Compliance Issues For Charities & Charitable Gift Planners Part I - State Law Compliance

Compliance Issues For Charities & Charitable Gift Planners Part I - State Law Compliance

Article posted in Compliance on 28 July 2000| comments
audience: National Publication | last updated: 18 May 2011
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Summary

The federal government and many states have rules regarding charitable solicitation, filings, registration and other things that charities and charitable gift planners must comply with to ensure lawful operation. Sorting these rules out can sometimes be difficult, particularly when a charity operates in more than one state. In Part I of a two part article, PGDC legal editors provide an overview of the state law compliance area. Part II will focus on federal compliance issues affecting charities and charitable gift planners.

by: Emanuel J. Kallina, II, Esquire & Jonathan D. Ackerman, Esquire

Click here for Part II.

Introduction

The federal government and many states have rules regarding charitable solicitation, filings, registration and other things that charities and charitable gift planners must comply with to ensure lawful operation. Sorting these rules out can sometimes be difficult, particularly when a charity operates in more than one state. Part I of this article provides an overview of the state law compliance area. Part II of this article will focus on federal compliance issues affecting charities and charitable gift planners.

State Compliance Issues

Charitable Solicitations Laws

The state charitable solicitations rules are not often discussed in the planned giving arena. However, these rules have clearer application to charitable gift planners, because many planned giving officers at charities and their consultants, as well as professional advisors to donors, will visit one-on-one with potential donors across the country.

Although the state laws represent a patchwork of different rules and requirements, as further discussed below, the intent of these laws is to protect a state's citizenry from fraud - a consumer protection motive. It should be noted that there are movements on both sides of the compliance issue. For instance, one organization, American Charities for Reasonable Fundraising generally takes a position that state regulation of charities should be strictly limited or eliminated, while others think that effective governmental oversight is essential to the well-being of the charitable community.1 Certainly, a movement towards uniformity of these rules amongst the states should be promoted, as discussed below.

Nevertheless, the failure to comply with these rules open up the charitable gift planner to civil, and even criminal sanctions. Certainly, a charity's (or their professional fund raisers') failure to comply will create a severe public relations issue.

First Amendment Applies to Charitable Solicitations Laws

The constitutionality of regulating the solicitation of charitable contributions was unsettled until the 1980s. Beginning with Village of Schaumburg v. Citizens for a Better Environment,2 three United States Supreme Court cases came out on this issue during that decade. The Supreme Court has essentially had to balance the right of a state to regulate activities within its borders, while preserving the constitutional right of a charity to solicit funds. A brief description of these cases follows.

In Schaumburg, the issue before the Supreme Court was whether a municipal ordinance in Illinois which prohibited charitable solicitation unless the fundraising charity could demonstrate that at least 75 percent of receipts are devoted to its charitable purposes was an undue intrusion upon the rights of free speech. The Supreme Court relied on prior authorities to find that the entire solicitation is protected speech under the First Amendment rather than commercial speech. The Court observed that charitable solicitations contain, among other things, the dissemination of information in addition to appeals for funds. Since a charitable solicitation is protected speech, a strict scrutiny standard of review was applied, and the Court found the ordinance unconstitutionally overbroad. The Court distinguished between traditional charitable organizations and advocacy charities, which were organizations "whose primary purpose is not to provide money or services--but to gather and disseminate information about and advocate positions on matters of public concern." The Court indicated that the 75-percent limitation might be enforceable against traditional charitable organizations, but it could not be constitutionally applied to advocacy charities.3

A few years later, the Supreme Court issued Secretary of State of Maryland v. Joseph H. Munson Co.,4 which dealt with Maryland's solicitation statute. The statute prohibited charitable organizations, "in connection with any fundraising activity, from paying expenses of more than 25% of the amount raised, but [also authorized] a waiver of this limitation where it would effectively prevent the organization from raising contributions." As with the ordinance in Schaumburg, the Court found that the Maryland statute was unconstitutionally overbroad. The Court stated, "The statute cannot distinguish organizations that have high fundraising costs not due to protected First Amendment activities from those that have high costs due to protected activity." Unlike the Court in Schaumburg, the Court in Munson did not differentiate between different types of charities.5

