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WHAT ARE CHARITABLE PURPOSES OF A NONPROFIT?

WHAT ARE THE CHARITABLE PURPOSES OF A NONPROFIT?

Groups organized for “charitable purposes” are exempt from income tax pursuant to Internal Revenue Code section 501(c)(3).  Such groups include those organized and operated for religious, charitable, scientific, educational, or literary purposes.

BROAD PUBLIC INTEREST

The term “charitable purpose” is defined broadly and includes those services that are beneficial to the public interest.  The organization must serve an open class of people and not a limited number of group members. For instance, charitable purposes include providing food to the homeless in the community, but not to specifically-named people.  The beneficiaries of the organization’s purpose must be open and unspecified, but does not need to be large.  Other examples of charitable purposes include: relief of the poor, distressed, and underprivileged; advancement of education and science; maintaining public buildings or monuments; lessening burdens of government; eliminating prejudice and discrimination; promoting the arts; or defending human and civil rights.

EDUCATIONAL PURPOSE

Educational purposes include instructing the public on subjects that are useful for the benefit of the community or for self-development.  Particular viewpoints are allowed to be the focus, but there must be a full and fair exposition of pertinent facts so that individuals can form their own opinions and conclusions on the subject.  If the curriculum only focuses on an unsupported opinion, the purpose is not considered educational for charitable purposes.  Examples of educational purposes include: publishing public interest materials; public discussion groups, lectures, or workshops; correspondence courses; or museums, zoos, planetariums, orchestras, or other performances.

LITERARY PURPOSE

Literary purposes must involve books and reading.  The organization must not target commercial markets and must sell the publications only at a modest price.  Examples of literary purposes include: environmental preservation, highway safety, or drug and alcohol publications.

COMMUNITY DEVELOPMENT AND SOCIAL WELFARE

Charitable purposes may include those that promote social welfare by lessening neighborhood tensions, eliminating prejudice and discrimination, defend human civil rights, and prevent the deterioration of the community and juvenile delinquency.  Charitable purposes may also include services that assist minorities, women, immigrants, or other classes that have been historically denied equal treatment because of race, gender, citizenship, or any other protected status.

Community development programs include job training, small business development, or affordable housing programs.  Such purposes qualify for Federal tax exemption by: relieving the poor and distressed, combating community deterioration, eliminating discrimination, and lessening government burdens.  The IRS defines a group as “poor and distressed” when there is an inability to afford “necessities of life” without undue hardship, and factors the lack of adequate housing, unemployment rate, and the government’s classification of the group as economically disadvantaged.

RELIEF OF THE POOR, DISTRESSED, OR UNDERPRIVILEGED

There is no uniform definition of “poor.” This “charitable class” is essentially made up of low-income, minority, elderly, disabled, or other 501(c)(3) organizations.  Examples of organizations that qualify include: Organizations that offer services to obtain and maintain employment, vocational training, child care, counselling, financial services to businesses owned by “needy” individuals, or housing, legal, food, and transportation services to the “needy.”

LESSENING THE BURDENS OF GOVERNMENT

In order to qualify as lessening government burdens, the activity must be government’s responsibility and the activity must in fact lessen the burden to the public.  Generally, there must be a government policy or code that applies to the activity, such as housing or economic development.  The government must have an involvement in the activity on a regular basis, provide funding, and perform the activity directly.  The nonprofit organization’s purpose must directly address the burden to the public.  The nonprofit should have a favorable relationship with the government entity and improve the government’s function without additional government expenditures.  Examples include: affordable housing for low-income families, job creation, small business growth, recycling services, community land use plan, recreational facilities and public parks.

WHAT ARE NONPROFIT PUBLIC BENEFIT CORPORATIONS?

A Public Benefit Corporation must be formed for public or charitable purposes and cannot be formed for private gain of any individual.  Public benefit purposes include organizations such as childcare centers, shelters for homeless people, community health care clinics, museums, hospitals, schools, performing arts groups, conservation groups, and affordable housing groups.

The Public Benefit Corporation is legally restricted in that all its assets must be irrevocably dedicated to charitable, scientific, or educational purposes.  In this sense, the nonprofit corporation is owned by the public.  No private individual can claim ownership of the corporation.  The board of directors and the officers cannot own the corporation’s assets.

For this reason, the Public Benefit Corporation cannot distribute dividends to any individual.  If the organizers of the Public Benefit Corporation later decide to terminate the corporation, the assets of the Public Benefit Corporation must be transferred to another charity that has the same or similar purpose.  The assets remaining after the debts and liabilities are paid must be transferred to another public benefit organization and cannot be transferred to any members of the former corporation or any private individual or any for-profit corporation.  The property must be permanently used for charitable purposes.  Moreover, a valuable asset to the nonprofit is its intellectual property.  It is important that the nonprofit corporation also make the appropriate filings to protect its intellectual property, such as trademarks, service marks, copyrights, and patents.

In addition, because the Public Benefit Corporation is formed for charitable purposes, it must register and submit reports with the Attorney General’s Registry of Charitable Trusts.  Moreover, Federal tax law requires that charitable organizations make available at their principal place of business the organization’s financial information, including applications for tax exemption, IRS Form 990, IRS Form 990EZ or IRS Form 990PF returns for the past three (3) years, and its IRS determination letter.  These copies must also be provided upon written request from any person.

WHAT IS THE LEGAL FORMATION OF A NONPROFIT?

The primary business entity formation for a nonprofit is the corporation.  The corporation is a separate legal entity from the people who own, manage, and operate it.  The corporation is composed of a Board of Directors and officers.  The Board is responsible for overseeing and supervising the officers and employees of the corporation.  The officers are responsible for the daily operations of the corporation. The directors and officers have limited personal liability for the business debts of the nonprofit organization.  Creditors can only satisfy their debts incurred by the nonprofit organization from the corporate assets.

The difference between a for-profit corporation and a nonprofit corporation is that the for-profit corporation has shareholders who are the owners of the corporate property.  Nonprofit corporations cannot have owners of the corporate property.  There can be no private inurement or improper private benefit to anyone involved in the nonprofit.  Whereas, a for-profit corporation can distribute its assets to its shareholders at any time during its operation through dividends.  This encourages investment in the for-profit corporation and allows the shareholders to obtain a return on their investment.  Nonprofit corporations do not allow this type of distribution.

A nonprofit is a corporation that:

(1) Has a mission to undertake activities in which profit is not the primary goal,

(2) Nobody has ownership of shares or interest in its property, and

(3) The property and income of the corporation are never distributed to any of its members, but are instead distributed to support the charitable activities.

Upon dissolution of the nonprofit, the earnings and assets of the nonprofit are directed toward the charitable activities rather than distributed to individuals for personal gain.  Even if the organization fails to obtain tax exempt status by the Internal Revenue Service (IRS), the funds must still be used for charitable purposes and cannot be refunded or distributed to the donors.

California recognizes three types of nonprofit corporations: (1) Public Benefit Corporations, (2) Mutual Benefit Corporations, and (3) Religious Corporations.

 

OVERVIEW OF NONPROFIT LAW

WHAT IS THE LEGAL FORMATION OF A NONPROFIT?
WHAT ARE NONPROFIT PUBLIC BENEFIT CORPORATIONS?
WHAT ARE THE CHARITABLE PURPOSES OF A NONPROFIT?
BROAD PUBLIC INTEREST
EDUCATIONAL PURPOSE
LITERARY PURPOSE
COMMUNITY DEVELOPMENT AND SOCIAL WELFARE
RELIEF OF THE POOR, DISTRESSED, OR UNDERPRIVILEGED
LESSENING THE BURDENS OF GOVERNMENT
WHAT ARE MUTUAL BENEFIT CORPORATIONS AND RELIGIOUS CORPORATIONS?
WHAT ARE SOCIAL WELFARE ORGANIZATIONS UNDER INTERNAL REVENUE CODE SECTION 501(c)(4)?
WHAT IS THE INCORPORATION PROCESS FOR PUBLIC BENEFIT CORPORATIONS?
HOW DOES A NONPROFIT OBTAIN TAX EXEMPT STATUS?
FEDERAL INCOME TAX EXEMPTION
ORGANIZATIONAL TEST
OPERATIONAL TEST
PUBLIC CHARITIES AND PRIVATE FOUNDATIONS
PUBLIC CHARITY
PRIVATE FOUNDATION
PRESUMPTION OF PRIVATE FOUNDATION
IRS FORM 1023
CALIFORNIA STATE INCOME TAX EXEMPTION
PROPERTY AND SALES TAX
LOCAL BUSINESS LICENSE
CAN A NONPROFIT BE TAXED ON UNRELATED BUSINESS INCOME?
NONPROFIT RESIDENTIAL REAL ESTATE ACTIVITIES AND LOW INCOME HOUSING PROJECTS
NONPROFIT COMMERCIAL REAL ESTATE ACTIVITIES
HOW DOES A NONPROFIT MAINTAIN TAX EXEMPT STATUS?
INFORMATIONAL RETURNS: IRS FORM 990 AND CALIFORNIA FTB FORM 199/199N
UNRELATED BUSINESS INCOME TAX RETURNS: IRS FORM 990T AND CALIFORNIA FTB FORM 109
ADDITIONAL CALIFORNIA REQUIREMENTS
WHAT ARE MEMBERS OF THE NONPROFIT PUBLIC BENEFIT CORPORATION?
WHAT ARE DIRECTORS AND OFFICERS OF THE NONPROFIT PUBLIC BENEFIT CORPORATION?
COMPENSATION AND SELF-DEALING
LIMITED LIABILITY
HOW DO NONPROFITS RAISE FUNDS?
HOW DOES THE ATTORNEY GENERAL REGULATE NONPROFITS?
CAN A NONPROFIT HIRE EMPLOYEES?
WHAT ARE THE ALTERNATIVES TO A NONPROFIT CORPORATION?
FISCAL SPONSORSHIP
UNINCORPORATED NONPROFIT ASSOCIATION

 

WHAT IS THE LEGAL FORMATION OF A NONPROFIT?

The primary business entity formation for a nonprofit is the corporation.  The corporation is a separate legal entity from the people who own, manage, and operate it.  The corporation is composed of a Board of Directors and officers.  The Board is responsible for overseeing and supervising the officers and employees of the corporation.  The officers are responsible for the daily operations of the corporation. The directors and officers have limited personal liability for the business debts of the nonprofit organization.  Creditors can only satisfy their debts incurred by the nonprofit organization from the corporate assets.

The difference between a for-profit corporation and a nonprofit corporation is that the for-profit corporation has shareholders who are the owners of the corporate property.  Nonprofit corporations cannot have owners of the corporate property.  There can be no private inurement or improper private benefit to anyone involved in the nonprofit.  Whereas, a for-profit corporation can distribute its assets to its shareholders at any time during its operation through dividends.  This encourages investment in the for-profit corporation and allows the shareholders to obtain a return on their investment.  Nonprofit corporations do not allow this type of distribution.

A nonprofit is a corporation that:

(1) Has a mission to undertake activities in which profit is not the primary goal,

(2) Nobody has ownership of shares or interest in its property, and

(3) The property and income of the corporation are never distributed to any of its members, but are instead distributed to support the charitable activities.

Upon dissolution of the nonprofit, the earnings and assets of the nonprofit are directed toward the charitable activities rather than distributed to individuals for personal gain.  Even if the organization fails to obtain tax exempt status by the Internal Revenue Service (IRS), the funds must still be used for charitable purposes and cannot be refunded or distributed to the donors.

