California Nonprofit Corporations: A Brief Primer on Legal and Tax Considerations, with Guest Blogger Tyler Willis

This week, the ladies of Smith Shapourian Mignano LLP are excited to collaborate with Tyler Willis, CPA, of willisCPA to address the legal and tax considerations for California nonprofit corporations.  

We first met Tyler through a mutual business contact, and since then, our firm has worked with Tyler on a variety of business formation matters.  Tyler assists individuals and businesses with respect to tax compliance and preparation, including but not limited to, income tax preparation and filing; tax accounting methods review; ​IRS or State Agency audit and appeals; tax projections and tax planning; ASC 740, or accounting for income taxes; tax consulting with respect to starting a business; and business profitability review.

Formation of a California Nonprofit Corporation
By: Smith Shapourian Mignano LLP

California Corporations Code Section 5000 et seq. governs the formation of California nonprofit corporations, which include: (1) public benefit corporations, pursuant to Sections 5110-5122 et seq.; (2) mutual benefit corporations, pursuant to Sections 7120-7122.3 et seq.; and (3) religious corporations, pursuant to Sections 9110-9122 et seq.  

Benefits of Forming a California Nonprofit Corporation

Forming a nonprofit corporation in California has many benefits, some of which are benefits afforded to corporations, generally.  For example, the members of the corporation are generally shielded from personal liability, with limited exceptions.  Second, the nonprofit corporation reaps the benefits of corporate structure and formality.  This in turn streamlines the decision-making process and guides the resolution of disputes between members.  Third, forming a corporation allows for a clear separation between the nonprofit and its members.  Essentially, the nonprofit is a separate legal entity from its members, and may continue to exist in perpetuity and beyond the lifetimes of its founding members.  

Additionally, forming a nonprofit corporation affords principals who are employees some employee fringe benefits such as life insurance, medical expense reimbursement, pension and/or retirement plans.  

Moreover, nonprofit corporations benefit from discounts that are not available to for-profit corporations, such as discounted rates or packages, lower membership rates, public service announcements (“PSAs”), etc.

Finally, California nonprofit corporations reap certain state and federal tax benefits based on their nonprofit status.  This topic is covered in greater detail below by Tyler, under the section entitled, “Tax Benefits and Requirements for California Nonprofits.”

Qualifying for a Section 501(c)(3) Exemption

In order to be exempt from paying federal income taxes, a nonprofit corporation in California must qualify for exemption under Internal Revenue Code Section 501(c)(3).  The Internal Revenue Service (“IRS”) provides guidance on exemption requirements here.  

Generally speaking, in order to prove that it is entitled to a 501(c)(3) exemption, the California nonprofit must show that:

• It is organized and operates as a charitable (i.e., publically beneficial), religious, educational, literary, or scientific organization;
• None of its earnings inure to a particular private person, but rather an indefinite, open community of people; and
• It does not, as a substantial portion of its activities, endeavor to influence legislation or participate in political activities.

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Tax Benefits and Requirements for California Nonprofits
By: Tyler Willis, C.P.A. of willisCPA

Applying for Tax Exempt Status

Nonprofit organization must apply with the Internal Revenue Service (“IRS”) using Forms 1023 or 1023-EZ to receive tax exempt status. This application focuses on the three areas that qualify an entity under §501(c)(3), which is described in more detail above.  Generally, a newly created California nonprofit corporation projecting annual gross receipts of less than $50,000 per year for the next 3 years will qualify to file the 1023-EZ and pay the reduced user fee.  Organizations required to file Form 1023 must submit a user fee of $850 with their application.

Most organizations have until the end of the 27th month after legal formation to file for exempt status with the IRS.  If filed within this timeframe, the exempt status will typically date back to the formation date.  If filed late, the exempt status may begin on the date the application was filed.  Although you may operate while your application is pending, donors will have no assurance that their contributions will be tax deductible until the application is approved.  Therefore, in practice, it is best to file for exempt status soon after legal formation  so as to avoid any uncertainty.

California also requires separate approval for tax exempt status.  The process of applying for tax exempt status also requires filing Form 3500 or 3500A with the California Franchise Tax Board.  In my experience, this is most easily done once you have received a favorable IRS determination letter, which can then be attached to form 3500A.

A frequently missed filing is the initial registration with the California Registry of Charitable Trusts.  This is an office maintained by the Office of the Attorney General, and requires a nonprofit to register within 30 days of receiving assets.

Maintaining Tax Exempt Status

After receiving favorable Federal and California determination letters a nonprofit must take steps to maintain its exempt status.  Failure to operate within the rules set forth by the IRS or California could result in a revocation of tax exempt status, and result in donations and earnings being taxed.

A strong recordkeeping system is needed to track financial and nonfinancial activities.  The IRS requires a nonprofit to maintain information on its financial support to determine if categorization as a public charity or private foundation.  Another requirement is to allow inspection by the public of all IRS filings (initial application and subsequent tax returns).

Tax returns should be filed annually with the IRS.  The required form is dependent on your level of activity, exempt entity classification, and unrelated business income (if any).  The simplest form is the 990N “Postcard” return, and will generally apply to nonprofits that were able to file the Form 1023-EZ until average gross receipts exceeded $50,000 per year. Despite the misnomer, “postcard,” the Form is filed online with the IRS and requires only basic information to complete.

Keeping your Donors Happy

Many nonprofit organizations rely heavily on cash donations from the general public.  One of the most familiar documents from a nonprofit is the written acknowledgement of contributions.  The acknowledgement should clearly state the nonprofit name, date of the contribution, amount of the contribution and a definitive statement of whether any goods or services were received in exchange for the contribution.

In my practice, I have seen recent increased scrutiny by the IRS on charitable contribution claims, and complete disallowance of a deduction due to improper wording of an acknowledgement letter.  Creating an acknowledgement letter that conforms to IRS requirements ensures that donors will receive the tax benefit of their contributions.

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Smith Shapourian & Mignano, LLP is available to answer any questions or concerns you may have regarding incorporating your nonprofit in California.  Feel free contact us to learn more.

This blog does not constitute solicitation or provision of legal advice, and does not establish an attorney-client relationship. This blog should not be used as a substitute for obtaining legal advice from an attorney licensed or authorized to practice in your jurisdiction. You should always consult a suitably qualified attorney regarding any specific legal problem or matter in a timely manner, as statutes of limitations may bar your claim.