And the hits just keep on coming…

Nonprofit organizations have yet another hurdle to cross when applying for tax-exempt status.

A while back, a colleague of mine, a director of a nonprofit organization, applied for tax-exempt status in the United States. The IRS had questions for him, which was to be expected. What was not expected, however, was that after answering the IRS’ questions, his file was then forwarded to the Department of Homeland Security [DHS].

That’s right, the U.S. Government Department that oversees (no pun intended) counter-terrorism, border security, disaster response, and immigration is also an integral part of the tax-exempt approval process.

Why is the Department of Homeland Security Scrutinizing Charities?

The DHS investigating is no random act. As explained in a previous post:

The U.S. Internal Revenue Service (IRS) stresses that the risk that a grant will be used for non-charitable purposes increases drastically when dealing with foreign grant making and expenditures…intelligence information hinting “to the effect that international charities are the second principal source of money that underwrites terrorist activity”

Questions asked by Homeland Security

1. IRS Type Questions

Similar, if not exact repeats, of questions asked by the IRS.

2. Nature of Activities – Lobbying/Advocacy

The nature of the activities of the charities abroad that would be receiving the money. Specifically, if the receiving charity participates in lobbying and/or advocacy. In the United States, certain types of lobbying/advocacy label the organization 501(c)4 tax-exempt charity. Donations to (c)4 charities are not tax-deductible. If an organization is worried if they fit this category, they might want to look into the 501(h) test.

3. Control Measures

Control measures in place to ensure that the money will be used strictly for charitable purposes.

4. Legal Status of the Recipient Organizations

The DHS asked if the recipient charity is considered a 501(c)3 charity in its respective country. This question is a little tricky because countries have different definitions of what it means to be a nonprofit organization.

In Israel, for example, is the DHS referring to the Nihul Takin [Certificate of Proper Management] given out by the Registrar of Charities [Rasham Ha'amutot] or Seif 46a [Paragraph 46a] certification given out by the Tax Authorities [Mas Hachnasah]?

5. Independence

My colleague stressed that the DHS was very interested to know that the funds sent abroad were not limited to only one recipient. It is crucial for the IRS that the American entity be an independent, self-governing body that is not subservient to any other foreign or local individuals/organizations. And yes, this is a running theme in my blog posts. (A previous post, “Reasons Why Not to Establish an ‘American Friends Of’ elaborates on this Independence.)

Conclusion

What lessons can we learn from this organization’s experience?

1. Longer Process

US registered nonprofits who are applying for tax-exempt status can expect the process to take longer. This is not necessarily a must – maybe no red flags will be raised and it will be smooth sailing. However, I wouldn’t count on it.

2. Treat the DHS Seriously

Even though it might seem that the DHS shouldn’t be in the picture or that their questions are repetitive (maybe even ludicrous and pointless), don’t belittle their role. Whereas the IRS has control only over your tax-exempt status, the DHS can freeze your assets. The Patriot Act allows the U.S. Government to freeze assets first and ask questions second, if they should think that the accounts are connected to terrorism. As of today, the DHS has a big mandate. Don’t mess with them.

3. Adjust Accordingly

The right experts can help you write your By-Laws (including mission and mandate) in a way that raises less flags. I am not advocating lying, fibbing or stretching the truth. Just the opposite: Good charities shouldn’t suffer simply because they wrote their By-Laws in a way that doesn’t accurately describe the activities of the organization.

4. Plan in Advance

If you can theorize the types of questions that your organization’s application will elicit, then you should also being able to prepare answers in advance.

When fundraising, acquiring 501(c)3 tax-exempt status quickly can make-or-break attracting that big, elusive donor. Why unnecessarily lengthen the process?

Tizku Lemitzvot,

Shuey

Disclaimer: This blog houses my personal opinions and is for informational purposes only – not advice. As charity laws can be quite complex, please refer all questions to qualified and licensed professionals. Read the full disclaimer.

International organizations have been highly successful in raising funds from the United States through U.S. based charities commonly referred to as “Friends of” organizations. These charities are registered in the States and have 501(c)3 tax-exempt status, allowing donations to these essentially foreign organizations to be tax-deductible.

As you can imagine, many charities registered outside of the United States consider an “American Friends of” organization as a vital part of their fundraising strategy.

