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Non Profit Tax Exempt Entities

A non profit entity must declare the purpose for which they are formed. Non profit entities purposes are more narrow than other business entity purposes, such as a for profit corporation. The purposes of a non profit entity must be carefully spelled out in its charter or governing documents or they may be presumed not to exist. A non profit entities purposes go beyond the usual corporate purposes such as holding property or executing contracts. The non profit entity exists to accomplish the goals for which it exits. In other words, the purpose of the entity are the goals themselves, such as advancing or dissemination of knowledge or technology on a particular topic or in a particular field, or, in the case of medical marijuana collective associations, to promote maintain and or advance the health and well being of its members through collective and cooperative cultivation projects.

A non profit entity may take many forms, such as clubs, associations or corporations. A non profit entity is one that does not make a profit from its own conduct or operations. However, a non profit entity may conduct some other business for profit and still retain its classification as non profit.

To retain a non profit status, it is important that those persons closely involved in the operation of the entity do not personally profit from it. Typically, insiders who manage and control key aspects of the entity are in the best position to profit from it. Thus, the insiders (managers, officers, directors, etc). must carefully manage the entity so it cannot be used for the personal benefit of its insiders. The legal duties of directors or officers of for profit entities are substantially similar to those of non profit entities attendant with the same legal liabilities and exposures.

A non profit entity should closely follow its charter or bylaws. The necessity of a written charter, governing documents and or bylaws cannot be understated. Should any challenge be made as to the purpose of the entity, these documents are the first thing the Attorney General, the IRS or any other governmental agency will request and examine. .

It is recommended that the entity, whether it be an association, collective, cooperative, or some hybrid thereof, allow for, or elect a board of directors or other governing body which in turn should appoint the various officers of the entity. Governing documents should grant to the membership the right to control election or appointment of the board of directors or other governing board who in turn will make policy and oversee association affairs. The directors or other members of the governing body are directly accountable to the members of the association. However, the powers of the members are limited in that they cannot take over the management of the association and cannot run the association themselves. They must select others to do that for them.

A non profit entity may or may not be a tax exempt entity at its election. That is, it may choose or not choose to be tax exempt. Note that IRC 277 provides that a membership organization not exempt from tax may deduct expenses attributable to the provision of goods, services, or insurance to members only to the extent of income derived from members. In any tax year in which deductions exceed income, excess deductions are treated as paid in the following year Thus, it may not be necessary for any entity to seek a tax exempt status if its revenue is generated solely from member contribution. Here, as mentioned elsewhere, a tax specialist should be consulted regarding this issue.

Tax exempt status allows the entity to avoid taxes generated from business income derived from activities related to its tax exempt purpose. A tax exempt entity may, in some states, avoid sales tax, and in some cases, be exempt from state and federal employment discrimination laws, Government funding, or other benefits may also be available. However, be aware that the acquisition of a tax exempt status submits the entity to the qualifying and operational rules of federal tax law, which in turn must be followed and obeyed. Failure to comply will result in the loss of exemption and penalties may follow. Tax exempt status is a privilege and not a right and is subject to the discretion of the IRS. Tax exempt entities must be organized and operated exclusively for tax exempt purposes. This requirement is mandatory and basic and forms the basis for any IRS inquiry. The rules that define these requirements are to numerous to mention here. A tax specialist should be consulted to discus the desirability of the entity to apply for tax exempt status.

With respect to complying with rules governing tax exempt status, a ruling or determination of private inurnment (personal benefit of insiders, however insubstantial) will result in loss of tax exempt status, and may result in other collateral damage. State laws limit the purposes and activities of non profit entities and prohibit private inurnment. Failure to comply will result in the loss of nonprofit status. Therefore, non profit entities should not engage in activities not related to its purpose and guard against insider gain. However, reasonable compensation for services rendered and goods supplied is not prohibited. Officers and employees may therefore be paid fair remuneration for their services. Excessive bonuses or wages, free use of entity assets or property or excessive allotments for expenses should be avoided.

To be recognized as tax exempt, the entity must apply to the IRS for such exemption. The application process includes the submission of various documents to the IRS, such as the entity charter, bylaws or other governing documents as well as financial statements which include income and expense statements and a current balance sheet. For more detailed information, a tax specialist should be consulted. It is the burden on the organization to show that it qualifies for the tax exemption claimed. It is not necessary to be incorporated to achieve tax exempt status.

An unincorporated association should pay particular attention to its internal book keeping and accounting. . Its existence, financial condition, accounting principles, and daily operation depend on accurate record keeping. Decisions made by the directors or other officers of the association that substantially affect its operation or management should be properly documented in the books and records of the association. For example, any resolutions by the directors or other governing board should be memorialized in writing to prevent future disputes over the nature and content of such resolutions. Any entity that disregards responsible accounting methods or other record keeping procedures invites disaster.

There has been discussion in the medical marijuana community regarding IRC 501(c) (7) and its applicability to medical marijuana collectives and cooperatives. IRC501(c)(7) holds that a club must have an established membership of individuals, commingling, and fellowship to be a social club within the meaning of the statute and must operated exclusively for pleasure, recreation or other nonprofitable purposes. It is not necessary to be incorporated to gain this exemption. Any club, association or corporation that qualifies may gain IRC 501(c) (7) status. Clubs must be organized for pleasure, recreation and other non-profitable purposes. The IRS has held that these other nonprofitable purposes must be similar to providing pleasure and recreation. Sponsoring activities of a noncommercial nature can lead to denial or revocation if the activities are not similar to providing pleasure and recreation. At this writing, no source could be found that describes a medical marijuana club, association, collective or cooperative (incorporated or otherwise) as a "social or recreational club". It is suggested that the form and structure, as well as the actual operation of such "club" will determine its status and eligibility to tax exemption under 501(c) (7). Again, whether or not medical marijuana associations, collectives or cooperatives are eligible for this status should be discussed with a qualified CPA or tax attorney familiar with this issue

Caveat. A major factor to consider when applying for 501(c) (7) status is the federal ban on possession, manufacture, sale or distribution of marijuana. Because 501(c) (7) status is a privilege and not a right, and the IRS has the discretion to deny or revoke this status, acquiring or maintaining such status could be problematic. Further, because most collectives, cooperatives or associations generate their income from membership payment for their medicine, and one of the requirements for 501(c)(7) status is that 501(c)(7) entities must, in general, generate their income from fess, dues and assessments, the IRS may not consider payment for medicine as dues, assessments or fees. This may also present a substantial hurdle.

