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.

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Under the Internal Revenue Code, all 501(c)(3) organizations are prohibited from participating in any political campaign on behalf of or in opposition to any candidate for elective public office.  This includes contributions to political campaigns or public statements of position made on behalf of the organization in favor of or in opposition to any candidate for public office.  The IRS explains on its website that non-partisan voter registration and get-out-the-vote drives may be permissible as long as they do not bias, favor or oppose one candidate over another, or have the effect of favoring a candidate or group of candidates.   For private foundations, there are more specific rules restricting their grantmaking for voter registration activities.  

Although public charities are prohibited from engaging in political campaign activities on behalf of or in opposition to candidates, the IRS states that “The political campaign intervention prohibition is not intended to restrict free expression on political matters by leaders of organizations speaking for themselves, as individuals. Nor are leaders prohibited from speaking about important issues of public policy. However, for their organizations to remain tax exempt under section 501(c)(3), leaders cannot make partisan comments in official organization publications or at official functions of the organization.” (IRS Rev. Rul. 2007-41).

If you lead or work for a public charity and plan to get involved in political activities in a personal capacity, you should keep the following guidelines and best practices in mind.    

• Employees who endorse or support candidates, make public comments in person, express themselves in writing or online, or engage in other electioneering activities, should refrain from using organizational titles or the organization’s name while making such endorsements or expressing such support.  
• If an employee is identified by name or title in public communications, the employee should include this statement: Titles and affiliations of each individual are provided for identification purposes only and do not reflect the views of the organization or imply an endorsement by the organization. 
• Organization leadership and employees who use personal email communications, personal social media platforms, and any online platforms not affiliated with the organization to communicate about or engage in political campaign activities should include the following disclaimer in the ‘About/Bio’ section and where possible, at the end of such communications:  All personal views and opinions expressed are my own and do not represent or reflect the views of any organization.  Although this disclaimer will not provide absolute cover, its inclusion helps to draw a clearer line between the individual’s affiliation with an organization and their rights as a private citizen.
• Organization representatives cannot support or oppose candidates at organization-sponsored events.  For example, an employee should not, while attending a charity-sponsored event, wear any political t-shirts, buttons, hats, etc. 
• Employees should not use organizational resources, including phones, copiers, computers, office space, email addresses, office addresses, organization name, organization online and social media platforms, donor or mailing lists, for supporting or opposing candidates.  

If you lead or work for a public charity, consider the following tips to help keep your organization in compliance during election season.   

• Organization leaders should provide written notice to members of the Board, staff, and volunteers of its policy against using organizational resources for political campaign activity.  In addition to developing a policy on political activities, leaders should regularly update the policy and train the Board, staff, and volunteers.

• Charities should not report or comment on staff and volunteer personal campaign intervention activities in the charity’s newsletter, on its websites, or any social media accounts.  
• When dealing with the public on issues relating to an election, charity spokespersons should regularly include disclaimers that the charity cannot and does not endorse political candidates (The organization can post a disclaimer on the charity’s website to this effect). While such disclaimers will not excuse partisan activity, they can help explain that a charity’s public communications are not intended to support or oppose candidates, particularly where members of the public might construe certain communications to involve political campaign intervention. 

When it comes to political campaign activities, public charities have different restrictions than the individuals who lead and work for them have in their personal capacities.  That said, to help keep your organization out of trouble, the best thing you can do is to understand the rules and make sure there is a clear line between what you do in your personal capacity from that of the organization you work for.

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So how is advocacy different from lobbying, and exactly where is the line between the two? As I wrote in my previous article, advocacy is a broad term which  describes various facets of the work nonprofit organizations undertake.  Although it isn’t a statutorily defined term, advocacy refers to many types of activities, which include educating about and raising awareness of an issue; advancing the organization’s charitable mission; raising funds; communicating with members and the public; and influencing behaviors, attitudes, and policies related to the organization’s mission.

By contrast, lobbying is a statutorily defined term.  The Lobbying Disclosure Act regulates federal lobbying, and each state and many cities have their own  laws that define and regulate lobbying.  For public charities, the IRC defines lobbying as “any attempt to influence any legislation through an attempt to affect the opinions of the general public or any segment thereof, and any attempt to influence any legislation through communication with any member or employee of a legislative body, or with any government official or employee who may participate in the formulation of the legislation.” This federal tax code definition covers both grassroots and direct lobbying. 

