Volume 19, Number 7
Lisa A. Runquist
An old client, Sam Goodman, came by your office today to advise you he was starting an organization, "Save the Chipmunks," and wanted you to handle it. You've always wanted to represent the people wearing white hats and agreed to do so. You know that the law affecting nonprofits is complex, and it will take some time to get up to speed. Where do you start?
What Is a Nonprofit?
A profit entity exists ultimately to benefit the shareholders, but a nonprofit organization is focused on a specific purpose, which must be carefully defined because it controls what the corporation may or may not do. You might want to suggest to Sam that he consider expanding the purpose of his corporation to all rodents, not just chipmunks. On the other hand, "Save the Animals" is probably too broad to satisfy Sam's desires.
A nonprofit corporation generally is formed under a state nonprofit corporation act for some particular nonprofit purpose. A nonprofit can either be taxable or tax exempt. Nonprofit does not mean tax exempt.
A tax-exempt organization is exempt from income tax under the Internal Revenue Code (most federal exemptions are listed in Section 501(c)) and/or a similar state tax provision. A nonprofit school, hospital, or museum normally is exempt under section 501(c)(3) of the Code. Only contributions to Section 501(c)(3) organizations may be deductible as charitable contributions, although payments to some others, such as those covered by (c)(6)-business leagues and chambers of com- merce-may qualify as a business deduction. Other common nonprofits include 501(c)(4), social welfare organizations; 501(c)(5), trade associations; and 501(c)(7), social clubs. To be exempt, the organization must meet the qualifications required for that particular type of exemption; the organization must be both organized and operated for exempt purposes.
Sam decides he wants to qualify under 501(c)(3) as a charitable organization so that contributions will be deductible to the donor.
Forming the Nonprofit
A corporation is formed by filing Articles of Incorporation (sometimes called a Certificate of Incorporation) with the state (generally with the secretary of state). This is the "birth certificate" of the corporation; until it's filed, the corporation does not exist. Each state's form differs; however, the articles must include the name, a purpose clause, an agent for service of process, and-to be a 501(c)(3)-provisions dedicating the assets to a charitable purpose and requiring distribution of assets to other exempt 501(c)(3) organizations upon dissolution. Although provisions that may go in the bylaws also may be in the articles, including only required provisions can avoid conflicts among the documents.
Unless the initial directors already are listed in the articles, the incorporator(s) elect the directors and sometimes adopt the bylaws after the articles are filed. The bylaws are internal rules by which the organization operates: how many directors, how they are elected, whether there are members, when meetings are held, how meetings are noticed, etc.
Next, the initial directors meet to adopt bylaws (if not done by the incorporator); elect officers; authorize payment of incorporation expenses; choose an accounting year; authorize bank accounts, exemption applications, and governmental forms; establish a principal place of business; and oversee other matters.
Profit corporations are owned by shareholders; no one owns a nonprofit. However, nonprofits can have members who, like shareholders, elect the directors and vote on major decisions like mergers and dissolutions. Most state laws do not require members; if there are none, the directors are self-perpetuating and elect themselves. Membership must be defined in the bylaws and members' records diligently tracked. If they forget to inform the organization when they move, for example, the corporation may be unable to gather a quorum of members needed to take action.
Directors direct. They make policy decisions and shape direction. Directors have no individual authority; they must act jointly, as a board. Each decision must be based on what is best for the organization, and a conflict of interest policy is highly recommended.
Officers (usually elected by the board) implement. Unlike directors, officers act individually but are authorized to carry out only responsibilities delegated by the directors, to whom they report.
Directors sometimes form committees. In some states, members of a committee with board powers (a "board committee") must be made up only of directors. A committee of nondirectors is an administrative committee that, like officers, can implement only the responsibilities specifically delegated by the directors; they cannot make board-level decisions.
Because the corporation is an entity apart from the members and directors, all actions taken by the members and directors on behalf of the corporation must be documented in the corporate minutes.
Establishing Exempt Status
Most section 501(c)(3) organizations must apply for recognition of exemption by filing Form 1023 with the IRS. Additional recognition may be required from state and local governments for various additional charitable exemptions like sales and property taxes, etc. If the organization works in more than one state, each state's requirements must be met.
o The nonprofit organization cannot be organized or operated to benefit a person. Everything must be done to benefit the purpose. If an individual having substantial influence over the organization receives a benefit greater than what he/she provides to the organization, substantial penalties are invoked, and the organization may lose its exempt status.
o Most suits against directors have to do with employment matters. A nonprofit is not exempt from compliance with good employment practices.
o Nonprofits are sued regularly. Directors and officers insurance is essential; do not expect the charitable immunity statutes to protect you.
o Ensure that annual or other periodic filings with the IRS (Form 990) and other state agencies are up to date.
Lisa A. Runquist is a partner in the law firm of Runquist & Zybach LLP, with offices in California and Washington, and is the author of numerous publications on nonprofit and religious organizations.
Guidebook for Directors of Nonprofit Corporations, 2d ed., ABA Section of Business Law (2002).
Nonprofit Governance and Management, ABA Section of Business Law (2002).
Tax Exempt Toolkit: www.abanet.org/tax, click on Tax Tips 4 U, scroll to Tax Exempt Toolkit.
http://CharityChannel.com: Listservs, archived comments, and other materials.
http://nonprofitrisk.org: Nonprofit Risk Management Center.
www.runquist.com/articles.htm: Related articles.