California recognizes three types of nonprofit corporations: (1) Public Benefit Corporations, (2) Mutual Benefit Corporations, and (3) Religious Corporations.

WHAT ARE NONPROFIT PUBLIC BENEFIT CORPORATIONS?

A Public Benefit Corporation must be formed for public or charitable purposes and cannot be formed for private gain of any individual.  Public benefit purposes include organizations such as childcare centers, shelters for homeless people, community health care clinics, museums, hospitals, schools, performing arts groups, conservation groups, and affordable housing groups.

The Public Benefit Corporation is legally restricted in that all its assets must be irrevocably dedicated to charitable, scientific, or educational purposes.  In this sense, the nonprofit corporation is owned by the public.  No private individual can claim ownership of the corporation.  The board of directors and the officers cannot own the corporation’s assets.

For this reason, the Public Benefit Corporation cannot distribute dividends to any individual.  If the organizers of the Public Benefit Corporation later decide to terminate the corporation, the assets of the Public Benefit Corporation must be transferred to another charity that has the same or similar purpose.  The assets remaining after the debts and liabilities are paid must be transferred to another public benefit organization and cannot be transferred to any members of the former corporation or any private individual or any for-profit corporation.  The property must be permanently used for charitable purposes.  Moreover, a valuable asset to the nonprofit is its intellectual property.  It is important that the nonprofit corporation also make the appropriate filings to protect its intellectual property, such as trademarks, service marks, copyrights, and patents.

In addition, because the Public Benefit Corporation is formed for charitable purposes, it must register and submit reports with the Attorney General’s Registry of Charitable Trusts.  Moreover, Federal tax law requires that charitable organizations make available at their principal place of business the organization’s financial information, including applications for tax exemption, IRS Form 990, IRS Form 990EZ or IRS Form 990PF returns for the past three (3) years, and its IRS determination letter.  These copies must also be provided upon written request from any person.

WHAT ARE THE CHARITABLE PURPOSES OF A NONPROFIT?

Groups organized for “charitable purposes” are exempt from income tax pursuant to Internal Revenue Code section 501(c)(3).  Such groups include those organized and operated for religious, charitable, scientific, educational, or literary purposes.

BROAD PUBLIC INTEREST

The term “charitable purpose” is defined broadly and includes those services that are beneficial to the public interest.  The organization must serve an open class of people and not a limited number of group members. For instance, charitable purposes include providing food to the homeless in the community, but not to specifically-named people.  The beneficiaries of the organization’s purpose must be open and unspecified, but does not need to be large.  Other examples of charitable purposes include: relief of the poor, distressed, and underprivileged; advancement of education and science; maintaining public buildings or monuments; lessening burdens of government; eliminating prejudice and discrimination; promoting the arts; or defending human and civil rights.

EDUCATIONAL PURPOSE

Educational purposes include instructing the public on subjects that are useful for the benefit of the community or for self-development.  Particular viewpoints are allowed to be the focus, but there must be a full and fair exposition of pertinent facts so that individuals can form their own opinions and conclusions on the subject.  If the curriculum only focuses on an unsupported opinion, the purpose is not considered educational for charitable purposes.  Examples of educational purposes include: publishing public interest materials; public discussion groups, lectures, or workshops; correspondence courses; or museums, zoos, planetariums, orchestras, or other performances.

LITERARY PURPOSE

Literary purposes must involve books and reading.  The organization must not target commercial markets and must sell the publications only at a modest price.  Examples of literary purposes include: environmental preservation, highway safety, or drug and alcohol publications.

COMMUNITY DEVELOPMENT AND SOCIAL WELFARE

Charitable purposes may include those that promote social welfare by lessening neighborhood tensions, eliminating prejudice and discrimination, defend human civil rights, and prevent the deterioration of the community and juvenile delinquency.  Charitable purposes may also include services that assist minorities, women, immigrants, or other classes that have been historically denied equal treatment because of race, gender, citizenship, or any other protected status.

Community development programs include job training, small business development, or affordable housing programs.  Such purposes qualify for Federal tax exemption by: relieving the poor and distressed, combating community deterioration, eliminating discrimination, and lessening government burdens.  The IRS defines a group as “poor and distressed” when there is an inability to afford “necessities of life” without undue hardship, and factors the lack of adequate housing, unemployment rate, and the government’s classification of the group as economically disadvantaged.

RELIEF OF THE POOR, DISTRESSED, OR UNDERPRIVILEGED

There is no uniform definition of “poor.” This “charitable class” is essentially made up of low-income, minority, elderly, disabled, or other 501(c)(3) organizations.  Examples of organizations that qualify include: Organizations that offer services to obtain and maintain employment, vocational training, child care, counselling, financial services to businesses owned by “needy” individuals, or housing, legal, food, and transportation services to the “needy.”

LESSENING THE BURDENS OF GOVERNMENT

In order to qualify as lessening government burdens, the activity must be government’s responsibility and the activity must in fact lessen the burden to the public.  Generally, there must be a government policy or code that applies to the activity, such as housing or economic development.  The government must have an involvement in the activity on a regular basis, provide funding, and perform the activity directly.  The nonprofit organization’s purpose must directly address the burden to the public.  The nonprofit should have a favorable relationship with the government entity and improve the government’s function without additional government expenditures.  Examples include: affordable housing for low-income families, job creation, small business growth, recycling services, community land use plan, recreational facilities and public parks.

WHAT ARE MUTUAL BENEFIT CORPORATIONS AND RELIGIOUS CORPORATIONS?

A Mutual Benefit Corporation is an organization formed for the benefit of its own members, not for the purpose of charity.  Mutual Benefit Corporations include organizations such as private homeowners’ associations, private clubs, and trade and professional associations.  The assets of the Mutual Benefit Corporation can only be distributed to its members upon dissolution, not during its operation.  Whereas, Religious Corporations are nonprofit organizations formed solely for religious purposes.

Mutual Benefit Corporations are different than Public Benefit Corporations and Religious Corporations in that they are generally not considered charitable organizations.  Therefore, because Mutual Benefit Corporations do not benefit the public, they do not qualify for 501(c)(3) tax exempt status.

WHAT ARE SOCIAL WELFARE ORGANIZATIONS UNDER INTERNAL REVENUE CODE SECTION 501(c)(4)?

Social welfare organizations, also known as “Civic Leagues,” involve activities that are directed toward members or toward influencing public opinion and legislation.  These organizations are exempt from Federal income tax pursuant to Internal Revenue Code section 501(c)(4) if the organization operates primarily to further the common good and general welfare of the community.  These organizations may engage in political activities, but politics must not be their primary purpose.  Examples include: volunteer fire companies, community associations, crime prevention groups, or groups promoting industrial development in the community.  The difference between 501(c)(3) status and 501(c)(4) status is that donations to an organization exempt pursuant to 501(c)(4) are not tax deductible.

WHAT IS THE INCORPORATION PROCESS FOR PUBLIC BENEFIT CORPORATIONS?

A California Nonprofit Public Benefit Corporation may be formed by completing certain steps.  These include:

  1. Name Availability ($10.00 Fee): It is best to check the availability of a particular name for the nonprofit corporation and reserve the name with the Secretary of State.
  2. Articles of Incorporation ($30.00 Fee): The Articles of Incorporation is the formal document that legally creates the corporation and must be filed with the Secretary of State. The Articles must specify the charitable purpose of the organization, the name of the organization, the principal place of business, its officers, and any limits on its operation.  The Articles must include language ensuring that is not organized for private gain of any individual, that it will comply with the requirements for nonprofit status, and comply with the requirements for tax exemption.  The specific clauses that should be in the Articles include:
    • Clause stating the corporation is organized and operated exclusively for charitable purposes and shall not engage in any activities or exercise any powers that are not in furtherance of its primary charitable purpose, except to an insubstantial degree;
    • Clause stating that no substantial activities should consist of propaganda, influence legislation, and the corporation shall not participate in any political campaign in support or in opposition of any candidate for public office;
    • Clause dedicating income and assets to charitable purposes, and no part of net income or assets shall inure to the benefit of any director, officer, member, or private individual; and
    • Clause stating that upon dissolution, the remaining assets shall be distributed to another corporation exclusively for charitable purposes with 501(c)(3) tax exempt status.
  3. Bylaws: The incorporator or the initial board of directors should prepare and adopt the Bylaws immediately after filing the Articles of Incorporation. A copy of the Bylaws, signed by an officer or certified by the Secretary, must be submitted with the application for Federal and State tax exemption.  The Bylaws set out the structure and rules of operation for the Public Benefit Corporation.  The Bylaws should include the method for electing directors and officers, the procedures for how the board of directors shall operate, and the procedures for amending Bylaws.
  4. Incorporator’s Initial Action: If the Articles were only signed by an incorporator and not the initial board of directors, the incorporator will need to appoint the first board of directors as an initial action.  At this time, the incorporator may also adopt the Bylaws, appoint officers, and authorize a bank account to be opened in the name of the Public Benefit Corporation.  The corporate minutes should reflect these actions.
  5. Employer Identification Number (EIN) (No Filing Fee): An Employer Identification Number (EIN) must be obtained from the Internal Revenue Service (IRS) by filing an IRS Form SS-4. The EIN will be the identification number on all Federal tax returns and reports for the nonprofit.
  6. Statement of Domestic Nonprofit Corporation ($20.00 Fee; also referred to as Statement of Information; Form SI-100): Within ninety (90) days of filing the Articles of Incorporation, a Statement of Information by Domestic Nonprofit Corporation must completed and submitted to the Secretary of State.  The Statement must be submitted every second year during the existence of the Public Benefit Corporation.
  7. Register with Attorney General (Up to $300.00 Annual Fee based on gross annual income sliding scale; $25.00 Initial Fee per Form CT-1, Renewal Fee based on sliding scale per Form RFF-1): Pursuant to California Government Code section 12585, all charities must register with the Attorney General within thirty (30) days after receiving their first assets. The Articles of Incorporation and the Bylaws must be filed with the Attorney General’s Registry of Charitable Trusts. The registration must be renewed every year.  In addition, the Public Benefit Corporation must file financial information reports every year with the Attorney General.  These include Form RRF-1 and Form 990, 990-EZ, or 990-PF.  Corporations organized primarily as a hospital, school, or religious organization are exempt and must provide substantiating evidence to the Attorney General.
  8. Board Meeting: The first board of directors meeting should involve adopting the Bylaws, electing officers, setting possible compensation amounts of wages or salaries for officers, establishing a bank account, authorizing the officers to apply for tax exemption, declaring the accounting year and the accounting procedures to be applied, setting a budget, clarifying operation procedures such as maintaining the minutes, Bylaws, and corporate records.  These actions may be conducted through unanimous written consent signed by the directors, rather than in-person, so long as it is permitted by the Bylaws.  The corporate secretary must record and maintain all signed meeting minutes and unanimous written consents.
  9. Tax Exemption ($400.00 or $850.00 Fee for IRS Form 1023 depending on Annual Gross Receipts; $25.00 Fee for California FTB Form 3500): The Public Benefit Corporation must file IRS Form 1023 as the application with the IRS for exemption from Federal income tax pursuant to sections 501(c)(3) or 501(c)(4) of the Internal Revenue Code. In addition, FTB Form 3500 must be filed with the California Franchise Tax Board as the application for exemption from State income tax.

HOW DOES A NONPROFIT OBTAIN TAX EXEMPT STATUS?