The IRC defines certain activities as exceptions, and, therefore, does not count them towards the organization’s lobbying limits.  These include: making available the results of nonpartisan analysis, study, or research; providing technical advice or assistance to a governmental body; appearances before, or communications to, any legislative body about decisions that might affect the existence of the organization, its powers and duties, and tax-exempt status; communications between the organization and its members on legislation or proposed legislation of direct interest to the organization and its members; and any communications with a government official other than communications that would be considered lobbying. 

The term advocacy generally encompasses a broad range of exceptions to lobbying.  If your organization is conducting and publishing research and disseminating it in a nonpartisan manner, it is not considered to be lobbying.  What about activities that don’t easily fall into one of these exceptions?  For example, perhaps your organization has a meeting with legislators and their staff about important policy issues without discussing specific legislation.   What if, during the meeting, your organization identifies legislative priorities and its position on various topics, some of which are addressed in currently pending legislation?  Most often, the answer to the question “is this lobbying” is going to be “it depends.”  It depends on who is present, what is said, and other factors. 

With this clear-as-mud guidance, it can be both confusing and onerous for a public charity to assess and determine whether the multitude of advocacy activities it engages in count as lobbying.   When clarity is called for, there are two recommended steps: 1) confer with legal counsel, and 2) establish written guidelines for organizational lobbying. 

Consulting with legal counsel serves a few purposes.  First and foremost, your legal counsel can analyze how the unique facts apply to the law – something an online search can’t do.  Next, talking to your lawyers about your current and planned lobbying activities gives the organization an opportunity to educate and train staff and Board members on the rules and limitations. Once the organization’s leadership is trained, they should draft guidelines based on the types of activities the organization typically engages in.  By developing guidelines for the organization, leadership can craft a strategy with respect to advocacy and lobbying activities with a better understanding of what is, and what is not, lobbying. This will ensure compliance while fostering the confidence to effectively advocate in furtherance of its charitable objectives. 

Because the rules can be confusing, many organizations shy away from engaging in certain activities for fear they may breach the regulations on lobbying.  It’s good to remember, however, that public charities are allowed to lobby up to a certain limit if they track their expenditures and report them.  Once understood and exercised with confidence, lobbying can be a powerful tool in assisting a charity to fulfill its mission. 

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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.

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Navigating the types of activities that tax-exempt nonprofits are allowed to engage in (and how much) without jeopardizing their tax-exempt status can be tricky.  Many charities engage in types of activities that are important to the organization’s mission, donors, and people they serve.  Two activities that charities may use to influence public policy include “advocacy” and “lobbying.”  While advocacy and lobbying are terms that are sometimes used synonymously, the two are distinct in important ways, most notably because federal tax law limits the amount of lobbying that charities may engage in.

How Does Advocacy Differ from Lobbying?

Advocacy can take many forms that do not constitute lobbying, including: leading, directing, conducting, and publishing research; and disseminating educational information.  Charities may engage in many different types of advocacy, and so long as that activity does not constitute lobbying, 501(c)(3) organizations are generally not limited in the amount of time or money they can spend on advocacy.

Lobbying, on the other hand, is subject to specific, restrictive rules.  Charities may engage in only an insubstantial amount of lobbying, and must take care not to jeopardize their tax-exempt status or run afoul of other lobbying restrictions.  Lobbying is any attempt to influence legislation, which can include acts, bills, resolutions, or ballot initiatives by Congress, state legislatures, local councils, or similar governing bodies.  An organization whose employees contact or urge others to contact members or employees of one of these bodies for the purpose of influencing (by encouraging them to adopt, reject, support, or oppose) legislation, is engaging in lobbying.

State and Local Lobbying Registration, Reporting, and Disclosure Requirements

In addition to following the strict federal tax rules governing the type of lobbying and amount of lobbying an organization can engage in,  charities should also be aware of any state and local requirements to register (including registration of certain employees as lobbyists, or registration of the organization itself, which retains and pays lobbyists) and to report lobbying expenditures and activities on a regular basis.¹ Federal and state lobbying rules can be confusing and complicated, and often depend on several factors, including: (1) whether the organization employs an in-house lobbyist or an outside lobbyist; (2) whether any of the organization’s employees are lobbying; (3) the total amount of expenses the organization spends on lobbying activities; and (4) the timing of any contacts or communications made with federal or state officials.

