by Doug Bechtel
The Actors Theater of Orcas Island
About the Author
Doug has been CEO of non profit cooperative corporations for
25 years and has served on dozens of non profit boards. He is
currently President of The Actors Theater of Orcas Island, which
was founded in 1999. He is also a founder and current Secretary
of The Orcas Island Community Foundation, and has recently served
on the following non profit boards: The Orcas Island Medical Center
Association, The Orcas Island Sportsmans Club, the Kiwanis Club
and the Chamber of Commerce. Active in the theater since 1996,
Doug has been producer, director, actor, techie and anything anyone
would let him do.
In its simplest form, a non profit organization is a state of
mind - an intention - to do public good. On the other hand, a
for profit company (whether or not it makes a profit) is in business
to make money for its owners (or stockholders) and has a fiduciary
or legal responsibility to do so.
There are a lot of facets to being non profit. Remember that
being non profit is not the same as not making a profit. A lot
of companies do not make a profit but that does not make them
non profit. Making a profit (called "margins" in non
profit parlance) does not make you a "for profit" company
either - you can make margins and still be non profit.
The IRS is even more specific about where margins of non profits
can be spent by requiring that no profit may go to the benefit
of the non profit organizations members. Any profit must be used
to further the charitable purposes of the organization.
The IRS and Community Theaters
There are dozens of types of non profit organizations recognized
by the IRS. Section 501© of the IRS Code lists almost two
dozen types of organizations which may be exempt from federal
income taxes. One of these classifications is of interest to us:
Section 501(c)(3), which refers to organizations formed
exclusively to accomplish "religious, charitable, scientific,
literary or educational" purposes. Community theaters fall
into this classification.
In making a determination as to whether your organization falls
under Section 501(c)(3) the IRS is going to look at many things.
Luckily there is some generic boilerplate language that helps,
and we will get to that in a minute.
Lets look at some of the issues that the IRS will consider in
making the determination:
- Non profit organizations can pay employees, but the IRS is
going to look closely at your organization if an officer or
other board member is highly compensated as a percentage of
the gross income. For example, if your organization has an income
of $30,000 and pays the President of the Board $20,000, it is
going to look questionable.
- The IRS will also look at the source of the income for your
organization. In this case, the IRS is looking at how much public
support you have. If most of the income is from ticket sales
to the public, the IRS will have no problem. You can expect
the IRS to look closely at anyone who makes donations amounting
to 5% or more of the annual income who is also an officer, an
employee, or is on the Board of Directors.
- The IRS has a list of forbidden activities. If you do any
of them, regardless of any other consideration, you will not
be considered non profit. Examples are donations to political
candidates, influencing legislation, or "propaganda"
(their words, not mine).
- The IRS wants to see a track record. They want to see actual
financial statements for a period of operation. If you have
not been in operation long enough, you can apply for a prospective
determination. The IRS will then grant you a temporary 501(c)(3)
status (usually for three years), and at the end of that period
they will send you a form asking for financial information on
the three year period. If you have operated in a non profit
manner, you will get your permanent determination.
Given this IRS scrutiny, why be a non profit?
The first and best known reason is that non profit organizations
can be exempted from paying Federal Income Tax, but there are
many other benefits that may vary by state. Non profits can receive
reduced postal rates. In some states non profits are exempted
from certain sales and property taxes. Most states take the IRS
501(c)(3) finding as proof of non profit status.
Many grants are available only to organizations with a 501(c)(3)
status. Some significant donors will only donate to 501(c)(3)
organizations to insure that their donation will go to the public
good and to eliminate any potential problems with deductibility
on their tax return.
Performances or copies of certain specific material made by nonprofit
entities may be exempt from federal copyright regulation. This
is a very narrow exemption so talk to someone who knows about
this before you try it!
While there are many types of non profit organizations recognized
by the IRS, only organizations which receive 501(c)(3) status
may receive donations for which the donors are allowed to deduct
the donation from their income when filing their federal income
Here are a couple of important issues to remember about tax deductible
- A person making a donation may receive a deduction on their
income tax PROVIDED they did not receive any benefit from the
donation. Someone who makes a $20 donation to their favorite
community theater and receives two $10 tickets to a performance
in return is not allowed to deduct the $20 donation. Someone
who pays $50 for a fund raising dinner worth about $15 can only
deduct $35 from their taxes. Most organizations give you a special
receipt meeting IRS rules that clearly states the value of goods
and services you received in return for your donation.
- If you charge $1,000 for that $15 dollar dinner, the entire
$1,000 might be deductible because the $15 is not considered
significant in terms of the donation.
As a taxpayer, you can also receive a tax deduction if you make
a charitable donation to an organization which does not have its
501(c)(3) classification from the IRS. If an organization has
its 501(c)(3) classification from the IRS, you, as a donor, may
rely on that classification and deduct your donation from your
income on your tax return.
Even if the organization does not have a 501(c)(3) approval,
you may deduct your donation provided YOU (the donor) can show
that your donation was expended for a purpose which is permitted
under Section 501(c)(3). Remember, it is up to you to show how
your money was spent by the organization. Suppose your favorite
organization does many things, some of which are permitted under
501(c)(3) (like theatrical productions) and some things that are
not permitted (like making campaign contributions). If you make
a $50 donation to this organization and they put it in their usual
bank account, you have no way to prove how your money was spent.
On the other hand, if you directly pay the royalties for a production
of a play that you have no financial benefit from, your expenditure
is most likely tax deductible.
How do we get this 501(c)(3) status?
In order to receive your 501(c)(3) status, a non profit must
be a formal organization - it can not be an individual or a casual
group of people. For most of us, this means a non profit corporation.
