Russell, Thomas J.

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DePaul Law Review Volume 15 Issue 2 Spring-Summer 1966 Article 2 Some Problems in Representing a Not-for-Profit Organization Thomas J. Russell Follow this and additional works at: https://via.library.depaul.edu/law-review Recommended Citation Thomas J. Russell, Some Problems in Representing a Not-for-Profit Organization, 15 DePaul L. Rev. 276 (1966) Available at: https://via.library.depaul.edu/law-review/vol15/iss2/2 This Article is brought to you for free and open access by the College of Law at Via Sapientiae. It has been accepted for inclusion in DePaul Law Review by an authorized editor of Via Sapientiae. For more information, please contact digitalservices@depaul.edu. SOME PROBLEMS IN REPRESENTING ANOT-FOR-PROFIT ORGANIZATIONTHOMAS J. RUSSELL*MERICA has become a nation of "joiners." Nearly everyone todayA belongs to one or more civic, patriotic, religious, educational,charitable, fraternal, social, business league or labor organizations.All these associations or groups are referred to as "not-for-profit,"since any income earned by the organization is not distributed to themembers. However, little has been written about the various legalproblems confronting these not-for-profit associations in their dailyactivities. It is the purpose of this article to discuss briefly some of themore common of these problems.INCORPORATION AND PERSONAL LIABILITYMost of the larger not-for-profit organizations are incorporated.'Some have received special charters from the United States Govern-ment,2 while others have been specially incorporated by private lawsin the State of Illinois.8Incorporation of a not-for-profit association protects the individualmembers from personal liability in the event of any adverse claimsfiled against the organization. On the other hand, an unincorporatedassociation, which is not a subordinate body of a larger organization,* MR. RUSSELL is a Lecturer at De Paul University College of Law. He received hisJuris Doctor, cum laude, from De Paul University College of Law in 1949, and is a mem-ber of the Illinois Bar. He is a partner in the firm of Mitchell and Russell.1 In recent years, a majority of states have adopted statutes setting out the procedurefor incorporation of a not-for-profit corporation. In Illinois, prior to 1872, special char-ters were granted most not-for-profit corporations. From 1872 to 1944, only five sectionsof the Corporation Act covered not-for-profit corporations. At present, Illinois has adetailed General Not-For-Profit Corporation Act, containing over 100 separate sections.ILL. REv. STAT. ch. 32, §§ 163 (a) (l)-163 (a) (100) (1965).2 Those which have received their charters from the United States Congress includethe American Red Cross, 36 U.S.C. S 1 (1964); the Daughters of the American Revolu-tion, 36 U.S.C. S 18 (1964); the Boy Scouts of America, 36 U.S.C. S 21 (1964); the GirlScouts of America, 36 U.S.C. § 31 (1964); and certain national veterans' organizations.a Two of the many institutions specially chartered by the State of Illinois areNorthwestern University (Private Laws, 1861) and The Chicago Law Institute (PrivateLaws, 1857).PROBLEMS IN NOT-FOR-PROFIT ORGANIZATIONShas no legal recognition separate from its members If such an asso-ciation were to be sued, each member would be personally liable forpayment of any judgment entered against the group.5 Furthermore,this unincorporated association has no standing to sue at law or besued in its own name, but any action must be in the name of all mem-bers comprising it, however numerous they may be."This presents a problem for a local Parent-Teachers' Association, asuburban bowling league, or any other small group who may hold adinner or other social affair for its members and their guests. If some-one is injured at the affair, each member of the group can be heldpersonally liable for payment of the damages. The risk becomes greaterif alcoholic beverages are served at the affair, since the provisions ofthe Dram Shop Act then apply.Accordingly, any organization which engages in activities whichcould result in adverse claims should incorporate in order to avoidthe risk of liability otherwise imposed upon each member.8INCOME TAXMost not-for-profit associations, whether incorporated or not, areentitled to an exemption from payment of federal income taxes onfunds received by the association.9 However, the mere fact that anorganization is not for profit does not automatically entitle it to anexemption. It must submit proof of its right to an exemption. Until a4 Chicago Grain Trimmers Ass'n. v. Murphy, 389 Ill. 102, 58 N.E. 906 (1945). Sub-sequent to this decision, the legislature authorized unincorporated lodges or subordinatebodies