After the organization makes a determination about which federal and state registration requirements apply to its lobbying activities, the organization and its lobbyists must file regular reports (often quarterly or semi-annually) until the registration terminates (the method by which registrations are terminated also varies from state to state), or otherwise expires.

If an organization decides to engage in lobbying activities, it is critical to ensure that executive staff are aware of the applicable requirements for registration, reporting, and disclosure.  Failure to comply can result in fines, censure from the regulatory agency, and possible negative press exposure for the organization.

1 While this article is focused on the lobbying rules as they pertain to 501(c)(3) public charities, it is worth noting that 501(c)(4) organizations, which may engage in unlimited lobbying in furtherance of their tax-exempt missions, are more likely to trigger lobbying registration and disclosure requirements.

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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.

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What is a fiscal sponsorship?  A fiscal sponsorship generally refers to a contractual arrangement in which one entity that is a 501(c)(3) tax-exempt organization (the “fiscal sponsor”) serves as the fiscal and legal “host” of a charitable project.  While the term fiscal sponsor is not officially defined in the federal tax code, the IRS has generally approved of the function of fiscal sponsors. The critical requirement is that the fiscal sponsor must retain the legal right to ensure that the project funds are used to accomplish the tax-exempt purposes of the sponsored project.

Benefits of a Fiscal Sponsorship

There are many benefits to using a fiscal sponsorship to conduct a charitable project. Here are a few key reasons that frequently drive the decision to set up a fiscal sponsorship.

1. Ability to receive tax-deductible contributions. Donors will only receive a charitable tax deduction for financially supporting the project if the legal recipient of the donation is a 501(c)(3) tax-exempt organization.  A fiscal sponsor’s tax-exempt status and role as the legal fiduciary of the donated funds qualify them as tax-deductible.  Tax-deductible contributions, whether from the project organizer or from the public, are typically critical to funding the requirements of the project.
2. Piloting an innovative new program. Project organizers often seek to test a new approach to solving an issue, but are uncertain whether the project will have long-term viability and be worth the time and money it takes to establish a nonprofit organization.  A fiscal sponsorship can provide a convenient vehicle to pilot the project more quickly and at less cost than setting up a new tax-exempt entity.
3. Receiving the legal, financial, and administrative support of a fiscal sponsor. A fiscal sponsor takes on the legal responsibility for the funds raised. In the Direct Project Model (discussed below), it also takes on all of the legal obligations of the project. Having the benefit of a fiscal sponsor’s team to handle the legal, financial and administrative aspects of the project can allow the project organizers to focus on fundraising and implementation of the program.
4. Temporary fiscal sponsorship while awaiting independent 501(c)(3) tax-exempt status. Some organizations decide to enter into a fiscal sponsorship while their tax-exempt application is pending review. This allows them to begin receiving tax-deductible donations for the project much sooner. As of August 19, 2021, the IRS website says that applications postmarked after January 15, 2020 have not yet been assigned for review.  That seven-month queue doesn’t include the additional time needed for review once the application is assigned.  Although expedited application processing is available under limited circumstances, there is no guarantee that it will be granted.  Setting up a fiscal sponsorship may take time as well, but generally should not take as long as the IRS tax-exempt application review process.

What are the Roles and Responsibilities of a Fiscal Sponsor?

