By Stephen J. Dunn
This is the second of two articles on charitable giving. The first article questioned the wisdom of leaving property to individuals, and urged instead the making of charitable gifts. This article prescribes basic due diligence in charitable giving.
Charitable giving should be encouraged. Before giving to a charity, however, it is important to ascertain that the charity is what it purports to be. Charitable entities are often formed by volunteers, who may or may not do a good job of forming them. Several years ago I was asked to review the formation and tax exempt status of a nondenominational church. I found that the church had been defectively organized—under the state’s general nonprofit statute rather than its ecclesiastical organization statute. Moreover, an application for recognition of tax exempt status had not been filed with the Internal Revenue Service for the church. Surely the church’s members would not be pleased if the IRS examined the church, determined that contributions to the church are not tax deductible, identified contributors to the church, examined the contributors’ tax returns, and disallowed the contributors’ tax deductions for their contributions to the church.
I formed a new entity for the church under the state’s ecclesiastical entity statute, and had the church transfer its assets to the ecclesiastical entity. I also applied to the IRS for recognition of the entity’s tax-exempt status.
Most tax-exempt entities are exempt from income tax under either Section 501(c)(3) or Section 501(c)(4) of the Internal Revenue Code. A Section 501(c)(3) entity, also called a “public charity,” is organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition, or for prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting to influence legislation, and which does not participate in (including the publishing or distributing of statements) any political campaign of behalf of (or in opposition to) any candidate for public office.
A Section 501(c)(4) entity, also called a “civic league,” is not organized for profit but operated exclusively for the promotion of social welfare. A local association of employees, the membership of which is limited to the employees of a designated person or persons in a particular municipality, may be a civic league. The net earnings of a civic league must be devoted exclusively to charitable, educational, or recreational purposes.
A 501(c)(3) entity as well as a 501(c)(4) entity is exempt from income tax on its income directly related to its exempt purpose. The difference between the two forms of entity is that contributions to a 501(c)(3) entity are deductible on the contributor’s income tax return as charitable contributions, whereas, contributions to a 501(c)(4) entity are not.
That an entity has been effectively organized, and recognized by the IRS as tax exempt is no guarantee that it is being operated as a charitable entity. A good rule of thumb is that a charitable entity’s general and administrative expenses should not exceed ten percent of its total revenues. General and administrative expenses are those not incurred directly for the entity’s charitable purpose(s). Advertising and promotion, administrative salaries and benefits, rent, insurance, depreciation expense, interest, and professional fees are examples of general and administrative expenses. The ratio of an entity’s general and administrative expense to its total revenues can be ascertained from its Federal income tax return, Form 990, Return of Organization Exempt from Income Tax. Both a 501(c)(3) entity and a 501(c)(4) entity must file an annual Form 990. In Form 990, total revenues appear at Part VIII, Line 12, Column (A), and general and administrative expenses appear at Part IX, Lines 4-24(a)-(e), Columns (C) and (D).
An entity’s Forms 990 can be obtained at http://foundationcenter.org. By submitting a Form 4506-A, Request for Public Inspection or Copy of Exempt or Political Organization IRS Form, to the IRS concerning a 501(c)(3) entity or a 501(c)(4) entity, a person can obtain the following concerning the entity:
- Forms 990
- Application submitted to IRS for recognition of tax-exempt status (Form 1023 in the case of a 501(c)(3) entity; Form 1024 in the case of a 501(c)(4) entity)
- Determination letter issued by the IRS declaring the IRS’ determination that the entity is tax-exempt under Section 501(c)(3) or Section 501(c)(4)
There is no filing fee for a Form 4506-A submitted to the IRS by a non-commercial user. The IRS takes up to 60 days to respond to a Form 4506-A filed with it. Form 4506-A and Instructions are available at http://www.irs.gov/.