The Southern Michigan Railroad Society is a nonprofit public charity, under 501(c)(3) of the Tax Code. It is a membership organization. Though Michigan law does not make this distinction, it is a "public benefit charity".
For-profit vs non-profit
For-profit companies can be set up many ways, but they all lead to paying taxes. A nonprofit must have a charitable purpose of some kind, but avoids most tax obligations.
501 flavors and then some
The IRS recognizes an amazing variety of nonprofits. Churches, credit unions, foundations, retirement trusts. Some of them are reserved for very specific things. The one you're most familiar with is the 501(c)(3), which is the most versatile (and most tax-deductible, hmm!)
IRS recognizes the Southern Michigan Railroad Society as a 501(c)(3) non-profit organization. SMRS doesn't have to pay taxes, and donations are tax deductible. The trade-off is that SMRS assets can never benefit any other entity except another charity. Money is a one-way street.
Deals can happen, but only at fair market value. Profiteering or buddy deals are not allowed - neither is coercion. Penalties are severe. Even more, conflicts of interest are prohibited.
Courts give great deference to the management decisions of 501(c)(3)'s.
Public Charity vs. private foundation
The IRS distinguishes two kinds of 501(c)(3)'s.
A public charity is an institution which serves the public, draws its funding from the public, and has a suitable purpose, including education and science. Almost any museum will be a public charity.
The other kind of 501(c)(3) is a private foundation - like the Ford Foundation. They typically take a large amount of money, invest it, and give the investment proceeds to public charities.
The Southern Michigan Railroad Society is a public charity.
Public-benefit vs. mutual-benefit
Michigan law doesn't recognize this difference, but many other states do. A public-benefit charity serves the general public, such as a museum. A mutual-benefit corporation serves only a limited group - for instance a homeowner's association, or some clubs. You might think "Oh, a school serves the students" - but in fact a school is a public-benefit corporation.
The Southern Michigan Railroad Society would be a public-benefit nonprofit if it were in a state which recognized the concept.
Membership organization vs. Board-only
For any given nonprofit... how does the Board of Directors get picked? It depends. Usually, either the members elect the board, or the board itself appoints replacement members.
An Indiana nonprofit survey shows three-fourths of Indiana nonprofits are membership organizations (p. 6). 76% of those use volunteers and value them highly. Most have boards of directors. Notably, 87% report that finding new volunteers is a challenge. (p. 7). Museums are a tiny minority.
In a membership organization, political governance comes from the members. A member is expected to have a legitimate, constructive interest in the organization's purpose. Some nonprofits have additional requirements to vote, such as being an active volunteer.
But always, "one member, one vote". Michigan law is badly written in this area. Proxies are generally disallowed in nonprofits. Michigan law defers to the nonprofit's bylaws. SMRS's bylaws invoke Robert's Rules of Order. Robert's Rules say this.
A board-only nonprofit has a board who picks its own replacements. The board appoints the board. Some people dislike this, since the board does not answer to the people it serves. Fortunately, the Southern Michigan Railroad Society is a membership organization.
Board-selected boards are most common in foundations, which hold enormous amounts of money. Membership wouldn't work there - a conspiracy could join in mass, vote themselves in, and give the money to each other.
A very rare form is the "share based" nonprofit. That's how private companies work. This can work in a nonprofit if the number of shares is fixed, and tied to something of high value - such as sidewalk frontage in a business district, or acreage in a farm co-op. Obviously, a share-based system cannot possibly work if unlimited additonal shares can be acquired cheaply - because someone could simply buy an overwhelming number of shares and seize control.
Shares based nonprofits are only worth mentioning because Michigan law is lazy. They wanted to cover "membership" and "shares" nonprofits in the same law (Act 162 of 1982). So "shareholders" and members" are always mentioned together. (click for examples: 1 2 3 4) A fellow might get the impression that members and shares are the same thing! Anyway, shares nonprofits are rare, and many states prohibit them, and Michigan is considering it.
Membership Organization vs "private club"
It's easy to get confused. After all, if it's a membership organization, doesn't that mean it's a private club? Not at all.
The simple fact is, most public charities are membership organizations - as the Indiana report revealed. They serve the public generally - think Kiwanis or Rotary. Membership merely reflects a special interest and level of involvement in the charitable cause.