1. Project selection responsibilities
   1. Mission fit. The fiscal sponsor must ensure that any project it sponsors is consistent with, and within the scope of, the fiscal sponsor’s legal and tax-exempt mission and purposes. For example, a fiscal sponsor whose legal purposes are focused on environmental conservation will generally only take on projects that are consistent with that core mission.
   2. Written fiscal sponsorship agreement. The terms of the relationship between the fiscal sponsor and the sponsored project should be clearly outlined in a written agreement detailing the terms and expectations of the parties. Key terms include: (1) the duration of the fiscal sponsorship; (2) a clear description of the project; (3) fiscal sponsorship service fees, if any; (4) confirmation of which party will be responsible for key compliance obligations on behalf of the project; (5) the timing and process for distributing funds to, or using funds for, the sponsored project; (6) ownership of intellectual property; and (7) a clear outline of how the project will be transitioned at end of the relationship.
2. Financial responsibilities
   1. Use of project funds. The fiscal sponsor should only utilize funds raised for the project for the stated charitable purposes of the project.
   2. Donation tax receipts. The fiscal sponsor is responsible for issuing tax receipts to all donors in accordance with applicable law.
3. Legal oversight responsibilities
   1. Compliance with laws. The fiscal sponsor should comply with all applicable federal, state, and local laws and regulations. This includes annually filing its Form 990 with the IRS, and maintaining its registration with applicable state charity regulatory agencies, based on where the fiscal sponsor (including all of its projects) are operating and soliciting charitable contributions.  Project organizers should ensure that they select a fiscal sponsor that is aware of and willing to comply with all of the compliance requirements necessary to support the needs of the project.

What are the Most Common Types of Fiscal Sponsorships?

The two most common types of fiscal sponsorships are the Direct Project Model and the Pre-Approved Grant Model.

Direct Project Model:  In this model, the project has no separate legal existence from that of the fiscal sponsor.  That said, the fiscal sponsorship agreement outlines how the fiscal sponsor provides ultimate oversight of the project, in accordance with its fiduciary duties, while delegating the day-to-day operation of the project to the project organizers.  All revenues/expenses and assets/liabilities of the project are attributed to the fiscal sponsor, and are incorporated into the fiscal sponsor’s financial reports, and all legal compliance obligations (e.g., federal and state compliance filings; execution of contracts; hiring of employees) are undertaken by the fiscal sponsor.  Project organizers should consider whether the fiscal sponsor has appropriate insurance policies reflective of the activities and risks associated with the project (e.g., employer practices liability insurance; cybersecurity insurance).

Pre-Approved Grant Model: In this model, the fiscal sponsor is the legal recipient of all donations in support of the project, and issues donation tax receipts to the project donors.  The fiscal sponsor distributes the funds raised as a grant to a separate project grantee.  The fiscal sponsor must pre-determine that the project grantee, a separately incorporated entity lacking 501(c)(3) tax-exempt status, is an appropriate recipient of grant funds to carry out the purposes of the project.  Once funds have been raised for the project, the fiscal sponsor grants the funds to the project grantee, pursuant to certain oversight requirements.  For example, the project grantee must provide reports to the fiscal sponsor on how granted funds have been used in furtherance of the charitable purposes of the project.  This model is often used by organizations that are in the process of applying to the IRS for 501(c)(3) tax-exempt status.

Beginning at the End

While the start of a new project is exciting, one of the most important steps in selecting a fiscal sponsor is to plan for the end of the relationship.  The fiscal sponsorship agreement should outline a clear process for the project to be transitioned to a successor tax-exempt organization (including a newly formed organization whose 501(c)(3) tax-exempt status has been approved), subject to the fiscal sponsor’s ultimate discretion to ensure that the successor is capable of carrying out the project.

[1] For many people who have a long-term vision for their charitable program, the best approach may be to set up your own separate tax-exempt organization. An FAQ on setting up a new nonprofit organization is available here.

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This article answers five key questions about private operating foundation status that can help philanthropists determine if it is the right tax-exempt vehicle for their charitable objectives, including:

• What are the key characteristics of a private operating foundation?
• How does private operating foundation status differ from public charity status and private non-operating foundation status?
• What are the financial tests that must be met in order to maintain private operating foundation status?
• What expenditures are considered “directly for the active conduct of” an operating foundation’s tax-exempt activities?
• What if the organization meets the private operating foundation tests initially, but fails to meet it in a given future year?

(1)  What are the key characteristics of a private operating foundation?

A private operating foundation is a 501(c)(3) tax-exempt private foundation that devotes most of its resources (i.e., earnings and/or assets) toward the active conduct of its tax-exempt activities.  More specifically, a private operating foundation is any private foundation that spends at least 85 percent of its adjusted net income or its minimum investment return (whichever is less) directly for the active conduct of its exempt activities – this is known as the income test.  In addition to meeting the income test, the foundation must also meet one of the following tests: (1) the assets test; (2) the endowment test; or (3) the support test. Questions 3 and 4 of this blog post explain these requirements in greater detail.

