Choking Out Local Community Service Organizations: Rising Federal Tax Regulation and Its Impact on Small Nonprofit Entities
29 Pages Posted: 18 Dec 2012
Date Written: 2011
Small community nonprofit and charitable organizations are a vital component of American life and culture. These organizations encourage community collaboration and are in-tune with the acute needs of their respective local populations. In the face of pressure to downsize government and reduce federal, state, and local spending, small nonprofits have become integral to delivering basic human and social goods and services to the public. These groups endure almost solely on donations of time and money and do not have cash reserves or extensive assets that will allow them to hire legal or other professional counsel to assist in business and legal compliance matters.
Obtaining and maintaining Internal Revenue Code (IRC) § 501(c)(3) tax-exempt status allows the balance of these groups to operate as viable entities by opening the door to vast grant and donation opportunities with which to fund their programs. Gaining tax-exempt status requires in-depth business and financial planning and a complex application process, which many small nonprofits complete without the benefit of counsel. Until recently, small nonprofit organizations were subject to modest federal regulatory compliance measures in excess of compliance with the tax code under which they gained exemption.
Over the past decade, in the name of strengthening transparency, accountability, and governance, Congress and the IRS have increased federal regulation of nonprofit and charitable entities, which includes many measures that were otherwise within the purview of state rule, and have not spared small nonprofits in this effort. New regulations of significant interest to small nonprofit groups include the 2004 revision of the federal application for tax-exempt status, which now includes extensive governance provisions, and the new annual reporting requirement for small nonprofits and revocation of tax-exempt status for consecutive non-filing, pursuant to the Pension Protection Act of 2006. This increase in regulation creates a certain “federalization” of nonprofit law that has overly burdensome consequences on valuable small nonprofit organizations with limited resources.
This Article begins by identifying and describing the unique and essential roles of, and challenges that face, small nonprofit tax-exempt organizations and their leaders. This Article then reviews the promulgation of new and heightened federal regulatory requirements that most concern small nonprofit groups and the impact and implications of these regulations. Informed by the theoretical models of Responsive Regulation and New Governance, this Article concludes by offering a reasonable regulatory approach as it relates to the restoration of federal tax-exempt status for small nonprofits facing revocation of tax exemption for failure to file consecutive annual returns.
Keywords: Community Economic Development, Small Business, Nonprofit, Tax Regulation, Social Capital
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