A number of day-to-day operations present compliance risks for not-for-profit organizations. Organizations need to be aware of the regulations surrounding activities such as soliciting contributions and classifying contractors in order to avoid penalties. Failing to address and mitigate these areas of risk could lead to the loss of an organization's tax-exempt status.

Below are three common risk areas facing not-for-profit organizations.

State Regulations

Sales Tax

Not-for-profit organizations must collect sales tax on all sale items. Consider which of your organization's transactions may be subject to sales tax and where these transactions take place. The issue of nexus, or the level of interaction between an entity and the state before the entity is subject to the state's tax, impacts not-for-profits in the same way it impacts for-profit entities. Be sure your not-for-profit is licensed to do business in the state(s) involved in its transactions.

Physical presence in a state is not the sole determinate of whether an organization needs to register with a state. Online transactions also factor into nexus considerations. If a consumer who lives outside of the state where the organization is located purchases items from the organization's website, the organization would likely need to register with the consumer's resident state.

Soliciting  Contributions

Before not-for-profits solicit contributions in a state, they should consider that state's regulations. Charitable solicitation statues exist in 40 states, and most require a charity to register with the state before it can seek donations there. Exemptions to the requirements placed on solicitations vary from state to state, so it is important for your not-for-profit to understand which state requirements could apply to your organization.

Telecommuters

Employees living in other states and conducting work remotely frequently cause nexus issues for not-for-profits. If your organization has telecommuters, be sure that your not-for-profit is registered to do business in the state where the telecommuter lives.

Public Charity Status

501 (c)(3) organizations are classified as either a public charity or a private foundation. Entities that qualify as public charities benefit from more advantageous tax treatment. Private foundations are subject to a 2 percent excise tax on net investment income and an annual minimum distribution requirement.

An entity can qualify as a public charity under three main categories. The type of public charity determines the support test an organization must pass in order to prove it is a public charity. If the organization does not pass the test, it is considered a private foundation and is subject to the excise tax.

170(b)(1)(A)(vi) organizations: Groups that are publicly or governmentally supported on an ongoing basis qualify as public charities under this section of the Internal Revenue Code. To prove it is publicly funded, an organization must show it receives at least 33 1⁄3 of its total support from governmental units and/or contributions from the general public. If public support is only 10 percent for the current or past year, then the organization must apply the facts-and-circumstances test to determine whether it still qualifies as a 170(b)(1)(A)(vi) organization.

509(a)(2) organizations: These organizations may not typically receive many public donations or gifts. They often are funded by providing services that materially support their exempt function. An example would be a zoo that receives funding from ticket sales. To qualify for this type of public charity, organizations must demonstrate that at least 33 1⁄3 of their financial support comes from the public and/or related-service revenue. Investment income can also not be more than 33 1⁄3 of the organization's total income during the current or previous year.

509(a)(3) organizations: Organizations that support another not-for-profit and have restrictions on who can make donations to the organization are 509(a)(3) public charities. These organizations do not have support tests like the previous two types of public charities. As a result, 509(a)(3) organizations face more stringent regulations and IRS scrutiny than other types of public charities.

Organizations can easily move within these public charity definitions, and so they must be careful to meet the appropriate support tests in order to avoid private foundation tax treatment.

Employee Classification

With employees, organizations must withhold income taxes, withhold and pay Social Security and Medicare taxes and pay unemployment taxes. Organizations are not required to pay or withhold any of these taxes on independent contractors.

The difference between an employee and a contractor is not always clear-cut. Telecommuters classified as contractors, management roles that are contracted, and former employees returning to work for the organization can cause employee classification issues.

To determine how to best classify employees, organizations should consider the level of control the organization can exercise over the employee. Organizations can evaluate the employee relationship based on the behavior and financial control they have over the position as well as the employer/employee relationship structure. For further guidance on whether an individual is an employee or a contractor, please see the following IRS guidance on how to classify employees.

Navigate  Your Organization's Tax Issues

The above tax issues are just a few of the areas not-for-profits must navigate in order to stay in compliance with IRS regulations. To learn more about the tax risks facing your organization, contact your local CBIZ office.

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