A private operating foundation is a type of private foundation because it is funded by one or a few sources, however, since it operates more like a public charity (e.g., by conducting programs rather than focusing primarily on grantmaking), the Internal Revenue Code treats the organization partly like a private nonoperating foundation and partly like a public charity.

When seeking 501(c)(3) tax-exempt status, the default classification is that of a private non-operating foundation. Non-operating foundations must distribute a certain amount of their assets annually to support charitable purposes, but those distributions can be solely in the form of grants to other charitable organizations. Organizations seeking private operating foundation status must affirmatively explain or demonstrate to the IRS at the time of applying for tax-exempt status that they meet or will meet the requirements of private operating foundation status, and must annually provide financial disclosures to the IRS demonstrating that they continue to meet those requirements.[2]

(2)  How does private operating foundation status differ from public charity status and private non-operating foundation status?

Private operating foundations are subject to a number of the same regulations as public charities on a few key matters, which are generally more favorable than the rules applicable to non-operating foundations:

• Greater tax-deductibility of donations than non-operating foundations: Private operating foundations are subject to the more generous donation deductibility limits applicable to public charities (whereas donations to non-operating foundations have lower deductibility limits). Because wealthier donors are sensitive to the deductibility cap, the more generous tax-deductibility limits available to private operating foundations is typically the primary motivation for founder-philanthropists to seek private operating foundation status over non-operating foundation status.
  • Like public charities, cash contributions to operating foundations are deductible up to 60%[3] of a taxpayer’s adjusted gross income (“AGI”) (compared with 30% for non-operating foundations).
  • Like public charities, donations of long-term capital gain property (e.g., artwork; real property) to operating foundations are deductible up to 30% of the taxpayer’s AGI (compared with 20% for non-operating foundations).[4] In addition, the deduction for long-term capital gain property for an operating foundation is typically based on the fair market value of the property on the date of the contribution, whereas for non-operating foundations, the deduction for long-term capital gain property (other than qualified appreciated stock) is deductible only to the extent of the donor’s tax basis in the property.
• Differing requirements with respect to annual distributions: Private nonoperating foundations are required to make “qualifying distributions” (most typically in the form of charitable grants) each year equal to at least five percent (5%) of the fair market value of the foundation’s assets.[5] Non-operating foundations are subject to a tax on their failure to distribute income as “qualifying distributions.” Private operating foundations are subject to a different “qualifying distribution” requirement — they are required to devote most of their resources to the active conduct of tax-exempt activities (instead of through grantmaking), as further discussed in Question 3, below.
• Private operating foundations can obtain grants from private non-operating foundations more easily than non-operating foundations: The federal tax laws make it easier for an operating foundation to receive grants from a non-operating foundation compared to a non-operating foundation grantee.[6]  As such, this more favorable treatment of grants to operating foundations than non-operating foundations is a distinct advantage of operating foundation status over non-operating foundation status.  This benefit might not be that important to all operating foundations because many (and perhaps most) operating foundations are fully funded by their founder(s), and as such, may not be seeking external funding.

Now that we’ve reviewed some of the key “advantages” of private operating foundation status, we should also recognize that operating foundations are still subject to many of the stricter tax regulations applicable to all private foundations, which are not applicable to public charities.  The penalties for violating these rules are in the form of tax penalties.  In some cases, those penalties are significant enough that the restricted activities are effectively viewed as prohibited.  Private foundations (including both operating and non-operating foundations) are subject to the following taxes:

• Taxes on Self-dealing: The taxes on self-dealing are designed to prevent “disqualified persons” (e.g., directors, officers, and managers of the foundation, and their related businesses and family members) from benefiting personally from any transactions that the foundation engages in.[7]
• Taxes on Excess Business Holdings: A significant tax is assessed against any private foundation where the combined holdings of the private foundation and all of its disqualified persons exceeds 20 percent of the voting stock in a business enterprise that is a corporation.[8]
• Taxes on Jeopardizing Investments: Certain excise taxes are imposed on foundations that engage in risky investments, with the goal of discouraging such investments, which may detract from a foundation’s ability to further its charitable purposes.
• Tax on Net Investment Income: Operating foundations are subject to the tax on net investment income and to the other requirements and restrictions that gener­ally apply to all private foundations. [9]
• Taxes on Failure to Distribute Income (generally, grants): As discussed earlier, non-operating foundations that fail to distribute the required annual minimum qualifying distributions are subject to a tax. However, the types of distributions that constitute “qualifying distributions” differ for operating vs non-operating foundations.