The major benefit of charitable nonprofit organizations is that they may qualify for exemption from Federal and State income tax.  In addition, corporate donors may deduct contributions to organizations that are exempt under section 501(c)(3) of the Internal Revenue Code from their personal Federal income tax.  A tax professional must be retained by the nonprofit because of the complexities involved.  The process for obtaining tax-exempt status is separate from the incorporation process.

FEDERAL INCOME TAX EXEMPTION

Section 501(c)(3) of the Internal Revenue Code, which is codified in Title 26 of the United States Code, states that the following are exempt from taxation:

“Corporations, and any community chest, fund, or foundation, organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary, or educational purposes, or to foster national or international amateur sports competition (but only if no part of its activities involve the provision of athletic facilities or equipment), or for the prevention of cruelty to children or animals, no part of the net earnings of which inures to the benefit of any private shareholder or individual, no substantial part of the activities of which is carrying on propaganda, or otherwise attempting, to influence legislation (except as otherwise provided in subsection (h)), and which does not participate in, or intervene in (including the publishing or distributing of statements), any political campaign on behalf of (or in opposition to) any candidate for public office.”

Essentially the advantage of obtaining charitable Internal Revenue Code (IRC) Section 501(c)(3) tax-exempt status are:

  • Exemption from Federal and State income tax on earned and investment income, except for net income from unrelated business purposes, or investment income from assets acquired with debt;
  • Charitable contributions from individuals are tax-deductible;
  • Many grants from Government, foundations, and corporations are limited to 501(c)(3) organizations; and
  • Tax-exempt organizations qualify to purchase property through bargain sales, in which the property may be bought at a less than fair market value, and the seller will receive a tax deduction for the difference between the value and the sales price.

To qualify for exemption from Federal income tax, a nonprofit organization must satisfy both the organizational test and the operational test.

ORGANIZATIONAL TEST

According to the Internal Revenue Code, a section 501(c)(3) organization must be “organized and operated exclusively for religious, charitable, scientific, testing for public safety, literary or educational purposes.” The organizational test is satisfied if the Articles of Incorporation includes language that limits the purpose of the organization to the exempt purposes listed in section 501(c)(3) of the Internal Revenue Code.  The Articles of Incorporation must state that the organization cannot engage in any substantial activities which does not further the exempt purposes.  Moreover, the organization must expressly dedicate its assets to exempt purposes in the event of dissolution.

OPERATIONAL TEST

The nonprofit must also satisfy the operational test, which requires the organization to engage primarily in activities to accomplish an exempt purpose specified in section 501(c)(3) of the Internal Revenue Code.  The organization must not divert charitable assets to private individuals, pay excessive compensation to officers and directors, or engage in prohibited political activities.  The organization must not participate in politics by supporting or opposing a particular candidate for public office.  The organization must not engage in substantial lobbying.  Moreover, to obtain tax exemption in California, more than half of the board of directors must be disinterested – meaning that not more than 49% of the directors can receive compensation or be related to a person receiving compensation from the organization.

PUBLIC CHARITIES AND PRIVATE FOUNDATIONS

A 501(c)(3) organization must be classified as either a Private Foundation or a Public Charity based on the level of public involvement in its activities.

PUBLIC CHARITY

A Public Charity receives the majority of its financial support from the general public or Government entities.  In doing so, Public Charities interact greatly with the public. An organization will be classified as a Public Charity if it receives a certain percentage of its total financial or program support from Government sources, other Public Charities, or a broad base of individual donors.  The calculation required to obtain Public Charity status from public donations is complex.  Tax professionals will need to be consulted and an IRS Form 8940 must be submitted.  If the organization is classified as a Public Charity due to receiving financial support from the public, the IRS classification status will be valid for five (5) years.  In advance of the end of the five (5) year period, the organization will be required to submit IRS Form 8734.  In addition, an organization can be classified as a Public Charity, and avoid the more rigorous classification as a Private Foundation, if it satisfies the IRS definition of a church, school, hospital, or museum.

Most active 501(c)(3) organizations are Public Charities because they have higher donor tax-deductible contribution limits and can attract support from other Public Charities and Private Foundations.  Also, Public Charities have three possible tax filing requirements that range in complexity and depend on annual revenue: (1) Form 990 must be filed for Public Charities with annual revenue greater than $200,000.00; (2) Form 990-EZ must be filed for Public Charities with annual revenue between $50,000.00 and $200,000.00; or (3) Form 990-N E-Postcard can be filed for Public Charities with annual revenue less than $50,000.00.  Whereas, Private Foundations must file the rigorous Form 990-PF each year regardless of revenue (it is comparable to the more complex Form 990 for Public Charities).

PRIVATE FOUNDATION

A Private Foundation is many times controlled by members of a single family, by a small group, or by a corporation retaining control over operations and grants.  As a result, much of the Private Foundation’s financial support is from specific sources and investments.  Private Foundations are not subjected to strict public scrutiny.  However, Private Foundations are instead subjected to various operating requirements and restrictions.  For instance, classification as a Private Foundation has disadvantages in that a two percent (2%) excise tax is imposed on the organization’s net investment income, there are limits on the deductions of charitable contributions by individual donors, and there are more burdensome financial reporting requirements.

PRESUMPTION OF PRIVATE FOUNDATION

Pursuant to tax laws, a section 501(c)(3) organization is presumed to be a Private Foundation.  The organization must request and qualify as a Public Charity and receive a ruling or determination by submitting IRS Form 8940.

IRS FORM 1023

To apply for Federal tax exemption, IRS Form 1023 must be filed within twenty-seven (27) months of incorporation with the Internal Revenue Service.  Form 1023 must be signed by a principal officer, an authorized employee, the Attorney for the nonprofit, or an agent with Power of Attorney to act on behalf of the nonprofit.  Included with the Form 1023 must be:

  • Certified copy of the Articles of Incorporation from the Secretary of State;
  • Copy of the Bylaws signed by a principal officer or certified by a declaration from an authorized officer stating that the Bylaws are the true and complete copy;
  • Statement of receipts and disbursements;
  • Current balance sheet;
  • Proposed budget for two (2) years; and
  • Executed copy of a consent to extend the period in which to assess tax (Form 872-C), unless the organization is a Private Foundation which does not need to submit Form 872-C.

The fee for Form 1023 is based on the projected gross receipts of the nonprofit.  The fee is $400.00 if the nonprofit has an annual gross receipts of less than $10,000.00 in the preceding four (4) years of existence or if the projection for a newly formed nonprofit is less than $10,000.00.  The fee is $850.00 if annual gross receipts are more than $10,000.00.  It takes at least three (3) months after filing Form 1023 to receive an approval from the IRS.

CALIFORNIA STATE INCOME TAX EXEMPTION

In California, corporations are subjected to an annual franchise tax on net income.  However, nonprofit corporations can apply to be exempt from this annual franchise tax.

To obtain exemption from State income tax, FTB Form 3500 must be filed with the California Franchise Tax Board with a $25.00 Fee.  If the corporation has already received a letter from the IRS recognizing its 501(c)(3) exemption status, the corporation may file Form 3500A for no fee and attach the IRS letter.

PROPERTY AND SALES TAX

Even though a charity is exempt from income tax, the organization is still responsible for applicable property tax and sales tax.  Local and State property and sales tax statements and returns must be filed.

However, in California the corporation may apply for a property tax exemption known as the Welfare Property Tax Exemption for its taxable real or personal property.

In California there is no exemption from sales tax for charities.  If the nonprofit is selling merchandise, a Sellers Permit and Resale Certificate from the California State Board of Equalization must be obtained.

The State Board of Equalization and local county tax assessor can be consulted to clarify what taxes are still required by the organization.

LOCAL BUSINESS LICENSE

The nonprofit may be subjected to local business license permits and local business taxes.  The local City Clerk should be consulted to determine if any other taxes are applicable to the nonprofit.  Charitable corporations are often exempt from payment of local business license taxes.

CAN A NONPROFIT BE TAXED ON UNRELATED BUSINESS INCOME?

Nonprofit corporations often retain an Attorney to provide an opinion on whether the corporation will be engaging in unrelated business activities that may be taxable.

To note, the organization’s activities can still be considered charitable even though they generate profits. However, the primary purpose must be charitable and not income generation.  A for-profit business generates income on a regular basis; whereas, a non-profit organization engages in fundraising not on a regular basis.  Factors that are considered in determining if the organization is charitable include:

  • How the income is derived, not how the surplus will be used;
  • The nature and size of the business – is it affordable, below cost?
  • Does it serve a charitable class – i.e. low-income, minority, elderly, disabled, other 501(c)(3) organizations; and
  • Does the nonprofit operate in a commercial manner and compete against private business?

A charitable corporation can engage in a limited amount of non-charitable unrelated business activity and still qualify for section 501(c)(3) status.  As a general rule, not more than 15% of the income can be non-charitable.

Section 501(c)(3) organizations will be subjected to tax on the net income derived from activities that are not substantially related to the exempt purposes.  The organization must submit additional State and Federal tax returns for its unrelated business income – IRS Form 990T and California FTB Form 109.  An exception from tax exists for the passive income, such as rent from real property, interest on dividends, and royalties.  However, if the activity is financed with debt the exception does not apply and the net income is taxed.

If too much of the organization’s activity is non-charitable, the 501(c)(3) status will be lost.  For this reason, many charitable corporations will form a for-profit subsidiary to conduct the unrelated business activity, allowing the charitable corporation to retain control by electing the directors of the subsidiary and the funds can be transferred back to the 501(c)(3) pursuant to a services contract or as after-tax dividends.   If the nonprofit corporation controls any subsidiary nonprofit or for-profit corporations, it is important that it monitors the performance and compliance with corporate formalities.

An activity may still be considered charitable even though it is partly supported by grants and also partly by income, such as a sliding scale fee based on ability to pay.  In such situations, the income received is used to subsidize those who pay less than cost and the grants make up the difference.

NONPROFIT RESIDENTIAL REAL ESTATE ACTIVITIES AND LOW INCOME HOUSING PROJECTS

Residential real estate activities may be charitable and qualify for 501(c)(3) status if the purpose is for the relief of the poor and distressed.  Pursuant to IRS Revenue Procedure 96-32, entitled Low Income Housing Guidelines, at least 75% of the units in a real estate project must be for recipients who earn 80% or less of the median income in the area.  Furthermore, either 20% of those units must be for families earning 50% or less of the area median income, or 40% of those units must for families earning 60% or less of the area median income.  The remaining units may be provided at the market rate.

Another method for residential real estate to qualify for 501(c)(3) status is based on the facts and circumstances.  For example, evidence may be introduced to show that the persons aided by the project could not otherwise obtain housing (i.e. housing for those who have very high medical expenses); or the project participates in a government housing program; or the project contains provisions for social services; or the project has a community-based board of directors and allows for community involvement in making operation decisions.

In addition, the residential real estate project may qualify for 501(c)(3) status by aiming to combat community deterioration.  For example, the project may aim to rehabilitate or provide new construction in a blighted area designated by the Government or the facts and circumstances show that the area is blighted.  Evidence of blight includes: studies showing that the area is old and deteriorated, the area has lower median income as compared to other neighboring areas, the area has few recreational facilities, declining property values, high abandonment and vacancies, high crime and drug rates, and many housing code violations.

The residential real estate project may also qualify for 501(c)(3) status by eliminating prejudice and discrimination.  The project may aim to provide housing to minorities who have historically been unable to obtain housing due to discrimination.  The project may also aim to provide specialized housing for the elderly and handicapped.

