Being a nonprofit organization is not the same as being a tax-exempt organization.  The two concepts are related, but are not the same. Almost all tax-exempt organizations are nonprofits, but not all nonprofits are tax-exempt. 

 To be considered a tax-exempt nonprofit organization in California, a nonprofit organization must meet certain legal and regulatory requirements.  If met, the Internal Revenue Service and Franchise Tax Board may grant recognition of tax-exempt status after the submission of proper applications and filing fees. 

Most tax-exempt organizations under the federal law are those that are described in Internal Revenue Code 501(c)(1)-(27).   Most charitable organizations (that is, organizations that operate primarily for charitable, educational, scientific, or religious purposes) must seek recognition of tax-exempt status from the IRS.  Requirements vary depending on the type of tax-exemption sought, but most charities must start by submitting Form 1023: Application of Recognition of Exemption Under 501(c)(3) of the Internal Revenue Code to the Internal Revenue Service. 

Typically, once recognition is granted from the IRS, a California nonprofit will submit Form 3500, Exemption Application or Form 3500A, Submission of Exemption Request to the Franchise Tax Board for its approval. 

 If you are interested in learning more about the process for gaining tax-exempt status in California, please contact Susan E. Bishop at (408) 369-0800

Federal law provides substantial tax benefits to certain nonprofit organizations established as exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code.  However, even after the exempt-status has been established, the charity’s officers, directors, employees and volunteers still have ongoing responsibilities to ensure that the tax-exempt status can be maintained. 

In order to maintain its tax-exempt status, a public charity must limit its participation in certain activities and cannot participate in other activities. 

 LOBBYING

 Public charities may engage in lobbying activities only to the extent that they are not substantial.  A public charity that engages in substantial lobbying is likely to have its tax exemption denied or revoked. 

 There is no black and white formula for defining “substantial.”  The Internal Revenue Service (“IRS”) considers a variety of factors, including the extent of lobbying in relation to the percentage of total funds expended in a designated period of time.  Of course, the IRS may also simply look to the impact on a legislative process to make its determination.  The IRS looks at each situation on a case-by-case basis.        

In the alternative, most public charities may elect to use the “expenditure” test by filing Form 5768, Election/Revocation of Election by an Eligible Section 501(c)(3) Organizations to Make Expenditures To Influence Legislation.  This allows a nonprofit to engage in a certain amount of legislative activities by allowing a certain percentage of expenditures to be spent on lobbying, depending on the size of the organization. 

PRIVATE BENEFIT AND INUREMENT

A public charity may not allow more than an “insubstantial” accrual of private benefit to individuals or organizations.  This limitation is to ensure that the nonprofit serves a public interest, not a private one.  A private benefit can be many things, including the payment of unreasonably high compensation to a director or employee.  

 POLITICAL CAMPAIGN INTERVENTION

Public charities are prohibited from engaging in virtually all political activities.  This includes any political campaign on behalf of a candidate for public office.  If a public charity engages in any political campaigning, its tax-exempt status will be taken away and it must pay taxes that it would not otherwise been required to pay. 

 Nonprofits must work hard to maintain their tax-exempt status.  If you have questions about acquiring tax-exempt status or maintaining it, please contact Susan E. Bishop at (408) 369-0800.

Employers in California are generally subject to unemployment insurance taxes on wages paid to employees.  Typically employers, whether for profit or nonprofit, are assigned a tax rate and make regular contributions to cover the occasional unemployment claim made by former employees.  Most employers do not have options when it comes to making those contributions.  Some nonprofits do. 

 The California Unemployment Insurance Code provides that nonprofit organizations recognized by the Internal Revenue Service as charitable organizations in accordance with Internal Revenue Code section 501(c)(3) have two options for covering claims brought by employees for unemployment.

A 501(c)(3) may:

             (1)  Pay the same unemployment insurance taxes paid by for-profit employers (the tax-rate method); or

             (2)  Reimburse the State of California for the full cost of all Unemployment Insurance Benefits paid to their former employees (the reimbursement method). 

             To elect the reimbursement method, a qualified nonprofit must file EDD Form DE1SNP (Selection of Financing Method by a Nonprofit Organization) and EDD Form DE 1NP (Registration Form for Nonprofit Employers) with the Employment Development Department.  An election of the reimbursement method must remain in effect for not less than five (5) years and the Employment Development Department may terminate the election based on delinquent payments. 

             The reimbursement method may be beneficial if a nonprofit employer has had few unemployment insurance claims and expects few in the future.  The tax-rate method makes sense for employers anticipating heavy layoffs or if it prefers predictability with respect to expenses. 

