Forming a California Non-Profit Public Benefit Corporation

In California, a non-profit organization that is incorporated to serve religious or charitable purposes is referred to as a “nonprofit public benefit corporation.” The legal requirements pertaining to these organizations are set forth in the California Corporations Code, beginning with § 5110. This article details the steps necessary to establish a California nonprofit public benefit corporation.

Laying the Groundwork
The philosopher Edmund Burke once said, “Good order is the foundation of all things.” In the spirit of Burke’s sage advice, we urge you to take your time with these preliminary steps, to ensure your new organization gets off to a good start with a solid foundation.

Direct your attention to your organization’s mission, funding sources, and annual budget. This is not the time to cut corners. Taking the time to write a mission statement that clearly identifies the needs your nonprofit corporation will address will assist you throughout the organization’s developmental stages, and will help you attract volunteers and donors.

Incorporate Your Nonprofit Organization
If you haven’t done so already, now is the time to choose name for the corporation and check the name availability with the California Secretary of State. Your organization’s name cannot be the same as, or deceptively similar to, other corporate names already on file (limited exceptions may apply).

You may also need to recruit directors to serve on your organization’s board. A California nonprofit public benefit corporation must have at least one director, and the number of directors must be stated in either the Articles of Incorporation or the corporate bylaws.*

Your Articles of Incorporation must be filed with the California Secretary of State. A filing fee is required; as of this writing that fee is $30. Current fees can be found on the Secretary of State’s website.

The Articles of Incorporation must contain specific language in order to qualify for tax-exempt status at the federal and state levels. Information about drafting the Articles of Incorporations, please consult California Corporations Code § 5130.

Once the Articles have been filed, you have 90 days to file a Statement of Information with the Secretary of State. This Statement is a public disclosure of information including a description of what the organization does, where it is located, and the names and addresses of its officers. After the original Statement is filed, you must file a new Statement of Information every two years. This Statement may be filed electronically via the Secretary of State’s website, or in paper format.

Draft Your Bylaws
The law requires that your organization adopt Bylaws, which are the internal governing document for your nonprofit corporation. The Bylaws establish the internal rules and procedures, including details about how business will be conducted, who has decision-making authority, and even the process by which the Bylaws can later be amended.

The Bylaws are not filed with any governmental entity, but must be kept with the organization’s corporate records at its principal place of business.

Hold an Organizational Meeting of the Board of Directors
The minutes from your Organizational Meeting of the Board of Directors will document the many of the remaining steps required to get your nonprofit organization up and running.
At this meeting, the incorporators and/or initial directors of the corporation will typically conduct the following business:

• Appoint additional directors


• Appoint or elect officers


• Adopt the corporate Bylaws


• Establish a budget


• Designate a bank for the corporate account


• Adopt a corporate seal


• Set up a Corporate Record Book

Your corporate record book contains the important documents concerning the formation, management and due diligence of your nonprofit organization. Detailed information regarding recordkeeping requirements a nonprofit public benefit corporation must follow can be found in California Corporations Code §§ 6320-6325.

Get Your Employer Identification Numbers
Your nonprofit corporation must get a federal Employer Identification Number (EIN) from the Internal Revenue Service (IRS). This can be obtained by phone, fax, mail or online application.
A California EIN is also required if your organization will be paying at least $100 in wages in a quarter. This EIN can be obtained online.

Apply for Tax Exempt Status
You will most likely want to apply for tax-exempt status with both the IRS and the California Franchise Tax Board (FTB). Without these exemptions, your organization may be obligated to pay at least the minimum federal and state corporate income tax.

The federal tax exemption under section IRC § 501(c)(3) is requested using IRS Form 1023, Application for Recognition of Exemption. This form may not be required, however, if your organization was established with a 501(c)(3) purpose and your annual gross receipts are normally less than $5,000.

California state tax exemption is requested on FTB Form 3500, Exemption Application. If you have already obtained a letter of determination from the IRS, you can apply to the FTB using the shorter Form 3500A, Submission of Exemption Request, and attaching a copy of the federal letter. These forms can be downloaded from the FTB’s website.

Register with the California Attorney General
Once your nonprofit public benefit corporation begins receiving donations, you must file the Initial Registration Form CT-1. This form must be filed with the Registry of Charitable Trusts within 30 days.

* Note: Under California law, no more than 49 percent of a board of directors may be interested persons. An interested person is a director who provides nondirector services to the nonprofit public benefit corporation and is paid for the services rendered. The law also extends to cover any close relative of the director. For more information, see California Corporations Code § 5227.