NONPROFIT COMMERCIAL REAL ESTATE ACTIVITIES

Pursuant to IRS Revenue Rulings, commercial real estate activities may be considered charitable when:

  • The property is used as office space for the nonprofit organization’s own use;
  • The property is rented out to other 501(c)(3) organizations at the lowest feasible rate;
  • The property is rented to poor and minority business owners particularly in blighted areas;
  • The property includes lease provisions requiring job training and employment of residents in a disadvantaged area;
  • The rental income is used to make grants to other 501(c)(3) organizations; or
  • The rental income is used to lessen the rent of other 501(c)(3) organization tenants of the property.

HOW DOES A NONPROFIT MAINTAIN TAX EXEMPT STATUS?

Annual financial reports must be submitted to the IRS and the California Franchise Tax Board.  The board of directors should review the corporation’s annual IRS and State filings before submitted.  Often, the nonprofit will retain an independent accountant to conduct a review of the organization’s financial statements and issue a report to the board of directors, which is a less expensive alternative to obtaining a complete audit.  The nonprofit should hire a professional accountant to help implement a fiscal management system, addressing issues such as dual-signature requirement on bank accounts, regular review of monthly statements by the board, and an annual audit.  The local chapter of the American Institute of Certified Public Accountants (AICPA) or the California Board of Accountancy’s Clearinghouse for Volunteer Accounting Services (CVAS) may be contacted for information on accountants who may provide free services or reduced-cost services to nonprofits.

Pursuant to California Government Code section 12586, referred to as the Nonprofit Integrity Act of 2004, a charitable organization with gross revenue of two-million dollars ($2,000,000.00 USD) or more must obtain independent audits and appoint an audit committee.  The audited financial statements must be made available for inspection.

At any time during the existence of the nonprofit organization, the IRS or the California Franchise Tax Board may audit the organization to determine tax liability, penalties, or revocation of tax-exempt status.

INFORMATIONAL RETURNS: IRS FORM 990 AND CALIFORNIA FTB FORM 199/199N

Public Charities must submit annual filings to the IRS, including IRS Form 990 or 990-EZ (Return of Organization Exempt from Income Tax) and accompanying Schedule A within four-and-a-half (4 ½) months following the close of the organization’s tax year.  This is the organization’s informational return stating its finances and activities.  Certain organizations are exempt from this filing requirements, such as churches and organizations with annual gross receipts of $50,000.00 or less (except for Private Foundations).  Rather, such organizations must file Form 990N, which is an annual electronic notice form.  Private Foundations must file the more rigorous Form 990PF regardless of their gross receipts.

The California equivalent for the annual exempt organization return is FTB Form 199 and 199N.

UNRELATED BUSINESS INCOME TAX RETURNS: IRS FORM 990T AND CALIFORNIA FTB FORM 109

An organization that has annual gross incomes of one-thousand dollars ($1,000.00 USD) or more from unrelated trade or business activities must file IRS Form 990T Exempt Organization Business Income Tax Return in addition to the annual informational return. The unrelated business income will be taxed at the same rate as the standard corporation Federal income tax.  Moreover, if the organization has a significant amount of unrelated business income, the IRS may determine that the organization is spending a substantial amount of time on non-exempt activities and investigate its tax exemption status.

The California equivalent for the unrelated business income return is FTB Form 109.

ADDITIONAL CALIFORNIA REQUIREMENTS

In California, the Statement of Information by Domestic Nonprofit Corporation with a $20.00 fee must be submitted to the Secretary of State every two (2) years. Failure to comply will lead to penalty charges.

In addition, every Nonprofit Public Benefit Corporation must register the Attorney General’s Registry of Charitable Trusts within thirty (30) days of receiving its first assets.  The initial registration form is Form CT-1.  The corporation must file the Registration Renewal Fee Report Form RRF-1 with the registry every year.  Nonprofit corporations with revenues of more than $25,000.00 during the preceding fiscal year must pay an annual registration fee based on a sliding scale.  Also, all IRS Form 990, 990EZ, 990N, or 990PF, and schedules must be submitted to the Attorney General.

WHAT ARE MEMBERS OF THE NONPROFIT PUBLIC BENEFIT CORPORATION?

Membership for a Nonprofit Public Benefit Corporation is optional.  The reasons for providing membership in a nonprofit include: (1) Attract funds through membership, or (2) Establish support in the community.  However, many administrative burdens are associated with forming a membership organization and it is more common for a nonprofit to not have members.

If the nonprofit includes membership, the Bylaws must address the controlling provisions for membership such as qualifications, method of selection, expulsion, dues and fees, notice and frequency of meetings, the number required for a quorum to make decisions, and the number of votes required to order action on a matter.  The Public Benefit Corporation may also create different classes of membership, which may be offered to individuals or corporate entities.  Based on the provisions in the Bylaws, the members may have voting and statutory rights or they may simply be donors who have only honorary membership without any voting and statutory rights.  In California, members have statutory legal rights when they possess voting power on electing directors or on how the charity’s assets will be disposed upon dissolution, merger, or conversion.  Pursuant to California law, voting members have the right to inspect corporate records, elect and remove directors, receive notice of meetings, and they may sue the directors in a derivative action or third-parties on behalf of the nonprofit corporation.  These statutory rights can be enforced in civil court actions.  In addition, classes of voting members cannot be abolished without their consent, and also their voting rights cannot be changed without notice, due process, and consent.

As a practicality, the nonprofit corporation should maintain an alphabetized list of its members, including their name, address, class of membership, and applicable membership dues.

WHAT ARE DIRECTORS AND OFFICERS OF THE NONPROFIT PUBLIC BENEFIT CORPORATION?

Every corporation must have directors and officers, who owe fiduciary duties to the corporation.  The Bylaws address the method for selecting the board of directors and officers.  The Public Benefit Corporation may have only one director, but it is more common for a board of directors to consist of three or more persons.  To note, the IRS is unlikely to grant 501(c)(3) status to a nonprofit corporation that only has one director.

The board of directors can be selected by voting members, act as a self-perpetuating body, be appointed by an outside organization or persons, or any combination of these procedures.  The Bylaws must address the number of directors, qualifications, term of office, removal, filling vacancies, notice and frequency of meetings, number required for a quorum, number of votes required, and method for appointing officers and committees.

The Public Benefit Corporation must also have certain officers named, including the President, Chief Financial Officer, and Secretary.  The responsibilities of the officers are addressed in the Bylaws, which often include maintaining the accounts, deposits, disbursements, meeting minutes, and notices.  A director can also serve as an officer.  However, pursuant to California Corporations Code sections 5213 and 9213, neither the Secretary nor the Chief Financial Officer or the Treasurer may serve concurrently as the President or Chair of the Board.

COMPENSATION AND SELF-DEALING

Charitable organizations must not pay its officers or employees unreasonable excessive compensation.  The amount of compensation must be authorized by the board of directors or an authorized committee appointed by the board.  The nonprofit corporation must conduct appropriate investigation to determine if loans, leases, and other transactions are made at fair market value to the nonprofit or are favorable to the nonprofit.

If any of the directors are to be compensated as an officer or employee of the Public Benefit Corporation, the amount of compensation must be approved by an independent board and the interested director must be excluded from the vote.  An independent board requires that less than 49% of the participating directors are paid or relatives of others paid as employees or officers of the Public Benefit Corporation.  That is, more than half of the board must not be receiving compensation or be a relative of someone receiving compensation from the Public Benefit Corporation.  For example, if there are five (5) directors on the board, only two (2) can receive compensation as an officer or employee.

Reasonable compensation paid to a director or officer is not considered self-dealing so long as it does not impair their ability to serve and be disinterested in making decisions concerning the corporation.  This determination is made on a case-by-case basis according to the facts and circumstances.

Self-dealing is prohibited and involves a contract, agreement, or transaction in which both the organization and a director are parties.  Both the organization and the director have a material financial interest and the organization’s assets or income are affected. This creates a conflict of interest and such deals are inherently suspect.  However, a self-dealing transaction will be valid if the terms of the deal are considered fair and reasonable to the organization. For example, the self-dealing transaction is fair when: the contract is for the corporation’s benefit solely, the corporation could not obtain a better deal, and the deal was approved in advance by a disinterested majority vote of the board of directors.  The disinterested board must conduct a good faith review of the deal rather than a sham, which would be considered fraud and collusion by all the directors thereby incurring liability for the damage to the corporation.

LIMITED LIABILITY

Generally, directors and officers of a Public Benefit Corporation are not personally liable for the debts, liabilities, or obligations of the corporation so long as the director or officer acted in good faith, in the best interest of the corporation, and with reasonable care.  However, a director or officer may be held personally liable when they have breached their duty of care and loyalty to the corporation.   Limited liability does not apply when the director engages in self-dealing or makes and receives a prohibited loan or distribution.  The Attorney General or other disinterested persons may sue the directors in a derivative action to recover actual damage suffered by the corporation, with interest, and even punitive damages.

The Public Benefit Corporation must not make loans to its officers or directors without the approval of the Attorney General.  There is a limited exception concerning a loan for the officer’s primary residence.  The Attorney General will apply a strict scrutiny standard of review when requested to review proposed loans from a Public Benefit Corporation to a director or officer.  The Attorney General will ask: Is the loan strictly necessary to carry out the charitable purpose and protect the charitable assets? Are better alternatives available? Are the terms and interest rate fair to the organization? Is the loan secured?

Moreover, a director will be personally liable for making or receiving prohibited distributions of assets belonging to the Public Benefit Corporation.  Prohibited transactions involving directors and officers include: transfer of corporate funds or assets without fair consideration, payment of excessive or unauthorized salaries, receiving non-contractual benefits or bonuses, improper gifts involving corporate assets, use of corporate assets unrelated to the organization’s charitable purpose.

In fact, California law requires that the Attorney General consents to certain transactions or at least receive notice, including those for dissolution, merger, sale of substantially all the corporation’s assets, and an amendment to the Articles of Incorporation to change the form of the organization from Public Benefit to for-profit.  In the case of a conversion in the form of the organization, all the charitable assets of the Public Benefit Corporation must be distributed to another charity with similar charitable purposes.

As a practicality, the nonprofit corporation should obtain commercial general liability insurance, errors and omissions or other professional liability insurance, directors and officers liability insurance, and bonding for the individuals responsible for handling the funds of the nonprofit.

HOW DO NONPROFITS RAISE FUNDS?

In order for donors to deduct their charitable contributions, the IRS guidelines require that the taxpayer donor show that the amount claimed as a deductible gift to charity is more than the fair market value of any benefit received.  Moreover, it is important that the nonprofit corporation complies with disclosure, substantiation, and reporting requirements for the contributions it receives.  The nonprofit must also comply with all State and local charitable solicitation laws and ordinances.  For example, the Federal government requires the nonprofit to give a receipt to the donor making the charitable contribution.  The receipt must be given before the earlier of when the donor’s income tax return is due or when the donor files the income tax return. The receipt must contain the following information: (1) Name of the donor; (2) Date the contribution was made; (3) Cash value of the contribution; (4) Description (but not the value) of the contribution if in the form of property; (5) Statement of whether the organization has or will provide any goods or services in return for the contribution; and (6) Description and good faith estimate of the value of any goods or services provided or to be provided by the organization.

Furthermore, if the nonprofit will be utilizing the mail, the nonprofit should obtain a nonprofit mailing permit to use special bulk third-class postal rates.