Associations, Collectives, Cooperatives and Corporations

Collectives and cooperatives are, by definition, an association of individual who have come together for a common purpose. California law defines an association as an unincorporated organization composed of a body of people partaking in general form and mode of procedure of the characteristics of a corporation. By its terms, this definition is not inclusive and exclusive and the formalities of quasi-corporate organization are not required.

''Association'' is defined for purposes of Corp. Code §§ 21300-21310 as any lodge; order; beneficial association; fraternal or beneficial society or association; historical, military, or veterans organization; labor union; foundation; federation; or any other society, organization, or association, or degree, branch, subordinate lodge, or auxiliary thereof [Corp. Code § 21300(a)]. ''Unincorporated association'' is defined as an unincorporated group of two or more persons joined by mutual consent for a common lawful purpose, whether organized for profit or not [Corp. Code § 18035(a)]. ''Nonprofit association'' is defined as an unincorporated association with a primary common purpose other than to operate a business for profit [Corp. Code § 18020(a)]. A nonprofit association may carry on a business for profit and apply any profit that results from the business activity to any activity in which it may lawfully engage [Corp. Code § 18020(b)]. ''Club'' is defined as a voluntary, incorporated or unincorporated association of persons for common purposes of a social, literary, investment, or political nature, or the like [Black's Law Dictionary, p. 256 (6th ed. 1990); see also Bus. & Prof. Code § 23037 (definition of ''club'' for purposes of Alcoholic Beverage Control Act)].

While a corporation may have a single share holder and therefore not qualify as an association, collectives or cooperatives are, at their core, associations in that it is necessary to have at least two persons to form such an entity. The designation "collective" or "cooperative" may define the activities of its members, but their essential nature is associational.

While a collective has no recognized, legal status in this state, an association has much all of the benefits of a corporation, such as perpetual existence, separate legal status, rights independent of its members and shields members from the debts of the association.

An association is a legal entity distinct from its members. The association represents the common or group interests of its members, as distinguished from their personal or private interests. Dues and assessments paid by members to an association become the property of the association and any severable or individual interest in them ceases on payment. As association property, they are subject to disbursement and expenditure by the association in pursuit of the lawful object or objects for which they were designated to be expended.

The constitution, rules, and bylaws of a voluntary unincorporated association constitute a contract between the association and its members. The rights and duties of the members as between themselves and in their relation to the association, in all matters affecting the association's internal government and the management of its affairs, are measured by the terms of the constitution and bylaws

A member's interest in association property is only incidental to his or her membership and will cease on his or her ceasing to be a member when the property was accumulated by reason of the payment of dues. However, courts may interfere for the purpose of protecting property rights of members of unincorporated associations, such as the right to participate in their benefit

The California Supreme Court has held that members of an unincorporated association are entitled to inspect financial records of the association on written demand, at least to the extent reasonably related to the member's interests in the association.

Except as otherwise provided by statute or by an unincorporated association's governing principles, the rules governing a member vote conducted pursuant to the provisions of the Corporations Code governing unincorporated associations are found in Corp. Code § 18330(a)-(e), such as:

  1. A vote may be conducted either (1) at a member meeting at which a quorum is present, or (2) by a written ballot in which the number of votes cast equals or exceeds the number required for a quorum. Approval of a matter voted on requires an affirmative majority of the votes cast.
  2. Written notice of the vote must be delivered to all members entitled to vote on the date of delivery. The notice must be delivered or mailed or sent electronically to the member addresses shown in the association's records a reasonable time before the vote is to be conducted. The notice may not be delivered electronically, unless the recipient has consented to electronic delivery of the notice. The notice must state the matter to be decided and describe how and when the vote is to be conducted.
  3. If the vote is to be conducted by written ballot, the notice of the vote will serve as the ballot. It must (1) set forth the proposed action, (2) provide an opportunity to specify approval or disapproval of any proposal, and (3) provide a reasonable time within which to return the ballot to the unincorporated association.
  4. One-third the voting power of the association constitutes a quorum.
  5. The voting power of the association is the total number of votes that can be cast by members on a particular issue at the time the member vote is held.

A member of a nonprofit association is not liable for injury, damage, or harm caused by an act or omission of the association or an act or omission of a director, officer, or agent of the association, unless any of the following conditions are satisfied: The member expressly assumes liability for injury, damage, or harm caused by particular conduct and that conduct causes the injury, damage, or harm. The member engages in tortuous conduct that causes the injury, damage, or harm. The member is otherwise liable under any other statute.

An unincorporated association may, in its name, acquire, hold, manage, encumber, or transfer an interest in real or personal property [Corp. Code§ 18105; see Corp. Code § 21200 (property rights of certain unincorporated medical societies)

As can be seen from above, the essential benefits that are granted by law to a corporation are also granted to an association. However, the formalities of formation and operation of an association are less cumbersome, and in many cases, less procedural than that of a corporation. However, as mentioned above, the necessity of proper book and record keeping to protect the existence of an association remains.

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