIL compensation for financial aid.) Athletic department staff are not allowed to represent student-athletes in marketing their athletic ability or reputation.  They also may not communicate with a recruit on behalf of an NIL collective.  In addition, such staff may not facilitate a meeting between an NIL collective and a student-athlete, including, for example, by sharing a recruiting list or watch list.

State Laws and School Policies
As noted above, the NCAA’s interim rules are subject to state law, which varies depending on the state.⁷  Therefore, NIL collectives should take steps to ensure compliance under any applicable state law, including any state law that applies to the collective, the school where the student-athlete is enrolled, as well as the state where the NIL activity will take place.

The collective should also look at any specific NIL policies established by the college.

Both state laws and school policies may include reporting requirements that NIL collectives should be aware of, and some state laws prohibit athletes from entering into a contract that conflicts with the student-athlete’s team contract.

Understanding the regulatory framework governing NIL collectives will help avoid missteps that can lead to punitive actions by the IRS, NCAA or State Attorneys General, or scrutiny from Congress, which has also taken an interest in these entities.  As the NIL’s regulatory environment continues to evolve, it is incumbent on both collectives and student-athletes to take affirmative steps, including consulting with legal counsel, to ensure compliance.

1 This dramatic shift by the NCAA also came on the heels of its loss before the U.S. Supreme Court in NCAA v. Alston 141 S. Ct. 2141 (2021). Though NIL compensation was not the subject of this case, Justice Kavanaugh wrote a concurring opinion which suggested that the NCAA’s NIL compensation rules could be in violation of antitrust laws, and stated that “the NCAA is not above the law.”  The NCAA’s change also follows action by numerous states that, since 2019, had led the way in creating NIL rights for student athletes.

2 As discussed later in this article, “pay-for-play” refers to any kind of arrangement that constitutes compensation in exchange for a student-athlete’s participation or performance in college athletics.

3 Other legal forms taken by NIL collectives have included formation as for-profit limited liability companies (“LLCs”), which provides more flexibility in a number of ways.  For example, unlike tax-exempt nonprofits, for-profit LLCs are not subject to a cap on what’s considered reasonable compensation.  They may therefore offer student-athletes NIL work at any compensation structure.  For-profit LLCs are also not subject to limitations on the type of activities they can facilitate.  Therefore, unlike tax-exempt entities, for-profit LLCs may facilitate NIL arrangements for student-athletes such as merchandising or endorsement deals which promote commercial activities.  NIL collectives should consult with counsel to discuss the various pros and cons of these options.

4 On September 29, 2022, Senators John Thune (R-S.D.) and Ben Cardin (D-Md.) introduced the Athlete Opportunity and Taxpayer Integrity Act which, if passed, would “prohibit individuals and organizations from using the charitable tax deduction for specific contributions that compensate college or incoming college athletes for the use of their (NIL).”   They argue that “(s)uch activity is inconsistent with the intended purpose of the charitable tax deduction, and it forces taxpayers to subsidize the potential recruitment of – or payment to – college athletes based on their NIL status.”  As of the time of this writing, this federal legislation is the latest of more than a handful of NIL proposals introduced, but not yet passed, in Congress.  Congress’ appetite for eventually passing NIL legislation is unclear, though these proposals do indicate that NIL collectives are facing increased scrutiny from Congress.

5 Regs. Sec. 1.501(c)(3)-1(e)(1) and Sec. 1.501(c) (3)-1(c)(1).

6 One example of this approach is discussed in the previous section – i.e.,  tax-exempt collectives that provide in-kind contributions of a student-athlete’s services to other charities to help them promote their charitable missions.

7 As discussed above, the NCAA is lobbying Congress for legislation that would create a national standard, and thereby pre-empt differing state laws.

The post Seeking Tax-Exemption for a Name, Image and Likeness Collective (NIL)? What to Know. appeared first on Perlman & Perlman.

The bill follows New York’s passage in 2019 of another diversity related law which calls for a study of the number of women serving on certain corporate boards.

The bill’s sponsors say ethnic diversity is critical to a nonprofit board’s ability to understand its community’s needs.  They say when the ethnic makeup of a nonprofit board mirrors that of the community it serves, the board is more able to relate to the shared experiences of its community, and is therefore better equipped to identify problems and feasible solutions.   The bill makes an analogy to ethnically diverse police departments, stating that as data bears out that diverse police forces provide better service to diverse communities, the same may be true for nonprofit boards.

On January 5, 2022, the bill was referred to the Senate’s Corporations, Authorities and Commissions Committee.  It’s unclear whether this bill will gain traction during this legislative session.  Nevertheless, the call for more diversity on boards is trending not only in New York, but in California, Maryland, Illinois and other states where board diversity requirements have either been enacted or proposed.  Given the growing expectation for greater inclusion of underrepresented minorities on boards, nonprofits should consider familiarizing themselves with best practices for board diversity.

The post New York State Legislature Considers Bills Requiring Diversity for Nonprofit Boards appeared first on Perlman & Perlman.

Historically, New York’s NPCL did not allow nonprofit organizations to hold virtual membership meetings. That changed with the COVID-19 pandemic, when New York offered temporary flexibility to the boards of charitable and religious nonprofits.  Under the COVID-19 rules, boards of charitable nonprofit or religious organizations could unilaterally decide to hold member meetings virtually. Under the revised law, boards of nonprofit charitable organizations may unilaterally determine whether or not to hold member meetings electronically, as long as their certificate of incorporation or bylaws do not prohibit such a decision.

Similarly, the newly-created default rule under New York’s Religious Corporations Act (RCL § 28) is that a board of a religious corporation may organize a virtual membership meeting if the board is already authorized to determine the place of a membership meeting, under either the organization’s governing documents or another provision of the RCL. However, leaders of religious organizations should bear in mind that the RCL contains different provisions depending on the denomination of the organization – leaders must be careful to review their organizing documents as well as the applicable sections of the RCL to confirm whether they have the requisite power to call virtual membership meetings or, if not, whether they could amend their governing documents to acquire that power.

Any boards considering adopting a virtual format for their upcoming membership meeting should consult with an advisor to review their organizational documents. Any nonprofit or religious corporations whose certificate of incorporation or by-laws prohibits virtual membership meetings should consider whether and how to revise their documents to provide the board with additional flexibility. We anticipate that many organizations and their members will decide to operate under virtual or hybrid formats in the near future.

The post New York Allows Virtual Membership Meetings appeared first on Perlman & Perlman.

