The board must be familiar with the hierarchy of laws and the legal framework within which the organization functions.

• Nonprofits are covered under federal, state, and local laws and jurisdictions.
• An organization’s bylaws comprise a legal document describing the board’s structure and practices.
• IRS Form 990 inquires about existing policies and procedures relating to federal and state laws.

A charitable organization is generally organized as a corporation or a trust under the laws of the state in which it was created. Some organizations choose to operate as unincorporated associations, although that legal form leaves directors and members exposed to a higher degree of liability for financial and other legal responsibilities of the organization. Unincorporated associations are still subject to legal requirements for charitable organizations.

In order to be exempt from paying federal income taxes and to be eligible to receive tax-deductible contributions from the public, organizations (with certain exceptions¹) must apply for and be recognized by the IRS as tax-exempt under section 501(c)(3) of the tax code. To receive this classification, an organization must file a formal application (Form 1023) with the IRS that describes its current or planned financial and programmatic activities, organizational documents, and governance structure. Depending on the organization’s sources of support and other key factors, the IRS will determine whether it is recognized as a private foundation or a public charity. 

Private foundations derive their primary financial support from the contributions of a limited group of sources, such as an individual, family, or corporation. Foundations are subject to substantially more restrictive rules governing their operations, and their donors receive less favorable tax treatment for donations. For example, private foundations are prohibited from engaging in most direct or indirect financial transactions with their donors, directors, and businesses and family members of those donors and directors, except for compensation or reimbursement of expenses related to personal services that are reasonable and necessary to fulfilling the foundation’s charitable purposes. A private foundation is required to make charitable distributions every year equal to at least 5 percent of the value of its noncharitable assets and must pay an annual excise tax generally equivalent to 2 percent of its net investment income.²  Private foundations are prohibited from engaging in lobbying activities (subject to certain exceptions) and are subject to specific rules regarding its holdings in for-profit business enterprises and the types of investments it is allowed to make. Private foundations and their managers may be subject to severe excise taxes and other penalties for violations of these prohibitions.

Public charities generally derive a substantial portion of their funding from the general public or from a governmental unit. Federal tax laws define four types of public charities:

1. Public institutions, such as churches and religious congregations, schools and other educational institutions, hospitals and medical research institutions, and governmental units;
   
2. Publicly-supported charities that receive at least one-third of their financial support from qualifying contributions and grants or from providing program services to a broad constituency;
   
3. Supporting organizations that are organized and operated exclusively for the benefit of or to carry out the functions of one or more publicly-supported charities;
   
4. Public safety testing organizations. 

Charitable organizations are prohibited from supporting or opposing candidates for public office or intervening in political campaigns, but they may lobby public officials regarding legislation that might affect their existence, powers and duties, tax-exempt status, or the deductibility of contributions, often referred to as “self-defense lobbying.”⁴ Public charities (but not private foundations) may also lobby directly or conduct grassroots advocacy efforts to influence the outcome of other legislation so long as such efforts constitute an “insubstantial part” of the organization’s overall activities. The tax laws permit public charities to elect to follow specific rules for the amounts they can spend on direct and grassroots lobbying activities.⁵

Organizations that solicit charitable contributions must be knowledgeable of and abide by charitable solicitation regulations and reporting requirements of the states and local jurisdictions in which they operate or raise funds. Thirty-eight states and the District of Columbia currently require certain charitable organizations to register before soliciting residents or conducting fundraising activities within their state. Organizations that hire third parties to raise funds on their behalf must also take steps to ensure that those third parties comply with state and local registration and reporting requirements.

Charitable organizations that conduct specific types of services, such as nursing homes and other types of residential facilities, providers of health care or day care for children or adults, educational facilities, etc., must also abide by other laws and regulations that apply to any business, for-profit or nonprofit, that operates in those service areas. Charitable organizations that employ staff must abide by federal, state and local labor laws and regulations, and applicable employment tax and income tax withholding requirements.

^1. Houses of worship, specific related organizations, organizations (other than private foundations) whose annual gross receipts do not normally exceed $5,000, and organizations (other than private foundations) subordinate to another tax-exempt organization that are covered by a group exemption letter, are not required to seek formal recognition of 501(c)(3) status.

^2. IRC § 4940(a), Reg. §53.4940-1(a).

³ IRC §4966(d)(2) defines a donor-advised fund as a fund or account that is owned and controlled by a sponsoring organization, separately identified by reference to contributions of a donor or donors, and to which the donor or a designated advisor has or reasonably expects to have advisory privileges with respect to the distribution or investment of the assets in the fund. The definition specifically excludes a fund or account that makes distributions only to a single identified organization or governmental entity or that makes grants for travel, study or similar purposes provided that certain conditions are met.

^4. Treas. Reg. § 53.4945-2(d)(2)(ii).

^5. IRC §501(h).

1. Do our orientation materials provide new board members with sufficient information about board members’ collective and individual legal responsibilities?
2. Legal compliance is an ongoing process.What steps have we taken to ensure we stay current and are proactive about our organization’s legal obligations?
3. Does the board ask for regular briefings on any significant legal issues facing the organization?
4. Whom do we rely on for legal advice? Is this sufficient and appropriate for the size and complexity of our organization?

• Board members?
• Legal counsel (whether in-house or outside)?
• Resources for charitable and nonprofit organizations?

• 16 Protection of Assets
  
• 15 Board Education and Communication
  
• 22 Annual Budget, Financial Performance, and Investments