of any society, or order, duly chartered by its grand lodge or body, to ownreal estate and sue and defend in its own name. ILL. REv. STAT. ch. 30, § 183-185 (1965).This, however, does not relieve the individual members from liability.5 Hodgson v. Boldrum, 65 Ill. 532 (1872).6 Sutherland v. Copeland, 350 II. App. 313, 112 N.E.2d 733 (1953); Cox v. Shupe,41111. App. 2d 413, 191 N.E.2d 250 (1963). See also, Fins, Re-examination of Jurisdictionin Light of New Illinois Judicial Article, 53 ILL. B.J. 12 (1964), wherein the author statesthat unincorporated associations can now be sued at law under the new judicial article,ILL. CONsT. art VI, § 9.7 ILL. REv. STAT. ch. 43, § 135 (1965), under which any person who either sells orgives away alcoholic liquor causing intoxication is liable to a person who is injured as aresult of acts of the intoxicated person.8 See Comment, 37 ILL. L. REv. 70 (1942).9 INT. Rzv. CODE OF 1954, §§ 401 (a) and 501(c) (d), lists the organizations which areexempt from taxation. The major types exempted include nonprofit corporations, suchas religious, educational and charitable institutions; civic and business leagues; and labor,social and fraternal associations. Also included in section 501 are trusts created by anemployer for the exclusive benefits of his employees, under section 401 (a).DE PAUL LAW REVIEWdetermination letter or revenue ruling establishes an exemption, anincome tax return must be field.10Even after exemption is granted, most organizations must thereafterfile an annual information return with the Internal Revenue Servicein order to continue to enjoy the exemption." In addition, all exemptorganizations are required to withhold taxes from their employees inthe same manner as any taxable employer.'2Furthermore, the exemption does not apply to all income receivedby the organization. If it operates a business enterprise which is un-related to its exempt purpose, it will be required to pay tax on allincome derived from "unrelated trade or business." 13However, churches are exempt from the tax imposed on unrelatedbusiness income. This exemption is strictly construed and is applicableonly to organizations fulfilling the technical definition of a "church"as defined in Regulation 1.511-2 (3) (i) and (ii). The Christian Broth-ers were denied an exemption from income taxes on earnings of theirworld-famous wine making operations because they were found notto qualify as a "church."' 4 The court held that even though theChristian Brothers were a religious order, organized under the aus-pices of the Roman Catholic Church, engaged in operation of paro-chial schools and novitiates, they did not constitute a "church" withinthe purview of the income tax law.The scope and extent of the exemption is dependent upon thesource of the income as well as the use made of the funds by theorganization. For example, a social club is entitled to an exemptionfrom federal income taxes if its income is primarily derived frommembership fees, dues and assessments. If the organization derivesa substantial part of its income from public patronage of its facilities,it will lose its exemption."5Even after an exemption has been granted, an organization maylose its exempt status if it enters into any "prohibited transaction,"' 8or accumulates an unreasonable amount of income.' 7 A "prohibited10 Treas. Reg. S 1.501 (a) (1) (1959). 11 INT. REv. CODE OF 1954, S 6033.12Treas. Reg. § 31.3401(d)-l(d) (1957).13 INT. REV. CODE OF 1954, S 513 (a).14 De LaSalle Institute v. United States, 195 F.Supp. 891 (N.D. Calif. 1961)."5 Treas. Reg. S 1.501(c) 7-1 (1958).10 INT. REV. CODE OF 1954, S 503 (c). 17 INT. REV. CODE OF 1954, S 504.PROBLEMS IN NOT-FOR-PROFIT ORGANIZATIONStransaction" is one in which an organization lends any part of its in-come or corpus without adequate security, pays unreasonable com-pensation for services rendered, makes its services available on apreferential basis, purchases or sells its securities for an inadequateconsideration or engages in any transaction resulting in a substantialdiversion of its income or corpus to the creator of the organization.Some not-for-profit organizations receive all, or a substantial part,of their income from a profit-making organization. Sometimes thisoccurs because the not-for-profit organization owns stock in the or-ganization carrying on the business for profit. However, the fact thatthe income is turned over to a tax-exempt organization does not en-title the profit-making organization to an exemption from incometaxes. If the organization carries on a commercial enterprise, its in-come is taxable despite the fact that the parent organization may betax-exempt. Such organizations are called "feeder organizations.1'8PROPERTY AND SALES TAXESThe obligations of a not-for-profit organization to pay real estate,sales and other local taxes depends entirely upon the constitution andstatutes of each state where either the property or organization, orboth, are located. In Illinois, the constitution authorizes the legisla-ture to exempt from taxation property "used exclusively for agricul-tural and horticultural societies, for school, religious, cemetery andcharitable purposes."' 