Jewish causes, especially those based in Israel, are no exception to this rule. A recent report compiled by Dr. Nissan Limor estimated that foreign donations to Israeli charities from sources outside of Israel stood at 2.165 billion dollars in 2007, with much of that coming from the United States (although, he didn’t stipulate how much). There are about 1,000 new Israeli charities [amutot] created every year and it would hold that many of these organizations will seek to create an “American Friends of” supporting charity.

Hence, recent conversations I have had are causing me to worry.

The Reduction of 501(c)3 Exemptions Granted

In late July, I wrote about the scandal that rocked the Jewish community of Brooklyn and Deal, culminating in the arrest of three mayors, five respected community rabbis, and a score of government officials. Specifically, my third post on the scandal described the The IRS Expected Response.

In that post, one prediction I made was the “Reduction of 501(c)3 Exemptions Granted”

The easiest way to prevent future international fraud is to restrict the organizations that can gain tax-exempt status…The U.S. Department of Treasury has only enough manpower to audit between 2 – 3% of registered charities in America. Scrutiny of organizations that already have 501(c)3, then, seems almost like an impossibility. However, as every new organization that wants tax exempt status needs approval from the IRS, it would be a relatively simple procedure to restrict approval to new charities; more specifically, to new charities that donate to international causes.

Well, unfortunately, this seems to becoming a reality. Three recent conversations are shedding light on what seems to be new practices by the IRS. (Specific names are being withheld as applications and relationships are still ongoing.)

The Name “American Friends of” Bothers the IRS

On a recent trip to the States, I had the fortune to sit with a prominent lawyer that represents many Jewish nonprofits. He informed me that he submitted a file for 501(c)3 approval for the “The American Friends of _______,” an organization that would like to raise funds for a charity operating outside of America (but not in Israel). The application is taking an inordinate amount of time, mostly due to the staggering number of questions the lawyer has received from the IRS representative assigned to his file. His application folder measures an astounding 2.5 inches! Having been submitting similar applications for decades, the lawyer is quite surprised at the level of scrutiny and feels that it is the organization’s name that is evoking this reaction. The lawyer is losing patience and if nothing changes, will close the application and resubmit under a different name, hoping this will solve the problem.

Charities Should be Supporting a Mission, Not Supporting an Organization

The following day I met with a well known nonprofit consultant that works with both Jewish and non-Jewish charities. He informed me that it has come to his attention that the IRS will no longer approve 501(c)3 status for organizations that are founded simply to support one specific institution. In other words, when applying for exemption, the papers should list the mission or objective that the charity supports, not what organization it supports. It was implied, however, that in practice, a 501(c)3 charity can transfer money to (i.e. support) a single foreign organization without fear of losing its tax-exempt status — the American nonprofit, though, must be able to prove its independence. (More analysis, tips and background on international charity emanating from America can be found on an article I wrote: “International Charity in the Face of Global Terrorism.”)

Don’t Go Against American Policy

And finally, upon returning to Israel, I was speaking to a director of a Israeli nonprofit who told me of a colleague of his whose American charity had applied for 501(c)3 tax-exempt status.  At the time, the applicant informed this director that in his application he stated that the mission was to support Judea/Sumaria/Gaza. The applicant assured the director that the approval was imminent. A half a year later, his approval had yet to come and this applicant soon gave up.

The Obama administration is not in favor of what it calls the “Territories.” Leaving politics aside, we are seeing organizations whose mission clashes with American policy and/or opinion having trouble obtaining 501(c)3 tax-exempt status.

Conclusion

In closing, I would like to stress that whether these trends are good or bad is not the issue. The important point is that Israeli nonprofits and their American supporting counterparts should take notice and act accordingly.

These conversations stress:

1. New organizations that have the words “American Friends of” in their name will have trouble getting their 501(c)3 tax-exempt status approved.
2. By-laws of organization should list the cause that the organization is supporting, and should not specify particular organizations.
3. When applying for tax-exempt status from the American government, it might be best to “tow the party line.”

Tizku Lemitzvot,

Shuey

Disclaimer: This blog houses my personal opinions and is for informational purposes only – not advice. As charity laws can be quite complex, please refer all questions to qualified and licensed professionals. Read the full disclaimer.

The arrests of 44 individuals–including, 3 mayors, 5 respected community rabbis, a score of government officials, and others–on Thursday of last week (July 23) should highlight the dangers of organizations donating to international causes; and I guarantee you, the I.R.S. is having similar thoughts.

I believe that two reactions can be expected.