Many times, the nonprofit may hire a commercial fundraiser or a fundraising counsel, which are both required to register with and are regulated by the Attorney General.  Pursuant to California Government Code section 12599, a commercial fundraiser is an entity or an individual who is compensated to solicit funds for charitable purposes or is compensated to receive or control the funds.  A fundraising counsel is a person who is compensated for planning, managing, or consulting on charitable solicitation within California.

A charitable organization is ultimately responsible for the control over its fundraising activities.  A commercial fundraiser or fundraising counsel who is not registered with the Attorney General must not be employed by the organization.  Proof of Registration with the Attorney General’s Office should be provided.  The organization may request a fundraiser’s bond as security.  Moreover, the organization must not raise funds for another charitable organization which is required to register with the Attorney General unless such organization is legitimately registered.

Registration with the Attorney General’s Registry of Charitable Trusts serves to protect against fraud.  A commercial fundraiser must submit a $350.00 fee and obtain a $25,000.00 bond.  The registration and bond must be renewed annually.  A commercial fundraiser must also submit an annual financial report with the Attorney General which discloses the amount of funds obtained during the preceding year.  Local cities and counties may also require the commercial fundraiser to register.

The charitable organization must comply with all county, city, and local ordinances regulating charity fundraising. To note, conducting a private lottery or raffle is illegal in California if it involves payment for a chance to win a prize.  However, charity bingo and raffles are expressly permitted.  California law and local ordinances permit tax-exempt organizations to raise money from bingo if: (1) Proceeds are used for charitable purposes; (2) The game is operated by volunteers from the nonprofit organization; (3) Proceeds cannot pay salaries; (4) The bingo proceeds cannot be commingled with other funds; (5) The nonprofit organization must obtain a license issued by the city or county; and (6) The nonprofit organization must account for all proceeds to the local licensing authority.  In addition, pursuant to California Penal Code section 326.6, a nonprofit organization may lawfully conduct a raffle if ninety percent (90%) of the revenue is put toward the charitable purpose or program.  Charity auctions are also permitted.

Moreover, the nonprofit corporation must comply with security laws by registering or qualifying for an exemption from registration for any debt instrument.

HOW DOES THE ATTORNEY GENERAL REGULATE NONPROFITS?

The California Attorney General represents all the public beneficiaries of charity, who cannot sue in their own right.  Therefore, all charities must register with the Attorney General and the Attorney General’s Registry of Charitable Trusts maintains public files and financial reports for all charities registered in California.  The Attorney General has the power to oversee the operations of Public Benefit Corporations.  The Attorney General’s Charitable Trust Section has investigative audit powers and may bring civil actions to recover diverted charitable assets.  The Attorney General investigates and audits charities to determine if directors have mismanaged, defrauded, or wrongfully diverted funds from the charity.  In doing so, the Attorney General accepts anonymous complaints and may file legal actions against the Public Benefit Corporation on behalf of the public.  The funds recovered by the Attorney General are returned to charity.

If a charity has two-million dollars ($2,000,000.00 USD) or more in gross revenue, which does not include government grants and contracts with government entities for which the government entity required an accounting for the funds received, the Attorney General will require the charity to do the following: (1) Prepare annual financial statements using generally accepted accounting principles and audited by an independent certified accountant; (2) Make those statements available upon demand by the Attorney General and the public; and (3) If the charity is a corporation, the board of directors must appoint an independent audit committee.

The Attorney General will frequently investigate the following: (1) Self-dealing transactions by directors of the Public Benefit Corporation; (2) Loans by a Public Benefit Corporation to a director or officer; (3) Losses of charitable assets from speculative investments; (4) Excessive salaries, benefits, travel, entertainment, legal, or other professional fees paid by a Public Benefit Corporation; (5) Sales of charitable assets or conversion of a Public Benefit Corporation to a for-profit corporation at a price that is unfair to the charity; (6) Illegal use of charitable funds; (7) Diversion of charitable funds from the intended charitable purpose; or (9) False or misleading solicitations of charitable donations.

Certain transactions must be noticed and consented to by the Attorney General.  For example, a Public Benefit Corporation must give advance written notice to the Attorney General of its dissolution, merger, or a sale or transfer of all or a substantial amount of the Public Benefit Corporation’s assets.  The Attorney General must give consent or a Court must approve the distribution of the Public Benefit Corporation’s assets upon dissolution.  Pursuant to California Corporations Code section 6615, the Certificate of Dissolution filed with the Secretary of State must include a certificate from the Attorney General waiving any objections to the proposed distribution of assets or confirming that there are no assets.

Moreover, a Public Benefit Corporation must obtain prior written consent from the Attorney General before making a loan to a director or officer.  As an alternative, the Court may approve the transaction.  Residential loans to directors or officers do not require Court approval or Attorney General consent.

In addition, the directors must obtain prior written consent from the Attorney General before amending the Articles of Incorporation to convert the organization to a for-profit business or a Mutual Benefit Corporation.  Prior consent from the Attorney General is also required when there is a merger of the organization with a for-profit business or Mutual Benefit Corporation.  In such a case, all the assets of the organization must first be distributed to another charity with a similar purpose.  If prior consent from the Attorney General is not obtained, the Public Benefit Corporation may only merge with another Public Benefit Corporation or a religious corporation.

The required documents that must be submitted to the Attorney General in order to obtain approval and consent of voluntary dissolution, merger, sale of assets, or a conversion include: (1) Letter signed by the nonprofit’s attorney or a director detailing the proposed action; (2) Copy of the election to dissolve, agreement of merger, or board resolution giving authorization to the proposed action; (3) Copy of the corporation’s current financial statement; (4) Copy of the corporation’s Articles of Incorporation and of any other corporation that is involved in the proposed action plan; and (5) Independent appraisal or evidence supporting a fair transaction including price and terms if required by the Attorney General.  In the case of a conversion to a for-profit business or Mutual Benefit Corporation, additional required documents included: (6) Certification that all charitable assets will be transferred to another charity as a condition to consent by the Attorney General; and (7) Distribution Plan Statement for the assets to be transferred to another charity or Payment Plan Statement for the directors or purchasers to pay the fair market value of the corporation to another charity.

Directors may give advance written notice to the Attorney General of any self-dealing transactions, which would then shorten the statute of limitations to bring a civil action.  The required documents that should be submitted to the Attorney General in order to obtain approval include: (1) Letter signed by the nonprofit’s attorney or a director detailing the transaction, including the financial interest of the interested director and all material facts; (2) Copy of the corporation’s current financial statement; (3) Copy of the Articles of Incorporation and any amendments; (4) Copy of the Bylaws and any amendments; (5) Copy of all minutes relevant to the transaction; and (6) Letter signed by the interested director detailing the director’s financial interest in the transaction, all material facts, and all relevant facts disclosed by the interested director to the Board.

Any charitable corporation that is formed outside of the State of California but is conducting business or holding property within the State, must still register with the Attorney General.  The foreign corporation must also satisfy the California Secretary of State’s requirements in order to conduct business in the State.  This includes maintaining an agent for service of process within the State.

CAN A NONPROFIT HIRE EMPLOYEES?

Many nonprofit organizations hire employees as staff to provide programs, conduct fundraising, maintain accounting, file taxes, and other services.  The nonprofit has the same legal obligations to its employees as any private business corporation, such as prohibitions against discrimination and harassment.  The nonprofit corporation is also obligated to report employee’s income and make withholder payments to the Federal and State governments, and is responsible for State unemployment insurance taxes, workers’ compensation insurance, State disability insurance, payment of the employer’s portion of Federal social security (FICA), Federal unemployment tax (FUTA), and Medicare.  The nonprofit must also comply with standard employment terms and conditions including minimum wage, overtime, and break periods.  The following forms must be filed with the Federal and State governments:

  • Employee’s Withholding Certificate (W-4) and California Form DE-4
  • Corporation Federal Quarterly Withholding Returns (Form 941E) and bank deposits of withheld income taxes and social security taxes
  • Annual Federal Wage and Tax Statement (W-2)
  • California Employer Registration Form
  • California Income Tax Withholding Form SE-44
  • California Quarterly Unemployment and Disability Insurance
  • Annual Federal Unemployment Tax Return

It is important that the nonprofit correctly classify employees for purposes of Federal and State wage-and-hour laws.  For independent contractors, the corporation must file IRS Form 1099 and California Form DE-542 if the contractor is paid more than $600.00.

As a practicality, the nonprofit should obtain Directors and Officers Insurance, which will protect the individuals from civil claims and employment lawsuits.  An Employment Practices Liability Insurance (EPLI) policy covering employment-related claims may also be obtained.

WHAT ARE THE ALTERNATIVES TO A NONPROFIT CORPORATION?

If the existence of the venture is for a short duration, the nonprofit organization may not be the best structure.  Nonprofits are good for long-term ventures.  Alternatives include: (1) Operating as an informal organization under the legal umbrella of an existing charity, also known as fiscal sponsorship; or (2) Forming an unincorporated nonprofit association.

FISCAL SPONSORSHIP

An alternative may be to obtain fiscal sponsorship, in which the “sponsee” can join an existing organization and operate under its tax-exempt status.  This provides a small project the opportunity to be tax exempt through the sponsor’s IRS status and also pass overhead costs onto the sponsor.  There are no incorporation costs in this situation.  However, the sponsor most likely will retain control over the direction of the project and may also charge a fee from the sponsee.  For example, a fiscal sponsor may charge administrative fees for the use of its facility, services, and staff.  The advantage of a fiscal sponsorship is that the fiscal sponsor will assume the risk of liability.

A fiscal sponsorship may be created by forming an employer-employee relationship, in which the sponsor has direct control over the project.  There is no legal separation between the sponsor and sponsee.  That is, the sponsor will be both fiscally and legally liable for the project.  Moreover, the insurance cost to the sponsee may also be lessened as the sponsor may be able to purchase an affordable blanket liability policy covering all projects.

A fiscal sponsorship may also be created by forming a grantor-grantee relationship, in which the sponsor remains separate from the sponsee.  The sponsor only provides fiscal support to the sponsee through grants.  The sponsor is not legally liable for the project, but the sponsor must exercise sufficient control over the project’s funds to ensure the funds are used according to the grant agreement.  In this relationship, the sponsee must still maintain its own tax liability and is required to comply with the required tax reporting requirements for its particular legal status.  That is, an organization that is an incorporated nonprofit that is receiving grants from a sponsor must still file its own IRS Form 990 even though it is receiving fiscal sponsorship.  As a practicality, the nonprofit grantor must have appropriate safeguards to assure that the corporate funds granted to other organizations are being used for tax exempt purposes.

In order to facilitate the separation from the fiscal sponsor, the Fiscal Sponsorship Agreement should specifically provide terms for how the relationship can be terminated and identify the rights and liabilities for each party upon termination.

UNINCORPORATED NONPROFIT ASSOCIATION

In addition, an unincorporated nonprofit association may also be created without the need to file forms with the Secretary of State and without compliance to the corporate formalities.  The unincorporated association need not have regular formal meetings, has no incorporation costs, and no ongoing filing and reporting requirements.  Essentially, there is no government scrutiny.  However, in such situations, the members of the association may not be protected from personal legal liability for their acts or the acts of their fellow associates.  In addition, such associations have difficulty in raising grants, contributions, and other funds.  Moreover, the association may be treated as a legal entity for tax purposes, and will be taxed on net income and be required to file partnership or corporate tax returns.

TRIAL

To resolve a dispute, the Court must: (1) Determine the facts of the dispute (decide what actually happened), and (2) Apply the appropriate law to the facts.