Within a week, the group created the ConstitutionDAO, organized its followers on Discord (a messaging and community platform), and raised roughly $47 million in virtual currency.⁴ Armed with their new war chest, the group bid on, but ultimately failed to win, the Sotheby’s auction, losing out to a hedge fund billionaire who purchased the copy of the Constitution for $43.2 million (the Constitution DAO had withheld some funds to cover costs associated with winning the auction).⁵

Following their loss, the creators of the group were faced with what to do with the virtual currency sitting in the DAO’s treasury. Many of the community members sought refunds, only to learn that the transaction costs (also known as gas fees) would eat up much of their original contribution.⁶ Ultimately, the ConstitutionDAO’s founders decided to shut it down.⁷ The token issued in connection with the project, originally intended to be used to allow holders to vote on what the DAO would do in the future, lives on, with some holders still hoping to profit.⁸

What if the ConstitutionDAO had succeeded? Who would have “owned” the copy of the Constitution the group would have purchased? In a later interview one of the founders of ConstitutionDAO, Jonah Erlich, disclosed that the group had partnered with a traditional nonprofit organization that would have had legal custody of the Constitution.⁹ The fact that this new type of organization would be reliant on a traditional nonprofit provides excellent insight into the emerging world of DAOs. It also gives us an entry point to examine this new structure.

WHAT ARE DAOS?

In a traditional corporation or limited liability company, the organization is formed by filing paperwork with a government office, typically a state’s Department of State. By creating a legal entity, the people behind the organization are protected from liability. When someone sues a corporation over a contract dispute or other liability, the directors, officers, employees, members, and volunteers are not liable individually. Rather, it’s the corporation that must answer for its liabilities.

In a DAO, however, there is no formal legal entity. Built using the same blockchain technologies that underly the virtual currency ecosystem, DAOs are organizations that are never incorporated in any state (with limited exceptions). The founders create the DAO, and it simply exists.

While DAOs actual structures vary, most DAOs issue a token that gives members of the DAO voting rights. Once tokens are issued, in order to make decisions, all token holders are allowed to vote. The idea, touted by DAO supporters, is that this new structure democratizes organizational decision-making, placing it in the hands of the members. An oversimplified comparison would be a for-profit company that has no paid executives or board of directors, making every decision by allowing all shareholders to vote.

Although the ConstitutionDAO is a well-known example, DAOs are proliferating in the nonprofit community. Here are a few interesting examples: DiatomDAO is raising support to protect the oceans;¹⁰ KlimaDAO hopes to speed up solutions for climate change by increasing the price of carbon assets;¹¹ Bloomeria is using NFTs to increase biodiversity; ¹² and The Regen Network is issuing a token as part of a group of entities to realign the agricultural economy with ecological health.¹³

While each of the foregoing organizations uses the language of the DAO and decentralization, they also demonstrate how the DAO community encompasses many different structures. For instance, the Regen Network is comprised of a traditional C-Corporation, a traditional 501(c)(3) public charity, and a decentralized DAO program.¹⁴ The DiatomDAO is purely a decentralized entity, “owned and directed” by its token holders (see more on this below). The ConstitutionDAO, while operated as a decentralized DAO, would have relied on a traditional 501(c)(3) public charity (one named EnDAOment¹⁵) had it won the Sotheby’s auction and needed a legal entity with which to hold the copy of the Constitution. As you can see, while many groups use the mantle of “DAO”, the term encompasses many different structures.

WHAT ARE THE BENEFITS OF DAOS?

Now that we’ve discussed what DAOs are, and seen some examples, let’s step back to consider what DAO proponents like about the structure. In theory, a pure DAO offers each supporter the opportunity to participate in the group’s decision-making. If a member of a charitable DAO wants to make a grant, they would propose it to the rest of the DAO community. The members then hold a vote. Using this structure, a DAO represents a more direct form of organizational decision-making and, for donors, more direct-action philanthropy.

Further, by avoiding any legal structure, some DAO proponents believe this new structure will give DAOs greater flexibility. Without a state’s laws dictating how decisions have to be made or how boards have to be structured, a DAO might be nimbler. Some libertarians believe that DAOs, who have no real jurisdictional nexus to any state, might even be able to avoid generally applicable laws.¹⁶

WHAT ARE THE DRAWBACKS OF DAOS?

While there is a lot to be excited about by DAOs, they use an organizational structure in its infancy, with many more questions than answers. One critique is that the voting structure adopted by most DAOs (1 token = 1 vote) replicates existing problems with shareholder structures, namely, that the larger shareholders control organizational decision-making, alienating smaller shareholders. If one person holds 60% of the DAO’s tokens and the DAO implements a 50+1% vote threshold decision-making could be even more centralized than it would be in a traditional organization with a board and executives who can counterbalance a large shareholder’s interests. The DAO community has proposed some possible solutions to this problem, such as limiting votes to one per token holder, or creating non-transferable tokens to limit token holder hoarding. Each of these solutions have drawbacks, but they could drive decision-making closer to the idealized notion of the DAO.

Another issue is the legal uncertainty of DAOs. Assume that the libertarian notion that DAOs are legally unaccountable as organizations, since they are not organized in any state nor do they have any other jurisdictional nexus with any local, state, or federal government. That might put the DAO beyond the reach of regulators and law enforcement, but it would not exempt the individuals participating in or working for the DAO, all of whom are real people subject to normal laws. Actually, the idea of a group of people running an unincorporated organization isn’t new. In New York, for instance, such an entity would be deemed an “unincorporated association.” Under longstanding common law, an unincorporated association is not legally separate from the members who comprise it.¹⁷ That means that members of a DAO could be taking on direct legal risk from their participation in the DAO. If the DAO were to breach a contract, discriminate against an employee, or cause other real-world harm, the DAO’s members might be jointly and severally liable.

It’s also an open question whether regulators will share the libertarian view that DAOs are not subject to local, state, or federal laws. It wouldn’t be surprising to see the Securities and Exchange Commission (SEC) bring an enforcement action against a DAO, given that it has already notified the Decentralized Finance (DeFi) community that it considers many DeFI products analogous to products regulated by the Commission.¹⁸ The SEC has already brought an enforcement action against a Wyoming organization operating under the guise of a DAO, albeit only after the entity sought SEC approval to register two tokens as securities.¹⁹

Finally, DAOs in the philanthropic sector face the additional hurdle of providing tax-deductibility to donors. In general, a contribution to a non-charitable intermediary doesn’t allow a donor to take a tax-deduction. The answer to that question isn’t clear²⁰ as it depends on how the entity is treated for tax-purposes, whether its distributions would otherwise qualify for a tax-deductions, and whether it is considered an agent for the donors or beneficiary charities. A person hoping for a tax-deduction should contact a tax professional to examine the particular DAO’s structure and the taxpayer’s circumstances. To date, I’m unaware of any DAO specifically advertising the deductibility of contributions to its treasury, nor having considered tax-deductibility as part of their DAO structure (except, of course, for DAOs like Endaoment and Regen Network that operate using a traditional 501(c)(3) corporate structure).

WHAT’S NEXT FOR DAOS?

Despite the novelty of and the uncertainty surrounding DAOs, their popularity is undeniable. This was exemplified by the incredible enthusiasm around ConstitutionDAO. Taking advantage of the late 2021 surge in the value of many cryptocurrencies, DAOs provide an opportunity for the crypto community to put its assets to work in novel ways, including philanthropy. While they are evolving, DAOs will likely persevere, barring regulator intervention to shut them down.  Donors and charities looking to participate in the DAO community should do so carefully, and with the benefits of advisors familiar with the DeFi and DAO space.

