Beyond providing a place for their members to meet, socialize and entertain, private clubs regularly look for opportunities to make a positive impact in their community. Due to limitations in their operations and the fact that donors are not entitled to charitable contribution deductions, private clubs may struggle with making a significant impact in a direct way. However, by establishing and maintaining an affiliated tax-exempt charity, the private club may identify new ways to address community needs. This article identifies the key points in creating such an organization.
Community impact
Tax-exempt charities can effect positive change in their communities in a variety of ways. Those affiliated with private clubs often do so by making grants or contributions to other local charities, by directly aiding individuals in the community through hardship grants or scholarships, or through a combination of these activities.
A newly formed tax-exempt charity can raise funds through events (e.g., charity golf tournaments) or donation drives. These funds can then be granted to other community-based charities to be used in furtherance of their exempt purposes or held by the affiliated charity to support families affected by sudden illnesses, catastrophic events, natural disasters or other hardships. The affiliated charity could also establish a scholarship program to assist local students in paying for school.
Legal formation
Like private clubs, most tax-exempt charities are nonprofit corporations formed under state law. Legal counsel can assist in drafting the organizing documents, the articles of organization (commonly referred to as Articles of Incorporation) and the bylaws, to ensure that the documents comply with the provisions of state law. To qualify as a tax-exempt charity described in section 501(c)(3) of the Internal Revenue Code, these organizing documents also must contain certain language limiting the organization’s purposes and explaining how the assets will be distributed upon dissolution.
As part of its formation, the nonprofit organization will appoint officers and directors to oversee the operations of the new entity. The criteria for such individuals will be set forth in the organizing documents; however, it is a best practice to select individuals who are independent of the private club.
Application for recognition of exempt status
The IRS must affirmatively recognize the organization as a tax-exempt charity in order for the entity to claim exemption from tax and to receive tax-deductible contributions. The newly formed organization applies for such recognition by completing and submitting the Form 1023, Application for Recognition of Exemption under section 501(c)(3) of the Internal Revenue Code, to the IRS and paying the user fee (which is currently $600). Certain organizations may be entitled to complete Form 1023-EZ, Streamlined Application for Recognition of Exemption under section 501(c)(3) of the Internal Revenue Code, and pay a reduced user fee (which is currently $275).
Provided that the organization submits the application within 27 months of the date of formation under state law, a favorable determination of the IRS generally will be retroactive to the date of formation. The IRS’s current response time on these applications is approximately six months from the date of submission and longer in some circumstances.
Maintaining exempt status
Charities, like private clubs, have an annual Form 990 filing requirement with the IRS. However, the rules for preserving tax-exempt status under section 501(c)(3) (and computing unrelated business income tax) are entirely different from those that apply to private clubs. Of primary importance is the requirement that charities ensure that all of their funds are used exclusively for purposes set forth in section 501(c)(3)—general educational, scientific, artistic and charitable.
Another area in which charities need to exercise caution is in the solicitation of tax-deductible contributions, particularly in the notification provided to donors where the charity provides something of value in exchange. For example, if the organization hosts a charity golf tournament that requires a participant to make a minimum contribution to play, there is likely something of value being received in exchange, whether it is green fees, complimentary food, or other goods or services. The fair market value of these items generally must be disclosed to the participant, resulting in a reduction of the amount of the charitable contribution deduction.
Charities may also be able to leverage state gaming laws to offer raffles or other games of chance to raise funds for their exempt purposes. These activities may result in unrelated business income to the organization but may prove to be an easy way to generate large contributions. For example, participants can purchase golf balls to be dropped from a helicopter onto the green. The player with the golf ball that lands closest to the hole wins the stated prize while the charity retains the proceeds from the various players. Please note that these activities may impose additional reporting (and withholding) requirements on the charity.
Conclusion
Establishing an affiliated tax-exempt charity may be an exciting opportunity for a private club to positively and meaningfully affect its community. Although the rules for establishing and maintaining tax-exempt status may be overwhelming at first blush, specialized tax advisors can assist in formulating a business plan, consulting on operations and preparing returns.