A Trial is the formal judicial examination of the parties’ evidence and the determination of legal claims in the adversarial proceeding.  The Trial is a public hearing in which each side presents evidence backing its version of the facts.

The length of the Trial varies depending on how many witnesses will be called to testify and the amount of evidence that will be introduced. The Trial can be either a Bench Trial or a Jury Trial.  The Jury (or the Judge if there is no Jury) decides the questions of fact. The Judge decides the questions of law, such as which laws apply to the facts. Each party must provide legal arguments to the Judge about which laws apply to the case.

APPEAL OF THE TRIAL COURT’S DECISION

A decision by the California Superior Court can be reviewed by the California Court of Appeal.  The party appealing the Trial Court’s decision is known as the Appellant, and the other party to the lawsuit is known as the Appellee.  Generally, only Judgments and Orders After Judgment (such as an Order on a Motion for Attorney Fees) are appealable. Generally, Orders Before Judgment, such as Orders from Motions ruled on before Trial, or during Trial before there is a Judgment, may only be reviewed by the Court of Appeal by a Petition for Writ.  An Order on a Demurrer, Motion for Summary Judgment, a Motion resulting in a Dismissal, or a Final Judgment after a Trial are appealable.

NOTICE OF APPEAL

A Notice of Appeal must first be filed in the Superior Court that decided the case.  The Notice of Appeal can be filed as soon as the Trial Court files on the record the Order or Judgment for which is appealable.  In California Superior Court, the Notice of Appeal and a Proof of Service of the Notice on the other party in the civil lawsuit must be filed the earlier of:

(1) Sixty (60) days after either the Trial Court Clerk or the other side serves you with Notice of Judgment or a copy of the filed Judgment, or

(2) 180 days after the Entry of Judgment.

A filing fee is also required by the Court.  It is important that the Notice of Appeal is filed timely.  The Appeal will be dismissed if the Notice is filed late.

When the Notice of Appeal is filed, the Superior Court Clerk will send a notice of the filing to the Attorneys of record.  Within fifteen (15) days after the Superior Court Clerk sends the notification, the Appellant must serve and file in the reviewing Court a completed Civil Case Information Statement (Form APP-004), attaching a copy of the Judgment or appealed Order that shows the date it was entered.

DESIGNATING THE RECORD

Generally, ten (10) days after the Notice of Appeal is filed, the Appellant must “designate the record” by indicating to the Trial Court what documents and transcripts should be included in the record that will be sent to the Appellate Court.  Fees for producing the record are required to be paid.  In California Superior Court, the Trial Court that heard the case will prepare a packet for the District Court of Appeal, usually consisting of the Clerk’s Transcript, the Court Reporter’s Transcript, and a Settled Statement or Agreed Statement describing what took place in the disputed case.

THE APPEAL PROCESS

California has six (6) Appellate Courts known as District Courts of Appeal.  The Appeal will be presented to a panel of three (3) Judges who will review the record in the Trial Court.  The Judges will decide if any legal mistakes were made that affected the final outcome of the Trial.  The Court of Appeal does not provide a re-Trial or a new Trial of the case.  Generally, the Court of Appeal will not consider new witnesses or new evidence.  Rather, the Court of Appeal reviews the case to determine if the law was correctly applied by the Trial Court, usually involving material errors in the Trial’s procedure or errors in the Judge’s interpretation of the law.

The Appellant must file an Appeal Brief, which is a written argument containing the facts and the legal authority upon which supports a reversal of the Trial Court’s decision. The Appellee then may file an Answering Brief responding to the Appellant’s brief. The Appellant may file a second brief responding to the Appellee’s Answering Brief.

The Appellate Court may make a decision based on the briefs.  Or, the Appellate Court may schedule a hearing for oral arguments. In addition, either party may request a hearing.  The Attorneys will present their case to the Court and answer questions by the Judges.

If it is determined that an error of law was committed by the Trial Court, the lower Court’s Judgment will be reversed.  However, if the error was harmless, the Judgment will not be reversed.  Harmless error is one which does not prejudice the rights of the parties to a Fair Trial.  An example of a prejudicial error may include the admission of improper evidence and therefore be considered a reversible error.

If the Trial Court’s Judgment is affirmed, the losing party may still appeal to a higher Court.  If the Trial Court’s Judgment is reversed, the case will be remanded back to the Trial Court with an order, such as:

(1) Hold a new trial,

(2) Modify or correct the Trial Court’s Judgment, or

(3) Reconsider the facts, in light of additional evidence and recent Appellate Court decisions.

The Trial Court’s Judgment is still enforceable despite the filing of an Appeal.  However, the Appellant can file with the Court a Supersedeas Bond, also known as the “Defendant’s Appeal Bond,” which is a surety bond that stays the execution of a Judgment while the Appeal is pending.  The filing of this bond guarantees that the Appellant will satisfy the Judgment if affirmed.

CALIFORNIA SUPREME COURT

The California Supreme Court is the highest Court in the State of California and is responsible with reviewing the decisions made by the Courts of Appeal.  The California Supreme Court consists of seven (7) Judges.  Four (4) of the Judges must agree to form a decision, which must be followed by all other lower State Courts in California.

UNITED STATES COURTS OF APPEALS

The United States District Courts are organized into twelve (12) Circuits which cover a particular region.  Each Circuit has a designated Court of Appeals, which hears appeals from the District Courts within the region.  In addition, the Court of Appeals can hear appeals from decisions of Federal administrative agencies.  Moreover, the Federal Circuit Court also has a designated Court of Appeals for matters involving specialized cases such as patent law, international trade, and civil claims against the Federal government.

UNITED STATES SUPREME COURT

The United States Supreme Court is the highest Court in the United States. A Writ of Certiorari must be granted in order for the U.S. Supreme Court to review a decision.  A Writ of Certiorari is a request to the U.S. Supreme Court to order a lower Court to send up the record of the case for review. The U.S. Supreme Court can only choose a limited number of cases from the cases it is asked to decide. The cases may come from the Federal or State Court system, typical from the U.S. Court of Appeals or the highest State Court. The U.S. Supreme Court usually only hears cases with national significance or that involve important questions about the United States Constitution or Federal law.


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POST JUDGMENT: HOW TO COLLECT YOUR MONEY?

A Judgment is valid for ten (10) years and can be renewed for another ten (10) years as many times as is necessary until the Judgment is paid. It can result in a garnishment of your wages, a levy of your bank accounts, property liens, and other collection methods.

The party who loses the case and owes a monetary Judgment is known as the Judgment Debtor.  The prevailing party is known as the Judgment Creditor.  If the Judgment is not paid within a few days of being issued by the Court, the Judgment Creditor should make a Demand in writing to the Judgment Debtor in order to facilitate the satisfaction of the debt.  If the Judgment Debtor refuses to pay the Judgment Creditor or delays the payment, the Judgment Creditor may take the following actions: (1) Request a Court Order for Appearance of Judgment Debtor; (2) Request for an Issuance of Writ of Execution; or (3) Request an Abstract of Judgment.

Once the Judgment is paid, the Judgment Creditor must file a Satisfaction of Judgment with the Court within fifteen (15) days. Otherwise, the Judgment Creditor may be liable for any damages incurred by the Judgment Debtor for failure to do so, such as the inability to obtain a loan or employment because of the inaccurate reporting of the debt on a credit report.

COURT ORDER FOR APPEARANCE OF JUDGMENT DEBTOR

If the property that belongs to the Judgment Debtor is unknown or the location of such property is unknown, then a request for a Court Order for the Judgment Debtor to Appear in Court is appropriate.  In a Court Order for Appearance of Judgment Debtor the Court will require a fee in order to call the Judgment Debtor for an examination of assets, income, and property. The Order must be served on the Judgment Debtor.  Failure to comply with a Court Order for Appearance of Judgment Debtor may be punished by contempt of Court and the Court may issue a warrant leading to the Judgment Debtor’s arrest.  The Judgment Debtor will be required to answer questions about his or her property under oath.

WRIT OF EXECUTION

Pursuant to California Code of Civil Procedure section 681 to 688, in order to levy the Judgment on the Judgment Debtor’s property, a Writ of Execution is required.  The Court will issue the writ so that the levying officers can serve the debtor.  The writ is the legal device required to collect or seize the Judgment Debtor’s assets in order to satisfy the Judgment in addition to costs.  The Court Clerk will provide three (3) copies of the writ, which gives the Sheriff the authority to seize the Judgment Debtor’s property within 180 days after its issuance.  The Sheriff will charge a fee for each levy. The party seeking execution upon the other party’s property must submit a refundable fee deposit with the Sheriff ranging from $30.00 for a wage garnishment to $1,500.00 or more for a levy on a business.  Other costs may include storage, moving, and towing.

All money that is collected by the Sheriff is deposited into the County Treasury and held for twenty-one (21) days.  The County Auditor will then disburse the funds accordingly.

If the Judgment Debtor is not an individual person, but rather an entity, the Writ of Execution must state the legal entity, such as a corporation, partnership, or limited liability company.  To note, a fictitious name (also known as a “doing business as” or “dba”), is not considered a legal entity.  The dba name should be listed with the individual’s legal name, i.e. “John Doe doing business as (dba) John Doe Hardware.”

WAGE GARNISHMENT

In order to levy the Judgment Debtor’s wages and earnings, the Judgment Creditor must provide the Sheriff with an Application for Earnings Withholding Order, two (2) copies of the Writ of Execution, and a $30.00 fee deposit.  Once the Judgment Debtor’s employer is served with the documents by the Sheriff, the employer is required to submit a completed Employer’s Return to the Sheriff which discloses the income of the Judgment Debtor.  A copy of the Employer’s Return will be provided to the Judgment Creditor by mail.  The Judgment Debtor’s employer will be required to remit 25% of the Judgment Debtor’s net wages to the Sheriff’s Department.  The period in which earning shall be withheld commences ten (10) days after the Order is served on the employer and will continue to be in effect for up to ten (10) years.

BANK GARNISHMENT

In order to levy the Judgment Debtor’s bank account, the Judgment Creditor must provide the Sheriff with signed written instructions which indicate the exact address of the Judgment Debtor’s bank, the account number if known, two (2) copies of the Writ of Execution, and a $30.00 fee deposit.  Once the Judgment Debtor’s bank is served with the documents by the Sheriff, the bank is required to submit a completed Memorandum of Garnishee to the Sheriff which discloses the status of the Judgment Debtor’s bank account.  A copy of the Memorandum of Garnishee will be provided to the Judgment Creditor by mail.  Within ten (10) days of being served with the documents, the Judgment Debtor’s bank is required to remit any money in the Judgment Debtor’s bank account to the Sheriff’s Department, up to the amount of the total Judgment plus any costs.

BUSINESS LEVY

If the Judgment Debtor is a business owner, the Judgment Creditor may instruct the Sheriff to seize the money in the cash register of the Judgment Debtor’s place of business till it is “tapped out,” i.e. there is no more money left in the register.  This is known as a “Till Tap” Levy.  The fee for a Till Tap is $85.00.

In addition, the Judgment Debtor may instruct the Sheriff to place a “Keeper” in the Judgment Debtor’s place of business for a designated period of time to collect all the money received by the business and to prevent the removal of equipment, property, inventory, or other assets.  This is known as “Place a Keeper Installation.” The fee to Place a Keeper is $300.00 for each eight (8) hour period.

The Keeper may be installed to prevent the transfer of any property at the business until it is moved to a storage facility.  The Judgment Creditor must then give Notice of Sale ten (10) days before the actual sale of the property at a public auction.  The Fee for Notice of Sale is $1,500.00 in addition to costs to move and store the property, which can be expensive.