1 https://www.sothebys.com/en/digital-catalogues/the-constitution-of-the-united-states

2 Id.

3 https://www.theverge.com/22820563/constitution-meme-47-million-crypto-crowdfunding-blockchain-ethereum-constitution

4 https://www.constitutiondao.com/

5 https://www.vice.com/en/article/qjb8xv/hedge-fund-ceo-who-bailed-out-gamestop-short-seller-bought-the-constitution

6 https://www.theverge.com/2021/11/24/22800995/constitutiondao-refund-progress-steep-gas-fees-cryptocurrency

7 https://www.theverge.com/2021/11/23/22799192/constitutiondao-shutting-down-lost-auction-refunds

8 The latest price quote for the PEOPLE token can be found at  https://coinmarketcap.com/currencies/constitutiondao/.

9 https://www.theverge.com/22820563/constitution-meme-47-million-crypto-crowdfunding-blockchain-ethereum-constitution.

10 https://diatom.fund/

11 https://www.klimadao.finance/

12 https://bloomeria.org/

13 https://www.regen.network/

14 https://www.regen.network/faq/organization

15 https://endaoment.org/

16 For instance, in his conversation on the Deep Background podcast, Erik Voorhees argued that a DAO could avoid the difficulties of employment law because no states employment laws would apply. https://www.pushkin.fm/episode/whats-the-deal-with-decentralized-autonomous-organizations/

17 See, generally, New York Elec. C. Assn. v. Local Union No. 3, (NY Sup. Ct. 1941), available at https://casetext.com/case/new-york-elec-c-assn-v-local-union-no-3

18 https://www.sec.gov/news/statement/crenshaw-defi-20211109

19 https://www.sec.gov/news/press-release/2021-231; https://www.coindesk.com/policy/2021/11/11/sec-stops-wyoming-based-dao-from-registering-2-digital-tokens/.

20 For an excellent discussion, see Prof. Samuel Brunson’s blog post https://lawprofessors.typepad.com/nonprofit/2021/11/charitable-daos-revisited.html.

The post DAOs and the Nonprofit Sector – How Can they Work Together? appeared first on Perlman & Perlman.

Virtual currency is gaining mainstream attention with each passing day. Nonprofits such as the American Red Cross, UNICEF, and American Cancer Society leverage platforms including The Giving Block and other services to accept a wide range of virtual currencies, as part of their overall fundraising strategies.

At our firm, we continue to work with nonprofit clients as they consider whether and how to fundraise using cryptocurrency. Here are a few questions we have been asked and other questions charities should be asking of potential fundraising platform partners.

Frequently Asked Questions

Should we accept virtual currency?

For many organizations, this is an easy answer – yes. There are few risks to accepting donations of virtual currency, especially if nonprofits immediately liquidate those donations.  Donors of virtual currency typically skew younger, possibly opening up a new demographic of supporters for the organization. The board should consider including virtual currency in its Gift Acceptance Policy, a document every organization should have to guide its board, executives, and staff in their development work.

Should we immediately liquidate donations of virtual currency, or hold onto them?

This is more difficult to answer, as it is based on how much risk the organization can tolerate. Virtual currency is highly volatile – its value can skyrocket or plummet within a matter of hours or days, making it a risky asset to hold onto. Whether to hold onto virtual currency is a decision that should be made with the input of a nonprofit’s board and executive team. If virtual currency is held as part of the organization’s investments, or if a donor asks the organization to hold the virtual currency as an endowment or long-term investment, the organization should consider how that fits within the organization’s overall investment strategy and portfolio, and the applicability of state laws governing the prudent management of institutional funds/assets.

One concern is volatility – few organizations want to see their donations halve in value. For many organizations, the potential upside isn’t worth the potential risk.

A second concern is regulatory risk. As the Chinese central bank, SEC, FINCEN, IRS, and other domestic and international regulators grapple with how to regulate virtual currency, the liquidity and accessibility of virtual currency markets is up in the air. Even major players like Coinbase and Ripple have been subject to or threatened by regulatory action.

Charities are often cautious when holding virtual currency, concerned that the regulatory environment could shift in a way that devalues or freezes their holdings. If a nonprofit is using a virtual currency account on a platform that is subject to an SEC action, for instance, the platform might be forced to freeze transactions until such time as the SEC allows it to continue operations.

Organizations that are highly diversified and have the financial cushion to absorb a zeroing out of their virtual currency donations, taking into account the diversification of risk across the organization’s entire investment portfolio,  might be comfortable with the risks of virtual currency. The potential upside of assets like Bitcoin are hard to ignore – despite volatility, Bitcoin’s value has been on a consistent march upward. Other coins, like Ethereum, have not been far behind. If your organization is willing to take the risk, and has considered the prudent investment regulatory considerations, you can create a wallet at a prominent, legally-compliant platform, and park your virtual currency there and “Hold On for Dear Life” (HODL, as some in crypto-world like to say).

Fortunately, the major virtual currency fundraising platforms allow immediate liquidation of donations. Again, this is the option chosen by most nonprofit organizations. As I mentioned above, nonprofits should include virtual currency in their Gift Acceptance Policy and Investment Policy to help guide their development professionals as they consider whether and how to accept virtual currency donations.

How do we treat virtual currency for accounting purposes?

Despite continued regulatory action in other parts of the crypto market, IRS rules around donations of virtual currency have been relatively stable. Since 2014, the IRS has been clear that virtual currency should be treated as property. A taxpayer donating virtual currency they have held for more than a year may deduct the fair market value of the currency at the time of its donation, similar to other forms of property, such as publicly-traded stocks. This provides a tax benefit to donors who invested in virtual currency in its infancy – they can support their favorite charities without being taxed on the gains they’ve enjoyed on paper.

This consistent treatment from the IRS means that charities can rest assured that they can accept virtual currency in the same way that they can accept donations of appreciated stock or other forms of property. The accounting department or external accountants should be able to handle booking donations of virtual currency without much trouble. A caveat is that, in a nonbinding FAQ, the IRS has said that nonprofits must fill out Form 8282 whenever the nonprofit sells, exchanges, or otherwise disposes of its virtual currency. This is a departure from the IRS’s treatment of virtual currency as akin to stocks, which a nonprofit can sell without filing Form 8282. While not insurmountable, nonprofits and their fundraising platforms should discuss how to operationalize capturing the information required for filing Form 8282.

Questions to Ask a Fundraising Platform

Now that we have considered some of the frequent questions nonprofits ask their advisers, let’s consider questions nonprofits should ask a prospective fundraising platform as part of their due diligence.

Are you registered as a professional fundraiser?

Fundraising is regulated in most states, with each state using its own regulatory regime. Individuals and organizations that support charities are often subject to laws regulating charitable solicitation (here’s an excellent overview from my colleague Tracy Boak). Charities are affected by these regulations and are obliged to make sure they only partner with organizations that are properly registered and licensed, if required.

