Non-Profit, For-Profit, a Personal Donation? What's the Best Choice For You?
- karim182
- Oct 3, 2018
- 7 min read
The philanthropic spirit is alive and well in Minnesota: a 2017 study found the state ranked as the 3rd most charitable in the country. Giving money or gifting assets is fulfilling and allows you to establish a legacy of charitable giving that will live on long after you’re gone. If done right, there are also potentially significant tax advantages, which makes philanthropy a valuable estate planning tool as well. For people seeking this long-term impact with their charitable giving, setting up a charity or family foundation may be a perfect way not only to leave a legacy that lasts well beyond a lifetime, but also to engage younger generations with philanthropy. For more entrepreneurial types who are interested in starting a socially conscious, for-profit business that also gives back, setting up a public benefit corporation may be an ideal option.
To make an informed decision about which option is best for you and to realize the full benefits of that choice, it is important to have a basic understanding of the applicable state and federal laws.
NON-PROFITS
On the non-profit side, Section 501(c)(3) of the Internal Revenue Code specifies what types of organizations are considered exempt from federal income tax. Under that section there are effectively two broad classes of organizations that may be considered exempt: public charities and private foundations. Federal tax laws presume that an organization is a private foundation unless the IRS issues a ruling or determination, upon request, that it is a public charity.
Public Charities
Public charities are generally organizations that, a) receive most, if not all, of their financial support from the government or general public; b) have a fundraising program; and c) receive income from their charitable activities. They typically also have more interaction with the general public and include things like churches, schools, and hospitals.
Private Foundations
Private foundations, on the other hand, are usually operated by a family or small group of people, and derive their support from a smaller number of private sources and investment income. The IRS applies additional restrictions and taxes to these private foundations, depending on which one of the following three subcategories the organization falls under (you should work with an attorney to ensure your organizing documents make clear which one):
1. Private operating foundations
2. Exempt operating foundations
3. Grant-making foundations
Private foundations have to pay a 2% excise tax on their net investment income unless they qualify as exempt operating foundations by meeting certain requirements. Furthermore, the organization—and, in some cases, its managers, contributors, and other people affiliated with the organization—may be subject to additional taxes if they engage in certain prohibited conduct.
IRS Requirements
The most important requirement for any public charity or private foundation is that it be organized and operated exclusively for an “exempt purpose”. This means that it must engage in activities that accomplish any one of the exempt purposes specifically listed in 501(c)(3), which are:
1. Charitable, which means:
a. relief of the poor, the distressed, or the underprivileged;
b. advancement of religion;
c. advancement of education or science;
d. erecting or maintaining public buildings, monuments, or works;
e. lessening the burdens of government;
f. lessening neighborhood tensions;
g. eliminating prejudice and discrimination;
h. defending human and civil rights secured by law; and
i. combating community deterioration and juvenile delinquency.
2. Religious
3. Educational
4. Scientific
5. Literary
6. Testing for public safety
7. Fostering national or international amateur sports competition
8. Preventing cruelty to children or animals.
“Exclusively” means none of the earnings of a 501(c)(3) organization may inure to the benefit of private shareholders or individuals—i.e., a person having a personal and private interest in the activities of the organization. Running afoul of this “no private benefit” requirement could lead to penalties and/or losing tax exempt status.
Minnesota Requirements
The first step in establishing any type of non-profit organization is working with an attorney to create an operating entity with the proper organizing documents, the requirements of which are determined by state law. In Minnesota, the law that governs all non-profits is the Minnesota Nonprofit Corporation Act, Minnesota Statutes Chapter 317A. The Act is much like the laws governing for-profit corporations and LLCs in that it requires non-profits to be governed by a board of directors, specifies the roles officers should play in carrying out the organization’s mission, and details the rights and obligations of members under the organization’s bylaws. The Act likewise imposes fiduciary duties of care, loyalty, and obedience on the board members and officers of a non-profit.
Once established as a non-profit under Minnesota law, an organization must apply to the IRS for recognition of exempt status and request an Employer Identification Number (EIN). Any entity properly organized under Minnesota law for any of the exempt purposes specified above which continues to be operated for that purpose will qualify as exempt from federal income tax under Section 501(c)(3).
