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Q: Can a family-run non-profit obtain 501c3 status? ( Answered,   0 Comments )
Subject: Can a family-run non-profit obtain 501c3 status?
Category: Business and Money
Asked by: mel2005-ga
List Price: $25.00
Posted: 18 Jul 2006 08:16 PDT
Expires: 17 Aug 2006 08:16 PDT
Question ID: 747359
I would like to incorporate a non-profit in New York and apply for
501c3 status. The purpose of the non-profit would be to obtain grants
to commission composers to write chamber music that includes classical
guitar. All the money of the non-profit would go to this purpose, to
commission new chamber works for classical guitar. The 501c3 status is
necessary because foundations such as Meet the Composer and the New
York State Council on the Arts will only deal with 501c3

I have no partners, but New York State requires that a corporation
have at least 3 officers, so my husband and sister have agreed to be
listed as officers.

My question is, would this arrangement make it much more difficult to
obtain 501c3 status? Does the IRS frown on corporations that are made
up of family members when they make their determination? (In reading
through form 1023, they do ask many questions about the relationships
between the principals.)
Subject: Re: Can a family-run non-profit obtain 501c3 status?
Answered By: boquinha-ga on 18 Jul 2006 12:15 PDT
Hello mel2005-ga!

I?ve thought of forming a non-profit organization for a long time now
and will likely be in a similar situation, with family occupying key
positions. Researching this question has been helpful to sort out
issues that may arise when we decide to start our non-profit. One
source that we have in our family library is the book ?How to Form a
Nonprofit Corporation,? by attorney Anthony Mancuso. It is published
by Nolo and can be seen on their website You may
be way past this stage, but it is a valuable resource nonetheless.

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Ultimately, if your organization meets all the requirements otherwise
to be designated a 501(c)(3), you may face a bit more scrutiny when it
comes to finances, but should not be denied nonprofit status.

?Again, it looks best if your board and officers are not related to
your more highly compensated employees or contractors. But in the real
world of small nonprofits, it may be impossible to start your
nonprofit without getting Uncle Bill or Aunt Sally to provide their
expertise by volunteering as an unpaid board member. As long as you
disclose these arrangements and make sure to fairly pay?and not
overpay?anyone, the IRS should conclude that your nonprofit is on the
up-and-up and is entitled to its exemption if it meets all the
substantive requirements.?
(From ?How to Form a Nonprofit Corporation,? by attorney Anthony Mancuso, p. 8/21)

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Section 4958 of the Internal Revenue Code grants the IRS the ability
to penalize organizations that unfairly compensate (grant ?excess
benefits?) employees or other officials (like CEOs, members of the
Board, etc.). Family members are more likely to receive ?excess
benefits? than others, so that is one reason why they ask about family
relationships on Form 1023 when applying to become a 501(c)(3)

?The regulations and guidance deal with Section 4958 of the Internal
Revenue Code?also known as ?intermediate sanctions??which provides
that the IRS can impose a penalty or tax on both an overpaid CEO and
on the individual board members who approved the excessive payment.

Before Congress passed Section 4958, if the IRS was displeased with
the amount of compensation being paid to a nonprofit CEO, it had two
options: It could do nothing, or it could revoke the tax-exempt status
of the organization.

Since the IRS was extremely reluctant to revoke an organization's
tax-exempt status, more often than not it simply did nothing.?

The IRS has essentially aimed to eliminate ?excess benefits? as a way
to unfairly compensate employees or members of a nonprofit board. By
asking about family relationships, it effectively provides a quick way
to ?flag? an entity and closely scrutinize the organization.

?Needless to say, Section 4958 and the regulations do nothing to make
administration of a nonprofit organization any easier. In trying to
catch the bad guys, the IRS is putting the good guys through an
enormous amount of anxiety and trouble. It is to be hoped that the
regulations will prevent real abuses and not simply increase
administrative costs.?