FAQ: Should I Incorporate My Business?

The primary advantages of operating as a corporation are liability protection and potential tax savings. Like any important decision, choosing whether to incorporate involves weighing the pros and cons, and should only be done after careful research and consultation with a legal or tax professional.

Once incorporated, the business assets of the corporation are separated from the owner’s personal finances. As a result, the owner’s personal assets generally can be shielded from creditors of the business.

To maintain this legal separation (and avoid “piercing the corporate veil”), the corporation must observe certain formalities, including:

• Keeping corporate assets and personal assets separate (no commingling of funds)


• Holding shareholder and director meetings at least annually


• Maintaining a corporate record book including bylaws, minutes of shareholder and director meetings, and shareholder records


• Filing annual information statements with the Secretary of State


• Filing a separate tax return for the corporation

Many people are concerned about “double taxation” of income, but you should do your own research, and compare the features of the C-corporation and S-corporation. The double taxation results when a C-corporation has profit at the end of the year, and that profit is then distributed to the shareholders. That profit is taxed to the corporation, at the corporate tax rate, and then the dividends are taxable income to the shareholders on their personal tax returns. However, the corporate tax rate is typically much lower than the individual tax rate that a sole-proprietor will pay on a 1040 Schedule C, and a competent accountant can help the corporation minimize double-taxation (or eliminate it completely).

For example, a small C-corporation will likely have a shareholder who is also an employee. Paychecks to the shareholder/employee are, of course, tax deductible to the business. To the shareholder/employee, they are taxable income (as would be the case with a paycheck from any employer). A bonus could be paid to the shareholder/employee in order to lower the corporation’s taxable profit, eliminating the double-taxation. These calculations should be performed by your accountant or tax advisor, but shifting income from the corporation to the shareholder/employee (or vice versa, depending on which has the lower tax rate) can be a great way to lower your overall tax liability. In addition, there are certain advantages that are only available with a C-Corporation, such as full tax-deductibility of medical benefits for a shareholder/employee.

The S-Corporation avoids the double-taxation by offering a tax structure similar to the Limited Liability Company (LLC, which is not an option for businesses that are required to hold a license, certification or registration). A corporation with 100 or fewer shareholders can elect to be treated as an S-Corporation. If the corporation is profitable, the shareholder/employee must draw a reasonable salary (and pay employment tax on it), but then all remaining corporate profits flow through to the shareholder’s personal tax return (thereby avoiding the FICA tax on the portion of profits that is taken as a dividend).

Before deciding to incorporate, you should seek legal and tax advice on what type of ownership best suits your business. An experienced attorney and tax advisor can help you decide which form of ownership is best for your business. For the do-it-yourselfers, we highly recommend “Own Your Own Corporation” by Garrett Sutton, Esq. (part of the Rich Dad series).

What is a Notice of Pendency of Action (Lis Pendens)?

A “notice of pendency of action,” also known as a “lis pendens” (Latin for “a suit pending”), is a written notice that a lawsuit has been filed that may affect either the title to, possession of, or a claimed ownership interest in real property. The notice is usually filed in the county Recorder’s office. Recording the notice alerts a potential purchaser or lender that the property’s title is in question, which can make the property less attractive to a buyer or lender.

A notice of pendency of action is available in actions involving “real property claims,” which are defined in California Code of Civil Procedure § 405.04 as “the cause or causes of action in a pleading which would, if meritorious, affect (a) title to, or the right to possession of, specific real property or (b) the use of an easement identified in the pleading, other than an easement obtained pursuant to statute by any regulated public utility.”

Unless otherwise specified, the notice must be recorded in the office of the Recorder of each county in which all or part of the property is situated. The notice must contain the names of all parties to the court action and a description of the property.

An attorney of record in an action may sign a notice of pendency of action. Alternatively, a judge of the court in which an action that includes a real property claim is pending may, on request of a party, approve a notice of pendency of action. Such a request is usually made in the form of an ex parte application. Both the notice and the ex parte application are routine legal documents that you can prepare yourself, with a little help from the law library, or a non-attorney legal document preparer can assist you.

Federal Courts React to Tide of Pro Se Litigants

From The National Law Journal

In response to a growing tide of pro se litigants in federal courts, legal centers in at least three districts have been set up to provide services and advice to parties who represent themselves in civil cases.

The newest center opened on March 5 at a federal courthouse in downtown Los Angeles. Last year, a similar one opened in the federal courthouse in San Francisco. A third program, operating out of the federal courthouse in Chicago, has been operating since 2006.

