Not-for-profit organizations (“NFPs”) may not realize that operating outside their home state may create regulatory and tax compliance responsibilities. States have a vested interest in making sure that NFPs are operating for their intended charitable purposes, and are not fraudulently soliciting its residents for donations.
Of course, states are also interested in making sure that NFPs are paying any and all taxes and fees that are properly due. NFPs should consider the following factors before beginning business activity within a state.
As information becomes more readily available to the general public, it also becomes more important for NFPs to be compliant with state and local laws and regulations. Potential donors will be looking to ensure that the NFP is in compliance with state laws, and not acting as a fraudulent enterprise. In an effort to increase revenue, and protect their residents, state officials are likely to review any and all publicly available information about a NFP. Further, the IRS and many states are sharing information about NFPs, increasing the likelihood that the NFP will be subject to some scrutiny.
Solicitation and annual compliance requirements
A solicitation is defined as any request for a contribution through any medium, i.e., asking for a gift, or selling goods or services. If the NFP is soliciting or conducting business in a state, it may need to register with one or more offices within that state. States define “conducting business” in a number of ways, often including solicitation, having property or employees in the state, or selling goods or services in the state. The NFP also may need to renew its status annually.
As part of their registration requirements to solicit donations, states may require specific disclosures on the NFP’s solicitations, written acknowledgments, receipts, or advertisements. Most state disclosures let the donor know where to find financial and registration information about the organization.
It is important, once an organization registers with the state, that it maintain its annual compliance. Many states are issuing severe penalties for noncompliance, and are also reluctant to provide any relief from such penalties.
Sales and use tax
Tax-exempt organizations must comply with each state’s sales and use tax rules. The analysis to determine whether an organization has sales tax “nexus” is the same as it is for a commercial business entity—namely, does the NFP have any physical presence in the state? In general, NFPs may make purchases that relate to their charitable purpose exempt from sales tax, but may still be required to collect and remit sales tax for taxable sales, such as T-shirts or souvenirs from a gift shop. The ability to make tax-free purchases may require the NFP to request and receive some form of exemption from the state taxing authority prior to making such purchases.
Many NFPs have income, or are considering generating income from activities unrelated to their exempt purpose—unrelated business taxable income (“UBTI”). Such UBTI may create state income tax compliance issues, because states generally conform to the federal income tax definition of UBTI, and impose some form of income tax on UBTI earned in the state.
If the organization is not otherwise doing business in the state by soliciting contributions, then it should analyze whether it has income/franchise tax nexus in the state from the activities giving rise to UBTI, (it is possible to have income tax nexus without having sales tax nexus). If an organization is already registered with the state to solicit contributions, then it likely owes income tax on its UBTI attributable to that state. On the other hand, NFPs may have unrelated business losses, so it may be beneficial to file in a particular state to preserve a net operating loss. Some states impose corporate income tax on all NFPs as a general rule unless the NFP actively applies for an exemption.
ConclusionStates are increasingly looking for more revenue, and to protect their residents from fraudulent organizations by stepping up their regulation of NFPs. Preventive action is crucial when reviewing multistate activities and related compliance requirements. NFPs should consult with their CPA and legal counsel to determine their filing and tax compliance requirements when they enter into a new state.
Seek the services of a legal or tax adviser before implementing any ideas contained in this blog.