The federal and state governments reward nonprofit organizations for the good work they do by not requiring them to pay taxes. The trade-off is that all of their funds must be allocated for the purpose stated in their charter. Nonprofit organizations can accumulate profits, but they can’t distribute them to the founders or owners, or use them to increase employee salaries beyond the norm.
Each type of nonprofit organization has government regulations that it must follow to retain its nonprofit status. The federal government delegates most of the responsibility for regulation and oversight of nonprofit organizations to the state governments. Currently, nonprofit organizations have little or no impact on the political landscape, but will that soon change?
Types of Tax-Exempt Organizations
The most common type of tax-exempt organization is a nonprofit 501(c)(3) organization, but there are many types of tax-exempt entities, including:
- Social clubs
- Business leagues
- Veterans’ associations
- Labor unions
- Political parties
- Advocacy organizations
State Governments Follow the Government Regulations for Nonprofits
The laws that govern nonprofit entities vary from state to state. Nonprofit organizations must follow the laws of their states and other states in which they operate. This rule also applies to fundraising efforts. Nonprofits need to pay attention to the laws of other states when seeking donations from out-of-state donors.
The board of directors has the final say on making decisions for the organization. There are only two authorities higher than the board that have the authority to override board decisions. They are the Attorney General and a state court of law.
The Purpose of the Charter Documents
One of the first duties that a new nonprofit board of directors takes on is to write the charter documents and bylaws. The articles of incorporation state the name and location of the organization and the names and addresses of the founding members. The articles also state that the nonprofit organization is being formed for the exclusive purpose of charitable, religious, educational or scientific purposes. The articles will also spell out that no one should profit from the organization and indicate how assets would be distributed in the event that the organization dissolves.
Attorneys that specialize in nonprofit law are the best resource to review the charter wording for new nonprofits to make sure that the organization qualifies as a tax-exempt organization. Attorneys can help the founding members understand the things they can and can’t do to avoid legal concerns.
Founding board directors and all directors who come after them have duty of care, duty of loyalty and duty of obedience. As part of these duties, board members need to manage the organization’s money and other assets responsibly.
Government Regulations for Public Charities and Nonprofit Organizations
Two types of nonprofit organizations qualify as tax-exempt under section 501(c)(3) of the IRS code. Organizations can qualify as tax-exempt by incorporating as a public charity or charitable nonprofit. There are some important similarities and differences between them.
Public charities get their funding from investment income and large donors. Public charities are subject to an excise tax on any investment earnings, and they are subject to stricter rules than charitable nonprofits. Nonprofit entities get their funds from grants, donors, service income, government contracts and fundraising.
While there are many benefits to being a public charity or nonprofit organization, there are a few things that the government doesn’t allow such organizations to do. Nonprofit organizations cannot participate in electioneering, which means that they can’t do anything to improve or damage a politician’s chance of winning an election. Nonprofit organizations also have limited power to advocate for policies that affect their cause, and they can’t dedicate any substantial part of their activities to lobbying. Activities like electioneering and lobbying put nonprofit organizations at risk of receiving a penalty or having their 501(c)(3) status revoked.
Nonprofit organizations are not allowed to divert undue benefits to any person or organization. This includes inurement and excessive compensation. Inurement is when an insider takes the nonprofit’s money or assets without justifying that it pertains to the organization’s mission. A nonprofit is guilty of offering excessive compensation when it pays employees amounts over a customary wage for those positions.
Regulations for Conducting Business with Nonprofit Organizations
While federal and state governments play a central role in setting regulations for nonprofit organizations, 501(c)(3) entities have other rules to which they must pay attention. Nonprofit organizations frequently conduct business with other businesses like landlords, marketers, caterers and many other types of vendors that are required to pay taxes. Some businesses mistakenly believe that their interactions with nonprofits might be different than those with their other business partners, but in reality, the tax-exempt status doesn’t affect normal business transactions.
How Might the Johnson Amendment Change the Future of Nonprofits?
The provision in the 501(c)(3) code that prohibits nonprofit organizations from endorsing or opposing political candidates is called the Johnson Amendment, which dates back to 1954. It was named after its sponsor, Lyndon B. Johnson, who was a U.S. senator at the time.
President Trump has announced that he plans to work toward repealing the Johnson Amendment to allow churches and other nonprofit organizations to speak freely about the candidates they support. Currently, churches and other nonprofit organizations can publish and promote their views on social and political matters, but they can’t openly endorse any particular candidate.
A repeal of the Johnson Amendment would have serious implications for political campaigns. In essence, the donations that the public makes to their favorite charitable organizations could be used to support political candidates. This would also mean that large religious sects would have a much stronger influence on the outcome of major political contests.
President Trump will not be able to abolish the Johnson Amendment without significant help from Congress. To repeal an amendment, he would need for two-thirds of both Houses of Congress to propose a new amendment to repeal it. Another way that he could accomplish this is to get two-thirds of the state legislatures to call a constitutional convention, where the new amendment would then need to be ratified by three-quarters of the states.
Concluding Thoughts about Government Regulations of Nonprofits
Nonprofit organizations are like every other type of organization in that the type of IRS filing guides the activities that they can and cannot perform. As long as they follow the federal, state and local laws for their type of organization, they will remain fully compliant with tax laws.
As for the future, the Johnson Amendment is now more than a half-century old. The near future may decide if it will last for another half century.