REAL ESTATE LEVY

It is very complex to levy on the real estate of a Judgment Debtor.  Courts usually have a separate section within the Courthouse to exclusively handle such levies, in which the Sheriff or Marshal can take possession of the Judgment Debtor’s real estate and sell it at a public auction.  The Judgment Creditor must first obtain information about the Judgment Debtor’s real estate by researching the County Assessor’s Office and the County Recorder’s Office.  It must be determined if a bank or a lender has an interest in the property or if there is also an another owner of the property.  The Court must issue a Writ of Execution to the Sheriff or Marshal in the county where the property is located.  If the property is a dwelling, the Court must also issue an Order of Sale. The fees for the levy on real estate is approximately $1,000.00.  A Notice of Sale must then be served on the Judgment Debtor and any occupant of the property.  The Notice of Sale must be posted in a public place on the property, published in a local newspaper, and mailed to any lien holders.  The proceeds of the sale will be distributed thirty (30) days after the sale.

USING AN ABSTRACT OF JUDGMENT TO PLACE A LIEN ON REAL PROPERTY

In order to place a lien on the Judgment Debtor’s real property, an Abstract of Judgment is required.  The Abstract of Judgment is issued by the Court Clerk.  The Judgment Creditor must record the Abstract with the County Recorder’s office in the county where the debtor’s real property is located.  The County Recorder will charge a fee for recording the Abstract.  In the event of a sale or refinancing of the property, the Judgment described in the Abstract must first be satisfied.

THIRD PARTY CLAIMS

Before the Judgment Creditor instructs the Sheriff to levy on the property of the Judgment Debtor, the Judgment Creditor should attempt to determine if the property is owned wholly or partially by another.  A party not involved in the lawsuit may file a claim with the levying officer if the personal property of the Judgment Debtor is attempting to be levied.  The third party is claiming that the property does not belong to the Judgment Debtor but instead the property at issue belongs to the third party.  For instance, the legal owner of an automobile may be a bank, and therefore the bank will attempt to get paid the amount owed on the automobile.  The Third Party Claim must provide a description of the property, the value, and the facts supporting the third party’s title and right to possession of the personal property.  If the Judgment Creditor contests the claim, the third party may demand that the Judgment Creditor post a bond and then a hearing can be set by the Court to decide which party is entitled to the property.

CLAIM OF EXEMPTION

The Judgment Debtor may claim that the property or asset being levied on is exempt.  There are various reasons why an exemption may apply, such as the exempted property is required for the basic necessities of life.  The Sheriff will notify the Judgment Creditor if a Claim of Exemption has been filed with the Court.  The Judgment Creditor may then oppose the exemption.  Otherwise, if there is no opposition filed, the subject property will be released from levy.


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POST TRIAL MOTIONS

Once the Judgment has been rendered and formalized in writing, either party may file with the Court a post-Trial motion, which may include: (1) Motion to Amend the Judgment, (2) Motion to Nullify the Judgment, (3) Motion for New Trial, or (4) Motion for Judgment Not-withstanding the Verdict (JNOV).

MOTION TO AMEND THE JUDGMENT

The Trial Court can amend the Judgment at any time to alter the language of the written Judgment or to correct any calculation errors.   However, the Court cannot change the substance of the Judgment.

MOTION TO NULLIFY THE JUDGMENT

A Motion to Nullify the Judgment may be granted if: (1) it is determined that the Judgment was obtained by fraud, (2) the Judgment Debtor was not properly served with process of the legal papers, or (3) the Court did not have proper subject matter jurisdiction to hear the lawsuit.

MOTION FOR NEW TRIAL

A Motion for a New Trial may be granted if errors were committed by the Trial Judge.  In many cases, a Motion for New Trial must first be made before an Appeal is filed.

MOTION FOR JUDGMENT NOTWITHSTANDING THE VERDICT (JNOV)

The losing party to the lawsuit may Motion for a Judgment Not-withstanding the Verdict (JNOV).  If granted, the Court will render a verdict that is contrary to the verdict provided by the Jury.  The standard for granting a Motion for Judgment Not-Withstanding the Verdict (JNOV) is that reasonable Jurors could not arrive at a contrary verdict.  The Court will only grant the Motion for JNOV if the facts and inferences are overwhelmingly in favor of one party that reasonable Jurors could not disagree with the Judgment that the Court will render, despite the fact that the actual Jury rendered a contrary verdict.  The Trial Judge has the sole discretion to grant the Motion for JNOV.   In doing so, the Trial Judge should not consider the credibility of the witnesses. Rather, the Trial Judge must make all reasonable inferences and factual determinations in favor of the non-moving prevailing party in the lawsuit, i.e. the non-moving party is given the legal “benefit of the doubt.”


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WHAT IS A CIVIL TRIAL?
BENCH TRIAL
JURY TRIAL
JURY SELECTION
OPENING STATEMENT
CIVIL STANDARD OF PROOF
EVIDENCE
WITNESS EXAMINATION
DIRECTED VERDICT
PLAINTIFF’S REBUTTAL EVIDENCE
CLOSING ARGUMENT
JURY INSTRUCTIONS
MISTRIAL
JURY DELIBERATIONS
JUDGMENT, ADDITUR, AND REMITTITUR

OVERVIEW OF A CIVIL TRIAL

WHAT IS A CIVIL TRIAL?

To resolve a dispute, the Court must: (1) Determine the facts of the dispute (decide what actually happened), and (2) Apply the appropriate law to the facts.

A Trial is the formal judicial examination of the parties’ evidence and the determination of legal claims in the adversarial proceeding.  The Trial is a public hearing in which each side presents evidence backing its version of the facts.

The length of the Trial varies depending on how many witnesses will be called to testify and the amount of evidence that will be introduced. The Trial can be either a Bench Trial or a Jury Trial.  The Jury (or the Judge if there is no Jury) decides the questions of fact. The Judge decides the questions of law, such as which laws apply to the facts. Each party must provide legal arguments to the Judge about which laws apply to the case.

BENCH TRIAL

A Bench Trial involves the facts at issue in the case being decided by the Judge, not a Jury.  Bench Trials may be preferred if the case is very complicated and may confuse a Jury. However, Bench Trials tend to have outcomes more favorable to Defendants.  In order to have a Jury Trial in a civil case, the Demand for a Jury Trial must be timely.

The Judge can decide in the following ways: Judgment for Plaintiff; Judgment for Defendant; Judgment for the Cross-Complainant against the Cross-Defendant; Net-Judgment (i.e. upon deciding a Cross-Complaint, the Judge finds that each party is liable for a certain amount and that there is a balance remaining for which the net amount will be awarded to the prevailing party); or an Off-Set Judgment (i.e. each party is awarded nothing and each party bears their own costs).  The Attorney for the prevailing party must serve the Notice of Entry of Judgment on all parties with a Proof of Service.

JURY TRIAL

A Jury is a group of persons selected and granted the power to decide questions of fact and return a verdict in the case.   The Trial Jury is chosen from a list called a venire or Jury pool that has been compiled by the Court.  The Jury consists of “peers in the community.”  If a case is tried before a Jury, the Judge will rule on questions of law and instruct the Jury on how to apply the law.  The Jury will be provided Jury Instructions which are submitted to the Court by the Attorneys before the start of Trial.

The Judge is also the gatekeeper as to what evidence may be presented and will rule on objections asserted to the introduction of evidence. The Jury determines the facts based on the evidence presented.

Pursuant California Code of Civil Procedure section 631, Trial by Jury is waived unless a Jury Demand is timely made “at the time the case is first set for Trial, if it is set upon notice or stipulation,” or “within five days after notice of setting if it is set without notice or stipulation.”  If either party requests a Jury in a California Superior Court case, that party must deposit Jury Fees at least twenty-five (25) days prior to the scheduled Trial Date.

Pursuant to the California Constitution, in civil cases “the Jury shall consist of 12 persons or a lesser number agreed on by the parties in open court.”  The parties may stipulate “in open court” to a Jury of less than twelve (12) members.

After Closing Arguments, the Jury will retire for deliberation.  The Jury can review the Jury Instructions, the Exhibits admitted into evidence, and the Verdict Slips.  Three-fourths of the Jury must agree upon a verdict before returning to the Court.

SELECTING A JURY

The Court Clerk will call twelve (12) people from the Jury list to take a place in the Jury box. The Voir Dire process will then commence, in which the potential Juror must “speak the truth.” The Judge will explain the case and inquire whether there is any reason the potential Juror cannot serve. The Judge or the Attorneys will then question whether the potential Juror has any knowledge of the case or any experiences that will make them biased or unfair.

If the Attorneys believe that a Juror is prejudiced, a request can be made to the Judge to dismiss that Juror for cause.  The dismissal of the Juror is discretionary to the Judge.  Examples of prejudice include: the fact that a Juror is related to a party or an Attorney, or the fact that a Juror is employed by the company that is involved in the lawsuit. An unlimited number of Jurors can be requested to be dismissed for cause.

In addition to challenges for cause, both parties are allowed six (6) peremptory challenges in California Superior Court. Peremptory challenges allow the Attorney to excuse the Juror without stating a cause. However, peremptory challenges cannot discriminate on the basis of race or sex.

When both parties have agreed upon a Jury, the Jurors are sworn in to try the case by the Court Clerk.

Once impaneled, the Jurors’ role is to weigh the evidence and determine the facts of the case. The Jurors may not discuss the case with anyone, including each other until after the evidence has been presented during deliberations on a verdict. Jurors cannot ask questions of witnesses.  However, the Judge may allow the Jurors to submit written questions to the Judge and Attorneys.  These questions may be objected to accordingly, just as any other question posed by an Attorney during the Trial.

OPENING STATEMENT

Each side has the opportunity to tell the Jurors about the case that is being heard. Arguments cannot be made during opening statements.  Rather, the opening statement must be confined to only facts that will be proved by the evidence.  Since the Plaintiff has the burden of proof in a civil case, the Plaintiff presents the first opening statement.

CIVIL STANDARD OF PROOF BY A PREPONDERANCE OF THE EVIDENCE

In a Civil Trial, the Plaintiff bears the burden of proof, which means that the Plaintiff must prove the facts in the case by a preponderance of the evidence (i.e., the greater weight of the evidence, that it is more likely than not that the fact is true). The Defendant does not have to prove that he or she is not liable, rather the burden is on the Plaintiff.  The degree of proof required in a civil case is far less strict than in a criminal case, which is “beyond a reasonable doubt” (i.e. the Judge or Jury must be absolutely convinced of the Defendant’s criminal liability).  In order for the Plaintiff to succeed at Trial in a civil case, the Plaintiff’s case must be more believable than the Defendant’s case.  The amount of evidence is not controlling, rather the side with the more believable evidence satisfies the civil standard of proof “by a preponderance of the evidence.”

EVIDENCE

Each party presents the case by introducing direct and circumstantial evidence.

Direct evidence supports the truth of an assertion directly.  It is proof which directly supports a factual conclusion and requires no other supporting evidence.  For example, direct evidence includes party admissions and witness testimony of what he or she personally experienced firsthand through the senses – sight, hearing, smell, touch, or pain.  Direct evidence is probative in and of itself.

