Archive for October 31st, 2007

The many meanings of “non-profit”

October 31st, 2007

I’m often asked various questions about non-profits. It seems many people have a general idea of what “non-profit” means but very few have a specific, technical understanding. This makes perfect sense. he technical understanding is a legal and accounting mix, and specific to legal jurisdiction as well.

So here’s a brief outline of what “non-profit” means — techncially — to the Mozilla Foundation. It’s pretty dense stuff, and I’ll provide only the most basic summary.

I. “Non-profit” status

The Mozilla Foundation is incorporated as a “non-profit public benefit” corporation under California law. (So yes, even a non-profit “foundation” is a “corporation.” In this sense “corporation” means a form that is recognized as having a legal existence.) Its property is dedicated to charitable purposes. It also means that the Mozilla Foundation is governed by the California Nonprofit Corporation Law, which is different from California’s General Corporations Code. I’ve found that the distinctions between the general Corporations Law and the Nonprofit Corporation Law include structural elements — members instead of shareholders and so on, and a set of distinctions which I think of as designed to ensure that the organization is pursuing a non-profit goal rather than pursuing private gain.

For example, the Articles of Incorporation of the Mozilla Foundation (and other non-profit corporations) provide that:

“This Corporation is a nonprofit public benefit corporation and is not organized for the private gain of any person . . . The specific purpose of the Corporation is to promote the development of, public access to and adoption of the open source Mozilla web browsing and Internet application software.”

II. “Tax-exempt” status

The Mozilla Foundation is also a tax-exempt organization as determined by the U.S. Internal Revenue Service. To be a tax-exempt organization one needs to show that one is incorporated as a non-profit organization (see Section 1 above), and that the purpose of the organization fits within additional specifications. Once this status is granted, a tax-exempt organizations is governed by a body of regulations and policies promulgated by the IRS. These regulations are in addition to any requirements imposed by the Nonprofit Corporation Law. These regulations relate both the purpose of the tax-exempt organization and also require that the organization’s actions be in furtherance of the tax-exempt purpose. They also limit the kinds of activities in which a tax exempt organization can engage, particularly activities that generate revenue. To help me understand this, I think of this as a trading general flexibility of action by the organization in exchange for tax-exempt status.

The Mozilla Foundation’s tax exemption determination letter can be found on the Foundation’s website.

III. “501(c)(3)” status

The Internal Revenue Service grants tax-exempt status to several different kinds of organizations.

More specifically, the Mozilla Foundation is a “501 ( c) (3) corporation.” The “501” here stands for the section number of the U.S. tax code that defines tax-exempt organizations. Section 501(c ) (3) allows tax exempt status for an organization that is ” . . . organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes . . .” You can find the text of Section 503 of the US tax code here:—-000-.html

Before I was involved with the Mozilla Foundation, I thought that the definition of a 501(c )(3) corporation covered most of what one needs to know. It turns out that are two quite different kinds of 501(c )(3) corporations. There are “private foundations” and there are “public benefit” charities. Each type is subject to different regulations. Here’s a description of the differences written in generally understandable language.

The Mozilla Foundation is a public benefit charity. In addition, the Mozilla Foundation is a tax-exempt organization as determined by the State of California.

2. Mozilla Foundation and Mozilla Corporation.

It’s hard to find documents in this area that are relatively easily understood. I am including an excerpt from a document at the IRS site that is a useful starting point. It describes how the tax-exempt parent and the taxable subsidiary must act separately, and not as one. The document, known as ectopic86 (written for a training seminar in 1986) says this about the activities of a tax-exempt parent and a taxable entity:

“1. Introduction. Taxable for-profit subsidiaries of organizations exempt under IRC 501(c) are not a new phenomenon. The formation of such organizations, however, has increased markedly in recent years.”

It goes on to state:

“A parent’s exempt status may be jeopardized if the commercial activities of its subsidiary can be considered to be, in fact, activities of the parent . . . . That is, where a corporation is organized with the bona fide intention that it will have some real and substantial business function, its existence may not generally be disregarded for tax purposes. Britt, 431 F.2d at 234. However, where the parent corporation so controls the affairs of the subsidiary that it is merely an instrumentality of the parent, the corporate entity of the subsidiary may be disregarded. (See IRC 482; see also 1 W. Fletcher, Cyclopedia of the Law of Private Corporations Section 43.10 (Perm. Ed. 1983).)

B. Application of Principles Whether the activities of a separately incorporated taxable subsidiary may be attributed to its parent is, therefore, a question of evidence. Basically, once it is established that a taxable subsidiary was formed for a valid business purpose, the activities of such a subsidiary cannot be attributed to its parent unless the facts provide clear and convincing evidence that the subsidiary is in reality an arm, agent, or integral part of the parent. This presents a considerable evidentiary burden that is not easily overcome. Clear and convincing evidence of the subsidiary’s lack of separate existence could be produced, however, in situations where the parent is involved in the day-to-day management of the subsidiary, where the subsidiary’s Board of Directors has no independence of action, or where transactions between the two entities are conducted on a basis that is otherwise than at arm’s length. (Transactions between parent and subsidiary should be scrutinized carefully from another point of view: the possibility of inurement always exists, and a parent-subsidiary relationship cannot function as a shield against the assertion of inurement.)”

You can find the full document the IRS website.

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