9 Pursuant to this authority, the legislature hasgranted a number of exemptions from property taxes.20 These statutesare strictly construed, and all debatable questions are resolved in favorof taxation.21In addition, the courts have held that property which is owned by18 Treas. Reg. 5 1.502-1 (1963). 19 ILL. CONST. art. IX, S 3.20 ILL. REV. STAT. ch. 120, S§ 500.1-500.20 (1965), which contains a description of thevarious properties entitled to exemption. Included are burial grounds, school property,property of charitable institutions used for charitable purposes, and property used ex-clusively for religious purposes.21 Rotary International v. Paschen, 14 Ill. 2d 480, 153 N.E.2d 4 (1958), wherein thecourt denied an exemption to the administrative headquarters of the Rotary Interna-tional on the grounds that the organization was not "charitable" within the meaningof the law. It defined charitable as follows: "An organization is charitable only whenit exists to carry out a purpose recognized in law as charitable, and the law recognizesas charitable only those purposes which, if carried out, will benefit the public in sucha way that there is a consequent relief, to some extent, of the burden upon the Stateto care for and advance the interests of its citizens." (Id. at 488, 153 N.E.2d at 9).280 DE PAUL LAW REVIEWan exempt institution will not be entitled to an exemption unless theproperty itself is used for exempt purposes.22 This applies even thoughthe income received from the property is devoted to the exempt pur-poses of the organization.23 It is now generally recognized that notonly must the property be used for an exempt purpose, but it mustalso be owned by an exempt organization.24Recently, the legislature imposed a duty on owners of exemptproperty located in Cook County to file with the County Assessor,annually, a certificate to the effect that there has been no change ineither the ownership or use of the exempt property as of January1st of that year. Failure to file such certificate can result in loss of25exemption.Until August 1, 1961, most not-for-profit associations enjoyed anexemption from the obligation to pay retailer's occupation tax on anysales made to its members and guests.2 This was changed by legisla-tive amendment in 1961, and the only exemption granted at presentis with respect to sales by charitable, religious and educational institu-tions of items specially made for their members, such as uniforms,insignia, choir robes and isolated non-competitive sales by churchand educational groups, such as the annual Scout cookie sales, churchrummage and cake sales, and meals prepared by church workers.2 7 Thepresent law even requires schools and universities to pay a retailer'soccupation tax on proceeds of sales of school books to students.28This change in sales tax status of not-for-profit organizations hasnow imposed a duty on officers of these associations to prepare and file22 People v. Trustees of Schools, 364 I11. 131, 4 N.E.2d 16 (1936), wherein propertyowned by a public school district in Evanston was denied an exemption because theproperty was leased for commercial purposes at an annual rental of $22,500.23 Turnverein "Lincoln" v. Board of Appeals, 358 Ill. 135, 192 N.E. 16 (1934).24 Coyne Electrical School v. Paschen, 12 Ill. 2d 387, 146 N.E.2d 73 (1957).25 ILL. REV. STAT. ch. 120, § 500 (1965).26Svithiod Singing Club v. McKibbin, 381 Ill. 194, 44 N.E.2d 904 (1942), whereinthe court held that the Retailer's Occupation Tax Act, ILL. REV. STAT. ch. 120, § 440(1965), applied only to persons engaged in the business of selling at retail, and not-for-profit associations were not engaged in "business."27 Retailer's Occupation Tax Act, ILL. REv. STAT. ch. 120, § 440 (1965). See also,Illinois Dep't of Revenue, Rules and Regulations, Rule 38.28 See Follett's Book and Supply Store v. Isaacs, 27 Ill. 2d 600, 190 N.E.2d 324 (1963),wherein it was held that the legislature did not intend to exempt sales by schools whichwere in competition with profit-making establishments who had to pay a tax in con-nection with such sales.PROBLEMS IN NOT-FOR-PROFIT ORGANIZATIONS 1.751returns with the Department of Revenue of the State of Illinois. Theadded costs involved in such matters has also placed an additionalburden on the treasury of many organizations.29WORKMEN'S COMPENSATION