6.1 – Commercial Activity

501(c)(3) tax-exempt organizations are subject to restrictions on commercial activities. Generally, nonprofit organizations may engage in commercial activities similar to those of for-profit entities so long as the activities are directly related to the organization’s exempt purpose. Although limited unrelated commercial activities are typically not cause for revoking an organization’s 501(c)(3) tax-exempt status, courts have held under the “commerciality doctrine” that a nonprofit organization is not engaged primarily in its exempt purpose if the organization engages in too much commercial activity. Courts and the IRS have been inconsistent on the question of how much commercial activity (even activity related to the organization’s exempt purpose) is too much, but they take into consideration:

  • whether the organization’s operations appear similar to those of a for-profit entity;
  • the size of the trade or business conducted by the organization compared to the size, extent, and amount of activities carried on in furtherance of the exempt purpose;
  • the manner in which the activities are carried out (e.g., does the organization charge market price for its services? does it engage in advertising just like for-profits?);
  • the use of retained earnings to benefit individuals within the organization, or to fund capital expenditures unrelated to the exempt purpose.

6.2 – Unrelated Business Income Tax (“UBIT”)

501(c)(3) organizations should be aware that unrelated commercial activities are subject to UBIT. Unrelated business activities are those that lack a substantial causal relationship with the achievement of the exempt purpose. If a commercial activity undertaken by the 501(c)(3) tax-exempt organization is unrelated to that organization’s exempt purpose, any profits from that commercial activity are subject to UBIT.

6.3 – Disclosures

Nonprofit organizations must comply with all relevant disclosure laws and regulations. Nonprofit organizations have a duty to accurately report fundraising costs on their IRS Form 990, to obey the requirement regarding what portion of the cost is deductible, and to comply with state charitable registrations laws and regulations.

6.4 – Accumulation of Surplus

Although a nonprofit organization is permissible to accumulate a surplus, it should explain to the IRS and to donors why it is not spending all its revenues on its programs. For example, the organization may be building a reserve for future downturns or may be saving for a new building.

6.5 – Salaries and Benefits

Organizations that grow in scope and begin hiring employees should be aware that there are limits on the salaries those employees may earn. When setting a salary, the organization should consider the size and complexity of the organization, what others in similar organizations are earning, and whether the salary is defensible to the public.

6.6 – Insurance for Nonprofits and Nonprofit Personnel

Nonprofit corporations should consider obtaining insurance, particularly if its activities subject the organization to possible tort liability. Types of insurance that a nonprofit corporation may consider purchasing include:

  • commercial general liability insurance;
  • commercial property insurance;
  • directors & officers’ insurance;
  • crime coverage;
  • professional liability insurance; and
  • workers’ compensation and employer’s liability insurance.

6.7 – Risk Management

Nonprofit organizations should develop a risk management plan. The risk management plan should consider the risks that the organization faces and develop a strategy to respond to those exposures. This risk management plan should be evaluated and updated periodically.

6.8 – Liability of Officers, Directors, and other Volunteers

  • Nonprofit volunteers may be exposed to liability for actions in performance of their duties. However, state and federal laws provide some protections to nonprofits.
  • Director Immunity in North Carolina:
    • Immunity Provision in Articles of Incorporation (N.C. Gen. Stat. § 55A-2-02). North Carolina nonprofit corporations can limit or eliminate directors’ personal liability for monetary damages by the inclusion of certain language in the nonprofit organization’s articles of incorporation. The immunity applies to monetary damages arising out of any action whether that action is taken directly by the nonprofit organization or in the name of the organization, or the action is a breach of the director’s duty. However, the following are exceptions to this immunity and no provision in the articles will protect a director from:
      • Any liability arising from an act or omission that the director, at the time of the act or omission, knew or believed was clearly in conflict with the best interests of the corporation;
      • Any liability associated with the loan, guarantee or other form of security made or provided by a nonprofit corporation to or for the benefit of its directors or officers;
      • Any transaction from which the director derived an improper personal financial benefit.
    • Immunity from Civil Liability (N.C. Gen. Stat. § 55A-8-60). North Carolina also provides that a director is immune individually from civil liability for monetary damages for the director’s act or failure to act arising from service as a director, except to the extent the nonprofit corporation has insurance coverage. Again, however, there are exceptions and this statutory immunity does not apply if the director:
      • is compensated for his or her services beyond reimbursement for expenses;
      • is not acting within the scope of his/her official duties;
      • is not acting in good faith;
      • commits gross negligence or willful or wanton misconduct that resulted in damage or injury;
      • derives an improper personal financial benefit from a transaction which involved the nonprofit corporation;
      • incurs the liability from the operation of a motor vehicle; or
      • is involved with an improper loan or guarantee with the nonprofit corporation
  • Mandatory Indemnification of Directors, Officers, Employees and Agents
    • In North Carolina, unless the articles of incorporation provide otherwise, nonprofit directors, officers, employees, and agents shall be indemnified when wholly successful on their merits or otherwise, in the defense of any proceeding to which the person is a party because he/she was a director or officer of the nonprofit corporation against reasonable expense actually incurred by director in connection with the litigation (N.C. Gen. Stat. § 55A-8-52; N.C. Gen. Stat. § 55A-8-56).
  • Advances to Cover Legal Costs (N.C. Gen. Stat. § 55A-8-53)
    • To address the burden of expensive attorney fees, North Carolina allows a nonprofit corporation to advance expenses to defend a lawsuit prior to the final disposition in the lawsuit.

Typically, this obligation is memorialized in a written agreement by the nonprofit corporation or in the language of the articles of incorporation and/or bylaws.