by Doug Bechtel

President
The Actors Theater of Orcas Island

About the Author

Doug has been CEO of non profit cooperative corporations for 25 years and has served on dozens of non profit boards. He is currently President of The Actors Theater of Orcas Island, which was founded in 1999. He is also a founder and current Secretary of The Orcas Island Community Foundation, and has recently served on the following non profit boards: The Orcas Island Medical Center Association, The Orcas Island Sportsmans Club, the Kiwanis Club and the Chamber of Commerce. Active in the theater since 1996, Doug has been producer, director, actor, techie and anything anyone would let him do.

In its simplest form, a non profit organization is a state of mind - an intention - to do public good. On the other hand, a for profit company (whether or not it makes a profit) is in business to make money for its owners (or stockholders) and has a fiduciary or legal responsibility to do so.

There are a lot of facets to being non profit. Remember that being non profit is not the same as not making a profit. A lot of companies do not make a profit but that does not make them non profit. Making a profit (called "margins" in non profit parlance) does not make you a "for profit" company either - you can make margins and still be non profit.

The IRS is even more specific about where margins of non profits can be spent by requiring that no profit may go to the benefit of the non profit organizations members. Any profit must be used to further the charitable purposes of the organization.

The IRS and Community Theaters

There are dozens of types of non profit organizations recognized by the IRS. Section 501© of the IRS Code lists almost two dozen types of organizations which may be exempt from federal income taxes. One of these classifications is of interest to us: Section 501(c)(3), which refers to organizations formed exclusively to accomplish "religious, charitable, scientific, literary or educational" purposes. Community theaters fall into this classification.

In making a determination as to whether your organization falls under Section 501(c)(3) the IRS is going to look at many things. Luckily there is some generic boilerplate language that helps, and we will get to that in a minute.

Lets look at some of the issues that the IRS will consider in making the determination:

• Non profit organizations can pay employees, but the IRS is going to look closely at your organization if an officer or other board member is highly compensated as a percentage of the gross income. For example, if your organization has an income of $30,000 and pays the President of the Board $20,000, it is going to look questionable.
  
  
• The IRS will also look at the source of the income for your organization. In this case, the IRS is looking at how much public support you have. If most of the income is from ticket sales to the public, the IRS will have no problem. You can expect the IRS to look closely at anyone who makes donations amounting to 5% or more of the annual income who is also an officer, an employee, or is on the Board of Directors.
  
  
• The IRS has a list of forbidden activities. If you do any of them, regardless of any other consideration, you will not be considered non profit. Examples are donations to political candidates, influencing legislation, or "propaganda" (their words, not mine).
  
  
• The IRS wants to see a track record. They want to see actual financial statements for a period of operation. If you have not been in operation long enough, you can apply for a prospective determination. The IRS will then grant you a temporary 501(c)(3) status (usually for three years), and at the end of that period they will send you a form asking for financial information on the three year period. If you have operated in a non profit manner, you will get your permanent determination.

Given this IRS scrutiny, why be a non profit?

The first and best known reason is that non profit organizations can be exempted from paying Federal Income Tax, but there are many other benefits that may vary by state. Non profits can receive reduced postal rates. In some states non profits are exempted from certain sales and property taxes. Most states take the IRS 501(c)(3) finding as proof of non profit status.

Many grants are available only to organizations with a 501(c)(3) status. Some significant donors will only donate to 501(c)(3) organizations to insure that their donation will go to the public good and to eliminate any potential problems with deductibility on their tax return.

Performances or copies of certain specific material made by nonprofit entities may be exempt from federal copyright regulation. This is a very narrow exemption so talk to someone who knows about this before you try it!

While there are many types of non profit organizations recognized by the IRS, only organizations which receive 501(c)(3) status may receive donations for which the donors are allowed to deduct the donation from their income when filing their federal income tax return.

Here are a couple of important issues to remember about tax deductible donations.

• A person making a donation may receive a deduction on their income tax PROVIDED they did not receive any benefit from the donation. Someone who makes a $20 donation to their favorite community theater and receives two $10 tickets to a performance in return is not allowed to deduct the $20 donation. Someone who pays $50 for a fund raising dinner worth about $15 can only deduct $35 from their taxes. Most organizations give you a special receipt meeting IRS rules that clearly states the value of goods and services you received in return for your donation.
  
  
• If you charge $1,000 for that $15 dollar dinner, the entire $1,000 might be deductible because the $15 is not considered significant in terms of the donation.

As a taxpayer, you can also receive a tax deduction if you make a charitable donation to an organization which does not have its 501(c)(3) classification from the IRS. If an organization has its 501(c)(3) classification from the IRS, you, as a donor, may rely on that classification and deduct your donation from your income on your tax return.

Even if the organization does not have a 501(c)(3) approval, you may deduct your donation provided YOU (the donor) can show that your donation was expended for a purpose which is permitted under Section 501(c)(3). Remember, it is up to you to show how your money was spent by the organization. Suppose your favorite organization does many things, some of which are permitted under 501(c)(3) (like theatrical productions) and some things that are not permitted (like making campaign contributions). If you make a $50 donation to this organization and they put it in their usual bank account, you have no way to prove how your money was spent. On the other hand, if you directly pay the royalties for a production of a play that you have no financial benefit from, your expenditure is most likely tax deductible.

How do we get this 501(c)(3) status?

In order to receive your 501(c)(3) status, a non profit must be a formal organization - it can not be an individual or a casual group of people. For most of us, this means a non profit corporation.