Private clubs do exist. Some states call them "mutual-benefit nonprofits". They exist to provide services to their members - and not to the general public. Like a co-op, or an employee credit union, or an HOA. Yes, those are nonprofits, but they cannot be 501(c)(3) public charities.
The Southern Michigan Railroad Society is a 501(c)(3) public charity. It is a membership organization because that is how railway and technology museums are traditionally set up. Anyone can volunteer. But hard-working volunteers tend to really care about how the nonprofit is governed. And that's what membership is all about.
Friday, January 22, 2010
The three sectors
One very basic question about the Southern Michigan Railroad Society (indeed, any railway museum) is, "what kind of institution is it?" You've heard of the public sector - the government. And the private sector - industry. Less well known is the civic sector - nonprofits.
The civic sector is a significant part of our economy. It includes hospitals, schools, churches, retirement funds, museums, civic associations like the Boy Scouts or Kiwanis - even homeowner's associations.
A nonprofit is considered different from private industry because it works in a very different way. First, its causes are charitable - worthy of tax deduction and tax exemption. And second, once money enters the nonprofit system, it can never leave. No person or company can draw dividends or profits of any kind. They also cannot overcharge for goods or services. There are special rules constraining directors of a nonprofit from acting with a conflict of interest. This is enforced at the Federal level by the IRS.
Now, let's talk about taxation and liability. And for that, we need to look at the structure of companies, because a nonprofit is a kind of company. We journey back into the private sector.
What if you paint somebody's house and they pay you? It's just you, doing an informal business. The IRS calls that a "sole proprietorship" and you just tally the income and expenses on your personal 1040 (schedule C). As for liability, you have no protection, you can be bankrupted. If you do the same thing with friends, it's called a "partnership", and all the same applies.
Suppose you create "Paint Your House, Inc." Everything changes. A corporation is a separate legal "person". The corporation files its own taxes with its own SSN. You must keep your personal money carefully separate from corporation money, or else the corporation could be declared invalid! Why bother? Because a corporation stops liability. They can sue and bankrupt the company, but they can't touch you personally.
What is a nonprofit? Money put into a nonprofit is tax deductible, but can never leave the nonprofit system. Money must be carefully separate from personal finances of volunteers. It files a different tax return (form 990). The corporate model that fits this best is "corporation". And so, every nonprofit must also be a corporation.
It seems strange because we often associate corporations with all sorts of evil. But in this case, it's merely an organizational structure. Once a nonprofit incorporates, they apply to the IRS, which confers nonprfit status. There are many kinds of nonprofit status, both from the IRS, from states, and just in the nature of the structure chosen.
But that's for another blog entry.
The civic sector is a significant part of our economy. It includes hospitals, schools, churches, retirement funds, museums, civic associations like the Boy Scouts or Kiwanis - even homeowner's associations.
A nonprofit is considered different from private industry because it works in a very different way. First, its causes are charitable - worthy of tax deduction and tax exemption. And second, once money enters the nonprofit system, it can never leave. No person or company can draw dividends or profits of any kind. They also cannot overcharge for goods or services. There are special rules constraining directors of a nonprofit from acting with a conflict of interest. This is enforced at the Federal level by the IRS.
Now, let's talk about taxation and liability. And for that, we need to look at the structure of companies, because a nonprofit is a kind of company. We journey back into the private sector.
What if you paint somebody's house and they pay you? It's just you, doing an informal business. The IRS calls that a "sole proprietorship" and you just tally the income and expenses on your personal 1040 (schedule C). As for liability, you have no protection, you can be bankrupted. If you do the same thing with friends, it's called a "partnership", and all the same applies.
Suppose you create "Paint Your House, Inc." Everything changes. A corporation is a separate legal "person". The corporation files its own taxes with its own SSN. You must keep your personal money carefully separate from corporation money, or else the corporation could be declared invalid! Why bother? Because a corporation stops liability. They can sue and bankrupt the company, but they can't touch you personally.
What is a nonprofit? Money put into a nonprofit is tax deductible, but can never leave the nonprofit system. Money must be carefully separate from personal finances of volunteers. It files a different tax return (form 990). The corporate model that fits this best is "corporation". And so, every nonprofit must also be a corporation.
It seems strange because we often associate corporations with all sorts of evil. But in this case, it's merely an organizational structure. Once a nonprofit incorporates, they apply to the IRS, which confers nonprfit status. There are many kinds of nonprofit status, both from the IRS, from states, and just in the nature of the structure chosen.
But that's for another blog entry.
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