Over the years, numerous clients have asked for advice on how to form an Arizona nonprofit organization. I’m glad they asked, because forming and running a nonprofit is not the same as a for-profit LLC or corporation, and if not done correctly, the nonprofit could run afoul of state and federal laws.

The most common form for a nonprofit is a Public Benefit Corporation, which is a charitable or social-welfare organization, including educational, scientific, and religious entities. Nonprofit does not mean that the organization cannot bring in revenue; however any profits are retained by the organization and no individuals (or for-profit entity) can take profits for their own benefit.

One of the greatest advantages of operating a nonprofit is that it can be recognized by the IRS and state taxing authorities as “tax-exempt.” This means that, among other things, the organization:

• Is exempt from state and federal taxes
• Can accept donations that are tax deductible for the donor
• Can apply for state, federal and private grants
• Pays no sales tax on purchases

Running a nonprofit properly will protect it from jeopardizing this tax-exempt status. And to run the entity properly, certain policies and procedures should be adopted, and followed, by the board of directors and the officers.

Policies Required for Tax-Exempt Status

Conflict of Interest/No Self-Dealing Policy

The IRS prohibits a nonprofit’s board members, officers and key employees from using nonprofit funds to personally benefit themselves by directing the entity to purchase goods and services from for-profit companies they own or manage. This is called “self-dealing” and it is so important to the IRS that a nonprofit not engage in this practice that having a policy against self-dealing is required for the initial approval of tax-exempt status.

Record Retention/Destruction Policy

Certain records of the entity must be retained so that the entity can show the IRS or any other governmental body that its practices have complied with the law. Some of these records include financial, accounting and tax records related to donations and expenses, employment records, entity formation documents, contracts and legal records, and the like. On a nonprofit’s annual tax return, it must acknowledge that it has adopted a policy addressing the time frames for retention.

Whistleblower Protection Policy

Also required on the annual tax return is a policy that encourages staff and volunteers to come forward if they have credible information on any illegal practices or violations of policies committed by any person in the organization. The policy must also protect those individuals from retaliation should they make a formal report of wrongdoing.

Additional Policies that are Prudent to Adopt

In addition to the above, it is a good idea for a nonprofit to establish the rules by which it intends to operate. While the needs of nonprofits vary from one to another, some of those policies should include:

Confidentiality Policy

This policy stresses the importance of confidentiality, not only related to the organization’s operations, but related especially to its donor’s personally identifiable information and certainly any HIPAA protected medical information that the organization might collect if the nonprofit’s mission relates to medical research or helping people with certain medical challenges.

Compensation Policy

While a nonprofit does not distribute profits to individuals, its employees certainly can be compensated with salaries that are reasonable for the job they do. This policy might dictate that salaries are determined only after compensation experts are consulted, market surveys are done, or the board votes on a compensation schedule, to ensure that no individual is personally compensated at unreasonably high levels.

Employment Policies

Documenting policies related to employees is always a smart idea. For a nonprofit, these may be no different than a for-profit company, but they will communicate the entity’s expectations for its workers and how the entity handles issues or disputes with employees.

Travel and Expense Reimbursement Policy

This will clarify what expenses are covered by the entity for any employee, volunteer, or fundraiser that incurs expenses as part of their duties.

Volunteer Policy

This document will make it perfectly clear to a nonprofit’s volunteers that they are donating their time and services, and should have no expectation of pay or benefits, like an employee would.

Fundraising Policy

If fundraising is a significant component of a nonprofit’s activities, a policy related to this is a good idea. The entity should determine how it will track all fundraising income and expenses, what will be provided to donors to document their donation, and under what terms external fundraising personnel will be hired.

Investment Policy

Arizona law requires that any person managing and investing institutional funds do so “in good faith and with the care an ordinarily prudent person in a like position would exercise under similar circumstances.” A nonprofit should clearly define what guidelines it will establish to meet this legal standard.

Next Steps

This is not a comprehensive list, of course, but having these various policies written, adopted by the board of directors, reviewed periodically, and enforced on a regular basis by the officers will go a long way toward protecting that all-important tax-exempt status.

If you feel that your nonprofit’s operations could be shored up, or if you are just forming your organization, please give me a call so that we can ensure you have the right procedures in place.

NOTE: THIS ARTICLE IS FOR GENERAL INFORMATIONAL PURPOSES. IT DOES NOT CONSTITUTE LEGAL ADVICE, NOR DOES IT CREATE AN ATTORNEY-CLIENT RELATIONSHIP. EACH SITUATION IS DIFFERENT. YOU SHOULD CONSULT WITH AN ATTORNEY TO DETERMINE YOUR LEGAL RIGHTS, REMEDIES, AND DUTIES.

By Wendy M. Anderson, Esq.
Law Office of Wendy Anderson, PLLC

480-825-4509
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