AND UNEMPLOYMENTCOMPENSATIONThe Workmen's Compensation Act provides that any "publicservice, eleemosynary, religious or charitable corporation or associa-tion who has any person in service or under any contract for hire,express or implied, oral or written . . ." may elect to become subjectto the provisions of the Act. 0 Many persons working for and onbehalf of not-for-profit associations are volunteers and not employeeswithin the statutory definition.3' However, what is the status of astudent who received a reduced tuition and is injured while in theservice of the school? In Todd School for Boys v. Industrial Commis-sion," the Illinois Supreme Court held that unless the reduction intuition was compensation for the services of the student, he was notan employee within the meaning of the Act. Likewise, in AthleticAssociation of the University of Illinois v. Industrial Commission,33a student at the University of Illinois who was injured while perform-ing at an event sponsored by the University was not considered anemployee, since he received no payment for his services. Even thoughhis work was under the direction of the University and resulted infinancial benefits to the University, it did not in itself create a rela-tionship of employer and employee.Thus, it would seem that unless a volunteer worker or a studentreceives some direct compensation for his services, he is not an em-ployee. However, an officer of an organization who receives a yearlystipend for his services would seem to qualify as an employee andcreate a duty on the organization to protect itself under the Work-men's Compensation Act.The Federal Unemployment Tax Act 4 exempts certain organiza-29 See, e.g., supra, wherein it was stated that the annual volume of sales by collegeand university book stores to students in Illinois was $4,791,350. This now requirescolleges in Illinois to pay to the state approximately $190,000 in sales tax each year.30 Workmen's Compensation Act, ILL. REV. STAT. ch. 48, § 138.1 (a) (2) (1965).31 Id. at § 138.1 (b) (2). 32 412 Ill. 453, 107 N.E.2d 745 (1952).33 384 IIl. 208, 51 N.E.2d 157 (1943).34 68A Stat. 447 (1954) ; 26 U.S.C. § 3306 (1964).DE PAUL LAW REVIEWtions from the requirement of contributing to federal unemploymentcompensation for their employees.85 Notably among them are servicesperformed in the employ of religious, charitable, educational orother organizations described in the Internal Revenue Code,86 whichare exempt from federal income tax by the Code." In addition,services performed for most not-for-profit organizations exempt fromfederal income tax will not be included if the remuneration for suchservice is less than $50 in any calendar quarter.88The State of Illinois Unemployment Compensation Act89 is almostidentical with the federal law with respect to exemptions for not-for-profit organizations. Both the above exemptions allowed by the federalact are recognized by the state. °CONCLUSIONThe above constitutes only a brief discussion of a few of the prob-lems facing an attorney who may be called upon to represent a not-for-profit organization. The coverage is not comprehensive but onlyintended for the purpose of alerting legal counsel for a not-for-profitorganization to certain areas of the law that may affect the operationof the organization. Since most attorneys belong to a number of suchorganizations, for social, civic and other reasons, they are calledupon from time to time to advise the members regarding their legalobligations. The constitution, by-laws and Corporate Charter of theorganization must be carefully reviewed before any opinion should berendered by any attorney called upon to represent the organization.Both the courts and tax officials place great weight on the purposeclauses and membership qualifications set forth in the constitution, by-laws and charter of the organization. In addition, the actual operationsof the group are also scrutinized to determine its eligibility for ex-emption. Today, more than ever, as the need for taxes, both on thelocal and federal level, increases, not-for-profit organizations muststrictly comply with the law in every respect before they will beentitled to exemption from taxes.35 68A Stat. 447 (1954); 26 U.S.C. S 3306 (1964).86 TNT. REv. CODE OF 1954, S 501(c).37 INT. REv. CODE OF 1954, S 501 (a). See also, Federal Unemployment Tax Act, 68AStat. 447 (1954); 26 U.S.C. S 3306(c) (8) (1964).38 68A Stat. 447 (1954); 26 U.S.C. § 3306(c) (10) (1964).39 ILL. REv. STAT. ch. 48, § 300-820 (1965). 40ld. at SS 331 and 333.

Some Problems in Representing a Not-for-Profit Organization

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Some Problems in Representing a Not-for-Profit Organization

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