The terminology is really confusing when it comes to ?disqualified
persons? (don?t you just love the IRS!). In Section 4958,
?disqualified persons? are defined as those that could potentially
receive ?excess benefits? from a nonprofit organization. However,
these people are not disqualified from serving on a nonprofit board or
participating in the organization of a 501(c)(3) organization.

?Intermediate Sanctions may be imposed on any disqualified person who
receives an excess benefit from a covered non-profit organization and
on each organization manager who approves an excess benefit. If you
are a disqualified person you are subject to having participated in
excess benefit transaction, if the transaction is so defined.

Being a disqualified person does not automatically result in a finding
that a transaction involves an excess benefit. . . .?

There are a number of people that are considered ?disqualified,?
including family members (spouse, siblings and their spouses,
ancestors, children, grand-children, great grandchildren, and spouses
of children, grandchildren and great grand-children).

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Above all, no nonprofit should have to fear fairly compensating anyone
associated with its activities, including family members. The IRS has
just made it such that 501(c)(3) organizations need to be careful. In
the case of family members, the reality is that there have been enough
cases of impropriety in our country that one needs to be careful.
Congress provides for a ?safe harbor? so that legitimate dealings are
protected from IRS scrutiny.

?Even though a transaction between a nonprofit and a DQ [disqualified
person] may be perfectly legitimate, it always has the potential of
looking ?fishy.? What seemed reasonable to the board at the time of
the transaction may seem unreasonable to the IRS after the fact. This
is especially true of employee compensation. Because of this
uncertainty, the regulations include ?safe harbor? procedures that, if
followed, will create a rebuttable presumption of propriety. It stands
to reason that organizations will prefer to keep to the safe harbor
whenever possible. Alas, the safe harbor provisions are lengthy and

The regulations surrounding safe harbors are so lengthy that this
article has a checklist to guide organizations and their attorneys.

* Disclosure. Make any information about the details of payments
clear, including the relationships of involved parties.
*Recusal. Decision makers should be neutral third parties as much as
possible. In the case of a small nonprofit organization this may not
be feasible.
*Data. Compile comparable data regarding fees and expenses, preferably
from similar organizations or individuals in your immediate area.
*Advance approval. If you have a committee or board that can approve
salaries, benefits, payments, etc. in advance, take advantage of this
*When in doubt, get an opinion. While not a guarantee, hopefully a
professional with experience can help keep you out of trouble.
*Contemporaneous minutes. Keep accurate minutes and approve them in a
timely fashion.

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In the end, as long as each potential director or board member meets
basic eligibility requirements in New York, it should not matter if
they are related or not. Nonprofit status depends more upon the nature
of your organization. You do need to be careful and understand that
the IRS will examine more closely chief parties within a 501(c)(3)
organization if they are family members.

I hope that you find this information useful. It has been good for me
to learn a bit more, too. Good luck with your organization! I?m a big
music lover myself so I sincerely wish you much success! It sounds
like a great idea! If you have any need of further clarification,
please let me know how I can help.


Search strategy:

Online search
Reference books in personal library

Search terms:

red flags IRS non-profit
"family relationship" nonprofit IRS
section 4958 nonprofit
safe harbor nonprofit

Request for Answer Clarification by mel2005-ga on 18 Jul 2006 15:00 PDT
Thanks for the very thorough answer and links. From your research it
looks like we might be fine, as none of us in the corporation would be
receiving any pay. Any payment I'd receive would come from performing
the works after they were completed, but this is a separate matter
having nothing to do with the non-profit. Still, I wonder if it would
be better to try to find 2 non-related partners who are professional
musicians...this isn't a request for clarification, just thinking out

Thanks again for the thorough work.

Clarification of Answer by boquinha-ga on 18 Jul 2006 19:34 PDT
Yeah, from what I've read, it raises less red flags to have unrelated
partners, but if having related partners is the way to get your
non-profit going and you stick to its purposes, you shouldn't have any
problems. I wish you much success! I'm glad you like the answer--that
means a lot to us researchers. Thank you!

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