What Is Nonprofit Law? What Are Nonprofits?

Introduction

Nonprofit organizations play a crucial role in society by addressing a wide range of social, educational, environmental, and cultural needs. Unlike for-profit businesses, nonprofits are not designed to generate profits for owners or shareholders. Instead, they reinvest any surplus revenue into furthering their mission. But what exactly defines a nonprofit, and how does nonprofit law govern these entities?

Nonprofit law encompasses the legal framework that regulates how nonprofit organizations are created, managed, and dissolved. This area of law is essential for ensuring that nonprofits operate transparently and in line with their stated missions. Understanding the basics of nonprofit law is crucial for anyone involved in starting or managing a nonprofit, as well as for donors and stakeholders who support these organizations.

In this blog post, we will explore the fundamentals of nonprofit law, explain what nonprofits are, and discuss the key legal considerations involved in operating a nonprofit organization. By the end of this guide, you’ll have a clear understanding of how nonprofits function within the legal landscape and what is required to ensure their success and compliance.

Understanding Nonprofits

Nonprofits are organizations that exist to serve the public good rather than to generate profit for private individuals. They operate in a wide variety of sectors, including education, healthcare, the arts, social services, and environmental conservation. The defining feature of a nonprofit is its commitment to using its resources to advance a specific mission rather than to benefit private interests.

Key Characteristics of Nonprofits:

·       Mission-Driven: A nonprofit’s primary goal is to advance its mission, which is typically focused on addressing a social, educational, cultural, or environmental issue.

·       Tax-Exempt Status: Many nonprofits qualify for tax-exempt status under Section 501(c)(3) of the Internal Revenue Code, meaning they are exempt from federal income taxes and can receive tax-deductible donations.

·       No Profit Distribution: Nonprofits cannot distribute profits to owners or shareholders. Instead, any surplus revenue must be reinvested into the organization’s programs and services.

·       Public Accountability: Nonprofits are held to a high standard of public accountability and transparency, especially when they receive public funds or tax-deductible donations.

Types of Nonprofits:

·       Public Charities: These are the most common type of nonprofit, typically engaged in activities like providing direct services, educating the public, or advocating for social change. Examples include food banks, museums, and environmental advocacy groups.

·       Private Foundations: These organizations typically receive funding from a single source, such as an individual, family, or corporation, and often make grants to other nonprofits rather than operating their own programs. The Bill and Melinda Gates Foundation is an example of a private foundation.

·       Social Welfare Organizations: These groups focus on promoting social welfare and may engage in lobbying and political advocacy. They are classified under Section 501(c)(4) of the Internal Revenue Code, which allows for more political activity than 501(c)(3) organizations.

Legal Structures and Formation of Nonprofits

The legal structure of a nonprofit is critical to its operations and compliance with laws and regulations. Establishing a nonprofit involves several key steps, from choosing the right legal structure to filing the necessary documentation with state and federal authorities.

Choosing a Legal Structure

Before forming a nonprofit, it’s essential to choose a legal structure that aligns with the organization’s mission and operational goals. The most common legal structure for a nonprofit is a corporation, but other options include trusts and unincorporated associations.

·       Nonprofit Corporation: Most nonprofits are structured as corporations, which provides limited liability protection to the organization’s directors and officers. A nonprofit corporation is a separate legal entity that can enter into contracts, sue or be sued, and own property.

·       Trust: Some nonprofits, particularly foundations, are structured as trusts. A trust is a fiduciary relationship where one party holds assets on behalf of another. Trusts are often used for charitable purposes, such as managing endowments or making grants.

·       Unincorporated Association: This is a less formal structure where a group of people come together for a common purpose without forming a corporation. While easier to set up, unincorporated associations offer less legal protection and are generally not eligible for tax-exempt status.

Formation Process

Once a legal structure is chosen, the next steps involve formalizing the organization and ensuring compliance with both state and federal regulations.

·       Drafting the Articles of Incorporation: The articles of incorporation are the legal document that establishes the nonprofit as a corporate entity. This document typically includes the organization’s name, purpose, duration, and the names of the initial directors. It must be filed with the appropriate state agency, usually the Secretary of State.

