© Kenneth C. Sandoe, Attorney-at-Law
published in The Draft Horse Journal, Winter, 2001 - 02
One of the best methods to organize a draft horse club is to establish a nonprofit corporation which adequately protects its directors, officers and members. The establishment of a nonprofit corporation is set forth by each state in its corporate code. However, a nonprofit corporation is not necessarily exempt from paying income taxes unless it meets the federal requirements of USC Title 26, Section 501(c)(3). This article will look at common state law requirements to establish a nonprofit club or association and also the federal law for income tax-exempt status.
In order to establish a nonprofit corporation, the first thing that must be done is select a name. The corporate name cannot imply that the corporation is a governmental agency, bank, savings institution or public utility. The corporate name also cannot be confusing or similar to the name of any other corporation registered in the state. The State Department will do a search of the name, and if it finds that the name is available for corporate use, it will reserve the name for the exclusive use of the applicant. Once the corporate name has been selected, incorporators must be designated. Incorporators can be one or more natural persons, at least 18 years of age, or corporations. Incorporators sign the initial Articles of Incorporation, which define the governing structure of the corporation, and establish the organization. The filing of the Articles of Incorporation with the Department of State, which includes the corporate name and the identity of the incorporators, formally initiates the existence of the corporation.
After the Articles of Incorporation have been filed, the incorporators or directors, if named in the Articles of Incorporation, must hold an organizational meeting. The purpose of the organizational meeting is to adopt bylaws for governing the corporation, elect directors and transact business.
Every nonprofit corporation must keep certain organizational records, and generally these records fall into four categories:
State law provides that a nonprofit corporation must be authorized to engage in only certain activities which meet the nonprofit status. Some examples of approved activities for nonprofit status include the following: athletic, beneficial, benevolent, charitable, civic, agricultural, fraternal, health, literary, prevention of cruelty to persons or animals, promotion of the arts, protection of natural resources, religious, research, scientific and social. The promotion and education of animals has been held to be a charitable purpose, and thus in compliance with the nonprofit requirements of the law.
Financial activities of a nonprofit corporation are also closely regulated by law. nonprofit corporations are statutorily limited with regard to their financial structure and business activities. A Nonprofit corporation can charge fees or prices for services or products and has the right to receive income and in fact make a profit. However, profits must be applied to the maintenance and operation of the lawful activities of the corporation, and the profit is not permitted to be divided or distributed among the members, directors or officers of the corporation. However, a nonprofit corporation may provide reasonable compensation to its members, directors or officers for actual services rendered.
Once the Articles of Incorporation are filed and the initial organizational meeting held, the corporation will be run according to the bylaws established by the corporation’s members. Bylaws are the rules adopted by the corporation for the regulation and management of the business affairs of the organization. The management of the business and affairs of a nonprofit corporation is vested in its Board of Directors. The bylaws generally impose and define the powers and duties of the Board. The Board of Directors must be made up of natural persons, at least 18 years of age, and consist of one or more directors, the number of which is defined in the bylaws. It is the duty of the Board of Directors to call meetings and give proper notice to members of the Board of the date, time and location of the meeting. Each director is entitled to one vote, and absent a bylaw to the contrary, a majority of the Directors in office is necessary to constitute a quorum for the transaction of business.
The general membership of the corporation elects the Board of Directors, normally at an annual meeting. The Board of Directors then elects the officers of the corporation, and a nonprofit corporation must generally have elected a president, vice-president, secretary and treasurer. The bylaws prescribe any qualifications needed to be an officer, and also define the selection, term, duties, removal and compensation, if any, of the officers. Unless otherwise provided in the bylaws, officers need not be directors.
