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Nonprofit and Tax-Exempt Organizations

While successful nonprofit organizations have many of the same concerns as for-profit businesses, they must also continually navigate...

Riker Danzig Nonprofit May 2017 Update

May 22, 2017

Amendments to the New York Nonprofit Revitalization Act

In November, New York Governor Cuomo signed into law an amendment to the New York Nonprofit Revitalization Act of 2013 (“NPRA”).  The 2016 Amendment clarifies and simplifies a number of provisions of the NPRA that are applicable to New York nonprofit corporations and charitable trusts.  Two of these changes, which ease slightly the burdens imposed by the NPRA, are discussed below.  These changes go into effect on May 27, 2017.      

1. Related Party Transaction Provisions.  

The NPRA originally prohibited a corporation subject to the New York Not-for-Profit Corporation Law (“NPCL”) from entering into a “related party transaction,” which was defined as “any transaction, agreement, or any other arrangement in which a related party has a financial interest and in which the corporation or any affiliate of the corporation is a participant,” unless the transaction is determined by the board to be “fair, reasonable and in the corporation’s best interest.”  

The 2016 Amendment eases the related party transaction rules by redefining the term “related party transaction” to exclude the following transactions:  

  1. Transactions where the transaction itself or the related party’s financial interest in the transaction is de minimis
  2. “Ordinary course of business” transactions that would not customarily be reviewed by the board or boards of similar organizations in the ordinary course of business and are available to others on the same or similar terms; and 
  3. Transactions that provide benefits to a related party due to the related party’s membership in a class of beneficiaries that the corporation intends to benefit as part of its mission, which benefits are available to similarly situated members of the same class on the same terms.   

If an action is brought by the attorney general with regard to a related party transaction that is not in accordance with the requirements of the NPRA, New York nonprofit corporations and charitable trusts have a limited defense if:

  1. The transaction was fair, reasonable and in the organization’s best interest at the time the organization approved the transaction; and
  2. Prior to the receipt of any request for information by the attorney general with respect to the transaction, the directors/trustees: (a) ratified the transaction in accordance with the existing requirements for approving related party transactions; (b) documented in writing the nature of the violation and the basis for the directors’, trustees’ or committee’s ratification of the transaction; and (c) implemented procedures to ensure that such violations will not occur again in the future. 

2. Independent Director Provision.  

The NPRA requires certain functions to be carried out by a board or audit committee comprised solely of “independent directors,” including oversight of the corporation’s accounting and financial reporting process.  The 2016 Amendment re-defines the term “independent director” by providing a sliding scale to trigger disqualification in certain limited situations, thereby causing the result that fewer directors will be disqualified from being an “independent director.”  

Now, a director who is employed by or has a financial interest in an entity that receives payments from or makes payments to a corporation subject to the NPCL may still be independent, depending on the gross revenues of the entity and the size of the payments to or from the entity.  For example, a director who is employed by or has a financial interest in an entity that receives payments from, or makes payments to, a corporation subject to the NPCL will be considered “independent” as long as the amount paid or received during each of the past three fiscal years does not exceed 2% of the entity’s consolidated gross revenues and the entity has consolidated gross revenues of less than $500,000.  The maximum permissible amount paid to or received from the entity increases in relation to the entity’s consolidated gross revenues.          

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PATH Act Adds New Notification Requirements for 501(c)(4) Tax-Exempt Organizations

Following the passage of the Protecting Americans From Tax Increases (PATH) Act of 2015, the Internal Revenue Service issued proposed and temporary regulations in July 2016, which set forth notification requirements for new 501(c)(4) tax-exempt organizations. This category of tax-exempt entities includes civic leagues and other not-for-profit organizations that promote “social welfare.”  Unlike 501(c)(3) organizations, whose focus must be on a more narrow set of charitable, educational, religious or certain other purposes, 501(c)(4) social welfare organizations are afforded a greater degree of latitude in terms of political participation.  Contributions to 501(c)(4) organizations are not deductible.

Previously, organizations claiming exemption from federal income taxes under Section 501(c)(4) of the Internal Revenue Code enjoyed a self-executing process that did not require an application or notification to the IRS.  

The PATH Act requires that 501(c)(4) organizations notify the IRS within 60 days of formation of their intent to operate as such. The new rules require that the notification (on newly created Form 8976) include: (1) the name, address, and taxpayer identification number of the organization; (2) the date on which the organization was formed and the state of incorporation; and (3) a statement of the purpose of the organization.

Failure to notify the IRS subjects an organization to a daily fine of $20, with a maximum aggregate penalty not to exceed $5,000. 

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Private Foundation Investing--Expanded

State prudent investor laws and federal tax law impose a number of restrictions on the manner in which the assets of a private foundation can be invested.  The investment of a foundation’s assets essentially must:

  • provide sufficient liquidity to allow 5% of the asset value to be paid in grants each year;
  • not include an interest in an active trade or business that (when combined with the ownership interests of insiders) exceeds 20%, unless a special rule applies;
  • not be so risky that the investment jeopardizes the ability of the foundation to carry on its exempt purposes (investments must be “prudent”); and
  • not provide significant benefit to an insider.

An investment is considered to jeopardize the carrying out of the exempt purpose of a private foundation if it is determined that the foundation managers, in making such investment, have failed to exercise ordinary business care and prudence, under the facts and circumstances prevailing at the time of making the investment, in providing for the long- and short-term financial needs of the foundation to carry out its exempt purposes.  No category of investments is treated as an automatic violation, but careful scrutiny is applied to: (i) trading in securities on margin, (ii) trading in commodity futures, (iii) investing in working interests in oil and gas wells, (iv) buying puts, calls, and straddles, (v) buying warrants, and (vi) selling short.

