Choosing the Best Structure for Your Nonprofit

One of the first choices nonprofit founders must make when forming a nonprofit is choosing a corporate structure. There is no one-size-fits-all approach. Rather, the appropriate structure depends on the organization’s charitable purposes, governance needs, liability preferences, and other considerations. This decision will impact your organization’s legal requirements, tax obligations, governance procedures, and ability to raise funds. Therefore, understanding the different options and their implications is essential for laying a strong foundation for your nonprofit’s success.

When choosing a corporate structure, nonprofit founders have four options:

1. Unincorporated association
2. Corporation
3. Limited Liability Company
4. Trust

Each structure has unique characteristics, benefits, and drawbacks. In this blog, we will give a quick primer on each structure to help nonprofit founders to determine the best fit for their organization.

Unincorporated Association

An unincorporated association consists of two or more individuals acting together in a joint enterprise for a common purpose. Unincorporated associations are largely informal ventures. For example, if a group of friends join together to raise funds for a local park, they have created an unincorporated association (whether they mean to or not). Generally, there are no reporting or registration requirements for unincorporated associations, making them very easy to setup.

An unincorporated association may qualify for tax exemption depending on the purposes for which it is formed. If the association’s purposes qualify under Internal Revenue Code Section 501(c)(3), the association can apply for recognition of tax exemption with the IRS. The primary advantage of being tax-exempt (other than the tax-exemption itself) is the ability to accept tax-deductible donations.

Note, however, that an unincorporated association will need to adopt a written governance document such as bylaws or a constitution to apply for tax-exempt status.

Due to their informal nature, unincorporated associations offer the least protection from liability. In most states, unincorporated associations are not considered separate legal entities. Accordingly, members of the unincorporated association are personally liable for the association’s debts and liabilities.

Further, unless state law recognizes it, an unincorporated association cannot purchase or hold property or sign legally binding contracts in its own name.

Corporation

A corporation consists of one or more individuals authorized to act as a single, distinct entity. Corporations are among the most common nonprofit structures. Corporations are required to register with the state upon formation and must comply with certain ongoing legal and regulatory requirements. For example, a corporation typically must have a board of directors, adopt bylaws, and submit annual or periodic reports to its state of domicile.

Similar to unincorporated associations, corporations that are organized and operated for tax-exempt purposes qualify for tax-exemption.

Generally, corporations are considered “persons” under the law. Meaning, members, officers, and directors are generally protected from personal liability.

Limited Liability Company

A limited liability company (LLC) is a hybrid structure somewhere in between a corporation and a partnership. LLCs combine the pass-through taxation of a partnership with the liability protection of a corporation. Just like corporations, LLCs are distinct entities. Also like corporations, LLCs must comply with ongoing legal and regulatory requirements, such as registering with the state, adopting an LLC or Operating Agreement, and submitting annual or periodic reports.

State laws differ with regarding to LLC requirements, so it is important to review and understand the law in your state to determine whether an LLC is the right structure for your organization.

LLCs may qualify for tax-exemption; however, the IRS has released strict rules on how LLLCs can be recognized as tax-exempt.

Trust

A trust is formed when a donor transfers assets to someone for the benefit of another. Charitable trusts are established to hold assets for charitable purposes. Greater privacy is one benefit of forming a charitable trust because a charitable trust can be formed without filing anything with the state or other governmental body.

A trust relationship is among the highest fiduciary relationships that exists under law. As such, trustees are at greater risk of being held personally liable for trust liabilities. Further, trustees are not afforded the same deference as officers or board members of a corporation. For example, trustees do not have the protection of the business judgment rule.

Conclusion

Choosing the right corporate structure for your nonprofit is a critical decision that will shape its future. Make sure to carefully evaluate your organization’s mission, liability needs, funding strategies, governance preferences, and long-term goals. Consulting legal and nonprofit advisors can provide invaluable guidance in making this pivotal decision. By selecting the appropriate corporate structure, you can build a solid foundation for your nonprofit’s success and impact.

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Ellis Carter is a nonprofit lawyer with Caritas Law Group, P.C. licensed to practice in Washington and Arizona. Ellis advises nonprofit and socially responsible businesses on federal tax and fundraising regulations nationwide. Ellis also advises donors concerning major gifts. To schedule a consultation with Ellis, call 602-456-0071 or email us through our contact form. 

Kyler Mejia is an associate (bar admission pending) with Caritas Law Group, P.C. Kyler counsels nonprofit and socially responsible businesses on corporate, trademark, tax, and fundraising matters nationwide and advises donors concerning major gifts. To schedule a consultation, call 602-456-0071 or email us through our contact form.