Many fundraising platforms (both traditional and those dealing with virtual currency) take the position that they are not professional fundraisers, due to the way they structure their platforms and services, e.g., because they don’t affirmatively solicit donations on behalf of any charity and don’t take custody of donations. Regardless, a platform should be able to tell you why it isn’t subject to fundraising registration requirements. By asking the question, nonprofits can rest assured their fundraising platform partner is on top of its compliance obligations.

Are you registered as a Money Service Business or Money Transmitter?

Money Service Business (MSB) and Money Transmitter (MT) regulations are implemented at the federal and state levels. Their purpose is to weed out fraud and money laundering in the money transmission business. Generally speaking, MSB and MT laws create licensing structures that require licensed entities to do some due diligence on their customers, including “KYC” (know your customer) and “AML” (anti-money laundering) requirements.

Since 2013, the Financial Crimes Enforcement Network (FinCEN) has applied money transmitter regulations to some entities within the virtual currency ecosystem. According to FinCEN, if a person or organization accepts money or another instrument with monetary value from one person and transmits it to another person, that person may be classified as a money transmitter under federal regulations. (A comprehensive rundown of FinCEN’s guidance is found here). This means that any entity that accepts virtual currency from one party and transmits it to another party could be considered a money transmitter subject to the federal rules. The same rules apply if the entity accepts virtual currency, converts it to fiat currency (i.e., U.S. dollars), and transmits the fiat currency to another person or entity.

FinCEN does provide some exceptions, including those entities that only provide network access or serve as payment processors, exceptions which largely do not apply to crypto-fundraising. Whether a person or entity will be treated as a money transmitter is a facts-and-circumstances determination, but FINCEN clearly intends to define money transmission broadly and interpret its exceptions narrowly (see the discussion on pages 12-22 of the guidance linked above).

Nonprofits considering crypto-fundraising options should ask the potential partner whether it is registered as a money transmitter. If not, ask how they ensure that their services aren’t used inappropriately – do they work with a partner that is a licensed entity? Who does their KYC and AML compliance work?

Do you accept anonymous donations?

Anonymous donations are nothing new – charities have received anonymous donations large and small since long before the birth of cryptocurrency. But many charities are wary of the “dark side” of cryptocurrency and its reputation (rightly or wrongly earned) for facilitating illicit activity. Nonprofits should check with their potential fundraising platform to confirm whether they allow anonymous donations. If so, ask whether the donations are anonymous to the platform, or only to the charity. If the donation is anonymous to the platform, ask whether and how the platform ensures the anonymous donations aren’t connected with illicit activity. The answer may be that the platform does not, or cannot, do anything else to ascertain the identity of donors who wish to remain anonymous. If that is the case, the nonprofit should consider whether it is comfortable with the risks of accepting anonymous donations.

Those risks are generally the same as accepting any other high-value anonymous donation – that a donation of virtual currency could be traced back to illicit activity or a potential clawback, if the virtual currency that is donated doesn’t belong to the donor.  One difference with anonymous donations of cash or other types of property is that the virtual currency environment is highly transparent, even if it may be highly anonymized. Bitcoin transactions are viewable on the blockchain, even if the participants in the transactions may remain anonymous.

Do you issue donation receipts? Do you fill out Form 8282? Will we get a donor list?

One of the core tasks in charitable fundraising is issuing receipts to donors. Donors need to keep those receipts on file, in case they want to claim a charitable deduction. Many platforms will create automatic receipts. Nonprofits should confirm that the receipts issued by its platform partners are compliant with IRS requirements, and ask for copies for your records.

Nonprofits should also ensure that the fundraising platform will provide you with a list of your donors, to make sure you can build out your donor base.

The post What Nonprofits Should Be Asking About Virtual Currency Regulation and Fundraising appeared first on Perlman & Perlman.

Nonprofits and for-profits (in this article, “Brands” for easy reference) can collaborate in a number of ways to benefit both organizations. Nonprofits benefit by receiving financial support and access to a wider audience. Brands benefit from the goodwill generated by supporting a charitable cause, while simultaneously furthering their own purposes. These collaborations may take a number of forms. (For further reading, see  articles on our website , Selfish Giving, and Engage for Good’s online resource Cause Marketing and the Law).

We’ve recently seen a number of nonprofits expand their efforts to more consciously address online collaboration. In this article, I provide a refresher to clarify where the IRS draws the line on these types of partnerships. Understanding this line can help Brands to maximize their benefits and charities to avoid unwanted tax consequences.

What are Qualified Sponsorship Payments?

A typical strategy for Brands and nonprofits to collaborate is through sponsored events. While the pandemic has thrown traditional fundraising events for a loop, many nonprofits have pivoted to digital engagements or are now beginning to plan live events again as vaccination rates rise. Whether an event is digital or live, many nonprofits underwrite their events with support from Brand sponsors. In exchange for this support, Brands typically receive certain benefits. Those benefits may include a page in the event program, placement of their logo on the step-and-repeat, or a booth at the event. In the virtual context, Brands may get a shout-out or other acknowledgment during the event, in thank-you emails to attendees, or in press releases issued by the nonprofit.

If a nonprofit wants to avoid tax on the sponsorship payments that are received in exchange for certain benefits to the Brand, one strategy is to ensure that the payments qualify as “Qualified Sponsorship Payments”, the term used in Section 513(i) of the Internal Revenue Code. In order to be categorized as a Qualified Sponsorship Payment, the payment must be made without any arrangement or expectation of a “substantial return benefit.” Payments made in return for advertising or marketing services may constitute a substantial return benefit, and cause the payment to be subject to tax under the IRS’s Unrelated Business Income Tax (“UBIT”) rules.

So when does including a Brand’s logo in the nonprofit’s event, or allowing the Brand to have a booth or table at the event, constitute a “substantial return benefit”? Fortunately, the IRS has provided guidance on this question. According to the IRS, one way to avoid providing the Brand a “substantial return benefit” is for the Brand and nonprofit to avoid language that “promotes or markets any trade or business”. The IRS goes on to provide several examples of activities that are allowable under the qualified sponsorship rules, including:

• Distributing a Brand’s products to the general public at the event, either for free or purchase
• Including a Brand’s logo, slogan, address(es), telephone number, descriptions of a Brand’s product line or services, PROVIDED that all the foregoing do not include any comparative or qualitive descriptions of the Brand’s goods and services.
• Exclusive sponsorship arrangements (i.e., having a Brand be the only bakery sponsoring the event. NOTE – this is different than an exclusive provider arrangement, described below)

The IRS, in its guidance, also describes what types of messaging and activities are considered “substantial” return benefits for Brands and therefore NOT qualified sponsorship activities, including:

• Advertising for the Brand (messaging that promotes or markets a Brand, including messaging that contains comparative or qualitative descriptions of the Brand’s goods/services)
• Exclusive provider arrangements that limit the sale, distribution, availability, or use of competing products/services in connection with the nonprofit’s event/activities (i.e., having a Brand be the sole provider of cookies for an event. NOTE – this is different from the exclusive sponsorship arrangements, described above)

Social Media Considerations

Many Brands and nonprofits have begun to include social media posts as part of their messaging around events and partnerships. In addition to concerns about UBIT and qualified sponsorships, Brands and nonprofits have to be wary of rules implemented by the social media platforms (Instagram, Twitter, and TikTok, for instance) and guidelines issued by the Federal Trade Commission.