The centers reflect the increasing number of pro se litigants in federal courts, particularly in employment and certain types of civil rights lawsuits.

"It's part of a whole movement that's taking place in the courts to try to recognize, as a practical matter, that most people just can't afford lawyers these days," said Richard Zorza, coordinator of the Self Represented Litigation Network, which works with organizations on pro se litigant issues.

About 150 centers exist nationwide to assist pro se litigants, but most are part of state courts and vary from clinics to telephone hotlines to online resources, Zorza said. "It's certainly unique doing it in federal court," he said.

Unlike state courts, where pro se litigants frequently show up in divorces, the vast majority in federal court appear with employment claims, such as violations of the Americans With Disabilities Act and other anti-discrimination statutes.

The new pro se centers focus on civil cases and, for the most part, litigants who are not prisoners. The services are free. At the Pro Se Clinic in Los Angeles, which covers the Central District of California, a poster advertising its services in the courthouse lobby already had drawn up to 15 people a day before its official opening on March 5, said Janet Lewis, supervising attorney of the clinic.

Lewis works for Public Counsel, a nonprofit legal organization that operates the clinic, which came about after judges grew frustrated with pro se litigants.

Many of their problems are procedural. "The complaints are not put together in a way so that the court actually feels comfortable they can use them," she said.

Lewis is one of two attorneys in the clinic who provide legal advice, review briefs or refer litigants to pro bono attorneys, said Hernán Vera, president of Public Counsel. But they stop short of writing briefs or appearing in court.

In San Francisco, the Legal Help Center, sponsored by the Bar Association of San Francisco's Volunteer Legal Services Program, opened in September.

"Often, there are people who are misguided in terms of not really understanding what the cause of action is, and what's recognizable, and the fact that they don't have a viable cause of action for one reason or the other," said U.S. Magistrate Judge Edward Chen of the Northern District of California, who came up with the idea of the clinic. "Often, people do have a cause of action but are at a loss as to how to prosecute their case."

He said the court has a handbook available to help pro se litigants with terms. But the handbook doesn't explain legal theories, he said.

Unlike attorneys at the other two centers, the supervising attorney of the San Francisco clinic, Jennifer Greengold, can give limited legal advice and write pleadings. But she can't go to court and can't do outside research for pro se litigants.

C-Corporation vs. S-Corporation

The difference between a C-Corporation and an S-Corporation is in the way each is taxed. Under the law, a corporation is considered to be an artificial person. Shareholders who work for the corporation are employees; they are not “self-employed” as far as the tax authorities are concerned.

The C-Corporation

In theory, before a C-corporation distributes profits to shareholders, it must pay tax on the income, at the corporate rate. Then, leftover profits are distributed to the shareholders as dividends, which are then treated as investment income and taxed to the shareholder. This is the “double taxation” you may have heard about. In reality, most (if not all) of a small C-Corporation’s earnings are paid out to its employees as wages, bonuses, fringe benefits, etc. Often, there is no “income” for the small C-Corporation to owe tax on, unless the shareholders choose to keep taxable earnings in the company to reinvest for future growth. Should you choose to keep profits in the corporation and pay tax on that income, it will be taxed at the corporate tax rate, which is typically lower than the individual tax rate the shareholders are subject to.

C-Corporations enjoy many tax-related advantages :

• Income splitting is the division of income between the corporation and its shareholders in a way that lowers overall taxes. By working with an experienced tax advisor, you can determine exactly how much money the corporation should pay you, as an employee, to ensure the lowest tax bill at the end of the year.


• C-Corporations enjoy the greatest variety of tax-favored fringe benefits of any business entity. Fringe benefits may include things like health insurance, retirement accounts, and medical reimbursement plans.


• With a C-Corporation, medical costs, including health insurance premiums, are 100% tax-deductible to the corporation and tax-free to the recipient.


• C-Corporations can also pay for an employee’s education expenses (if they are directly related to the job), and these expenses are also deductible to the company and tax-free to the employee. The company can also contribute – and deduct – up to $5,250 per year for an employee’s non-job-related education expenses.


• A C-corporation can provide tax-free financial and tax planning to help employees, provided this benefit is part of a written employee benefit plan.


• C-Corporations can deduct insurance disability insurance premiums for employees, and can provide employees and/or former employees with $50,000 in tax-free life insurance. Premiums paid for these policies are tax-deductible to the corporation.