·       Creating Bylaws: Bylaws are the internal rules that govern how the nonprofit will operate. They outline the responsibilities of the board of directors, the process for holding meetings, and other important governance issues. While not filed with the state, bylaws are critical for the organization’s management and legal compliance.

·       Obtaining an Employer Identification Number (EIN): The EIN is a unique identifier issued by the IRS and is required for tax purposes, including opening a bank account and filing tax returns.

·       Applying for Tax-Exempt Status: To qualify for tax-exempt status under Section 501(c)(3), a nonprofit must file Form 1023 or Form 1023-EZ with the IRS. This application requires detailed information about the organization’s structure, activities, and financial plans.

Governance and Compliance

Once a nonprofit is established, ongoing governance and compliance are crucial to maintaining its legal status and ensuring it can effectively pursue its mission. Nonprofits are subject to various federal, state, and local regulations, and failure to comply can result in penalties or loss of tax-exempt status.

Board of Directors

The board of directors plays a central role in the governance of a nonprofit. The board is responsible for overseeing the organization’s activities, ensuring compliance with laws and regulations, and safeguarding the nonprofit’s mission and assets.

·       Duties of the Board: Board members have fiduciary duties, including the duty of care (acting with diligence and competence), the duty of loyalty (acting in the best interest of the nonprofit), and the duty of obedience (ensuring the organization complies with laws and regulations).

·       Conflict of Interest Policies: Nonprofits must have policies in place to manage conflicts of interest. These policies help ensure that decisions are made in the best interest of the organization and not for personal gain.

·       Regular Meetings: The board must hold regular meetings to review the nonprofit’s activities, approve budgets, and make key decisions. Minutes of these meetings should be recorded and maintained as part of the organization’s records.

Compliance and Reporting

Nonprofits are required to comply with various reporting and regulatory requirements to maintain their tax-exempt status and operate legally.

·       IRS Form 990: Most nonprofits must file an annual Form 990 with the IRS, which provides detailed information about the organization’s finances, governance, and activities. This form is public and plays a significant role in ensuring transparency and accountability.

·       State Reporting Requirements: In addition to federal reporting, nonprofits must comply with state-specific requirements, such as annual reports, charitable solicitation registrations, and corporate renewals. These requirements vary by state and must be monitored closely to avoid penalties.

·       Employment Laws: Nonprofits with employees must comply with federal and state employment laws, including those related to minimum wage, overtime, and workplace safety. Nonprofits must also withhold and remit payroll taxes, even if they are exempt from income taxes.

Fundraising and Financial Management

Effective fundraising and financial management are essential for the sustainability of a nonprofit. However, these activities are also subject to legal regulations designed to ensure transparency and prevent fraud.

·       Charitable Solicitation Laws: Many states require nonprofits to register before soliciting donations from the public. This registration process typically involves filing an application, paying a fee, and providing annual reports on fundraising activities.

·       Donor Acknowledgment: Nonprofits must provide donors with acknowledgment letters for contributions, especially for donations of $250 or more. These letters are necessary for donors to claim tax deductions and must include specific information, such as the amount of the donation and whether any goods or services were provided in exchange.

·       Financial Transparency: Nonprofits are required to maintain accurate and complete financial records. Regular financial audits or reviews may be necessary, especially for larger organizations or those that receive significant government funding.

Conclusion

Nonprofit law is a complex and specialized area that governs the formation, operation, and dissolution of nonprofit organizations. Understanding the legal framework within which nonprofits operate is essential for ensuring compliance, protecting the organization’s mission, and maintaining public trust. Whether you are involved in starting a nonprofit, managing one, or supporting one as a donor or volunteer, a solid grasp of nonprofit law can help you navigate the challenges and opportunities that come with advancing the public good.

If you have any questions about nonprofit law or need personalized guidance on starting or managing a nonprofit, our Hotline is open and our attorney network is ready to provide you with the assistance you need!