(3)  What are the financial tests that must be met in order to maintain private operating foundation status?

To obtain and maintain private operating foundation status, operating foundations must meet a combination of financial tests on an ongoing basis, explained further below.

(Mandatory) Income Test

The one universal requirement applicable to every private operating foundation is that it must spend at least 85% of its adjusted net income or minimum investment return, whichever is less, directly for the active conduct of its exempt activities. This is known as the “income test.”

In addition, all operating foundations must also annually meet one of the following three financial tests: (1) the assets test, (2) the endowment test, or (3) the support test.  These three tests reflect different approaches by which a foundation can devote most of its resources towards the active conduct of its tax-exempt activities.

(a)  Assets Test: A foundation will meet the assets test if at least 65% of its assets:

1. Are devoted directly to the active conduct of its exempt activity, a functionally related business, or a combination of the two,
2. Consist of stock of a corporation that is controlled by the foundation (by ownership of at least 80% of the total voting power of all classes of stock entitled to vote and at least 80% of the total shares of all other classes of stock) and at least 85% of the assets of which are so devoted, or
3. Are any combination of (1) and (2).

Example: Assets such as real property, physical facilities or objects (such as museum artwork that is publicly displayed, classroom fixtures, and research equip­ment) and intangible assets (such as patents, copyrights, and trademarks) are directly de­voted to the extent they are used by the founda­tion in directly carrying on its exempt activities or program. Museums and research organizations are likely to meet the Assets Test.

(b)  Endowment Test: A foundation will meet the endowment test if it normally distributes at least two-thirds of its annual minimum investment re­turn for the active conduct of its exempt activities

Example: An organization whose founder funds the foundation with a significant endowment in the form of cash as well as stocks or other investments held primarily for the production of income, is likely to meet the Endowment Test.

(c)  Support Test: A private foundation will meet the support test if: (1) at least 85 percent of its support (other than gross investment income) is normally received from the general public and 5 or more unrelated exempt organizations; (2) not more than 25 percent of its support (other than gross investment income) is normally received from any one exempt organiza­tion; and (3) not more than 50 percent of its support is normally received from gross investment income.

Example: This test is used by operating foundations that are funded by fairly diverse sources of support (including at least five unrelated exempt organizations) rather than just by their founder-donor, but whose funding sources may not be diverse enough to consistently meet the public support tests required for public charity status. This is the least used financial test for meeting private operating foundation.

To qualify as an operating foundation in a given tax year, a foundation must meet the income test and either the assets, endowment, or sup­port test for any three years during a four-year period (“three-out-of-four-year method”), or based on a combination of all pertinent amounts of income or assets held, received, or distributed during the four-year period (“four-year combination method”). The four-year period consists of the tax year in question and the three years immediately preceding that year.

(4)  What expenditures are considered “directly for the active conduct of” an operating foundation’s tax-exempt activities?

Let’s look more closely at the principle that private operating foundations must devote most of its resources “directly for the active conduct of the activities” constituting the foundation’s tax-exempt purposes.  The following are examples of expenditures that would be considered “directly for the active conduct of the” foundation’s tax-exempt activities:

• Amounts paid to buy or maintain assets used directly in the conduct of the foundation’s exempt activities, e.g., the operating assets of a museum, public park, or historic site.
• Pro rata allocations of staff compensation, travel, overhead costs (office space, supplies) based on a reasonable allocation of use towards direct program activities.
• An amount set aside by a foundation for a specific project, e.g., to buy and restore or build buildings/facilities to be used by the foundation directly for the active conduct of the foundation’s exempt activities, if the set-aside meets certain requirements.

