Collaborative nonprofit projects are on the rise, such as through new joint venture opportunities, partnering with social enterprises, and even strategically engaging with business to further mutual interests. But Section 501(c)(3) organizations may not simply give their money or other assets without restrictions. After all, their resources are charitable: they held in trust for the “public” benefit and subject to high levels of legal accountability. So, what questions should these nonprofits ask themselves before engaging in these ventures?
In 1968, the IRS issued a brief but key ruling (Rev. Rul. 68-489), stating that 501(c)(3) organizations will not jeopardize their exempt status if they follow four rules when distributing funds to nonexempt entities. These rules specifically help public charities engaging in activities with nonexempt entities, as well as more broadly as they seek to use their funds safely, effectively, and with accountability.
What’s the Purpose?
Just as 501(c)(3) organizations must operate their programs for tax-exempt purposes, they must also ensure that the funds or other assets they distribute are likewise used exclusively for such tax-exempt purposes (i.e., charitable, religious, and/or educational). Essentially, they must make sure that their charitable funds further their purposes, whether the funds are used for their own programming or are distributed to other entities or individuals. This includes ensuring that the funds are not used for activities that are prohibited or restricted under Section 501(c)(3). For example, charities must limit distributions to prevent the recipient from engaging in political campaign activity or a substantial amount of lobbying. Charities must also make sure that the funds do not result in more than an incidental amount of private benefit to individuals or privately-owned business (other than fair compensation paid on a quid pro quo basis for goods or services rendered) .
Are We Funding on a Project-by-Project Basis?
When a public charity decides to distribute funds to another entity, it must do so on a project-by-project basis. For example, if a US organization wanted to grant funds to an organization overseas, the funds should not simply be distributed to further educational purposes. Rather, the funds should be provided for a specific project, such as building a school, books and uniforms, or funding tuition for a specific amount of students. Defining the scope and scale on a project-by-project basis best enables the charity to ensure that the funds are used to further exempt purposes.
Are We Retaining Control and Discretion?
An exempt organization’s responsibility does not end when the funds exchange hands; instead, the charity must continue to monitor the use of its funds. For example, a best practices approach would be to execute a written joint agreement requiring regular reporting from the business, international organization, or individual about how funds are used and establishing a right to repayment of the funds if they are not used for their exempt purposes. In addition, once the project is started and funds are received, any modifications to the use of the funds should require approval by the charity. .
Are We Maintaining Sufficient Records from the Nonexempt Organization?
Charities must maintain financial records and related documentation demonstrating that the funds were used to further their exempt purpose. This is important for not only an IRS audit or state regulator investigation, but for donors, directors, and other stakeholders with an interest in accountability. Commonly, the charity will require the nonexempt organization to provide a report once the project is completed that accounts how the funds were used. A charity might also send a director or staff member to visit the nonexempt organization and prepare a report on how the funds are being used. Photos or other supporting documentation also help the charity memorialize how the funds benefited a specific project.