1. Greater Scrutiny of Charities

The fear that a charitable donation might not be used for a charitable purpose is not new. The U.S. Department of Treasury has long known the important role that charities play in financing terror and released in 2006 its third version of “Financing Guidelines: Voluntary Best Practices for U.S. Based Charities.”

(For a more detailed analysis, I published an article entitled, “International Charity in the Face of Global Terrorism: The U.S. Department of Treasurys Response.”)

Until now the guidelines produced by the IRS and other groups have been voluntary in nature and not enforced by the U.S. Government. Incidents like the one from last week and the Spinka Hasidim in 2007 are convincing the IRS that terrorists aren’t the only ones abusing the system.

With President Obama’s civic-minded government, we can expect these recommendations to become laws (click here to read more about Obama’s nonprofit agenda). When the Treasury reviews the practices of international organizations they will find that many of them are not following the guidelines that have been suggested. Organizations that are found to be negligent can find themselves facing criminal charges, fines, and revocation of tax-exempt status.

The U.S. government has already invested the time. The literature exists. In just a few short weeks, we can theoretically find these voluntary principles mandatory, so read the letter of the law and obey even the spirit of the law. Remember, the Patriot Act of 2002 allows the IRS to freeze accounts first, and ask questions later.

2. Restriction of 501(c)3 Tax-Exempt Status

The general locker-room talk, as one accountant put it, is that the easiest way to prevent future international fraud is to restrict the organizations that can gain tax-exempt status. Many Israeli organizations currently have or are thinking of opening “Friends of” organizations in the States to help fundraise from American citizens. Donations to these American-based organizations are exempt from United States federal taxes and are channeled to the final destination in Israel.

The U.S. Department of Treasury has only enough manpower to audit between 2 – 3% of registered charities in America. Scrutiny of organizations that already have 501(c)3, then, seems almost like an impossibility. However, as every new organization that wants tax exempt status needs approval from the IRS, it would be a relatively simple procedure to restrict approval to new charities; more specifically, to new charities that donate to international causes.

This could be done simply by requiring additional paperwork or by imposing a minimum existence period, as is the case in Israel.

(More about the difference between USA and Israeli charities can be found in my article entitled “Defining an Israeli Nonprofit Organization.”)

Those that are worried about obtaining this status should forget about waiting for the “right” time and apply now. For those organizations that do not set up a “Friends of” charities, organizations such as the PEF, Central Fund, FJC, One Israel Fund and others can provide receipts to donors and forward the money to the intended Israeli causes.

Tizku LeMitzvot [May you continue to merit doing good deeds],

Shuey

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Related Posts:

The New Jersey Scandal, Pt. 1: The Facts

The New Jersey Scandal, Pt. 2: The Israel Fallout

For those individuals or corporations familiar with nonprofit organizations in the United States, any analysis of the status of an Israeli charity should begin with a comparison.  This contrast will shed light on the many differences that exist in the two countries’ legislation and definition of a nonprofit organization.

American Nonprofit Organizations

In the United States, all for-profit and nonprofit organizations are companies.  Each company is registered in the state where it is headquartered; the definition and governance of these companies differs slightly from state to state.  In the United States the title of nonprofit is a federal one, referring to any organization that is exempt from some federal income taxes (although many states use the federal guidelines to exempt similar organization from state taxes, as well).  All organizations that fall into this category are labeled as 501(c).  While there exist 28 categories, only those organizations belonging to the 501(c)3 category will allow an individual’s donation to be tax-exempt.  This group is divided into public charities and private foundations.  For the purpose of this article, the definitions of the two groups are not relevant.  In short, it is these 501(c)3 organizations that have been colloquially dubbed “nonprofits” in the United States.

Israeli Nonprofit Organizations

In Israel, traditional nonprofits are called amutot (or amutah in singular) and have their own governmental oversight body, called the Rasham Ha’amutot (Registrar of Nonprofit Organizations).  Companies have a separate federal group tasked with overseeing them called the Rasham Hata’agidim (Registrar of Companies).   Both registrars can contain organizations that would be considered non-profit and for-profit under American standards.

Further investigation reveals that within each registrar are subcategories that will be referred to as licenses or statuses for the purpose of this article.  As most nonprofits are registered with the Rasham Ha’amutot (Registrar of Nonprofit Organizations), it is logical to start the analysis from here.