There are many advantages to the corporation form for your organization.
A corporation is treated like a person. It can own property, it
can sign contracts, it can have bank accounts and can hire employees.
On the down side, it can be sued and it can go bankrupt. One of
the most important properties of a corporation is what is called
the "corporate veil". The corporate veil protects the
officers and employees of the corporation from actions of the
corporation. For example, if someone sues the corporation or if
the corporation has financial problems and can't pay its bills,
the officers are not personally at risk. Most states have statues
that protect the directors of non profit corporations for decisions
they make on behalf of the corporation as long as they were made
in good faith. This leads into a discussion of "due diligence",
"negligence" and "gross negligence" which
are outside the scope of this article. In general, as a director
you have a responsibility to make decisions to further the health
and purpose of the Corporation. You are expected to use the same
degree of care that you would use making major decisions in your
Each state has different rules on non profit corporations. Most
states specify the minimum number of directors for the corporation.
Usually, a phone call to your Secretary of State will yield more
information on forming a non profit corporation that you ever
thought you wanted (or needed) to know.
How do we incorporate?
The first step to incorporating is to determine what the goal
of your groups is. It needs to be specific and concise. A key
question is: Who is going to benefit from the existence of your
organization and how they will benefit? Your organization must
benefit the public. This is usually accomplished through a "Mission
Statement," which is a short paragraph that briefly describes
what is unique about the organization. It should contain the major
characteristics that define its operations.
There are two different documents you will need to prepare. First
is your Articles of Incorporation. The Articles
serve several important purposes: They will ultimately be filed
with your Secretary of State with your incorporation papers. The
Articles typically include the name and address of the corporation,
the general purpose of the organization and the name of the individual
to represent the corporation (the "Registered Agent"),
and the procedure to modify or change the Articles.
The second document you need to prepare is the By-laws
of your corporation. The By-laws typically specify the number
and respective duties of directors and officers and govern how
the business is run including classes of membership, voting by
the Board and members and how the By-laws can be changed.
There are many sites that have sample Articles and By-Laws -
including this site. There is just one
important thing to remember. If you want to receive your 501(c)(3)
status from the IRS, you need to include the following sentences
or something similar in your Articles of Incorporation:
"This corporation is organized exclusively for religious,
charitable, scientific, literary or educational purposes within
the meaning of Section 501(c)(3) of the Internal Revenue Code
"No substantial part of the activities of the Corporation
shall be the carrying on of propaganda, or otherwise attempting
to influence legislation, and the Corporation shall not participate
in, or intervene in (including, without limitation, the publishing,
lobbying or distribution of statements) any political campaign
on behalf of any candidate for public office. Notwithstanding
any other provisions of these articles, the Corporation shall
not carry on any other activities not permitted to be carried
on by: (a) a corporation exempt from Federal income tax under
I.R.C. Section 501(c)(3), as amended; or (b) a corporation, contributions
to which are deductible under I.R.C. Section 170(c)(2), as amended."
These are magic sentences to the IRS and without them you will
have an uphill struggle to get your 501(c)(3) determination.
When the Articles are completed, they are submitted with the
appropriate paperwork and fees to your Secretary of State and
in a few weeks you will receive a Certificate of Incorporation
and you are in business. Remember to incorporate as a non profit
The person who signs the filing to the Secretary of State (the
"incorporator") usually appoints the first Board of
Directors. After you receive your Certificate of Incorporation,
the incorporator will hold an initial organizational meeting of
the first Board of Directors. Several items need to be addressed
at this meeting like electing officers, opening bank accounts
in the name of the corporation, determining who can sign checks
and so on. The first order of business is approving the By-laws.
Where the Articles of Incorporation are mostly boilerplate, the
By-laws really define how your organization operates. Will you
have members? What rights will the members have? What are the
terms of office of Directors? How are Directors nominated and
elected? These are all very important issues that need to be resolved
before you can continue.
Your By-Laws also need to address the size of your Board of Directors.
This is a hard decision. On one hand, the smaller the Board the
easier it is to manage and direct the organization's affairs.
On the other hand, the larger the Board, the more hands to help
when it comes to your next production or fund raising. The smallest
board I am aware of has five directors. I am sure there is a board
with just three directors somewhere. On the other hand I am aware
of a board with over 50 members (not theater). In general, with
a large board, there is an Executive or Administrative Committee
of five to nine Directors that actually governs the day to day
affairs of the organization and the other Directors are honorary
positions or, more likely, fund raisers. I know of a Board which
makes it very clear that Directors are expected to "give
it" (make a donation), "get it" (solicit donations
from others) or "raise it" (chair fund raising efforts).
I would suggest you start small with five or seven directors,
and expand the board as you find people who share your goals.
I sit on an eighteen-member non profit board and work for a seven-member
board. Our local "big" theater has a fifteen-member
board, our small theater group has a five-member board. Fifteen
and eighteen members are far too large to oversee the day to day
activities of the organization, and both have powerful Executive
In closing, I have helped several organizations incorporate and
receive their 501(c)(3) exemption from the IRS. Some have spent
hundreds of dollars on attorneys and accountants filling out the
forms. It is not necessary. All you need are copies of your Articles
of Incorporation (with the magic language), By-laws, information
on your largest donors, and financial statements for your most
recent year(s) of operation and estimated budgets for the next
three years. It might take you four or five hours to put together
but the IRS forms are clear and straightforward. If all else fails,
talk to a nearby non profit and look at their application.
You can also send me an e-mail at email@example.com.
I am not an attorney or an accountant, just a community theater
enthusiast. I have tried to share my knowledge but there are no
guarantees. Good luck!