August 14, 2024

The danger of noncompliance is revealed in a recent federal Tax Court case called XC Foundation v. Commissioner, which presents a cautionary tale for nonprofit organizations. When an organization fails to do something as basic as remain in good standing in its state of incorporation, the consequences can be as severe as losing its ability to have standing in court, even losing its right to exist.

XC Foundation v. Commissioner

In the XC Foundation case, the IRS revoked the 501(c)(3) status of a California nonprofit organization in 2021.  The organization filed a timely request to appeal the IRS decision. The IRS argued that the appeal had to be dismissed because the organization had its “corporate powers, rights, and privileges” suspended years before under California law. The organization never rectified the situation on the state level and had all its corporate powers, rights, and privileges suspended during the time when the organization appealed to the IRS.  

In this situation, the Tax Court noted that it has limited jurisdiction. In particular, the Tax Court is bound by the Tax Court Rules of Civil Procedure. Rule 60(c) clearly states that “[t]he capacity of a corporation to engage in such litigation shall be determined by the law under which it was organized.” The federal Tax Court cannot simply determine that justice or fairness requires a case to be heard if an organization has lost its capacity to act under state law. Therefore, the Tax Court concluded that the organization did not have the power to file an appeal and the Tax Court had no jurisdiction to hear the case. The case was dismissed and the organization had no ability to appeal and have its 501(c)(3) status reinstated.

The Many Consequences of Noncompliance

Noncompliance by a nonprofit in a certain area of law can have unexpected consequences. There is a great risk that religious organizations will neglect seemingly minor compliance issues because they think that noncompliance may not be caught by the authorities, that it can be remedied later, or that noncompliance will not have serious consequences. As we can see in the XC Foundation case and in the examples above, none of this is true.

This is why Napa Legal exists. At the heart of Napa Legal’s mission is the work of educating faith-based nonprofits on the importance of legal compliance. We strive to help organizations realize the deep impact that noncompliance can have on accomplishing their mission and to assist them in taking action. For an organization to maintain compliance, there are many moving parts. Our organization wants to help as many religious organizations as possible to understand these moving parts and ensure they all run smoothly.

Sometimes encouraging compliance is positive. Compliance comes with the benefits of peace of mind and the ability to focus on the organization’s mission without being sidetracked by the serious legal issues that come from noncompliance. Understood well, legal compliance can be viewed not only as a necessary chore but as a spiritual practice that can be offered to God.

But the reality is sometimes the negative aspects of noncompliance need to be emphasized. As Napa Legal has emphasized in a previous resource concerning 501(c)(3) status, and as the XC Foundation case makes clear, the effects of noncompliance can be quite burdensome and dealing with them can be much more difficult than remaining compliant in the first place. An ounce of prevention is worth a pound of cure, as they say.

The XC Foundation case is just one example of how a compliance mistake can have seemingly unrelated but disastrous consequences. Failure to comply with state registration requirements can leave an organization without the ability to appeal an IRS decision regarding its tax-exempt status revocation. Compliance is a web of interconnected requirements. Your organization needs to ensure that it is compliant with all of them to protect itself and continue to work to accomplish its mission.

So, could your organization be missing a state requirement that is jeopardizing its ability to exercise its corporate power? Check the Multi-State Compliance Matrix and make sure you aren’t missing anything.

Is your organization compliant with charitable solicitation registration requirements in all the states in which it fundraises or receives donations? Read through Napa Legal’s toolkit on Charitable Registration and the Faith-Based Nonprofit to better understand the extent of these requirements.  

Does your organization’s political and campaign activity remain safely within the bounds necessary to protect your 501(c)(3) status? And does your organization have a policy in place to ensure that these boundaries are understood and respected by staff? Check out Napa Legal’s resource (including sample policy language) on Lobbying, Issue Advocacy, and Campaign Activity: Crafting an Organizational Policy.

For leaders and staff members of faith-based nonprofits, compliance may not be at the top of the list of most fulfilling professional activities. But careful compliance is necessary to safeguard your organization so that it can accomplish its mission. An organization can’t be focused on mission if it is exhausting its time and resources on the consequences of noncompliance. And as we see in XC Foundation, sometimes noncompliance can’t even be remedied with time and resources. Sometimes, noncompliance is fatal and can affect an organization’s very right to exist.

Napa Legal is here to help faith-based nonprofits take compliance seriously. Contact us, take advantage of the resources we provide, and begin the necessary work to bring your organization into legal compliance so it can stay on task and accomplish its mission.