Under certain circumstances, payments or grants to individuals (including scholarships) made in conjunction with ongoing supervision by the foundation and certain grantee reporting requirements may qualify as “active conduct” expenditures.  If a foundation awards grants or scholarships, or makes other payments to individuals (including program-related investments[10], such as to support active programs to carry out its exempt purpose, the payments will be treated as qualifying distributions made directly for the active conduct of exempt activities only if the foundation maintains some significant involvement in the programs. Whether the foundation is considered to maintain significant involvement sufficient for these grants to individuals to be treated as “active conduct” expenditures depends on the facts and circumstances in each case.

Examples of “significant involvement” in a program involving grants to individuals include: (1) a grant program in which the recipients, in addition to independent study, attend classes, seminars, or conferences sponsored or conducted by the foundation, or (2) a grant to engage in social work or scientific research projects which are under the general direction and supervision of the foundation.

If, however, a foundation’s role in the grant process is limited to selecting, screening, and seeking out applicants for grants or scholarships, pursuant to which the recipients perform their work or studies alone or exclusively under the direction of some other organization, such grants or scholarships will not be treated as expenditures made directly for the active conduct of the foundation’s exempt activities.

(5)  What if the organization meets the private operating foundation tests initially, but fails to meet it in a given future year?

For any year in which a foundation that has been approved as qualifying for private operating foundation fails to meet the income test and one of the other three tests in a given tax year, the foundation must report as a non-operating foundation on its Form 990-PF.

The deductibility of contributions to an operating foundation will not be affected until notice of a change in the status of the foundation is made to the public (such as by publication in the Internal Revenue Bulletin), unless, at the time of the contribution, the donor was aware that the IRS would remove the foundation’s operating foundation status, or the donor was responsible for, or was aware of, the act or failure to act which caused the foundation to be unable to qualify as an operating foundation.

[1] Philanthropists who do not have the time, interest, or intention to conduct direct programmatic activities on a continuous basis may find it more appropriate to establish a non-operating foundation or even a donor-advised fund. Note that private non-operating foundations can also conduct direct charitable activities, but are not required to do so.

[2] Public charities must also demonstrate to the IRS that they are not a private foundation, but that is not the subject of this article.

[3] The limitation was previously 50% of AGI, but the limit was temporarily raised to 60% as part of the Tax Cuts and Jobs Act of 2017 through January 1, 2026, but was increased to 100% of AGI for 2020 and 2021 under the CARES Act.

[4] 26 U.S.C. § 170(b)(1)(B). The deduction for long-term capital gain property is typically based on the fair market value of the property on the date of the contribution.

[5] 26 U.S.C. § 4942.

[6] A grant by a non-operating foundation to an operating foundation counts towards the non-operating foundation’s annual minimum qualifying distribution requirement, whereas a similar grant to a non-operating foundation generally would not.  26 U.S.C. § 4942. Note, however, that a non-operating foundation must still exercise expenditure responsibility with respect to grants to most operating foundations, whereas it would not have to do so for grants to public charities.

[7] See IRC §4941. The following transactions are generally considered acts of self-dealing between a private foundation and a disqualified person: (1) sale, exchange, or leasing of property; (2) leases; (3) lending money or other extensions of credit; (4) providing goods, services, or facilities; (5) paying compensation or reimbursing expenses to a disqualified person; (6) transferring foundation income or assets to, or for the use or benefit of, a disqualified person; and (7) certain agreements to make payments of money or property to government officials.

[8] The rules governing excess business holdings were designed to prevent individuals from retaining control of businesses by transferring a significant amount of ownership in the businesses to their private foundation.

[9] Effective January 1, 2020 following enactment of new legislation, the net investment income tax applicable to private foundations is a flat, one-tier rate of 1.39%. This is not an excise tax aimed at restricting any type of transaction, like some of the other taxes, but is simply applicable to all private foundations.

[10] An example of a program-related investment that can constitute the “active conduct of” an operating foundation’s exempt purposes is a low-interest loan program designed to stimulate the local economy and create jobs in an economically depressed area, where the foundation has significant involvement in the form of staff who design, implement, and supervise the program, and the provision of technical assistance and training to borrowers. In that case, the loan funds as well as the expenses of conducting such program would be considered qualifying distributions for the active conduct of the operation foundation’s exempt purposes. See, e.g., PLR 9826048.

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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.

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