1. Mispar Ha’amutah [Nonprofit Organization Number] – This is simply a number that the charity receives letting the public know that this organizations is registered with the government under the Registrar of Charities; as such, this charity is subject to government scrutiny under the Amutah (Nonprofit) Law.  This number will function like an I.D. number (for Israelis) or like a social security number (for Americans).  This number is for identification purposes only and does not label donations the charity receives as tax-exempt.  The process for receiving a nonprofit ID number takes approximately a month, according to the staff at the Registrar of Charities.   
2. Nihul Takin [Sound Management] – This is a certificate awarded to organizations that follow an additional set of management guidelines as decreed by the Registrar of Nonprofits.  This status is assigned to organizations that have been in activity for no less than two years.  For the first two years, there is an interim document that can be obtained called “Certification of Validity of Presentation of Documents.”  An organization will not be able to obtain grants or contracts from the government without the nihul takin status.  For better of for worse, many institutions outside Israel are using the nihul takin as their benchmark, as well. 
3. Mosad Tziburi [Public Institution] – This status is given by the Ministry of Finance and declares the organization’s funds are to be tax exempt; for example, profit earned from investments made with a bank or financial institution would be tax exempt for this kind of organization.  This status does not brand the donations that the charity receives as tax deductable.  A nihul takin license is required when applying to be a “public institution.” 
4. Se’if 46 [Paragraph 46] – This status is granted by the Finance Committee of the Knesset on the recommendation of the Finance Committee to organizations that have obtained status as a public institution.  It is the “Paragraph 46” status that is comparable to the nonprofit 501(c)3 status in the United States.  Individuals that donate to charities that have Paragraph 46 status can get up to a 35% refund on their taxes.  An expert accountant in the field estimated the minimum time required to receive Paragraph 46 status as six months.  Practically speaking, this means that two and a half years of existence is the absolute earliest an Israeli nonprofit can expect money donated to them to be tax-exempt.  It is important to note that only approximately a third of the charities operating in Israel have this status. 
5. Malkar [Institute Not-Intended for Profit] – This license is granted from the Ministry of Finance and can be interpreted as “additional level of fiscal approval.”[1]  Organizations with this status can sell goods and services without charging VAT [Value Added Tax], or sales tax.  Purchases made by the charity, however, are still subject to VAT. 

A small fraction of nonprofit organizations exist as Chevrot Leto’elet Hatzibor [Companies for the Benefit of the Public].  These organizations are governed by company laws and are registered with the Rasham Hata’agidim [Registrar of Companies].  These institutions can also apply for all of the above licenses, if they are founded “for the promotion of commerce, arts, science, religion, charity, or any other social function with the aim of benefiting the public.”[2]

While the Amutah (Nonprofit) Law established by the Knesset is quite clear and concise, the guidelines managing nonprofits in Israel are murky, cumbersome, and confusing; this is due to the Israeli Government having created additional licenses and leaving them in the control of different branches of the government.  Those individuals or institutions looking to make a comparison between organizations registered in the United States and Israel will, thus, find their compass missing its needle.  The simple charity ID number does not tell a donor or oversight committee anything about the organization.  The additional steps of obtaining public charity, tax-exempt, or malkar status are less an evaluation of the management of the amutah and more of an internal argument to the Israeli Government that the organization has earned to right to be tax-exempt.  This leaves the general public with only the nihul takin (albeit its own deficiencies and stringencies) as the only fair judge of an organization’s true nonprofit status.

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Works Cited 

[1]  Eliezer David Jaffe “The State, Volunteers and Nonprofit Organizations in Israel: the Nature of the Relationship” (Giving Wisely, The Internet Directory of Israeli Nonprofit
and Philanthropic Organizations), http://givingwisely.org/State.htm

[2]  Ibid

Bibliography

To supplement my own knowledge and experience, I drew upon the following resources:

“501(c)” (Wikipedia, The Free Encyclopedia), http://en.wikipedia.org/wiki/501(c)

“Application to be Recognized as a Public Institution” (Israeli Tax Authority), http://www.finance.gov.il/taxes/docs/malkar_2006-09-20.pdf

“Presentation of Documents to Obtain Certification of Sound Management for 2010” (Israeli Ministry of Justice) http://www.justice.gov.il/NR/rdonlyres/AA0674DA-C669-4242-B2A2-448BAE3257B2/14849/2012.pdf

“The State, Volunteers and Nonprofit Organizations in Israel: the Nature of the Relationship” Eliezer David Jaffe, (Giving Wisely, The Internet Directory of Israeli Nonprofit and Philanthropic Organizations), http://givingwisely.org/State.htm

Translations of Hebrew words to English were done through Morfix @ http://milon.morfix.col.il