Nonprofits often thank their Brand sponsors for their support. It’s important that the language included in those posts is agreed upon by the Brand and nonprofit, and is vetted to make sure it doesn’t amount to an advertisement or endorsement of the Brand’s products or services. Similarly, when a Brand posts to highlights its support of the nonprofit, the parties should ensure that the post doesn’t create the implication that the nonprofit is endorsing the Brand’s products.

Brands and nonprofits also have to make sure their posts include appropriate disclosures to put their respective followers on notice that the content they are posting is part of a partnership. How those disclosures should be structured depends on the platform and the nature of the post, but has to be clear enough so that the posts comply with the platforms’ rules and the FTC’s guidelines.

If the Brand and nonprofit have brought a celebrity or influencer into the event to help raise its profile, the same general principles apply to the influencer’s posts. The Brand and nonprofit should make sure there are contractual provisions as well as practical guidelines provided that clarify what the influencer can and cannot post, how those posts should be timed and structured, and what material disclosures must be included.

Advice for Brands and Nonprofits

Brands and Nonprofits need to carefully review their contracts and social media posts to ensure they are not violating the rules regarding Qualified Sponsorships or social media platform disclosures. All posts made by the nonprofit thanking the Brand should avoid any qualitative language. Here are two sample statements to differentiate between comments that could be considered advertising vs. those that are just acknowledgments:

• Acknowledgment – NONPROFIT thanks BRAND for their steadfast support of our event. With BRAND’s support, we raised $100,000 in furtherance of our mission to end childhood hunger.
• Advertising – NONPROFIT thanks BRAND, purveyor of the best chocolate chip cookies in the NYC-area, for their support of our event. BRAND is one of the best companies and we thank them for their continued support. Find their cookies available for delivery at [WEBSITE].

In the second statement, the nonprofit used qualitative language around the Brand and its products. It also made a general comparative characterization of the Brand and linked to the Brand’s website, not for general informational purposes but to encourage viewers to order the Brand’s products. The second statement would be considered advertising, and could trigger UBIT for the nonprofit. The first statement merely identifies the Brand as a supporter of the nonprofit and its mission, and would be considered an acknowledgment.

In the contract governing the sponsorship or collaboration, the nonprofit should include restrictions on the Brand’s ability to use the nonprofit’s name and trademarks. For instance, the nonprofit should include a clause that prohibits the Brand from using pictures and videos from a nonprofit’s event in the Brand’s television, print, or social media advertising to promote its products or services. If a Brand seeks to incorporate the nonprofit’s photos and videos into content that highlights the Brand’s social mission and corporate responsibility, the nonprofit should carefully define the limits of that right to avoid an inadvertent endorsement.

The Brand and nonprofit should also consider how to enforce their contractual rights with regard to one another and any social media personalities that are part of the event. Payments can be delayed until after certain deliverables, to ensure all parties remain in sync in the run-up to the event. The parties should also consider the duration of their contractual rights –event contracts often terminate immediately upon the completion of the event, but if the parties are allowed to use each other’s names and logos even after the event is over, the contract should cover that ongoing use.

In order to manage the logistics of the event and the many deliverables that are included in sponsorship agreements, Brands and nonprofits can designate point people to review and approve deliverables. Specifying in the contract who the points-of-contact will be, as well as the required turnaround times, will help ensure the parties remain on good terms and maximize the event’s potential.

The post Qualified Sponsorship Payments, UBIT, and Social Media – A Reminder For Nonprofits appeared first on Perlman & Perlman.

You may have heard a LOT about “NFTs”, or non-fungible tokens, recently. The buzz around NFTs reached a crescendo on March 11, when Beeple’s digital artwork with a unique NFT sold in a Christie’s digital auction for over $69 million.  Basketball fans are trading digital highlights in NFT form in an online marketplace. Charmin is even getting in on the NFT-craze, selling unique toilet-paper inspired digital artwork to raise money for Direct Relief.

Given the amount of money swirling around NFTs and the digital art world, nonprofits and their benefactors have started to consider how to leverage the new technology for charitable ends. With any new technology come questions and in this article I will try to cover some considerations for nonprofits that are getting into the NFT-craze.

The Basics – What Are NFTs?
NFTs (non-fungible tokens) are a fully-digital method of proving ownership of an asset. Most assets associated with NFTs are digital assets, but NFTs could be implemented with physical assets as well. In the same way that a unique piece of art might come with a certificate of authenticity and history of ownership, NFTs use a technology that was originally developed in connection with virtual currency (called blockchain) to record and track ownership. Blockchain uses cryptography to validate transactions, making the system relatively secure. Blockchains can be private or public, depending on the use case, and NFTs are mostly stored on a public-based blockchain associated with the cryptocurrency Ethereum.

Almost anything digital can be ascribed an NFT. A tweet can be given an NFT and sold. The rights to music can be sold using an NFT.  Uses for NFTs, and the underlying blockchain, are seemingly endless – anything that involves tracking custody, ownership, or use could make use of NFTs and blockchain.  Whether or not businesses and consumers will want to buy, sell, and store an asset’s ownership records digitally on the blockchain is a different question – while cryptocurrency and blockchain supporters have been touting the technologies for over a decade, blockchain and NFTs have only gone mainstream publicly in the past few months.

Some people question the value of some NFT assets – who really wants to own the rights to an NBA highlight that is available on YouTube for free? Apparently a lot of people (at the time of writing, a Lebron James dunk is listed at $250,000 – it is a very good dunk). The original Mona Lisa painting is extremely valuable, whose worth isn’t decreased by additional prints being sold or versions being viewable for free online. Ownership is key to the asset’s value, whether we’re talking about a physical painting or a digital highlight.

NFTs and Charities – Similar to Auctions of Traditional Art
When an NFT is auctioned to benefit charity, it is deeply analogous to a traditional art auction (a topic I discussed in another post). If the artist or collector who donates a piece of digital art for sale at a charity auction wants to receive a charitable deduction, they may need to get an appraisal. The charity will need to be careful to keep records related to the donation and valuation of the asset. Prospective bidders should be told what the value of the item is, assuming a reasonable value can be determined. And winning bidders must be given a receipt which describes how much of the amount paid exceeds the fair market value of the item, if any.

Valuation of NFT-assets will be an extremely nuanced part of the charity auction process because the market for NFTs is so new and valuations fluctuate wildly. As an example, last year Beeple “dropped” artwork on an NFT marketplace that was resold. Between October 30 2020 and January 9, 2021, a piece that sold for $1 was resold 10 times and increased in value to $7000. Any artist, donor, or charity that places a valuation on donated digital artwork or other NFT-assets should consult with experts to document the valuation appropriately and ensure that everything is properly recorded and filed.