Circumstantial evidence requires reasonable inferences in order to have any probative effect.  Circumstantial evidence merely suggests a fact by implication and is usually introduced when direct evidence is not available.  By its very nature, circumstantial evidence allows for more than one explanation.  Additional circumstantial evidence may need to be introduced in order to corroborate the conclusions drawn from other circumstantial evidence. When considered together as a whole, the circumstantial evidence more strongly supports one particular inference.  In addition, any alternative inferences will need to be ruled out and disproved.

EXAMINATION OF WITNESSES

The Plaintiff begins the presentation of evidence in support of their case-in-chief by calling witnesses to testify and conducting direct examination. The witness may identify photographs and documentary evidence. Generally, a witness may not give an opinion unless they are qualified as an expert in the particular field of questioning. The Attorney conducting direct examination may not ask leading questions – those that suggest the answer.  The Opposing Counsel may assert objections based on the rules of evidence. Common objections are based on questions that are leading, that call for an opinion or conclusion by a lay witness, or that are subject to the hearsay rule. Evidence is considered hearsay if it is an out of Court statement being introduced for the truth of the matter asserted. Hearsay is excluded unless an accepted exception applies. Hearsay evidence is unreliable because it cannot be subjected to cross-examination.

The Judge must sustain or overrule an asserted objection. If the objection is sustained, the Attorney must ask a different question. If the objection is overruled and the witness answers, the Judge’s ruling may be appealed after Trial.

After Direct Examination, the Opposing Counsel may cross-examine the witness. Cross-Examination is generally limited to the line of questioning raised on direct. Leading questions may be asked during cross-examination in order to test the credibility of the witness testimony.  Leading questions may also be asked if the witness becomes adverse or hostile to the party who called the witness to the stand.

The strategy on Cross-Examination is to discredit the witness’s ability to identify documentary evidence or recollect the facts. The witness testimony and evidence can be impeached and shown to not be trustworthy.  This can be accomplished by showing prejudice or bias in the witness, such as a personal relationship with a party or an interest in the outcome of the case.  Evidence of Felony convictions or crimes involving moral turpitude may be introduced because it is relevant to credibility.

The Attorneys will have an opportunity to question the witness again on re-direct and re-cross examination.  Re-direct is generally allowed, whereas re-cross generally must request the permission of the Court.  The Judge has discretion on what questions to allow on re-direct and re-cross. Generally, re-direct and re-cross is limited to the witness’s testimony that was not already addressed.  Re-direct gives the witness an opportunity to explain any damaging testimony that was elicited on cross examination.

Pursuant to California Evidence Code section 777, on the motion of any party or sua sponte (on the Court’s own order, without the motion of a party), the Court may order witnesses excluded from the courtroom so that they cannot hear the testimony of other witnesses “to prevent tailored testimony and aid in the detection of less than candid testimony.”

MOTION FOR DIRECTED VERDICT

The Plaintiff rests after presenting its evidence to support the case in chief during Trial.  At this point the Jury will leave the courtroom, and the Defendant may motion for a directed verdict on the grounds that the Defendant’s liability has not been proven by a preponderance of the evidence.

If the Court agrees that the Plaintiff has failed to prove the case, the Court will dismiss the case in favor of Defendant. The standard for granting a Motion for Directed Verdict is that no reasonable Jury could reach a decision to the contrary.  The Judge may order a directed verdict as to the entire case or only to certain issues in the case.

It is more common that the motion will be denied, and the Defendant must then proceed to present its supporting evidence.

After both parties have presented their case and all the evidence has been presented, the Jury will again exit the courtroom. At this time, either party may move for a directed verdict. If the motion is denied, the case will be submitted to the Jury.

PLAINTIFF’S REBUTTAL EVIDENCE TO DEFENDANT’S CASE

At the conclusion of presenting evidence in support of the Defendant’s case during the Trial, the Plaintiff can then present rebuttal witnesses or evidence to refute any evidence presented by the Defendant. Rebuttal evidence can only include evidence not already presented in the case, such as a new witness who offers contradicting testimony to the Defendant’s witnesses.

CLOSING ARGUMENT

The closing argument is the opportunity for each Attorney to summarize the evidence presented and to discuss the inferences that may be drawn supporting their theory of the case.  Only issues that were actually addressed and evidence that was actually presented during the case may be discussed in the closing arguments.  Before giving the closing arguments, the Judge will approve the Jury Instructions.  The Attorneys may comment on the selected Jury Instructions and discuss the related evidence in the closing argument.  Plaintiff’s Counsel will give the first closing argument, and then Defense Counsel has the opportunity to respond in its closing argument by indicating the defects in Plaintiff’s case. Because the Plaintiff has the burden of proof, the Plaintiff’s Counsel may then make a concluding rebuttal argument responding to the Defense Counsel’s argument.

JURY INSTRUCTIONS AND THE JUDGE’S CHARGE TO THE JURY

The Judge will instruct the Jury about which laws should be considered in deliberations. The Judge will conduct its “charge” to the Jury by reading the selected Jury Instructions, indicate the issues in the case, detail the role of the Jury as determining the facts and witness credibility, and discuss the civil standard of proof “by a preponderance of the evidence.”  The Judge will inform the Jury that the opening and closing arguments of the Attorneys are not to be considered as evidence.   The Jury must determine the facts and reach a verdict within the guidelines of the law as determined by the Judge.  In a Jury Trial, the Jury is the trier of facts and weighs the evidence.  The Judge serves as the gatekeeper of what and how the evidence can be considered.

MOTION FOR MISTRIAL

A Mistrial results when the Trial is not successfully completed and is therefore considered void.  A Mistrial is a form of extraordinary relief granted by the Court when, during the course of the Trial, a party’s rights have been seriously prejudiced to the point that a Fair Trial cannot be conducted and justice cannot be served. A Mistrial terminates the Trial mid-proceedings due to the error. Mistrials can occur for many reasons, including:

(1) Death of a Juror or Attorney;

(2) Impropriety in selecting the Jury which is discovered during the Trial;

(3) Fundamental prejudicial error which is seriously unfair to a party and cannot be cured by appropriate instructions to the Jury (such as highly improper remarks by counsel in Closing Argument);

(4) Juror misconduct (such as having contacts with one of the parties, considering evidence not presented during Trial, conducting an independent investigation of the matter); or

(5) The Jury’s inability to reach a verdict because it is deadlocked (i.e. Hung Jury).

Certain events during Trial will likely result in an Objection, Motion to Strike, Request for Curative Instruction, or even a Motion for Mistrial.  These include:

(1) Referring to Defendant’s liability insurance or insurer in testimony elicited by Plaintiff’s Counsel, or in Plaintiff’s Counsel’s Closing Argument;

(2) Referring to race or racial discrimination when the lawsuit does not involve a claim for discrimination;

(3) Referring to excluded matter;

(4) When an Attorney gives his or her own opinion on the issues in their Closing Argument;

(5) When an Attorney makes a derogatory remark about the opposing party;

(6) When an Attorney asks the Jury to “put themselves in the shoes of the Plaintiff” (this is known as the “Golden Rule” and traditionally has resulted in reversals);

(7) When an Attorney presents an argument based on facts not contained in the record;

(8) When an Attorney comments on the failure of a witness to testify if that same witness could have been called to the stand by the commenting Attorney;

(9) When an Attorney vouches personally for a witness; and

(10) When a Juror engages in misconduct, or inappropriate contact with the parties or their Attorneys.

JURY DELIBERATIONS

After the Jury Instructions and Closing Arguments, the Jury will retire and begin deliberating to deliver the verdict. In civil cases in California Superior Court, a Jury can render a verdict if three-fourths (¾) of the Jurors agree.  In Federal Court, the Jury must reach a unanimous verdict.  If the Jurors cannot agree on a verdict, the result is known as a Hung Jury, which leads to a Mistrial allowing the case to be tried again at a later date before a new Jury.

If the Jury cannot reach a decision within the first day of deliberating, the Jurors may be sequestered.  That is, the Jurors will be housed in a hotel and secluded from all contact with other people, newspapers and news reports. However, in most cases, the Jury will be allowed to go home and the Judge will instruct them not to read or watch news reports of the case, and not discuss the case outside of the Jury room.

If a verdict is reached, the Jury will either find in favor of the Plaintiff or the Defendant.  The Jury will also decide on any counterclaims in the case.  In addition, the Jury will set the amount of damages the Defendant should pay the Plaintiff.  Oftentimes, the amount of damages is determined by a separate hearing.

Generally, the losing party may request to poll the Jury, which means that each Juror will be asked if he or she agrees with the decision as announced.

JUDGMENT AND MOTIONS FOR ADDITUR AND REMITTITUR

The Jury verdict is not effective until the Judge enters the Judgment on the decision. The Judge must issue an order that the verdict be filed as public record.

However, once the damages amount has been announced, either party may file a Motion for Additur or Remittitur.

In California Superior Court, the Judge has the authority to increase or decrease the amount of damages awarded by the Jury before entering the Judgment.

The Court will review the damages award to determine if it is reasonable. If not, as a matter of law, the Court may reduce or increase the award.  Increase is known as Additur and decrease is known as Remittitur.  In making this decision, the Court will evaluate whether the damages award is supported by substantial evidence, whether it is grossly disproportionate, or whether it shocks the conscience.

Federal Courts do not allow Additur to increase damages amounts because it is considered in violation of the Seventh Amendment Right to a Jury.  However, all State Courts and all Federal Courts permit Remittitur to reduce damage awards.

If the party adversely affected by the addition or reduction disagrees, the Court must order a New Trial only on the issue of damages.


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MOTIONS IN LIMINE

A Motion in Limine is a request by a party to the Court for an order to limit or prevent certain evidence from being presented by the other side at Trial. Generally, this Motion is filed before Trial, but a Motion may also be presented during the Trial, before the particular evidence is presented to the Jury. The purpose of a Motion in Limine is to prevent irrelevant, inadmissible, or prejudicial evidence from being presented to the Jury.

Most objections to the admissibility of evidence are asserted at the time the evidence is offered at Trial, allowing the Jury to hear the question and the witness’ answer prior to the objection or even allowing the party’s Attorney to refer to the evidence at issue in the opening statement. A Motion in Limine filed in advance of the Trial completely prevents the evidence from being presented in front of the Jury whatsoever.

A common Motion in Limine that is filed prior to Trial will seek to exclude evidence of past criminal convictions, which are not admissible unless they are felony convictions within the last ten (10) years. In the absence of the Motion in Limine, the Defense Counsel may question the Plaintiff about misdemeanor convictions and therefore present evidence of a criminal record to the Jury.  An objection can be made at the time of the questioning.  The Judge may sustain the objection and instruct the Jury to disregard the question.  However, the damage has been done because the Jury cannot possibly ignore what they have already heard. The better Trial strategy for Plaintiff’s Counsel is to file a Motion in Limine preventing such questions at Trial.

Furthermore, even though evidence may be admissible, the prejudicial nature may allow it to be excluded.  For example, gruesome photographs of the legitimate nature and extent of the Plaintiff’s injuries may be considered to unduly influence the Jury’s decision in favor of Plaintiff. A Motion in Limine may be granted to exclude such evidence.

A Motion in Limine may also challenge an expert witness’ qualifications therefore preventing the expert witness from giving an opinion to the Jury.  The Court will set a hearing and decide this issue prior to Trial.


Let a West Hollywood Civil Litigation & Personal Injury Lawyer Assist You

Have you or someone you love been seriously injured in an accident? Are you involved in civil litigation or would like to pursue a claim or lawsuit? Contact an experienced West Hollywood Civil Litigation and Personal Injury Attorney at The Sterling Firm!

Call (310) 498-2750 to speak with an Attorney