Practical Considerations in Creating Nonprofits, 0520 SCBJ, SC Lawyer, May 2020, #34

• Author: By Paula Birch Billingsley
• Position: Vol. 31 Issue 6 Pg. 34

Practical Considerations in Creating Nonprofits

No. Vol. 31 Issue 6 Pg. 34

South Carolina BAR Journal

May, 2020

By Paula Birch Billingsley

One “hazard of the job” that many lawyers face is a request for help in the formation of a nonprofit corporation. While the process may appear simple, it is often far more complicated than many lawyers anticipate. While it is tempting to assist with these requests, usually for a noble cause, it is generally more ethical for the attorney to defer such requests to someone more qualified.

In much the same light, there have been substantial changes to the relevant forms and options in the past few years. Even seasoned attorneys might be inclined to approach the process in the same way they have done in the past. This strategy may work for some lawyers, but may not be in the best interest of the client. Therefore, this article will discuss certain procedural and ethical issues that a lawyer will likely face in setting up a nonprofit corporation.

Initially, it is most important to realize that actually applying for the 501(c)3 part is not the first or even the second step of the process. It is also not anywhere near the end of the lawyer’s obligations.

The form fled with the Internal Revenue Service (IRS) to request tax exempt status is Form 1023.^[1] Essentially, there are three phases to guiding a client through a 501(c)3: before 1023, the IRS 1023, and after the 1023.

Before the 1023

There are several pieces of information the lawyer must know before the 501(c)3 application process (a 1023 or 1023EZ) can be started.

This list includes: •A name and specific purpose that is considered a nonprofit purpose.

• A physical address (not a P.O. Box) which will be required to be formally incorporated.

• Nonprofit specific email address.

• Three people to incorporate.

• One person to act as designated agent.

• A board of directors.

• Articles of Incorporation properly fled with the South Carolina Secretary of State to create the nonprofit.

• A federally issued EIN number.

Also, while it is not always required to be submitted, it is important for the board to adopt bylaws that state the purpose—which should be a tax-exempt purpose—and outline how the nonprofit will be organized and function. While old examples and contemporary online templates are a good basis, as with many legal documents, boilerplate language can be dangerous and useless to the people using them.

Good bylaws should be clear, easy for the board to use, and address at least the following items in separate articles: I. Name and purpose

II. Directors (powers, requirements, dues, terms, election, removal)

III. Meetings (regularity, time and place, notice required, attendance required, quorum for voting)

IV. Officers (positions, duties, elections and removals - always have two treasurers who are unrelated)

V. Committees

VI. Voting

VII. Conflict of interest (policies and procedures)

VIII. Financial matters

IX. Liability, insurance and indemnification

X. Amending the articles Perhaps most important is the conflict of interest policy. Lawyers should advise clients that this same policy should be printed along with proper acknowledgment language in a waiver form for each board member to sign. These should be witnessed (though they do not need to be notarized) and kept on file for at least three years after the board member no longer serves.

An appropriate conflict of interest policy does not require board members to never be in competition with the corporation. The policy, however, should require that board members disclose their potential conflicts and require them to refrain from voting on any such matters.

For example, a conflict of interest can arise when members of the board serve in other capacities connected to the corporation’s mission, which is often the case in small communities. As another example, a director may end up in competition for resources with the organization, like bidding on the same plot of land for sale. Similarly, a director may stand to gain personally from the operation of the organization, such as if they own a business that may be paid to print its business cards. Again, the policy must make clear the need to have all directors: (1) sign a conflict of interest policy, (2) reveal any possible conflicts to the board before such conflict directly arises, and (3) refrain from voting on such matters where they may stand to gain personally.

In this way, much of the lawyer’s work will take place prior to the actual flings.

The IRS 1023

Only after these steps have been taken may the lawyer begin the IRS fling to apply for 501(c)3 nonprofit tax-exempt status.

When fling the IRS 1023, a careful review of the application, checklist, and instructions is essential. For example, smaller nonprofits often qualify for the lower cost and much shorter version of the application, the 1023EZ.^[2] Having the client pay twice as much and wait longer for the traditional application when they do not have to would be a poor decision.

At this time, it is important to make clients understand that tax exempt fundraising and donation solicitation cannot occur until after the tax-exempt status is officially received. Taking donations as a nonprofit prior to having the status is a crime subject to fines.

After the 1023

There is so much excitement once the federal government has approved 501(c)3 status that there could be a tendency to forget that the process is only halfway done. After the 1023, there must be at least two more flings with the South Carolina Secretary of State’s office, specifically the Division of Charities. These are a Nonprofit Registration as well as an Annual Application for Exemption.^[3] Each of these is brief.

It is important to remember that some nonprofit activities, such as raffles and hiring certain professionals, have to be reported separately in the state of South Carolina. In addition, the nonprofit’s board also needs to understand that the corporation will lose its nonprofit status unless flings are made every year with the IRS and the S.C. Secretary of State. Part of the lawyer’s duty is to make sure t hat board members understand exactly the fling requirements necessary to keep the exemption.

In fact, an attorney’s ethical duties to advise nonprofit clients can be summarized with acronym WISE.

WISE stands for: W. Wait. The corporation should wait until the 501(c)3 status is received before beginning to accept money as a nonprofit.

I. IRS. Even though the corporation is tax exempt, it must still file every year with the IRS like any other business. This fling will be a Form 990, 990EZ, or 990N, depending mostly on how much the nonprofit grosses.

S. State. After fling with the IRS, there are two simple forms that have to be fled annually with the South Carolina Secretary of State: the state’s Yearly Financial report (a form on their website) and an Application for Exemption with the state. While extremely easy and free to file, failure to make these flings within four months of the close of the corporation’s fiscal year (the anniversary of the date it was incorporated) results in a loss of the tax-exempt nonprofit status.

E. Every director must sign a conflict of interest waiver, disclose any possible conflict, and abstain from voting on such matters.

So, lawyers should tell their clients to be WISE. If not, the work that the lawyer has done for them will be rendered useless. This could lead to unhappy clients.

When in doubt, of course consult S.C. Code Annotated Title 33 Chapter 31 and the Rules of Professional Conduct, 407.^[4] Also, the University of South Carolina School of Law’s clinics includes a nonprofit clinic during the fall semester which assists people with the startup process. Additionally, the IRS provides accessible publications on all their requirements. Similarly, the South Carolina Secretary of State’s Office is able to answer questions about their flings, most effectively by phone or in person at their office conveniently located in downtown Columbia at 1205 Pendleton Street.

In the three phases of creating a 501(c)3, lawyers can best protect themselves by reading before they write and asking someone else before they answer.

Paula Birch Billingsley is a Columbia native and a 2014 University of South Carolina School of Law graduate. She also holds a masters in English and has primarily focused on writing and working with nonprofit education foundations for the past six years.

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Notes:

[1] ^[1] See I.R.S., Form 1023 (Rev. 12-2017), Cat. No. 17133K (Dec. 2017).

[2] ^[2] See I.R.S., Instructions for Form

1023, Cat. No. 17132z (Feb. 03, 2020).

[3] ^[3] South Carolina Secretary of State Public Charities Division, Charities Registration Statement (Dec. 2016); South Carolina Secretary of State Public Charities Division, Annual Application for Registration Exemption (Dec. 2013).

[4] ^[4] See generally, S.C. Code Ann. § 33-31-101 et seq; Rule 407, SCACR.

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