Creating Non-Profit/Tax-Exempt Organizations Pt. 1 — Initial Considerations

Over the next two weeks, we’ll discuss creating nonprofit/tax-exempt organizations (TEOs). Today in Part 1, we’ll talk about initial considerations in creating TEOs, including entity selection and structuring. In Part 2, we’ll cover the various tax-exempt categories in the Internal Revenue Code. In Part 3, we’ll go into detail on the basics most popular of the tax-exempt categories, the 501(c)(3). In Part 4, we’ll discuss in further detail the differences between the two types of 501(c)(3)s — private foundations and public charities — and the standards for qualifying as a public charity. Finally, in Part 5, we’ll review the necessary steps for forming and certifying a TEO. ——————————- Before beginning to organize and structure a tax-exempt organization, it is important to first identify the considerations and goals of the organization, as they will inform and possibly limit how the organization is set up. Some of the questions you need to answer include: – Do we need state and/or federal tax exemptions? – Do we need to offer donors the ability to deduct donations/contributions? – Will we be seeking public or private grants? – Are we willing to accept the regulatory and administrative requirements and oversight of our chosen form? – Public record of the organization’s management (such as directors’ residential addresses) – Public availability of tax records – Complying with corporate formalities (if applicable) – Using fund accounting (accounting for different sources of funds with different intended recipients) – Audits – State attorney-general oversight – Maintenance of status – Difficulty of dissolution – Who are the intended beneficiaries of the organization? – Who will fund the organization? – Is there another organization with the same mission as ours? – Can our goals be accomplished with a fiscal sponsor (utilizing another related organization’s non-proft/tax-exempt status)? Once you’ve determined answers to these questions, and determined that you should move forward with a TEO, the next step is to begin to structure it. First, which business form should the TEO be organized as? Perhaps the most popular choice is the corporate form, which is particularly beneficial for TEOs that are actively engaged in operations (such as running a shelter or a school), as opposed to simply making grants or donations. Limited liability companies are also growing in popularity for the same purpose, in particular when there is only one member in a TEO LLC, which grants disregarded entity status as a default, but there is a question of whether managers of tax-exempt LLCs are granted charitable immunity like other TEOs. However, both corporations and even LLCs have corporate formalities that must be observed; additionally, dissolution of a tax-exempt corporation or LLC is a judicial process that can be complicated. There is also the old-standby of the trust, which is still somewhat popular for TEOs that are primarily organized to distribute funds as grants or donations rather than actively run operations. Dissolution of a trust can also be easier to effect than with corporations or LLCs. Finally, a TEO can be run as an unincorporated association (the default if no form is organized), but it has no liability shield. It should be noted that if no form is chosen (or a form is chosen but is later changed), the organization will most likely need to go through the process of obtaining its tax-exempt status (particularly when it comes to 501(c)(3) status) all over again. You will need also need to decide in which jurisdiction to form the TEO. Like with for-profit companies, Delaware is a popular choice; however, factors that go into the decision include: – Whether the organization will be locally or nationally focused? (For example, if you’re forming a charity to help people in Boston, a Massachusetts non-profit corporation might have a little more cachet than Delaware corporation — you could also be ineligible for state-level grants or to work with the state or municipality) – Where the principal place of operations will be? (Even if you are formed in another state, you may be subject to state government oversight in the state(s) where you operate as well) – Where you will be soliciting donations (Same reason as the previous point) Every state has different rules and standards for regulation, some more numerous or complicated than others, so how much regulation you are willing to deal with can be a factor as well. Finally, you will need to decide how to structure the organization, which will be codified in the charter documents (such as the articles of organization, bylaws, or operating agreement). To start, who will have control of the organization? If the organization is a subsidiary of a parent organization, will the parent be the sole member/director, or will it appoint managers or a board of directors? In any event, with a parent/subsidiary relationship, it is important for the parent to maintain proper distinction with the subsidiary and observe corporate formalities. If a board is established to govern the organization, various structure details should be considered, including: – Number, composition, and selection – Self-propagating board (able to set its own number and composition and elect its own membership – Third-party selection – Selection or nomination (important if third-party selected board member must be removed) – Term limits (staggered?) – Board committees (i.e. standing committee, executive committee, finance/audit committee) These details are usually enumerated in the articles of organization and/or the bylaws/operating agreement. Other topics that are often covered in bylaws/operating agreements include: – Membership structure – “Managing” members vs. “supporting” members – Allows TEOs with large member bases to streamline and vest management in a select group – Procedure for board & member meetings – Voting – Director and officer compensation and indemnity

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