The Articles of Incorporation of a nonprofit corporation provide for members and provisions regarding members’ rights and obligations. These provisions include the qualifications for membership, rules for retention, suspension and expulsion, and generally provide that each member is given a membership certificate, rather than stock as a for-profit corporation. Each certificate entitles the member to one vote. The fact that the corporation is nonprofit must be noted on the face of each membership certificate, and members of a nonprofit corporation are not personally liable for the corporation’s debts or obligations. The bylaws of a nonprofit corporation set the number and time for membership meetings, however, a nonprofit corporate membership meeting must be held at least once a year where the members elect the corporate directors. Special meetings of the members may be called by a majority of the Board of Directors.
A nonprofit corporation may levy dues, fees and assessments on its members, if authorized by the corporation’s bylaws. The amount and method of collection may be fixed by the bylaws or assigned to the discretion of the Board of Directors, including the enforcement for collection of dues and assessments and provisions for termination of membership for non-payment.
A nonprofit corporation that has commenced business may also dissolve the corporation’s business and wind up its affairs. Voluntary dissolution must be proposed by (1) a resolution adopted by the Board recommending dissolution; 2) a petition of the members entitled to cast at least 10% of the votes which all members are entitled to cast, directed to the board and filed with the secretary of the corporation; or 3) any other method specified in the corporation’s bylaws. When all corporate assets have been collected and converted into cash, and all liabilities paid, the corporation may distribute any remaining assets. Unless otherwise required by Statute or member-adopted bylaw, surplus assets may be distributed by the board to the members pro-rata or other charity.
A nonprofit corporation is not automatically exempt from Federal income tax. To be exempt, the corporation must qualify for tax-exempt corporate status under Section 501 of the Internal Revenue Code. [IRC Section 501(c)(d); see also IRC Section 508(a); TREAS. REG. Section 1.508-1(a)(2).] A state nonprofit corporation seeking Federal tax-exempt status under federal law must file an application with the District Director of the Internal Revenue Service. Corporations that qualify for tax-exemption as described in Internal Revenue Code Section 501(c)(3) are either private foundations or organizations commonly referred to as public charities. Generally a nonprofit corporation such as a draft horse club is considered a public charity. Once the nonprofit corporation has received 501(c)(3) status, the corporation is then exempt from paying any federal income tax and deductions are permitted by contributors. Obviously obtaining 501(c)(3) status is a major accomplishment in terms of tax status and receiving contributions.
Further, most states do not impose corporate net income taxes or sales and use taxes on the sale to or use of property or services by charitable organizations. Thus, if the organization were to sell promotional articles, such as T-shirts, mugs, pens and the like, the fundraising activity would be exempt from payment of sales tax.
A nonprofit corporation which has received Federal tax-exemption status must file for a Federal employer identification number and must file an annual tax return with the Internal Revenue Service if receipts of more than $25,000 have been received over the last three years.
Finally, nonprofit corporations can be sued just like for-profit corporations, and thus the nonprofit corporation needs to be sure to protect its directors and officers in the event of such a suit. Whether or not to purchase insurance to protect the corporation and the corporation’s directors and officers depends upon many factors, including the laws of the state where the corporation conducts business and the activities of the corporation. Assuming that the corporation is active and engages in meetings, clinics, horse shows and other related horse activities, it is suggested that the corporation should look into purchasing director and officer liability insurance. This coverage is designed to cover directors and officers, who have been sued for some decision or activity within their scope of duties. This insurance not only covers the directors and officers’ personal liability, but also the legal fees associated with defending these individuals. It is also a good idea to look into the availability of both liability coverage, which would protect and defend against claims involving the corporation’s activities, and special event insurance, which might include such things as corporate-sponsored clinics or horse shows.
However, the real advantage of establishing a draft horse club is the fact that many people with common goals and desires are brought together to promote and educate themselves as well as others about the draft horse and the draft horse industry.
Enough legal talk–it’s time to hitch horses.
Ken is a practicing attorney in Myerstown, Pennsylvania, where a good bit of his practice involves negligence cases. Ken and his wife, Karen, own Sunny Hill Farm Belgians, and they have been exhibiting their six horse hitch for the past few years at most major shows in the east.
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