Finally, in Riley v. National Federation of the Blind of North Carolina, Inc.,6 the Supreme Court reviewed North Carolina's charitable solicitation statute. North Carolina's law did not place a limitation on fundraising expenses. Instead, it (i) limited the amount of fees that could be paid by a charity to a professional fundraiser or solicitor by instituting a three-tiered, percentage-based schedule for determining what constituted an "excessive and unreasonable" fee; (ii) required the professional fundraiser or solicitor to disclose to the potential donor the percentage of charitable contributions collected during the previous 12 months that were expended for charitable purposes before asking the donor for funds; and (iii) required professional fundraisers and solicitors to obtain licenses before soliciting while allowing volunteer fundraisers and solicitors to solicit after submitting an application. The Supreme Court ruled that all three parts of this law were unconstitutional. It found the three-tiered schedule unconstitutionally overbroad. It stated that the disclosure requirement did not retain "its commercial [speech] character when it is inextricably intertwined with otherwise fully protected speech." As to the prior registration requirement, the Court indicated that it placed an undue burden on speech because there was no requirement that the state respond within a specific time period.

Typical State Laws

Most every state regulates charitable solicitation in some fashion. This regulation may be in the form of registration requirements for charities, professional solicitors, professional fundraisers and/or commercial co-venturers. Or it may take the form of civil, criminal and deceptive practice sanctions. As noted above, charities operating in more than one state face difficulties in trying to comply with the charitable solicitation laws of each applicable state, because there is little uniformity among the states in the technical registration rules, exemptions from registration and disclosure requirements. It is also confusing when the states use the same terminology to mean different things. For example, terms such as charitable organization, charitable solicitation, professional solicitor, professional fundraiser and commercial co-venturer may have different meanings from state to state.

Generally, charities planning to solicit charitable contributions within a particular state must register with the appropriate state regulatory authority. Currently, Delaware, Hawaii, Idaho, Indiana, Iowa, Montana, Nebraska, Nevada, South Dakota, Vermont and Wyoming do not require charities planning solicitations to register within the state. Of these states, Hawaii, Indiana, Iowa, South Dakota and Vermont do require professional solicitors and professional fundraisers to comply with certain filing or registration requirements. Please note that these laws are constantly subject to change.

In many cases, the state requires a charity to file an initial registration and renew it annually. The state usually has a specific form for this purpose. The charity may need to include a copy of its Form 990, articles of incorporation, by-laws, determination letter, fundraiser contract(s), if any, and annual financial reports.

Movement Towards Uniformity

Although much of the information provided to the states is similar, there is no method of registration that is universally accepted by every state requiring registration at this time. However, many states now accept the Unified Registration Statement,7 which is part of the Standardized Reporting Project undertaken by the National Association of Attorneys General (NAAG) and the National Association of State Charities Officials (NASCO). Even so, these states may still require different attachments to the Unified Registration Statement or may limit its use to the initial filing.

Application of the Solicitations Laws

Charitable solicitation laws typically apply to the following:

1. Charitable Organizations - The specific definition of a charitable organization varies from state to state. Generally, it includes any person organized and operated for a charitable purpose, with broad definitions of "person" and "charitable." For state law purposes, charitable organizations may include organizations that are not public charities under Code8 Section 501(c)(3).

However, some states provide for exemptions from the initial and annual registration requirements for certain charitable organizations. Once again, the exemptions are not uniform among the states. As a general rule, churches are exempt from the registration requirement. Although schools or hospitals may be exempt in some states, many states still require them to register. For instance, some states require schools that only solicit students, alumni and family exempt, while others do not recognize that exemption. Some states require the charity to file a request to qualify for the exemption, while other states provide for an automatic exemption. Some states may have a gross receipts minimum, where no professional fundraiser or solicitor is retained.

2. Professional Solicitor - In most states, professional solicitors include any person, or an agent of a person, who is paid to solicit contributions for charitable purposes. Usually, the charity and professional solicitor are required to enter into a written agreement and a copy of the written agreement must be filed with the state. Some states use other terms, such as paid solicitor, professional commercial fundraiser, professional fundraising firm, commercial fundraiser or professional fundraiser, instead of professional solicitor. Interestingly, more states require registration of professional solicitors than require registration of charitable organizations. The reporting and disclosure rules vary, with many states including a bonding requirement.

3. Professional Fundraiser - Professional fundraisers are generally defined as someone who conducts, advises or acts as a consultant in connection with the solicitation of contributions for, or on behalf of, a charitable organization, and is paid a fixed fee under a written agreement. Many states require a copy of the written agreement to be filed. Some states refer to this person as a professional fundraising counsel, fundraising counsel, professional fundraiser consultant or fundraising consultant. As with professional solicitors, many states require annual registration and reporting by professional fundraisers. Professional fundraisers may be required to maintain accurate books and records and there may be a bonding requirement.

