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Nonprofit Knowledge: State Regulatory Oversight of Tax-Exempt Organizations

I n-house counsel who work for and with US tax-exempt organizations are generally aware of the level of federal oversight of their activities. This is mostly due to annual Internal Revenue Service (IRS) reporting and filing requirements tied to their federal tax-exemptions, whether as a 501(c)(3), 501(c)(4), 501(c)(6), or otherwise. However, it is important to also comply with the state regulatory oversight areas that apply to these organizations.  

Below, we provide an overview of the state oversight areas that involve registering or reporting to help you better understand how they might apply to your organization.

1. Business entities

Most tax-exempt organizations, at their core, are incorporated as corporate entities, often as nonprofit non-stock corporations, depending on their state of incorporation. Incorporated entities such as corporations are usually required to file annual or biennial returns with their state of incorporation, as well as in states in which they operate.

These filings ensure that the corporate entity is in "good standing" and usually include information about the entity's officers and require the filing of a fee. When a tax-exempt organization is no longer in good standing in a state, it generally cannot legally do business there, even as a tax-exempt organization.

2. Taxation

Although tax-exempt organizations are generally exempt from federal corporate income tax, they are subject to state and local taxation unless they qualify and apply for an exemption. These include income, property, sales and use, and realty transfer taxes. A tax-exempt organization should not assume that is it automatically exempt from state and local taxes just because it has an income tax exemption from the IRS.

Further, tax-exempt organizations that employ staff are not exempt from requirements to withhold state — and federal — taxes on behalf of their employees.

3. Employment

Tax-exempt organizations that employ staff are not exempt from complying with the requirements of the state Department of Labor, human rights commissions, or other agencies that oversee employment laws. For example, nonprofit organizations must comply with minimum wage requirements and other laws that apply to employers.

4. Fundraising

Tax-exempt organizations that fundraise are required to register to do so in many states, usually as part of state consumer protection oversight. Although these requirements are traditionally considered to apply only to 501(c)(3) organizations, some states are extending the requirements to 501(c)(4) organizations as well, because the concept of "fundraising" can be widely interpreted. These registrations differ from state to state and usually include a fee along with financial information, corporate information, and details about fundraising initiatives.

Further, if your charity works with a company to raise funds — whether through implementing a cause marketing initiative (e.g, percentage of sales going to charity), using a professional fundraiser (e.g., telemarketer or direct mail), or fundraising counsel (i.e., someone who helps the charity develop its fundraising) — those arrangements are also regulated by many states' consumer protection laws.

5. Lobbying

Every state requires registration of lobbyists, including tax-exempt organizations that employ lobbyists or spend certain amounts on lobbying. Tax-exempt organizations must comply not only with applicable IRS lobbying requirements, but also with state lobbying requirements and oversight. These filings differ from state to state as do the definition of lobbying, lobbyist, and the various expense thresholds.

6. Data breaches

Many states have requirements for reporting data breaches. Tax-exempt organizations are not exempt from complying with these requirements if and when they have a data breach, which can come with a financial and reputational cost. These data breach laws and requirements are complex and vary by state.  

7. Additional areas of federal oversight

Although the above summarizes some key areas of state oversight of tax-exempt organizations, there are areas of federal oversight beyond the IRS that they should also be aware of.

  • Department of Labor, Equal Employment Opportunity Commission, Fair Labor Standards Act, and other federal employment organizations and laws that impact tax-exempt organizations as employers.
  • The FTC oversight of activities, particularly for 501(c)(6) trade association compliance with federal antitrust laws, on telemarketers who may act as professional fundraisers and on cybersecurity and other digital activities. There is increasing interest in having clear FTC oversight over 501(c)(3) charities.
  • Lobbying Disclosure Act and related registrations with the House of Representatives for tax-exempt organizations that meet certain employment and spending thresholds for lobbying US Congress.
  • US Postal Service and reduced nonprofit postal rates, for which some tax-exempt entities may qualify.

Tax-exempt organizations must become increasingly aware of the regulatory landscape in which they operate. They should be mindful of the various areas of changing oversight on the local, state, and federal level and ensure that all of their activities comply with the various applicable rules.

About the Author

Lakshmi Sarma Ramani Lakshmi Sarma Ramani was the general counsel of the National Association for the Education of Young Children and senior attorney at The Nature Conservancy. She is currently a member of the firm at Outside GC LLC where she is the outside general counsel to multiple nonprofit organizations.

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