There is a specific exclusion from the definition of “jeopardizing investment”  for a program-related investment (“PRI”).  Generally, a PRI is an investment for which:

  • the primary purpose is to accomplish one or more charitable purposes; 
  • the production of income or the appreciation of property is not a significant purpose; and
  • lobbying or electioneering is not a purpose. 

A PRI might take the form of a loan to a charity or a loan to, or equity investment in, a business entity for a charitable purpose, such as to develop or distribute a lifesaving drug for use in developing countries that would not otherwise be commercially viable.  

Until recently, there was a question as to whether private foundation managers could consider the relationship between a particular investment and the foundation’s charitable purpose in deciding whether to make the investment (referred to as a “mission-related investment” or “MRI”), even where the production of income or the appreciation of property is a significant purpose.  The relevant treasury regulations provide that an investment will be considered jeopardizing if a foundation’s managers fail to exercise ordinary business care and prudence.  Since MRIs may offer lower returns than non-MRI investments, some questioned whether a lower return could cause them to be treated as “imprudent,” and therefore as jeopardizing investments.  

IRS Notice 2015-62 makes clear that foundation managers may consider the relationship between an investment and the foundation’s mission in making prudent, profit-driven investments. The Notice also indicates that MRIs will not be considered imprudent because they offer an expected return that is less than what could be earned on other investments.  This approach is consistent with state law requirements for charitable investments under the Uniform Prudent Management of Institutional Funds Act: foundation managers may consider the relationship of a proposed investment to the foundation’s charitable purpose as part of the determination as to whether an investment is prudent.

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Payout Requirement for Certain Type III Supporting Organizations

All Internal Revenue Code (“IRC”) Section 509(a)(3) supporting organizations derive public charity status from their relationship with one or more IRC section 509(a)(1) or (a)(2) public charities:

  • Type I supporting organizations are operated, supervised, or controlled by their supported organization(s) (“parent/subsidiary” relationship);
  • Type II supporting organizations are under common control with their supported organization(s) (“sibling” relationship);
  • Type III supporting organizations are “operated in connection with” one or more of their supported organizations. 

In the 2006 Pension Protection Act, in response to perceived abuses of Type III status, Congress established two sub-categories: “functionally integrated” Type III supporting organizations, which carry out the functions of their supported organizations, and “non-functionally integrated” Type III supporting organizations, which typically make grants to their supported organizations. Congress imposed additional requirements on the supporting organizations described below, and on private foundations and donor-advised funds making grants to them. It also provided that Type I and Type III supporting organizations may not receive gifts from persons who control the governing body of a supported organization, or from certain related individuals or entities.

A Type III non-functionally integrated supporting organization must distribute each year the greater of (a) 85% of the organization’s adjusted net income for the prior taxable year and (b) 3.5% of the aggregate fair market value of the organization’s non-exempt use assets, with certain adjustments, to one or more of its supported organizations. Certain excess amounts may reduce the distributable amount in subsequent years (for up to five years after the excess amount is generated).

Those distributions must also be sufficiently important to the supported organization to ensure that the supported organization has reason to pay attention to the supporting organization’s role in its operations. Distributions to a particular supported organization are deemed to meet this standard if the amount of support:

  • Equaled at least 10% of the supported organization’s total support for the prior year;
  • Was necessary to avoid interruption of a particular substantial activity of the supported organization; or
  • Based on all facts and circumstances (including actual evidence of attentiveness), was sufficient to ensure attentiveness.

At least one-third of the supporting organization’s distributable amount must be distributed to supported organizations (1) that meet this attentiveness requirement and (2) to which the supporting organization is responsive.

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Nonprofit and Tax-Exempt Organizations Group News

Recent News:

  • NJBIZ has selected Jason D. Navarino, a partner in Riker Danzig’s Corporate and Tax groups, as one of NJBIZ’s Forty Under 40 winners for 2016. Nominees came from all industries across the state.  The Forty Under 40 awards program celebrates the state’s most accomplished young businessmen and women who have been making headlines in their field and who share a commitment to business growth, professional excellence and to the community.  Jason and the 39 other winners were honored during an awards reception and ceremony in September, and Jason was featured in an NJBIZ issue that highlighted each honoree. 
  • Riker Danzig partners Tracy Green Landauer and Jason D. Navarino, both of whom advise numerous non-profit organizations on tax exemption and corporate matters, recently led a team of attorneys that represented the Alliance for Lupus Research (“ALR”) in its merger with the Lupus Research Institute (“LRI”) and the S.L.E. Lupus Foundation to form the Lupus Research Alliance.   The three legacy non-profit organizations have devoted more than 75 years collectively to finding better treatments and a cure for lupus and are responsible for funding over $200 million to support lupus research programs.  
  • Alexander Yarbrough joined Riker Danzig’s Nonprofit Group.
  • Hannah Greendyk joined Riker Danzig's Nonprofit Group. 

Recent Speaking Engagements:

On February 15, Tracy Green Landauer and Jason D. Navarino gave a presentation entitled “Donation of Complex Assets: Opportunities and Obstacles” to the Philanthropic Planning Group of Greater New York. The presentation touched on various legal and tax hurdles that both donors and donees must deal with when non-cash assets, such as business interests, real estate, and artwork, are donated to a charity.

Jason D. Navarino taught a CLE at a meeting of the New Jersey State Bar Association’s Tax-Exempt Organizations Committee meeting in September entitled “Structuring Investments by Tax-Exempt Entities.”  The focus of the presentation was on the tax complications faced by schools, charities, pension plans and other tax-exempt investors when they invest in various alternative asset classes, and how to structure those investments to minimize those complications. 

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Our Team

Robert C. Daleo

Robert C. Daleo

Jason D. Navarino

Jason D. Navarino

Hannah J. Greendyk

Hannah J. Greendyk

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