Before forming a nonprofit organization, you should understand the types of structures available so that you can choose the one that will provide the most benefits to the type of organization you are planning.
Association, Trust, or Corporation
A nonprofit organization can organize itself in four ways: an unincorporated association, a trust, a corporation, or a limited liability company. However, the IRS only recognizes LLCs as nonprofit 501(c)(3) if all its members are 501(c)(3) organizations. A corporation offers the most advantages for most groups, but a trust or an association may be the best fit in certain situations.
An informal group of people who get together for a common purpose, such as a bridge club, Parent Teacher Association, or a ski club, can be considered an unincorporated association. Such a group has some legal rights, like the right to open a bank account. However, this structure has some legal liabilities. For example, if the members of a ski club are driving together and get into an accident because of the negligence of the member driving, it is possible that all members of the club could be liable for the person injured, whether or not that person is a club member. For this reason, groups that are involved in risky activities generally incorporate.
Small groups of friends who do things together usually do not have to worry since their auto and homeowners' insurance cover most possible risks. However, it should incorporate if the group expands beyond a small group of friends, starts generating income, or wishes to apply for grants or deductible donations.
Groups that are more concerned with charitable giving may find that it is best for them to form a nonprofit trust. However, for most groups that have members, this is not a good entity since the trustees are not protected against liability. In fact, trustees may have greater exposure to liability because they are held to a higher fiduciary standard. This means that they must be extremely careful in their dealings, or they can be personally liable for their mistakes.
The corporation is the most common and usually best form for a nonprofit organization. Some of the benefits follow.
- Separate entity. Because a nonprofit corporation is its own entity, it can enter into contracts as its own entity, which protects the nonprofit members from liability.
- Tax-Exempt Status. While groups and associations are able to apply for tax-exempt status, it is much easier for a statutory business entity like a corporation to apply for and receive tax-exempt status.
- Protection from Liability. In most cases, the officers, directors, and members of a nonprofit corporation are protected from liability for the debts and obligations of the corporation. If the corporation incurs debts or if someone is injured by a member of the corporation, the others in the organization normally are not personally liable. There are exceptions to this, however. If the officers or members personally guarantee the debt or if they cause the injury, they are held liable.
- Eligibility for Grants. Many government and private programs can only make grants to organizations that are incorporated.
When an organization incorporates, it is then governed by state incorporation law. This law usually answers most of the issues that come up in such an organization, such as how many directors there must be, what is a valid quorum, and what are the rights of members. If the organization is unincorporated, it must make up its own procedures for all of these issues.