Choosing a Type of Nonprofit Organization

Choosing a Type of Nonprofit Organization

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 - as an unincorporated association, a trust, a corporation, or limited liability company. However, the IRS only recognizes LLCs as a nonprofit 501(c)(3) if all its members are 501(c)(3) organizations. For most groups, a corporation offers the most advantages, but in certain situations, a trust or association may be the best fit.

Association

Any 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 to 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, if the group expands beyond a small group of friends, starts generating income, or wishes to apply for grants or deductible donations, it should incorporate for the advantages listed under the corporation section.

Trust

A few types of nonprofit organizations are more often formed as trusts. For example, charitable gifts made in wills are often set up as charitable trusts. 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 a 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.

Corporation

The corporation is the most common, and usually best, form for a nonprofit organization. Some of the benefits follow.

There is a small price to pay for these benefits: the organization must register with a state and must make periodic filings and disclosures. There are also filing fees, but these are usually small. If professionals are hired to prepare these documents, the cost may be high, but you can prepare the basic formation documents and exemption applications and eliminate that expense.

  • Protection from Liability. The officers, directors, and members of a nonprofit corporation are protected, in most cases, 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.

Procedural Rules. 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.