There are many advantages to the corporation form for your organization. A corporation is treated like a person. It can own property, it can sign contracts, it can have bank accounts and can hire employees. On the down side, it can be sued and it can go bankrupt. One of the most important properties of a corporation is what is called the "corporate veil". The corporate veil protects the officers and employees of the corporation from actions of the corporation. For example, if someone sues the corporation or if the corporation has financial problems and can't pay its bills, the officers are not personally at risk. Most states have statues that protect the directors of non profit corporations for decisions they make on behalf of the corporation as long as they were made in good faith. This leads into a discussion of "due diligence", "negligence" and "gross negligence" which are outside the scope of this article. In general, as a director you have a responsibility to make decisions to further the health and purpose of the Corporation. You are expected to use the same degree of care that you would use making major decisions in your personal life.

Each state has different rules on non profit corporations. Most states specify the minimum number of directors for the corporation. Usually, a phone call to your Secretary of State will yield more information on forming a non profit corporation that you ever thought you wanted (or needed) to know.

How do we incorporate?

The first step to incorporating is to determine what the goal of your groups is. It needs to be specific and concise. A key question is: Who is going to benefit from the existence of your organization and how they will benefit? Your organization must benefit the public. This is usually accomplished through a "Mission Statement," which is a short paragraph that briefly describes what is unique about the organization. It should contain the major characteristics that define its operations.

There are two different documents you will need to prepare. First is your Articles of Incorporation. The Articles serve several important purposes: They will ultimately be filed with your Secretary of State with your incorporation papers. The Articles typically include the name and address of the corporation, the general purpose of the organization and the name of the individual to represent the corporation (the "Registered Agent"), and the procedure to modify or change the Articles.

The second document you need to prepare is the By-laws of your corporation. The By-laws typically specify the number and respective duties of directors and officers and govern how the business is run including classes of membership, voting by the Board and members and how the By-laws can be changed.

There are many sites that have sample Articles and By-Laws - including this site. There is just one important thing to remember. If you want to receive your 501(c)(3) status from the IRS, you need to include the following sentences or something similar in your Articles of Incorporation:

"This corporation is organized exclusively for religious, charitable, scientific, literary or educational purposes within the meaning of Section 501(c)(3) of the Internal Revenue Code of 1986."

"No substantial part of the activities of the Corporation shall be the carrying on of propaganda, or otherwise attempting to influence legislation, and the Corporation shall not participate in, or intervene in (including, without limitation, the publishing, lobbying or distribution of statements) any political campaign on behalf of any candidate for public office. Notwithstanding any other provisions of these articles, the Corporation shall not carry on any other activities not permitted to be carried on by: (a) a corporation exempt from Federal income tax under I.R.C. Section 501(c)(3), as amended; or (b) a corporation, contributions to which are deductible under I.R.C. Section 170(c)(2), as amended."

These are magic sentences to the IRS and without them you will have an uphill struggle to get your 501(c)(3) determination.

When the Articles are completed, they are submitted with the appropriate paperwork and fees to your Secretary of State and in a few weeks you will receive a Certificate of Incorporation and you are in business. Remember to incorporate as a non profit corporation!!

Now what?

The person who signs the filing to the Secretary of State (the "incorporator") usually appoints the first Board of Directors. After you receive your Certificate of Incorporation, the incorporator will hold an initial organizational meeting of the first Board of Directors. Several items need to be addressed at this meeting like electing officers, opening bank accounts in the name of the corporation, determining who can sign checks and so on. The first order of business is approving the By-laws. Where the Articles of Incorporation are mostly boilerplate, the By-laws really define how your organization operates. Will you have members? What rights will the members have? What are the terms of office of Directors? How are Directors nominated and elected? These are all very important issues that need to be resolved before you can continue.

Your By-Laws also need to address the size of your Board of Directors. This is a hard decision. On one hand, the smaller the Board the easier it is to manage and direct the organization's affairs. On the other hand, the larger the Board, the more hands to help when it comes to your next production or fund raising. The smallest board I am aware of has five directors. I am sure there is a board with just three directors somewhere. On the other hand I am aware of a board with over 50 members (not theater). In general, with a large board, there is an Executive or Administrative Committee of five to nine Directors that actually governs the day to day affairs of the organization and the other Directors are honorary positions or, more likely, fund raisers. I know of a Board which makes it very clear that Directors are expected to "give it" (make a donation), "get it" (solicit donations from others) or "raise it" (chair fund raising efforts).

I would suggest you start small with five or seven directors, and expand the board as you find people who share your goals. I sit on an eighteen-member non profit board and work for a seven-member board. Our local "big" theater has a fifteen-member board, our small theater group has a five-member board. Fifteen and eighteen members are far too large to oversee the day to day activities of the organization, and both have powerful Executive Committees.

In closing, I have helped several organizations incorporate and receive their 501(c)(3) exemption from the IRS. Some have spent hundreds of dollars on attorneys and accountants filling out the forms. It is not necessary. All you need are copies of your Articles of Incorporation (with the magic language), By-laws, information on your largest donors, and financial statements for your most recent year(s) of operation and estimated budgets for the next three years. It might take you four or five hours to put together but the IRS forms are clear and straightforward. If all else fails, talk to a nearby non profit and look at their application.

You can also send me an e-mail at atoi@seattletheater.net.

I am not an attorney or an accountant, just a community theater enthusiast. I have tried to share my knowledge but there are no guarantees. Good luck!