What is the distinction between a professional fundraiser and professional solicitor? In general, a professional solicitor solicits, or actually takes receipt of, charitable contributions, while a professional fundraiser merely advises charities regarding charitable solicitations. In some states, the definition of professional fundraisers include professional solicitors or vice versa. However, general exemptions apply to an employee of a charity, an attorney rendering legal advice, and an investment counselor or banker who advises a client to contribute to a charity.

4. Commercial Co-Venturer - Often a charity will enter into an agreement with a for-profit, commercial business allowing the business to use the name and goodwill of the charity in conjunction with the sale of goods or services. A few states regulate these sorts of agreements and may impose bond requirements.

Methods of Charitable Solicitations

Newsletters and brochures, which allow charities to easily reach large numbers of people virtually simultaneously through bulk-mailings, are two of the more common methods of charitable solicitation. Charities may target these to individuals who have already donated to the charity or who are likely to donate because of a connection to the charity or past donations to similar charities.

In-person solicitation is another popular method of charitable solicitation. Planned giving officers develop relationships with donors and potential donors by visiting with them at home and work. In-person solicitations also include solicitations made door to door, on the street and in the airport. Telephone solicitation is a growing method of charitable solicitation. However, charitable telemarketing is gaining wider attention from state agencies.

Currently, none of the states' charitable solicitations laws specifically address Internet solicitations. However, several states' laws may reach Internet solicitations because of their broad definitions of charitable solicitations and the use of phrases such as "through any medium," "each request for a contribution," and "request[s] of any kind for a contribution." Further, if state courts follow the reasoning of United States v. Thomas, 74 F.3d 701 (6th Cir. 1996), then communication via the Internet may be considered sufficient contact with a foreign state to subject the charity to that other state's law. The Internal Revenue Service ("IRS" or "Service") is presently considering various Internet-related issues for charities and is expected to issue guidance on the validity of charitable contribution acknowledgments for gifts over $250 sent to donors by e-mail.9 Notwithstanding the legal implications of this issue, it appears that state regulators are becoming more interested in internet solicitations and concluding that states have a legal obligation to enforce the charitable solicitations laws with respect to internet solicitations.

Disclosure Requirements

Many states require oral or written disclosure of the availability of certain information to prospective donors. Common information that must be provided includes where to obtain a copy of the charity's official state registration or financial statements and the identification number of the charity or professional solicitor. For more general information with respect to charity's disclosure requirements, please see http://www.charitableregistry.com.

Penalties for Noncompliance

Typical civil penalties for noncompliance with a state's charitable solicitations laws include revocation, cancellation, suspension or denial of state registration, an investigation by the appropriate state officials, fines on charities, officers, trustees or other persons with fiduciary responsibility, loss of tax-exempt status and prosecution under the state's unfair trade practices or deceptive practices law.

Criminal penalties may also be imposed. Failure to comply with a state's charitable solicitation laws may be a misdemeanor or a felony. Officers or trustees who engage in fraud or a wilful violation of the law may be subject to criminal sanctions.

State Enforcement

Typically, a state becomes aware of noncompliance or improper solicitation when someone makes an inquiry to or files a complaint with the state's regulatory agency about a particular charity. A state may also be alerted to a charity's noncompliance when a professional solicitor or professional fundraiser registers on behalf of the charity and files the contract with the state.

Needless to say, a charity accused of a violation of state law by the state or a donor's family may need to do extensive damage control to regain the public's trust. The level of public relations necessary to regain the public's trust likely will depend upon the extent or seriousness of the alleged violation or failure to comply. In any event and for all reasons, compliance with the state rules is always preferable, especially because compliance is not that burdensome.

It should also be noted, however, that several counties or cities across the country require registration if solicitations will take place in their counties, i.e., Columbus, Ohio, Jefferson County, Kentucky, many cities within California, and Pinellas County, Florida. One can understand that states should be able to amass information regarding charities that solicit monies from its residents; however, the rights of counties and other localities to require registration pushes these regulatory rights to the limits and appears to be over burdensome.

State Attorney General's Interest in Planned Giving

In most states, the state's attorney general (or other similar governmental agency) is granted general authority to act on behalf of the public with respect to charitable organizations and trusts. The attorney general may be authorized to conduct inquiries and initiate lawsuits if it believes mismanagement may have occurred. Typically, the attorney general (or other similar governmental agency) has specific statutory authority to enforce the state's charitable solicitations laws. The powers of the attorney general can include the right to investigate charities, professional fundraisers and professional solicitors, to initiate court actions for preliminary or permanent injunctions against charities, professional fundraisers and professional solicitors, to enforce and impose civil penalties and to initial criminal proceedings.

