March 23, 2009

501(c)(3) vs. 501 (c)(7) Non-profit Status

Note - I am neither a tax or legal expert or professional. Please consult with the appropiate, licensed professional before you make any changes to your organization structure!

At the end of 2007, my sorority was officially incorporated. In years past (maybe 15-20 years ago) you could put off incorporation if you only had one, maybe two chapters. Of course nowadays, that is difficult to do and not recommended. The threat of litigation and the feeling of being limited from an operational standpoint are not things that should be pressing issues to young organizations.

Like many new groups, we opted to use an incorporation service. We decided to do some research on our own first, but overall, the process was pretty painless (and not too expensive). Now incorporation is at the state level. When our corporate certificate was issued, we were filed as a non-profit. However since the state we incorporated in has no income tax, our attention was then placed towards obtaining non-profit status with the IRS (so on a federal level). This is where it got interesting.

An attorney friend of mine let me have a handbook entitled "How To Form a Nonprofit Corporation". I found it very interesting, but it was quite clear that the book only addressed the formation of a 501(c)(3) organization. Ok, that is a commonly used term, so no big surprise there. But there was a surprise; because, the definition of a 501(c)(3) is:

The exempt purposes set forth in section 501(c)(3) are charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. The term charitable is used in its generally accepted legal sense and includes relief of the poor, the distressed, or the underprivileged; advancement of religion; advancement of education or science; erecting or maintaining public buildings, monuments, or works; lessening the burdens of government; lessening neighborhood tensions; eliminating prejudice and discrimination; defending human and civil rights secured by law; and combating community deterioration and juvenile delinquency.

(The bolded part is my emphasis)

We were working with a legal office on the IRS application for 501 non-profit status. However the more I read in this book, the more I started to question if we would be approved for 501(c)(3) status. After an overview of our financial and activity records, they agreed that the sorority would be more suited for 501(c)(7) status, which is:

"[c]lubs organized for pleasure, recreation, and other nonprofitable purposes, substantially all of the activities of which are for such purposes and no part of the net earnings of which inures to the benefit of any private shareholder."

They key here is the distribution of revenue. If we had a budget where the majority of our funding could be funneled into "eliminating prejudice and discrimination", the 501(c)(3) status would be more suiting. However this is not currently the case with our current budget, and may not ever be.

What many older greek organizations have done are establish foundations which are 501(c)(3); probably because the bulk of any income coming into these foundations is then distributed out for the "charitable cause" of helping the sorority, providing scholarships, etc. I found this page online regarding an interesting question regarding the practice of having a 501(c)(3) pass money along to a 501(c)(7). I have also seen some organizations who are 501(c)(3) themselves. The details and specifics as to how they accomplished that I can't really fathom. I am definitely not saying that these organizations have done something improper. I simply do not have that great an understanding of the tax code to say anything one way or the other. If anyone out there is a member of such an organization and privy as to how this works, please feel free to comment. :-)

I must admit I have been pretty surprised regarding the common misconception that non-profit automatically equals 501(c)(3). Even in the office of the company we are working with, I've had administrative staff refer to my application as a 501(c)(3) application even after the determination that we would not be trying for that. Sorors in my sorority also question the designation. It seems to be a let down that donations and dues to the sorority will not be tax deductible. However since our dues in are less than $500 annually, they alone probably would be less than most of our sorors' standard deductible (unless they also have other significant charitible contributions).

I am also finding out that the 501(c)(7) status is not totally question-free for fraternities and sororities either though. In Rev. Rul. 66-360, 1966-2, it was determined that a sorority was not eligible for 501(c)(7) status! It seems that in this case, the IRS determined that the main function of the chapters was to fund the national headquarters of the sorority; whereas the point of a 501(c)(7) is to be organized for the exclusive purpose of fraternal bonding. Talk about a gray area! The only faux paus I can see this group could have committed is not allocating all of the costs out towards operations or for the public good. However it does bring into question programs administered by the national headquarters that will relay some cost benefit to the members; such as corporate discount programs and group rates. This is because dues paying members are "shareholders" and technically no shareholders are to take part in an fianancial gains (it's hard to say if "discounts" can be seen as fianancial gains).

In any case, no revenue generated by any kind of non-profit is taxable. Yet it is always advisable to file a tax return, even if your revenues are under $25,000.

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