• A shareholder can borrow up to $10,000 from a C-Corporation, interest-free. Tax-free loans are not available to sole proprietors, partners, LLC members, or S-Corporation shareholders.

S-Corporation

S-Corporations pass income through to their shareholders, who pay tax on it according to their individual income tax rates. To qualify for S-Corporation status, the corporation must have less than 100 shareholders; all shareholders must be individual U.S. citizens, resident aliens, other S-Corporations, or an electing small business trust; the corporation may have only one class of stock; and all shareholders must consent in writing to the S-Corporation status.

Electing S-Corporation tax treatment eliminates any possibility of the “double taxation” referenced above. S-Corporations pay no federal corporate income tax, but must file annual tax returns. Because losses also flow through, shareholders who are active in the business can take most business operating losses on their individual tax returns.

S-Corporations must still file and pay employment taxes on employees, as with a C-Corporation. An S-Corporation may not retain earnings for future growth without the shareholders paying tax on them. The taxable profits of an S-Corporation pass through to the shareholders in the year they are earned.

S-Corporations cannot provide the full range of fringe benefits that a C-Corporation can.

Further Reading:
Own Your Own Corporation, by Garrett Sutton, Esq.
Tax Savvy for Small Business, by Frederick W. Daily
Publication 15B, Employer’s Tax Guide to Fringe Benefits, Internal Revenue Service

Corporations: An Overview

Corporations are the most commonly used business entity. Corporations are, generally, a more complex form of business operation than either a sole proprietorship or partnership, and are subject to more state regulations regarding both their formation and operation.

In California, a corporation is created by filing Articles of Incorporation with the Secretary of State. The Articles of Incorporation serve as a public record of certain formalities of corporate existence. Adoption of corporate bylaws, or internal rules of operation, is often the first business of the corporation. The bylaws of the corporation outline the actual mechanics of the operation and management of the corporation.

There are two basic types of corporations: C-corporations and S-corporations. These prefixes refer to the particular chapter in the U.S. Tax Code that specifies the tax consequences of either type of corporate organization. There are significant differences in the tax treatment of these two types of corporations, however, they are both generally organized and operated in a similar manner.

In its simplest form, the corporate organizational structure consists of the following levels:

• Shareholders: who own shares of the business but do not contribute to the direct management of the corporation, other than by electing the directors of the corporation and voting on major corporate issues.


• Directors: who may be shareholders, but as directors do not own any of the business. They are responsible, jointly as members of the board of directors of the corporation, for making the major business decisions of the corporation, including appointing the officers of the corporation.


• Officers: who may be shareholders and/or directors, but, as officers, do not own any of the business. Officers (generally the president, vice president, secretary, and treasurer) are responsible for day-to-day operation of the corporate business.

Disadvantages

Due to the nature of the organizational structure in a corporation, a certain degree of individual control is necessarily lost by incorporation. The officers, as appointees of the board of directors, are answerable to the board of management decisions. The board of directors, on the other hand, is not entirely free from restraint, since it is responsible to the shareholders for the prudent business management of the corporation.

However, in most small, family-owned incorporated businesses, only one or two people may occupy all roles, from shareholder to director to officer to employee. In this type of situation, the shareholder/directors continue to exercise full control over the operation of the business.

The technical formalities of corporation formation and operation must be strictly observed in order for a business to reap the benefits of corporate existence. For this reason, there is an additional burden of detailed recordkeeping. Corporate decisions must be reflected in the corporate records. Corporate meetings, both at the shareholder and director levels, must be formally documented.

Advantages

One of the most important advantages to the corporate form of business structure is that it limits the liability of the founders of and investors in the corporation. Liability for corporate debts is generally limited, to the amount of money each owner has contributed to the corporation. Certain requirements must be met, however, to assure that the limitation on liability remains in effect. Courts may be able to pierce the corporate veil, that is, hold shareholders personally liable, for the following reasons:

• Failure to observe corporate formalities. The corporation must hold the required shareholders’ and directors’ meetings (or sign consents), keep a corporate minute book, comply with all state filing requirements, etc. Even a corporation with just one shareholder/director must still comply with these formalities. In addition, corporate officers must always sign all documents with the corporate title (e.g. John Doe, President).


• Commingling of assets. Shareholders must take care to avoid mixing their personal assets with those of the corporation. Corporate assets should not be used to pay personal debts. Corporate and personal funds should be kept in separate accounts. Transfers between the corporation and the shareholder, whether a loan, reimbursement, paycheck, etc., must be appropriate and clearly documented.


