You have just been elected to the board of an amateur sports club. What should you do to ensure that the organization is in good shape?
First, don’t just assume that everything must have been set up correctly when the organization was originally formed. Many sports clubs begin informally with little attention to the legal details, and then continue to operate that way for years, even after the scope and nature of what they do have changed. You should find out how the club or association is organized.
The entity will likely fall into one of the following three categories:
- Unincorporated Amateur Sports Clubs. If your amateur sports club is not incorporated under state law, it will likely be what is called an “unincorporated association” – which is much like a general partnership. If this is the case, it is possible that the association's directors, officers, and members may be responsible for any uninsured (or underinsured) club legal liability as well as any club unpaid financial obligations. This will likely come as an unpleasant surprise to club directors, officers, and members if an amateur sports club athlete is injured or believes he or she has some other basis for a claim, and a lawsuit is filed against the club, its officers, and members. Another issue that the leaders of the organization should be aware of is that to the extent club net income exists (gross income less legitimate club operating expenses), it is possible that taxes, interest, and penalties may be due. Note that it is possible for an unincorporated association to be recognized by the IRS as tax-exempt, but most often they are not.
- Incorporated But Non-Exempt Amateur Sports Clubs. This status arises when your amateur sports club is incorporated under state law as a nonprofit corporation, but it has not been recognized by the IRS as a tax-exempt §501(c)(3) organization (or exempt under another Internal Revenue Code section). Provided the organization’s articles of incorporation contain certain provisions, and the organization’s leaders have operated it properly, this type of organization will provide the club’s directors, officers, and members greater protection from liability than an unincorporated association. However, without exemption from taxes, the organization still may be liable for years of unpaid taxes, plus interest and penalties. Many people think a nonprofit corporation is automatically exempt from taxes. However, this is not the case. A nonprofit corporation is liable for taxes on its taxable income at corporate tax rates, UNLESS it is qualified and recognized as tax-exempt under federal law.
- Incorporated Tax-Exempt Amateur Sports Clubs. This status arises when your amateur sports club is incorporated under state law as a nonprofit corporation, and it has been recognized by the IRS as tax-exempt. Since the organization is incorporated, then, provided its articles of incorporation contain certain provisions, and the organization’s leaders have operated it properly, it will provide the club’s directors, officers, and members much greater protection from liability than operating as an unincorporated association. There are different types of tax-exemption available to nonprofit corporations, classified by the section of the Internal Revenue Code under which the exemption falls:
- charitable organizations exempt under Code Section 501(c)(3),
- social welfare organizations exempt under Code Section 501(c)(4), and
- social clubs exempt under Code Section 501(c)(7).
There are advantages and disadvantages to each of these types of exemption. Contributions to your club are not deductible unless it is exempt under Code Section 501(c)(3). In addition, officers and directors of 501(c)(3) organizations are eligible for enhanced liability protections under state law, and many organizations will not make grants to organizations other than those exempt under Code Section 501(c)(3). The main disadvantage of charitable status are that it will likely have to register with and make annual filings with the state’s Attorney General, and it subjects an organization to rules that do not apply to other nonprofits. Donations to sports clubs exempt under either Code Section 501(c)(4) or 501(c)(7) are not deductible, but these organizations generally do not have to register with state officials that oversee charities. In addition, a Section 501(c)(7) club must pay taxes on investment income, including interest on bank accounts.
How does an amateur sports club qualify for the more advantageous Section 501(c)(3) exemption? There are generally two ways:
- First, a club can qualify if it sponsors or participates in national or international amateur sports competitions, or supports and develops amateur athletes for such competitions. This is possible even if your club has a membership which is strictly local or regional in nature.
- Second, a club can qualify if its activities are primarily directed towards youth under the age of 18 and the club encourages growth of the sport.
In order to obtain 501(c)(3) status, an organization must apply to the IRS and receive a determination letter recognizing the organization as exempt. It must also file annual informational returns to maintain the status.
After finding out what type of entity the organization is, you should evaluate whether that is the appropriate form of entity for what your organization is doing. Does it give you the liability protection you need? Does it encourage donations? Does it offer any tax advantages? Are you meeting all of the organization’s state and federal filing requirements? Are you even aware what those filing requirements are? Is your organization subject to the tax on unrelated business income? Are you maintaining the proper documentation in case your organization is ever audited?
Potential problem areas for sports clubs:
- Failure to obtain a charitable solicitation license and/or hiring an unlicensed fund-raisers to solicit contributions.
- Failure to pay the tax on unrelated business income.
- Loss of exempt status with the IRS for failure to file informational returns.
- Dissolution by state officials for failure to make annual corporate filings.
- Insufficient liability protections for volunteer directors, officers, and others.
- Inadequate recordkeeping.
- Inadequate waivers for participants and/or officials and coaches.
- Out of date or nonexistent bylaws.
- Failure to understand the organization tax classification, or being mistaken regarding its classification.