This post was originally posted on the “State Bar of Wisconsin Business Law Section Blog” and was written by Attorney James M. Ledvina.
Annual legal reviews for nonprofit corporations can help maintain their tax-exempt status. James M. Ledvina outlines the steps to conduct legal reviews for a nonprofit entity, and discusses why they are necessary.
Many attorneys are involved with nonprofit entities, whether they donate to them, sit on their boards, or even create them.
Nonprofit entities are unique business entities at both the state and federal levels and can be fraught with compliance issues that could jeopardize their nonprofit status and inherent liability protection.
Most Nonprofits are Nonstock Corporations
In Wisconsin, most nonprofit entities are nonstock corporations subject to Wis. Stat. chapter 181.
As the name implies, nonstock corporations do not issue shares of stock and do not have shareholders. However, a nonstock corporation can have members who act as de facto shareholders (without any ownership interest) with the ability to elect the corporation’s directors.
Typically, a nonstock corporation’s board of directors controls the entity’s high-level activities and appoint officers to conduct the entity’s daily business, much like a typical business corporation.
A key difference between a nonstock corporation and a business corporation (subject to Wis. Stat. chapter 180) is that a nonstock corporation’s volunteers, directors, and officers are – with some exceptions – immune from liability arising out of their activities associated with the nonstock corporation.
Maintaining Tax-exempt Status Requires the Proper IRS Forms
Another key component of any nonprofit entity is the acquisition of tax-exempt status from the Internal Revenue Service (IRS).
There are many different types of tax-exempt entities, but the most prevalent is a 501(c)(3). Depending on the amount of the entity’s annual gross receipts, amongst other factors, an entity can automatically be tax-exempt, or it must file either Form 1023-EZ or Form 1023 with the IRS to acquire tax-exempt status.
If a nonprofit entity fails to file its tax return with the IRS, fails to file its annual report with the Wisconsin Department of Financial Institutions (WDFI), or fails to maintain corporate formalities, it can lose tax-exempt status, corporate status, and liability protection for its volunteers, officers, and directors.
What to Include in the Annual Review
Accordingly, attorneys representing nonstock nonprofit corporations should have their clients perform the following review on an annual basis:
1) Update Registered Agent and Principal Office
Search the WDFI’s online corporate records and update them accordingly to ensure that the entity’s registered agent and principal office are correct. For small nonprofit organizations with high turnover of officers and directors, this becomes especially important, to ensure that the proper person is receiving notifications from the state in a timely fashion.
2) File WDFI Annual Report
The WDFI will send an entity’s registered agent a postcard on an annual basis reminding the registered agent to file the entity’s annual report. If the registered agent fails to file the entity’s annual report timely, the WDFI may administratively dissolve the entity, which negates the entity’s corporate existence and liability protection under chapter 181.
3) File WDFI Charitable Organization Report
Subject to several exceptions, if a nonprofit entity solicits donations from the public, the entity must register as a charitable organization with the WDFI, and also file a separate charitable organization report with the WDFI on an annual basis.
4) Check Sales and Use Tax Exemption Status
Under Wisconsin law, certain nonprofit entities are exempt from paying sales and use tax on its purchases. However, it must acquire a Certificate of Exempt Status from the Wisconsin Department of Revenue (WDOR), and must submit Form S-211 to its vendors to prove that its purchases are exempt from sales and use tax.
5) Review Sales Tax Collection and Remittance Compliance
Despite being exempt from paying sales and use tax on its purchases, the WDOR requires some nonprofit entities to collect and remit sales tax to the WDOR for its sale of certain items and services. A nonprofit entity should review its sales on an annual basis to ensure that it is compliant with the WDOR’s rules regarding the collection and remittance of sales tax. This is especially important, as the WDOR has the ability to pierce a corporation’s corporate veil and collect the taxes, penalties, and interest from whomever the WDOR deems was responsible for collecting and remitting such taxes to the WDOR.
6) File Federal Tax Return and Ensure Federal Tax Exempt Status
By May 15 of each year, an officer should file the nonprofit entity’s tax return with the IRS, which – depending on the gross receipts of the entity, amongst other factors – will be on Form 990-N, 990-EZ, 990-PF or 990. If an entity fails to file its tax return for three consecutive years, the IRS will automatically revoke the entities’ tax-exempt status. On an annual basis, an officer should search the entity’s name on the IRS’s online Tax Exempt Organization Search to ensure that it is still tax exempt, and that it can receive tax-deductible donations. If a nonprofit entity loses its tax-exempt status because it failed to file its tax returns, the entity can retroactively regain its tax-exempt status by resubmitting Form 1023 or 1023-EZ to the IRS.
7) Corporate Governance
The entity should memorialize its corporate activities, including the election of its board of directors and officers, in written resolutions in its corporate record book.
Avoid Costly Errors Through an Annual Review
With the transition of officers and directors and the complexity of the reporting requirements, it is easy for an entity to overlook a component of its legal compliance. An entity can correct these errors, but it is time consuming and costly to do so. Accordingly, it is important to be vigilant to remain compliant with all of laws applicable to a nonprofit entity.