Is the non-profit structure abused for tax reasons?

There are times when a group of people may want to start a business, not for profit but for providing a public good or service. In that case the group may register a nonprofit organization. It can be registered as a corporation, trust, limited liability company, or unincorporated association. Even when it makes profits, none are distributed to the members, but they are ploughed back to fund the mission of the organization. That is why a nonprofit is generally eligible for 501c3 status (non-taxable) if it was formed for any of the following purposes: religious, charitable, literacy, education, prevention of cruelty to children or animals, promoting national (or international) amateur sports competition, and testing for public safety.

There are over a 1.56 million nonprofits in the US, including public charities private foundations, chambers of commerce, fraternal organizations, civic leagues, churches and other types. They are an important part of the US economy, employing about 25% of the workers in the US. They don’t pay tax and, if they are eligible, their donors can reduce their income tax by up to 40% of the donated amount. Religious organizations don’t even need to file applications for tax exempt status because they are automatically recognized as being exempt. That nonprofits don’t pay taxes has opened them up for abuse.

Ways in which the nonprofit structure is abused

U.S. tax authorities have spotted quite a lot of methods and schemes used to abuse charities to facilitate tax crime, money laundering and tax evasion. The most commonly detected ones are discussed below.

1. a) Some nonprofits pose as registered charitable organizations to perpetrate tax fraud.
2. b) Some of them knowingly engage in tax evasion schemes for the personal benefit of their organizers or directors.
3. c) Others engage in tax evasion schemes to benefit themselves and the donors with or without an intermediary.
4. d) A charity can be abused innocently by a taxpayer or a corrupt tax return preparer who prepares and presents false charitable receipts.
5. e) Tax sheltered donations can go to universities, private hospitals and other institutions that tend to the needs and prerogatives of the rich and privileged donors. This amounts to tax evasion.

f). Salaried employees are sometimes hidden as volunteer workers.

g). Receipts can be issued to individuals working for beneficiary organizations.

h). Criminals can use names of legitimate organizations to collect money.

i). Charities can be used to raise money or transfer money to support terrorist organizations.

j). Charities can misuse charity funds, e.g. charge exorbitant interest on student loans.

k). The value of donated assets can be manipulated.

These are some of the abuses that people who wish to register a nonprofit for a genuine mission should watch out for in their risk management strategies. They should also be aware that the economy is tough right now and it is becoming more difficult to get donations from the public or grants from government. Therefore, their planned nonprofit has to rely more on earned income. This is will make their mission ambiguous, and there will be pressure on the board to ensure that dilution of their charitable mission doesn’t occur.

The implication here is that anyone who wishes to start a nonprofit should pursue commercial ventures after deep soul searching that respects their stakeholders’ interests. They should also be aware that certain actions and business methods that are acceptable for profit-making businesses may be seriously unsuitable for nonprofits to practice. Those actions and methods will be noticed by the public and the tax authorities, and this may lead to loss of the tax-exempt status. As startup guru Henri Benezra said on a startup forum: “A nonprofit is not meant to overshadow your entire portfolio. It is not meant to reduce your legitimate tax obligations. It is simply used to carry out genuine philanthropic causes alongside your main business”.

Help to register a nonprofit

Anyone who wishes to register a nonprofit can either do it themselves or get help from professionals like those at TRUic. They have a comprehensive guide with all the information required to start a nonprofit and make it successful.  Read more…