• Inadequate capitalization. If corporate founders fail to raise or contribute enough operating capital, the courts may require the shareholders to pay the corporate obligations. If the shareholders do not have sufficient capital to fund the corporation, they should purchase adequate liability insurance.


• Fraud. A corporation may not be used to shelter fraud. Even if the fraud is committed in the name of the corporation, the shareholders may be held personally liable.

Depending on your personal situation, there may be significant tax advantages to incorporating.

Every corporation should have an experienced accountant or tax attorney on its team, to help determine whether tax treatment C-Corporation or an S-Corporation provides the most benefit, and to help with tax planning strategies before the close of each fiscal year.

In many cases, it is possible to reduce taxable profit to the point that the corporation pays only the corporate minimum tax. If the corporation stands to show a substantial profit at the end of the year, that tax is paid at the corporate tax rate (often much lower than individual tax rates), and that income can be reinvested in the corporation to further grow the business. Hiring a qualified tax advisor will pay for itself many times over.

Partnerships: An Overview

The General Partnership

A partnership is a relationship existing between two or more persons who agree to share profits and losses. A partnership is usually based on a partnership agreement of some type. No formal, written document is required in order to create a partnership. If a formal agreement is not signed, the partnership will be subject to the applicable state laws governing partnerships.

Disadvantages

Like the sole proprietorship, owners of a partnership have no asset protection. Each partner’s personal assets are at risk. However, with a partnership, the owners face twice the liability exposure of a sole proprietorship. Any partner may obligate the partnership, and each individual partner is liable for all of the debts of the partnership, regardless of which partner may have been responsible for their accumulation.

In addition to the risk of personal financial liability, general partners also face potential personal legal liability for the negligence of another partner. Furthermore, each partner may also be liable for the negligence of an employee of the partnership if such negligence takes place during the usual course of business of the partnership.

Continuity is also an issue for the partnership. A partnership terminates when one partner dies, leaves, or goes bankrupt. In addition, it often very difficult to sell an interest in a partnership. Most sophisticated buyers do not want the risk associated with a general partnership.

Finally, certain benefits of corporate organization are not available to a partnership. Since a partnership cannot obtain financing through public stock offerings, large infusions of capital are more difficult for a partnership to raise than for a corporation. In addition, many of the fringe benefit programs that are available to corporations (such as certain pension and profit-sharing arrangements) are not available to partnerships.

Advantages

For a business in which two or more people desire to share in the work and in the profits, a partnership is often the structure chosen. It is, potentially, a much simpler form of business organization than the corporate form. There are fewer start-up costs and regulation of partnerships is limited. However, this simplicity can be deceiving. A sole proprietor knows that his or her actions will determine how the business will prosper, and that he or she is, ultimately, personally responsible for the success or failure of the company. In a partnership, however, the duties, obligations, and commitments of each partner are often ill-defined. This lack of definition of the status of each partner can lead to serious difficulties and disagreements. In order to clarify the rights and responsibilities of each partner and to be certain of the tax status of the partnership, it is good business procedure to have a written partnership agreement.

The Limited Partnership

A limited partnership is similar to a general partnership, except that it has two types of partners: general partners and limited partners.

General partners have broad powers to obligate the partnership (as they do with a general partnership). General partners are also personally liable for the debts and claims against the partnership. If there is more than one general partner, each of them is liable for the acts and omissions of the remaining general partners.

Limited partners are “limited” to their contribution of capital to the business, and may not become actively involved in running the company.

As with a general partnership, limited partnerships are flow-through tax entities.

Disadvantages

General partners are personally liable for all partnership debts. However, a corporation or an LLC may be formed to serve as the general partner, thereby limiting the limiting the potential for personal liability.

Because limited partners are prohibited from participating in the management activities of the enterprise, the general partners maintain complete control of the partnership’s business affairs. Limited partners have no control of their investment.

Advantages

Limited partners are not liable for the partnership’s debts beyond the value of their capital contribution into the business. Creditors of a limited partnership can only reach the partnership assets and those of the general partner (which is further limited by utilizing a corporation or LLC as a general partner).

Creditors of the individual partners can only reach the partner’s ownership interest in the partnership, but not the partnership assets themselves.

With proper estate planning, family assets can be transferred from one generation to the next at discounted rates. By using a family limited partnership, gifting can be accelerated with an IRS-approved discount. If you are considering this option, you should consult with an attorney.

Limited partnerships afford a great deal of flexibility to the partners. A written partnership agreement can be tailored to the business, family and estate planning needs of any situation.