NFTS and Charities – New Platforms and New Problems
When Beeple’s Christie’s auction concluded, the winner paid in cryptocurrency, typical of many of the NFT marketplaces that use the Ethereum-based cryptocurrency Ether. NBA Top Shot, in contrast, will let you sign up with a credit card. As donors and charities work through the various platforms to decide with whom they want to partner to host an NFT auction, they need to consider what methods of payment are available and who their target audience will be. If the pool of potential bidders is Beeple-crazed crypto-enthusiasts, an NFT platform that requires Ether will probably work just fine. If, on the other hand, a charity wants to engage its traditional donor-base, it may want to find an auction platform that can receive traditional payments.

If the auction invites bids in cryptocurrency, the charity also needs to think through whether to hold that currency or convert it into fiat currency immediately upon receipt. Many charities, in the wake of the cryptocurrency boom of 2017, developed policies related to holding cryptocurrency – typically, the currencies were liquidated immediately upon receipt. Charities should consider crypto as a highly volatile asset, with potentially huge upsides and downsides. Most charities hold minimal amounts of crypto and only as part of a comprehensive, diversified investment strategy.

If the charity expects an auction to generate a lot of interest and a lot of funding, the charity needs to do some due diligence on the platform with whom they plan to work. With the interest in NFTs surging, so are the numbers of outlets that claim to support NFT marketplaces. If a charity wants to partner with a relatively new platform, the charity should vet the platform to make sure it is capable of performing – that it can host the auction, accept the payments, and deliver the winnings to the charity. Charities should make sure their agreement with the platform is crystal clear in terms of fees, timing, and the risk of loss if something should happen to an asset. Charities need to work with the platforms to make sure disclosures to bidders and donors are very clear on how the auction or donation will work – some states have begun to consider required disclosures for fundraising platforms, which can serve as a guide for charities and platforms.

Finally, some platforms that are operating in the NFT, blockchain, and cryptocurrency spaces may be subject to regulation as money transmitters, payment processors, or financial institutions. If a charity plans to store its assets with a platform that provides payment processing services, the charity should confirm that the platform is appropriately registered or is exempt from regulation.

Art Charities and NFTs
Similar to the concerns outlined above about vetting platforms, if an art-based charity wishes to accept a donation of NFT artwork to retain as part of its collection, the charity needs to work through the many issues around accepting and storing NFT artwork. Review the terms and conditions of any third-party platform involved in hosting or displaying the artwork. Work with the artist or collector to confirm details around the transfer, valuation, receipt, and the costs associated with the transfer on the network. Many of the tax rules governing NFT-art donations will be identical to those applicable to donations of physical art.

International Concerns
One of the appealing aspects of NFTs and blockchain is that transactions are borderless and frictionless. A digital marketplace based in ether cryptocurrency can receive payment without worrying about converting currency; there are no costs for shipping and the purchases can be delivered instantaneously. A charity that is considering receiving digital payments, selling digital goods, or transferring digital assets using NFTs or cryptocurrency has to be conscious of the risks associated with international transfers. The U.S. Department of the Treasury’s Office of Foreign Asset Control has published some guidance for charities working internationally, both in the context of specific countries as well as more generally. Charities should be cognizant of the risk posed by receiving large payments from or sending payments to individuals or organizations that are overseas and may only be known as a username or Ethereum address. Charities should work with their advisors to ensure they are taking reasonable precautions to avoid the legal and reputational trouble that could arise if the charity does business with disreputable donors or recipients. Additionally, the platforms dealing in NFTs and online fundraising may also have “Know Your Customer” requirements – charities should check with the platform that they are compliant with any applicable rules.

Other Compliance
Whether a nonprofit holds an auction online or in person, selling digital or physical art, there are traditional fundraising compliance considerations that will apply. Depending on the state in which the nonprofit is operating, the nonprofit may be required to register (my colleague Tracy Boak has a great article discussing charitable fundraising regulation). Depending on the nature of the items sold and where buyers are located, there may be sales tax considerations. Charities should check with their advisers to confirm they have considered all legal aspects of online fundraising compliance.

The post NFTs and Charities – What’s New and What Isn’t? appeared first on Perlman & Perlman.

The Basics
For purposes of this post, by “nonprofit” we mean a public charity exempt under § 501(c)(3) of the Internal Revenue Code, the most common type of nonprofit. Eligible to receive tax-deductible donations, 501(c)(3)s are prohibited from engaging in political campaign activity. Donations to political campaigns and committees are prohibited, whether monetary or in-kind (based on federal and local law). The rules apply at the primary stage of the campaign as well as the general election – wherever this piece or other guidance refers to different political parties, the guidance is really the same for the primary, and should be interpreted to refer to the various candidates.

Just because nonprofits cannot engage in political campaign activity doesn’t mean they can’t get involved in elections at all. Nonprofits, even 501(c)(3)s, can partake in voter education activities and voter mobilization, assuming both are conducted in a nonpartisan manner.  We’ve gone into greater detail, below, but the basic question nonprofits should ask themselves when considering whether an activity is permissible is – is this designed to help (or hurt) a particular candidate? If the answer is “no”, then the activity may be allowed.

Nonprofit Leaders
Nonprofit leaders tend to be leaders in their communities as well as leaders of their organizations. As such, their opinions and endorsements hold extra weight. While nonprofits themselves may be subject to restrictions (or outright prohibitions) on their ability to endorse a candidate, nonprofit leaders have a First Amendment right to speak their mind on the politics of the day, provided that the leaders are speaking in their personal capacities and not on behalf of their nonprofits.

Nonprofits
Further below we provide a list of activities that 501(c)(3)s may and may not engage in. The most popular activities in the run up to a high-profile election are generally candidate fora and voter education activities.

While public charities can host a candidate forum, the structure of the forum is important to ensure the nonprofit preserves its tax-exemption. The forum should be carefully thought through, from the selection of the moderator, the invitations to the candidates, the composition of the audience, and the questions that are asked of the candidates. With such a large field of candidates, nonprofits will have to make decisions about who to invite and how much time each candidate is allotted. It’s important to ensure that candidates are given comparable opportunities to voice their positions and respond to questions.

Some nonprofits also like to put together educational materials to distribute to their stakeholders. While this is permissible as well, it has to be done in a nonpartisan way to avoid violating federal, state, and city rules. Everything from the topics that are profiled and how candidates’ positions are communicated to voters has to be done carefully, and nonprofits should consult with counsel.

Other Types of Nonprofits
Other types of nonprofits (501(c)(4)s, 501(c)(6)s, etc.) do not face the same federal prohibitions on political campaign activity and therefore have more freedom to make statements about candidates and campaigns. However, NYC has strict campaign finance rules that prohibit contributions from corporate entities, meaning that nonprofits cannot donate (either cash or in-kind services) to a candidate’s campaign. While political action committees (PACs) may make certain donations and expenditures, a PAC cannot circumvent the prohibition on corporate donations by accepting a nonprofit’s money and then sending it on to the candidate. Campaign finance issues are closely monitored by the NYC Campaign Finance Board and any nonprofit that is considering creating a PAC or otherwise participating in political activity should consult with counsel before entering into the political fray.

