Rule 1

 

Most people have a pretty good idea what charity means in everyday conversation, but laws don’t always follow the popular definitions. To enjoy the benefits of operating a nonprofit charitable organization the organization's purposes must meet the requirements of both state and federal laws.

 

FEDERAL DEFINITION:

 

The IRS defines what qualifies for tax exempt status as a charity under Section 501(c)(3) of the IRS Code.  Under Section 501(c)(3), an organization may qualify for exemption from federal income tax if it is organized and operated exclusively for one or more of the following purposes:

Charitable

Religious

Educational

Scientific

Literary

Testing for public safety

Fostering national or international amateur sports competition

The prevention of cruelty to children or animals.

 

 

A charity's organizing document must limit the organization's purposes to one or more of the exempt purposes listed above, and it is prohibited from any substantial activities that fail to carry out that charitable mission. The creating document for the organization must limit the activities by reference to section 501(c)(3) of the IRS Code. In addition, assets of the organization must be permanently dedicated to the exempt purpose for which the charity was created.  If the organization dissolves, its assets must be distributed for an exempt purpose described in section 501(c)(3), or to the federal, state or local government for a public purpose.  To establish that an organization's assets will be permanently dedicated to an exempt purpose, the creating document for the organization must contain a provision insuring their distribution for an exempt purpose in the event of dissolution. 

For more detail go to the "Charities & Non-Profits" section of the IRS website or go to the IRS article on "Exemption Requirements." 

 

STATE OF MICHIGAN DEFINITION

 

Michigan law defines a charitable organization in the Charitable Organizations and Solicitations Act (COSA), the law that requires most charities to apply for a charitable solicitation license before soliciting or receiving contributions in Michigan.  COSA defines a charity as:  “a benevolent, educational, philanthropic, humane, patriotic, or eleemosynary organization of persons which solicits or obtains contributions solicited from the public for charitable purposes.”

You may want to read the entire definition in Section 2 COSA. 

 

MYTH:  Many people think that all nonprofit organizations are charities; or that a charity is any group of people doing some kind or good act.

 

FACT:  A charity must fit the definitions of charity contained in federal and Michigan law.  If your purpose is to help some particular individual or family, or small group of named people, then it’s not a charitable purpose.  Helping a person get money for a lung transplant, or chemotherapy, or helping a family rebuild after a fire, are all wonderful and kind, even charitable, things to do, but under federal and state law, they are very likely not charitable projects.  Under the law, a charity must provide a public benefit.  It may be a portion of the public, such as those suffering from a disease or those that need housing, but it must not be for named individuals.

 

Rule 2

 

To be considered charitable under federal and state law, an organization must provide some public benefit or service.  The kind acts or services must not be directed at some named individual, family or small group. The legal terminology is that there has to be "indefinite, uncertain beneficiaries." 

 

EXAMPLE: A fund set up to assist a particular family whose home has burned is not a charity, but an organization established to assist families who have financial difficulties or tragedies may qualify as a charity. 

 

EXAMPLE: An organization to collect funds to help a certain cancer patient pay for chemotherapy is not a charity, but an organization established to help needy cancer patients who apply for assistance would qualify as a charity.

 

EXAMPLE: A foundation established to assist a school or a certain group of people will probably qualify as a charity, so long as the particular people (beneficiaries) cannot be specifically named.  Those benefitting may be any or all students attending the school, or it may be anyone who fits a certain set of criteria such as anyone who has been the victim of a crime in a particular city.

 

 

Rule 3

 

An organization is not a charity unless the assets and all resources of the organization are dedicated to carrying out the chosen charitable purpose.  Before the IRS will recognize and organization as tax exempt status under section 501(c)(3) of the IRS Code, they will require language in the creating documents of the organization ensuring that the organization will be operated under guidelines required for tax exempt charitable organizations. Below is the kind of language the IRS will require. While the exact words may vary slightly, the ideas expressed must be included in the creating documents.

 

For more information on required language, go to the IRS website, Life Cycle of a Public Charity.

 

DEDICATION OF ASSETS TO THE CHARITABLE PURPOSE:

The organization is formed exclusively for charitable, religious, educational, and scientific purposes, including, for such purposes, the making of distributions to organizations that qualify as exempt organizations under section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code.

 

 No part of the net earnings of the corporation shall inure to the benefit of, or be distributable to its members, trustees, officers, or other private persons, except that the corporation shall be authorized and empowered to pay reasonable compensation for services rendered and to make payments and distributions in furtherance of the purposes of the organization. No substantial part of the activities of the corporation shall be the carrying on of propaganda, or otherwise attempting to influence legislation, and the corporation shall not participate in, or intervene in (including the publishing or distribution of statements) any political campaign on behalf of or in opposition to any candidate for public office. Notwithstanding any other provision of these articles, the corporation shall not carry on any other activities not permitted to be carried on (a) by a corporation exempt from federal income tax under section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code, or (b) by a corporation, contributions to which are deductible under section 170(c)(2) of the Internal Revenue Code, or the corresponding section of any future federal tax code.
 
 DISSOLUTION CLAUSE
Upon the dissolution of the corporation, assets shall be distributed for one or more exempt purposes within the meaning of section 501(c)(3) of the Internal Revenue Code, or the corresponding section of any future federal tax code, or shall be distributed to the federal government, or to a state or local government, for a public purpose. Any assets not so disposed of shall be disposed of by a court having jurisdiction over the corporation exclusively for such purposes or to such organization or organizations, as the court shall determine, which are organized and operated exclusively for such purposes.

 

 

Rule 4

 

The board of directors has responsibility for all operations of the organization.  The only exception to this rule is for organizations that have chosen to form as a membership corporation under the Michigan Nonprofit Corporation Act. In those instances the entire membership will have the right vote and make decisions about the operation of the organization. Ecclesiastical corporations formed under the General Corporation Act are membership corporations.

 

The board, whether in a membership corporation or a directorship, must carry out the business of the charity faithfully.  They must make business and financial decisions as responsibly as if they were carrying out their own personal business. They must be loyal to the organization when acting in their capacity as a director.  For example, a member of the board must not use information they obtain through their position as charity director to benefit their own interests. For more information on the duty of care and loyalty, go to the section of this website dealing with conflict of interest.

 

 

Rule 5

 

After the nonprofit charitable purpose organization is formed and a board of directors is chosen, the organization probably wants to apply for tax exempt status. The organization must apply to the IRS using Form 1023 for recognition as a  before an organization can call itself tax exempt.  There are two exceptions to this rule:  1. Churches, associations of churches and integrated auxiliaries of churches such as religious schools, mission societies and youth groups are exempt from applying for tax exempt status. For more information on the criteria, visit the IRS website and refer to Publication 1828 or Publication 557; 2. Very small public charities (not private foundations) that will normally have annual gross receipts of not more than $5,000.  

 

For more information go to the Tax Exempt Status section of the Forming A Charity page.