FOR PROFITS and PUBLIC BENEFIT CORPORATIONS
Socially-conscious entrepreneurs more interested in running a for-profit company oriented around the public good should consider organizing as a Public Benefit Corporation or “B-corp.” In Minnesota the statute governing this unique type of business is the Minnesota Public Benefit Corporation Act (MPBCA), Minn. Stat. 304A. While there are no particular tax advantages to this corporate structure, a B-corp is free from the IRS requirements that 501(c)(3) organizations must comply with to maintain tax exempt status because their stated intent as a company is to operate as a for-profit social enterprise. Further, a B-corp may elect to be taxed as an S corp, thereby qualifying as a pass-through entity and avoiding the double taxation that C corporations face. From a business standpoint there is also an upside in potentially being more attractive to investors looking to accomplish a broader social goal with their investment, and an advantage in hiring talented employees looking for mission-driven work.
Under Minnesota law, a public benefit corporation must first be incorporated under the Minnesota Business Corporations Act, Minn. Stat. 302A, and state in its articles of incorporation that it is 1) a general benefit corporation; 2) a general benefit corporation electing to pursue a specific benefit purpose; or 3) a specific benefit corporation electing to pursue a specific benefit purpose.
A general benefit corporation must also contain the phrase, “general benefit corporation” or “GBC” in its name, and a specific benefit corporation must contain the phrase, “specific benefit corporation” or “SBC” in its name. An existing corporation organized under 302A may, by the affirmative vote of the holders of at least two-thirds of its shareholders, amend its articles to become a public benefit corporation. As with any statutory requirement, understanding defined terms is key to interpreting the statute. A “general benefit corporation” must elect in its articles to pursue a “general public benefit,” which itself is defined as the business and operations of the company having a material positive impact on society, the environment, and the well-being of present and future generations. A “specific benefit corporation,” must state in its articles the specific public benefit purpose it elects to pursue. A “specific public benefit” is one or more positive impacts, or reduction of a negative impact, on specific categories of natural persons, entities, communities or interests, which (logically) cannot be shareholders in their capacity as shareholders.
Like a traditional C corp, officers and directors of a B-corp are bound by fiduciary duties. Unlike C corps, however, those duties are to advance the company’s purpose to pursue its stated general and/or specific public benefit. Directors are also prohibited by law from giving “regular, presumptive, or permanent priority” to shareholders’ pecuniary interests or “any other interest or consideration” that is not stated in the articles of incorporation. Minn. Stat. 304A.201. Thus, as with C corps, only a shareholder may assert a claim against the company, but only for a failure by its directors or officers to “pursue or create general public benefit or specific public benefit.” Minn. Stat. 304A.202, subd. 1.
Finally, B-Corps must deliver an annual report to the Minnesota secretary of state before April 1 each year that meets all of the statutory requirements outlined in Minn. Stat. 304A.301. Reports by general benefit corporations must satisfy some additional requirements, including identifying a third-party standard by which the company measures how it has pursued and created the general public benefit, and any circumstances that have hindered such pursuit and creation. No third-party audit or certification is required, however .
PRACTICALLY SPEAKING
Over the years, the attorneys at Sanford, Pierson, Thone & Strean, PLC have fielded various inquiries from well-intentioned people wanting to create non-profits to benefit, for example, an individual, family, or small group that has suffered some sort of tragedy or casualty loss. However, well-meaning intentions don’t always sync with state and federal laws. In many of those cases we’ve had to advise the client or potential client that if all of the funds for the entity they wish to set up are going to be distributed or awarded to one person or a specific family or a small group of people – in other words, not to a larger group of potential beneficiaries – a non-profit, tax-exempt corporation will not work because such distributions would violate the so-called Private Benefit Rule. The non-profit entity will not qualify for exemption from taxation under Section 501(c)(3) of the Internal Revenue Code, and contributions to it will not be tax deductible. Often in those cases, the best solution is simply for people to gift funds to the stricken individual or family. Gifts up to (currently) $15,000 per year can be made tax-free by any person to any other, BUT those gifts cannot be deducted by the donor.
There are cases where a non-profit is desired and does in fact meet all of the state and federal criteria. In these instances, Sanford, Pierson, Thone and Strean, PLC has found that, typically, it is appropriate to form a non-profit corporation under Minnesota state law, and complete the (lengthy) IRS application to become a 501(c)(3) organization under federal tax law. If the application is approved, then generally the entity is exempt from federal income tax, and contributions to it are tax deductible by the donor.
The key to ensuring that your philanthropic goals are met, then, is to identify your goals, understand the applicable state and federal laws and, if appropriate, carefully select an organizational structure. In-depth discussions with a financial planner and an attorney from Sanford, Pierson, Thone & Strean, PLC can help you work through these steps to realize the full benefits of your choice.
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