What 501(c)(3)s Can and Cannot Do
Nonprofits are allowed to engage in non-partisan activities in the run-up to an election, such as voter registration drives or education around a particular issue – see our list below for a breakdown of specific activities that a 501(c)(3) can engage in. In addition, a 501(c)(3) is allowed to engage in lobbying (attempting to influence legislation) so long as the lobbying activity does not constitute a “substantial” part of its activities. Of course, “substantial” is a fuzzy term, so the IRS allows most nonprofits (but not churches) to set a monetary limit to their lobbying activity (called a 501(h) election) below which no tax penalties will be assessed, so that nonprofits have some certainty when their lobbying activities will trigger tax consequences. In addition, if a nonprofit focuses on lobbying around issues that are highly salient to the campaign, the lobbying may be considered by IRS as political campaign intervention. The IRS has given some guidance on the factors it considers when deciding if issue-advocacy may be considered political campaign intervention (see the section titled “Issue Advocacy vs. Political Campaign Intervention” and example 14).

What 501(c)(3) Organizations CAN Do
501(c)(3) organizations may safely engage in the following activities:

• Conduct or participate in a nonpartisan candidate forum, so long as the forum: (a) is open to all candidates, (b) is run in a balanced way, and (c) includes a broad range of nonpartisan questions for the candidates.
• Conduct voter registration drives and nonpartisan get-out-the-vote efforts, subject to the following limitations:
  • Drives must be designed to educate the public about the importance of voting.
  • Activities cannot be biased for or against any candidate or party.
  • Nonprofits can target areas in nonpartisan ways. For instance, nonprofits may target low-turnout areas, low-income populations, minority populations, and students.
  • Nonprofits may target registration and turnout efforts to the areas or people they serve.
• Educate the public on issues and generally encourage participation in the political process.
• Make presentations on your organization’s issue to platform committees, campaign staff, candidates, media, and the general public.
• Educate all candidates and political parties on your issues.
• Continue your normal lobbying on issues, subject to the limitations described above.
• Rent or sell mailing lists to candidates at fair market value, if made available to all candidates.

What 501(c)(3) Organizations CANNOT Do
To maintain 501(c)(3) tax exempt status, organizations may not undertake the following activities:

• Endorse or oppose a candidate—implicitly or explicitly.
• Contribute money, time, or facilities to a candidate.
• Coordinate activities with a candidate.
• Restrict rental of your mailing list and facilities to certain candidates.
• Set up, fund, or manage a Political Action Committee (PAC), established under section 527 of the tax code mainly for electoral activity

These restrictions do not in any way prohibit officers, members, or employees from participating in a political campaign as private citizens, assuming those individuals ensure their actions or statements are not attributed to the organization.

If you are in any doubt regarding whether your organization’s activities might risk revocation of tax-exempt status, be sure to reach out to a lawyer with knowledge of the non-profit sector for specific advice.

The post The Mayor’s Race and Nonprofits appeared first on Perlman & Perlman.

The IRS prohibits tax-exempt organizations from engaging in activities that are illegal or contrary to public policy. Given the nature of the rally (an attempt to rally support to overturn the results of a presidential election) and its aftermath (an illegal and violent insurrection at the Capitol), some nonprofits that helped organize the rally could have their tax-exempt status revoked under the illegality and public policy doctrines. In this piece, I review the IRS’s rules, discuss how they might apply to the rally, and offer suggestions for nonprofits that want to avoid getting in trouble with IRS.

The Background
Under longstanding IRS rules, tax-exempt organizations must be organized and operated for exempt purposes. An organization is deemed to NOT be organized and operated for exempt purposes if its activities are illegal or contrary to public policy. (For a more detailed discussion of Illegality & Public Policy, see the IRS’s EO CPE Texts from 1985 and 1994). The illegality doctrine acts as a check to assure that the federal government does not support through tax exemption an organization engaged in behavior the government is charged with preventing. Similarly, the public policy doctrine ensures that the federal government isn’t supporting behavior that adds to government’s burdens. To determine whether a nonprofit might lose its exemption, the IRS looks to the nature and extent of the activities carried on by the organization.

The centrality of the improper activities to the nonprofit’s overall purpose is important. If the nonprofit is organized to accomplish an illegal purpose, it should never qualify for tax-exemption in the first place. In other words, if any of the nonprofits that sponsored the January 6 rally had as their central purpose “the armed overthrow of the U.S. government”, they would never have been recognized by IRS as tax-exempt in the first place.

Even if a nonprofit qualifies for tax-exemption, if its activities are illegal or contrary to public policy, the nonprofit may have its tax-exemption revoked. In determining whether illegal activity will lead to revocation of tax-exempt status, the IRS looks at whether the illegal activities were “substantial”, both in terms of how much time and attention were spent on the illegal activity, including the extent to which the illegal activity can be attributed to the organization by virtue of the involvement of its directors or officers or through clear ratification of the organization’s governing body (i.e., quantitatively substantial), as well as the seriousness of the illegality involved (qualitatively substantial). If a group is organized around a permissible exempt purpose, but engages in an isolated egregious illegal act, it could have its tax-exempt status revoked, notwithstanding the fact that a majority of its other activities are law-abiding.

The Seminal Case – Bob Jones University (461 U.S. 574 (1983))
The case that is often cited to explain the illegality doctrine is Bob Jones Univ. v. United States, a case from the 1970s and early 1980s, in which the Internal Revenue Service sought to revoke the University’s tax-exemption because it denied admission to applicants who were either “engaged in interracial marriage or known to advocate interracial marriage or dating.” The case was joined with another, involving the Goldsboro Christian Schools, which maintained “a racially discriminatory admissions policy based on its interpretation of the Bible, accepting… only Caucasian students.”

In the combined Bob Jones cases, the IRS had laid the groundwork by first telling all tax-exempt organizations in a Revenue Ruling that it could no longer justify tax-exempt status for any school that operated in a racially discriminatory manner. (Rev. Rul. 71-447). The IRS determined that to qualify under traditional understandings of the term “charity”, an organization must not act illegally or contrary to public policy. In the IRS’s opinion, the United States had a compelling interest in eradicating racial discrimination in schools.

Both Bob Jones University and Goldsboro Christian Schools claimed that their religious beliefs required the racially discriminatory policies. The Supreme Court nonetheless found that national policy was clearly in favor of racial nondiscrimination and, therefore, the IRS was justified in its requirement that schools operate without discriminatory policies. In other words, the Court determined that the government’s interest in overseeing racially nondiscriminatory schools was so compelling that it overrode the First Amendment interests asserted by the schools.

