From the Blog

Protecting Charities, Masjids, or Other Non-Profits

One of the favorite parts of my job as an attorney is helping non-profit organizations and masjids with their work in the American Muslim community.

Most of these groups are formed as 501(c)(3)s, named after the section of the tax code that gives tax-exempt status. In addition to the organization itself being tax-exempt, donations to these groups are tax deductible to the donor. I always receive questions from these groups about the legal restrictions they face in exchange for this tax-exempt status. One of the most common inquiries is into the type of activities that they can engage in to raise money.

501(c)(3)s are actually not restricted in the ways they can raise money. Charities and other groups can engage in activities that make a "profit," meaning generate income for the group. Examples of this could be selling advertisements in a newsletter, holding a bake sale, or leasing a building the group owns. But regardless of where the income of a nonprofit comes from, it has to be used for the purposes stated in the group’s formation documents, whether it is religious, educational, or charitable. Also, none of the profit can ordinarily go to any individual, except as a reasonable salary properly approved by the leaders of the non-profit.

The fact that a non-profit group can engage in business activities does not necessarily mean that they should do so directly. If the business activity is easily segregable from the nonprofit activities, like leasing out a building or running a book or grocery store,the business should probably be held by a separate organization. The other organization could be a for-profit corporation which the nonprofit owns stock in, a foundation, a trust, or another charity. This separate organization, which holds the business asset, is called a subsidiary.

Structuring the business activities this way could ensure that the non-profit is able to use the income from the business for its religious, educational, or charitable purposes and also protect the organization from any liability generated by the business interest. For example, if a non-profit leases out part of a business it owns directly and someone sues them, whether for breaking a lease or from any accident in the building, the rest of the non-profits assets will be at risk. Properly forming a subsidiary to hold the real estate or other business asset will generally limit the potential liability only to the assets held by the subsidiary and protect the other property of the non-profit.

In order to obtain this protection, however, the non-profit must make sure that it adheres to all corporate formalities. These formalities must be respected in terms of the non-profit and the subsidiary. Both groups must have filed all proper documents with the state and federal authorities. They must also have separate management, hopefully with some managers not in common. The managers must meet regularly and properly authorize the activities of the group, including any monetary transfers from the subsidiary to the parent non-profit. Making sure that all these rules are followed is also important to the managers and leaders of a non-profit, because it can protect them from personal liability.

This is only a brief description of some of the steps that charities, masjids, and other non-profits can engage in to protect their assets and ensure that they are able to carry out their mission. This article is not intended to be legal advice and does not create any sort of attorney-client relationship. Any non-profit, other group, or individual is encouraged to contact a licensed attorney for more information or advice regarding the content of this article.

Todd Gallinger is an attorney who often works with charities, masjids, and other non-profit groups. He has offices based in Irvine and can be reached at (949) 341-0207.