             Nonprofit organizations are encouraged to seek legal counsel to ensure that all of the appropriate paperwork is submitted before commencing the reimbursement method.  The penalties for failing to properly elect the reimbursement method can be significant.

           Note:  State Disability Insurance contributions by employees are required under either method, as are personal income taxes. 

What legal requirements apply to all businesses?

*Annual statement of information (officers, directors, and agent for service of process) and filing fee to the secretary of state (except sole proprietors and general partnerships).

*Taxes – annual franchise tax fee (except sole proprietor and general partnership), state and federal tax returns, employment taxes, sales and use taxes, personal property taxes.

*Local business license, professional licensing

*Federal Employment Identification Number

*Insurance – unemployment and workers’ compensation, liability, etc.

*Qualification to do business in other states if you do business elsewhere.

How to avoid personal liability?

1. Form an entity.
2. Avoid personal guarantees.
3. Observe appropriate formalities for the entity.
4. Remit all taxes withheld or collected.
5. Carry insurance.

Protecting Intellectual Property

1. Identify trade secrets and take steps to protect them.
   1. Trade secret defined as “(1) Derives independent economic value, actual or potential, from not being generally known to the public or to other persons who can obtain economic value from its disclosure or use; and (2) Is the subject of efforts that are reasonable under the circumstances to maintain its secrecy. 
2. Identify and protect creative works through copyrights.
3. Identify and protect distinctive phrases, logos and branding items through trademarks (or service marks). 

Buy-Sell Agreements

An agreement document how you or another owner can leave the business if one of you moves out state, goes to a new line of work, becomes physically or mentally disabled, dies, wants to sell to an outsider, or seeks to buy out a co-owner’s interest. 

What can happen if you don’t have a buy-sell agreement?

            *You may be forced to work with and share control of the company with someone you don’t know.

            *You may end up working with a family member of a deceased or divorced owner.

            *If you die, your survivors may end up stuck in a business they don’t want.

            *You may end up arguing with a co-owner on the price of the company.

Business Contracts

What makes a valid contract? An agreement, consideration and acceptance, and sometimes a writing.

Things to include in the contract:

            *Names and addresses of the parties

            *Date the contract is signed

            *Short preamble, i.e. background or recitals

            *What each party promises to do

            *When the work will be done or the product delivered

            *How long the contract will remain in effect

            *The price – or how it will be determined

            *When payment is due

            *Warranties

            *Conditions on how you can terminate the agreement

            *Liquidated damages if performance is delayed or defective

            *Whether or not a party can transfer their interest in the contract to another

            *Resolution of disputes through arbitration or mediation

            *Who will cover attorney’s fees and costs if a party breaches

            *Where notices of default and other communications can be sent

            *What state law applies if questions about the contract arise. 

Choosing an entity

Do the parties need limited liability?

Do the parties want profits and losses to pass through to their personal income tax returns?

Will all of the parties be actively involved in management?

If you are a small business owner with consistent legal needs, our Virtual In-House Counsel services are a cost-effective option for your business.  You can have the benefits of an in-house legal team, without the expense and overhead.

We will manage your legal affairs so that you can concentrate on running your business.  We provide personalized and responsive legal advice that may be customized and adapted to the issues your company is facing.

This service is set up on a quarterly payment basis.  You can receive continual access to an attorney and still stay within a predetermined budget.  Signing up for the Virtual In-House Counsel service will allow you to receive legal advice at a 25% discounted block rate for anything from transactional matters, contract review and drafting, risk management, and litigation strategy.

This flexible approach allows us to combine traditional legal services that keep a business owner’s budget in mind.  It allows you to have an attorney familiar with your business, who is just a phone call or email away.  Our attorneys are well-versed in varied areas of law, including:

- Business transactions,

- Corporate governance,

- Employment law

- Real estate law,

- Lending and collections,

- Insurance issues,

- Litigation, and

- Non-profit law.

If you are interested in learning more about this service and whether it would be a good fit for your small business, please contact us at (408) 369-0800.

Elena Rivkin Franz, attorney and counselor-at-law, is licensed to practice in all California court and the United State District Court of Northern California. During law school, she was a judicial extern for Judge James Ware of the Federal District Court in the San Jose Division.

To lean more about Elena’s specialties of law, please view her profile under attorneys. If you would like to speak with Elena, please call 408-369-0800.

If you would like to speak to one of our attorneys specializing in this area of law, please call us at 408-369-0800 or click on “contact” to send us an email message. We look forward to hearing from you.