Holding Groups Responsible For Actions by Members
Next, we should look at whether and how the IRS would hold an organization responsible for the actions its members (or attendees) take. As a general matter, an organization is not responsible for the actions of its members except where the organization “authorizes, advocates for, or ratifies” the members’ acts. If an organization urges its members to commit illegal acts, the organization may find itself subject to consequences, either through revocation of its tax-exempt status or civil action. The standard used in at least one IRS ruling (Rev. Rul. 75-384) was that those illegal activities “which violate the minimum standards of acceptable conduct necessary to the preservation of an orderly society, are contrary to the common good and the general welfare of the people in a community” would disqualify an organization from exemption under 501(c)(4). Similarly, if an organization “induces or encourages the commission of criminal acts by planning or sponsoring” events and, through criminal acts committed by its members, increases the burden on government, the IRS may revoke exemption under 501(c)(3).

Much of the guidance on illegality and public policy revocations is dated, but a new case related to protest activity and liability is instructive to see how our modern courts view organizer liability for actions by attendees at a protest event. A civil case currently winding its way through the courts, McKesson v. Doe, deals with the bounds of First Amendment protection for organizers. In the McKesson case, a police officer was injured by a rock thrown by an unknown protestor at an event where the attendees illegally occupied a roadway. There was no allegation that the organizers intended or foresaw that a rock would be thrown at the protest, but the court recognized that a jury may find that blocking the roadway was authorized, directed, or ratified by the organizers. The Fifth Circuit determined that because rock throwing was a consequence of the illegal activity that the organizers “authorized, directed, or ratified” (blocking the roadway), the organizers could potentially be held liable.

While McKesson v. Doe is far from finished and rests heavily on Louisiana civil law, the discussion by the Fifth Circuit and Supreme Court is instructive for the organizers of the March to Save America who may try to invoke the First Amendment as a shield from being held responsible for their attendees’ actions, whether in a civil case or for possible action by the IRS. If the violence that erupted at the March was more foreseeable than the rock throwing in the McKesson case – if the March’s organizers had notice that violence was a likely consequence of their event and if the March’s organizers invited speakers who they knew, or should have known, would increase the risk of violence – the McKesson case suggests that the First Amendment may not shield the March’s organizers from liability.

The March To Save America
Organized and supported by tax-exempt 501(c)(3) and 501(c)(4) organizations, among others, much of the content of the speeches at the March was a continuation of what those speakers and the nonprofits’ leaders had been saying since the November election – that the election result was somehow invalid (despite no evidence), should be overturned (despite numerous failed attempts in court to do just that), and that supporters of the outgoing President should “fight” to make sure the electoral college votes were tallied appropriately. This history is important under the IRS’s tests to determine whether the attendees’ violent and illegal insurrection at the Capitol is attributable to the organizers (discussed above). If the attendees’ behavior was “authorized, advocated for, or ratified by” the organizers, the IRS may try to attribute the violence in the Capitol to the organizing groups as it assesses whether to revoke their exemption. This might also be the case if a civil litigant injured in the melee and seeks recompense.

The nonprofits involved in the March might argue that the attendees’ later violent behavior should not be attributed to them.  As discussed earlier, the default rule is that organizations are not held accountable for unauthorized activities of their members. Should the IRS pursue any action against the groups, some important considerations will be whether the March’s nonprofit organizers can demonstrate that they did not authorize, advocate for, or ratify the violent actions of their attendees. How they must show this is less clear; they may try to show that they took steps to consider and minimize the likelihood of violence when they invited certain speakers, to try to avoid inflammatory rhetoric at the event, or simply miscalculated the levels of security and other precautions typically required of an event of this size.  Because many of the groups and their leaders have condemned the violence at the Capitol, it could undercut IRS’s argument that the groups condoned or ratified the resultant violence.  Whether that is sufficient to avoid liability or a revocation by IRS remains to be seen.

It’s important to note that the illegality and public policy doctrines are related, but separate.  Consider, then, whether the nonprofits’ peaceful and intentional activities at the March, namely a rally to protest a free and fair election, could be sufficient reason for a revocation as a violation of public policy. The Bob Jones case established that a nonprofit’s exemption can be revoked where no illegality is alleged but because the nonprofit’s activities are so contrary to public policy that they should not be condoned by the federal government with tax exemption. Challenging the tallying of the electoral votes without any real basis, even without illegality and acts of violence, may amount to a violation of the public policy doctrine – it is hard to think of a more central public policy in a democracy than the peaceful transfer of power. The IRS would never provide tax-exemption to an applicant whose stated purpose was to “challenge federal elections and undermine public faith in our democratic institutions, regardless of whether there is any basis to do so.” Yet that appears to be what those groups did, notwithstanding that they would argue they were simply ensuring all “legal” votes were counted.

Lessons to Be Learned
A nonprofit that plans to organize an event that deals with a topic likely to inflame the passions of its supporters must carefully consider how they will manage the risk of aggressive behavior by participants.  The goal is not only to avoid violence, but also to avoid any attribution of it to the organization.  The following are suggested steps to ensure both the protection of the public and the nonprofit organization.

1. Carefully vet the speakers

It may be tempting to invite a popular figure who is supportive of the cause.  If that person has a history of advocating violence, illegal behavior, or is prone to fiery language, it will likely creates a greater risk of inciting the crowd to dangerous behavior. Researching potential speakers before invitation is crucial, including a review of news coverage, social media accounts and other speaking engagements.

2. Develop written guidelines for the speakers

This is useful in many contexts (for instance, many nonprofits want to ensure their events don’t stray into politics, which is strictly prohibited for 501(c)(3) organizations). The guidelines will differ based on the nature of the event, but in general make should sure that speakers specify whether they are speaking on behalf of any organization and that they avoid topics or statements that could get the nonprofit in trouble (or are otherwise contrary to the views or interests of the organization).

3. Monitor the speech and have a plan to pull the plug on any speakers who violates the guidelines.

This step is a last resort in case the speaker makes statements that are inflammatory, advocate illegal activity, or otherwise overstep the guidelines the nonprofit has established. The organizers must monitor the speakers’ statements and be prepared to step in the immediately. If improper statements are made, the nonprofit should swiftly disavow any language considered improper if it were spoken by the nonprofit or its executives.

4. Make sure other safeguards are in place.

Large events require infrastructure.  A reliable vendor can help assess how best to safeguard participants and the public.  However, the organization that sponsors the event bears the ultimate responsibility for ensuring that basic issues are taken care of – the safety and security of the attendees, speakers, and surrounding community being the foremost concern. The organizers should give ample notice to potential attendees that certain guidelines must be followed – for instance, no weapons. And the organizers should coordinate with local authorities not just to secure any necessary license but also to ensure that adequate manpower is available to oversee and support the event.

Conclusion
We don’t know yet whether there will be any consequences for the organizations involved in the January 6 March for America. If IRS chooses to enforce its illegality and public policy doctrines, the nonprofits may have left themselves vulnerable. Nonprofit professionals can use the episode as a learning experience to avoid such catastrophe in the future and protect their organizations.

The views expressed here are those of the author which, do not necessarily represent the views of the Firm.

The post Nonprofits and the “March to Save America”– Lessons for Responsible Nonprofits appeared first on Perlman & Perlman.