Dear Nonprofiteer, Does an alumni association chapter have to file tax returns?

Dear Nonprofiteer,

I am the president of my local alumni chapter for a large university located in another state. The National Alumni Association is a 501(c)(3) organization with by-laws that state it can create various chapters around the country.   When our local chapter was created, the founding president filed the paperwork for an EIN so we could open a checking account. That is all he did; we are not incorporated as a 501-anything.   When he filled out the EIN paperwork, for “type of entity,” he clicked the “other” box and wrote “social club” in the blank. Our little chapter brings in less than $10,000 per year. We then funnel most of that back to the university’s scholarship fund.

My question is: are we supposed to be paying federal income taxes? State of Illinois income taxes?

My university is being remarkably unhelpful.   They did definitively say that they strongly advise their chapters against incorporating as their own 501(c)(3).

I have done some research and seen that other universities structure their alumni associations so that the national association is a 501(c)(3) and the local chapters are 501(c)(4)s. The local chapters then file what is called a “IRS-990 postcard.” This seems a reasonable solution, but it also requires that my chapter incorporate as a 501(c)(4), and I am hesitant to do that without official word from my university. I have a fellow board member who is breathing down my neck, convinced we are breaking all kinds of laws.  What should I do?

Signed, Clueless in Chicago

Dear Clueless:

The Nonprofiteer knows even less about tax law than you do, so she turned to her Association of Consultants to Nonprofits colleague Kathryn Vanden Berk, whose nonprofit law practice makes the Internal Revenue Code her constant companion.  Kathryn characterized your question as “easy but in multiple parts,” and her answer appears below.  Many thanks to her for her guidance, and for demonstrating that the author of Good Counsel isn’t the only nonprofit lawyer the Nonprofiteer knows!

There are four ways to handle this.  (1) ask the national association to take you on as a fiscal agent, (2) ask the national to file as a group exemption so that each chapter may get its exemption from the central organization of the group; (3) incorporate and go through the exemption application; and (4) do nothing.

Of these, the easiest is to be sponsored by the national (or any other already-existing) 501(c)(3).  The exempt entity confers the local chapter with its exempt status automatically and no paperwork needs to be filed.  However, the fiscal agent must report to the IRS on what happens within the local chapter.

The easiest for the locals, but harder for the national, is for the national to seek a group exemption.  It can then manage each of the local chapters as subsidiaries.  As above, the national is responsible for reporting to the IRS.

If the local decides to incorporate and seek its own exemption, it should identify its purpose as “educational and charitable”.  Generally, a scholarship organization must file a Schedule H with its exemption application, but it appears that this local forwards its funds to the national, and the national makes the selection.  In that case, it is not necessary for the local to go through the scholarship preparation.

An organization that identifies itself as a “social club” is exempt under 501(c)(6) of the Code.  However, I would not suggest that in this case.  The money collected is used for scholarships, and that is clearly a charitable purpose.  Since the national was able to get a 501(c)(3) ruling, it would be foolish for the locals to seek a different, less valuable exemption.  If the IRS balks at the (c)(3) classification, I would suggest that the national seek a group exemption.

Doing nothing is maybe not a crazy approach, but it risks exposure and the protections of the IRS Code and IL law are not available to the chapter leadership and members.  The reason I say it’s not crazy is the small amount of $$ that flows through the organization.  No one is going to come after them unless (and this is the big risk) something happens.  Then I can predict that there will be a great deal of embarrassment and perhaps even personal liability.

Bottom line: if you have not filed for a tax exemption, you must file as if you are a for-profit business, using Form 1120.  If you give your funds to the national at year’s end, then it is unlikely you will have to pay taxes.  However, your members cannot take deductions for the gifts they make to the local, even if they go to the national’s scholarship fund.  Same with Illinois: if the chapter is not tax exempt, then it is taxable and must file as such.

I should note that if you collect charitable funds in Illinois, you really need to be registered with the IL Attorney General, even if you are not exempt via the IRS.  The AG’s office is very strict about this.  You will have to pay a late filing penalty because you have been soliciting without being registered.  You might be exempt if you can convince the AG that $$ was raised only from members, but they are not as flexible on this as they once were.

I don’t know why the university advises against incorporation.  It’s a fairly inexpensive thing to do, and it gives liability protection to every member.  It’s a small price to pay for the protection it gives.  You need to have someone agree to be your Registered Agent, and to have his/her office or residence registered as the Registered Office.  You need to file annual reports (in Illinois and most states) to stay in good standing.  In Illinois, this costs $10.00 per year.

I don’t know why the (c)(3) and (c)(4) approach is used.  You would want every part of the organization to be classified as 501(c)(3) so that all gifts, grants and contributions are tax exempt and deductible to the donor.  I’d want to explore this further before acting.

So, Clueless, the answer is that no good deed goes unpunished.  Having investigated the question, you’ve now unearthed a series of obligations, decisions and tasks which I’m sure you’d rather not have known about.  You’re not about to go to jail but to protect yourselves it seems that getting your university to agree to serve as your fiscal agent, and then registering to raise funds in the state of Illinois, is the bare minimum you should do.

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One Response to “Dear Nonprofiteer, Does an alumni association chapter have to file tax returns?”

  1. Form 1023 Help Says:

    Nonprofiteer – Kudos to Kathryn Vanden Berk for an excellent response.

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