When establishing the legal structure of your nonprofit organization, you want to get it right. If you decide to change your legal structure down the road, you’ll be caught in an avalanche of paperwork. And nobody likes paperwork (except, perhaps, your friendly accounting team here at Lloyd & Hodge!).
But choosing a nonprofit structure for your charity isn’t exactly straightforward. It’s essential to select the structure that will benefit your charity the most and make the right resources available to you.
So below, we’ve outlined the three legal structures that you can choose from, and we discuss the types of charities that would be best suited for each one.
Nonprofit Corporations as a Limited Liability Company
This is by far the most common type of nonprofit structure, and it certainly has its appeal. Starting a Limited Liability Company (LLC) protects you and your personal assets from any liability your charity may incur. So, for instance, if your charity accrues debt in the course of your work, you (and your private bank account) are not personally responsible for it.
A nonprofit LLC is its own legal entity; it can enter into contracts and own property as such. This also gives nonprofit corporations the right to exist in perpetuity, regardless of whether the persons who established it are still involved.
This type of charity is governed by Articles of Incorporation, which is the document that you file with the government to establish your charity legally. The Articles of Incorporation usually include things like:
- Your charity’s name
- Your complete street address (not a PO Box)
- The name of the person responsible for accepting legal notices for the charity & their street address
- A statement that your charity is for the public benefit and not for personal gain
- The purpose of the organization
- A statement that the charity is structured for charitable or education reasons under the guidelines of IRC §501(c)(3)
- A statement that the charity will not engage in activities not listed under IRC §501(c)(3)
- A statement that the nonprofit will not engage in propaganda or try to influence legislation, or be involved in a political campaign in any way
- A statement that the nonprofit will not benefit any director, officer, or other member privately
- A statement that the charity will comply with private foundation rules if needed
- A statement that if the charity were to dissolve, any remaining assets after debts or liabilities were paid would be donated to a nonprofit fund, foundation, or organization recognized by IRC §501(c)(3)
- Your signature
Each state has its own method for filing Articles of Incorporation. You can find the form for organizations incorporating in Texas here (look for Form 202). The fee in Texas is currently $25.
The downside to incorporating your charity as an LLC is that it involves a lot of paperwork. There is the time-consuming investment of the initial paperwork, and there is usually a requirement to file yearly compliance paperwork as well.
Most of the charities you know are probably incorporated as LLCs. Incorporating makes your nonprofit more likely to qualify for 501(3)(c) status, making donations to the charity tax-exempt and giving your charity access to more grants, more credibility with donors, and other perks like discounted bulk mail rates.
Organizing your charity as a trust involves less paperwork. It’s a relatively simple nonprofit structure governed by a trust deed and can be very flexible because there is no prescribed legal framework.
But a charitable trust cannot enter contracts or purchase property as its legal entity. Instead, trustees are responsible for conducting those activities as private citizens. So if, for instance, you need to rent a van to conduct some charity work, you would not rent that van as ABC Charity but as a private citizen. If you had a wreck in the van and needed to pay for repairs, you would be personally responsible for those repairs, not ABC Charity.
Charitable trusts are usually established to oversee philanthropic donations of a person’s estate. It is not often chosen for any nonprofit organization that intends to hire employees, and it is not tax-exempt. However, if you’re looking for a way to manage wealth or property, check out these benefits of setting up a trust.
Unincorporated Nonprofit Associations
For smaller charities, the lack of paperwork involved in setting up an unincorporated nonprofit association may be appealing. Unincorporated nonprofits enjoy a looser structure than an LLC. In the State of Texas, they are defined as “an unincorporated organization consisting of three or more members joined by mutual consent for a common, nonprofit purpose.”
Unincorporated Nonprofits may be cheap and easy to establish, but like charitable trusts, they do come with the risk of liability for the members. Because there is no corporate structure protecting members, they are personally liable for any debts or legal proceedings incurred in the charity’s work.
And that lack of structure can cause problems within the organization as well. There is no formal structure in the organization and hence no recourse for addressing issues within the organization.
Donors, especially large or corporate ones, may find this informality off-putting. Corporate donations to nonprofits usually have rules they must follow for their charitable giving to be approved by their headquarters, and those rules often stipulate that benefiting organizations should have 501(c)(3) status.
You can qualify for 501(c)(3) status as an unincorporated nonprofit, but to do so, you’ll need to meet specific federal and state requirements, and you’ll need to file Articles of Association much like an incorporated charity. You can find a comprehensive guide to taxes as an unincorporated entity here.
But if you’re looking to set up a loosely-defined community group that doesn’t buy or lease property, hire employees, enter into contracts as a legal entity, or seek tax exemption, an unincorporated nonprofit association is a good fit for your organization.
Which Nonprofit Structure Is Best?
Choosing the right structure for your charity depends on your goals. Most charities will not be trusts. Trusts serve a niche market that likely doesn’t fit your charity’s needs.
The choice, then, becomes whether or not to incorporate. Most charities choose to incorporate because it protects members from legal action or debt, encourages donor trust, and allows them to enter contracts, hire employees, and conduct business. There are regulations to meet and papers to file, but this structure usually offers substantial benefits to the organization and the founding members.
If you are involved in small, local fundraising efforts, an unincorporated nonprofit may be the right fit. But if you plan to seek tax exemption for your unincorporated nonprofit, you should consider incorporating instead. Seeking tax exemption for an unincorporated charity will require almost all of the paperwork – but none of the legal benefits – of incorporation.
We know that choosing your charity’s structure can be tricky, and we’re happy to talk it over if you’d like advice. Complete the contact form (it’s quick, we promise!), and we’ll schedule a time to talk.