Many states also give the attorney general specific authority to enforce and otherwise protect the public's interest with respect to charitable trusts, including charitable lead and charitable remainder trusts.

Unauthorized Practice of Law in Planned Giving

Representatives of charities and non-attorney advisors should take care not to engage in the unauthorized practice of law. Exactly what constitutes the practice of law is a question of state law and, in many cases, activity with respect to a charitable gift will cross state borders. There are various definitions of the practice of law around the country as well as varying levels of enforcement of the prohibition against the unauthorized practice. The professional ethics rules governing attorneys generally prohibit assisting non-lawyers in the unauthorized practice of law.

Although it is clear that giving legal advice would constitute the unauthorized practice of law, it is not always clear where the line between legal and non-legal advice falls. Various activities by non-lawyers in providing legal documents, such as the drafting, marketing, selling and overseeing the execution of those documents, may constitute the unauthorized practice of law, depending on the law of the particular state and the particular facts involved. The funding of trusts by non-lawyers may also be restricted. One of the broadest applications of this rule is found in The Illinois Fraud and Deceptive Business Practice Act which provides that, with certain exceptions, the "assembly, drafting, execution and funding of a living trust document or any of those acts by a corporation or a nonlawyer is an unlawful practice within the meaning of this Act." A first-time violation of the Act is a misdemeanor and a subsequent violation is a felony.

Great care should be exercised by non-lawyers in assisting donors in structuring their charitable gifts.

Other Requirements

Charitable Remainder Trusts - Some states require the filing of charitable remainder trust agreements with the attorney general, i.e., Illinois and South Carolina, and may additionally require the filing of periodic reports by its trustees, the powers and duties of the trustee, and an inventory of assets. Record keeping requirements and annual auditing may also be imposed.

Charitable Gift Annuities - Among those states which regulate charitable gift annuities, states may require charities to obtain a permit, impose annual filing requirements, impose investment restrictions and require specific disclosure in the gift annuity agreement, or require that the charity be in existence for a stated period of time.

Charity - States may require a charitable organization to file its Form 990 with the applicable taxing authority.

Qualification to Transact Business - States require any entity which transacts business within its jurisdictional borders to qualify to transact business. Generally, a sufficient nexus with the state must exist in order to require a charity to so qualify. Clear lines are hard to come by in this arena. However, a physical presence within a state (such as an office) clearly establishes sufficient nexus. Anything less than a physical presence is unclear. Qualification generally requires a one page form to be filed with the state which selects a resident agent located in that state. Such qualification is sometimes required in complying with the charitable solicitations registration process.

Franchise, Personal Property, Real Property, Sales and other Local Taxes - A variety of taxing regimes apply in all states with state-by-state exemptions for charitable organizations conducting certain types of activities.

Conclusion

State law compliance is an important, yet sometimes confusing, issue for charities and charitable gift planners. To avoid potentially embarrassing publicity or expensive penalties, charities and charitable gift planners need to be familiar with the various state rules governing their operations. One component of compliance is making sure the rules on charitable solicitation are followed. As discussed above, many states regulate charitable solicitation but the rules and reporting requirements tend to vary from state to state.

Click here for Part II.


Footnotes


  1. Swords, Peter, Nonprofit Accountability: The Sector's Response to Government Regulation, The Tax Exempt Organization Tax Review, September, 1999 - Vol. 25, No. 3, republishing from the Norman R. Sugarman Memorial Lecture, Mandel Center for Nonprofit Organizations, Case Western Reserve University, March 16, 1999.back

  2. 444 U.S. 620 (1980).back

  3. Id.back

  4. 467 U.S. 947 (1984).back

  5. Id.back

  6. 487 U.S. 781 (1988).back

  7. Go to http://www.nonprofits.org to learn how to obtain a copy of a Unified Registration Statement. According to this web site, 33 states now accept this common form. Other excellent resources on the charitable solicitations laws include: Hopkins, Bruce K., The Laws of Fundraising, Second Edition and Giving USA - Annual Survey of State Laws Regulating Charitable Solicitations, published annually by AAFRC Trust for Philanthropy.back

  8. All references to the Code are to the Internal Revenue Code of 1986, as amended from time to time.back

  9. Robert C. Harper, Jr., Group Manager in the IRS Exempt Organizations Division, Remarks at 17th Annual Representing and Managing Tax-Exempt Organizations Conference, Georgetown University Law Center (May 5, 2000).back

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