|Volunteer Legal Handbook, 9th Edition
Handbook > Creating a Nonprofit
At least in a limited sense, creating a nonprofit corporation is a form of risk management. While the corporate veil may protect the members under some circumstances, it doesn't always work and, in any event, does nothing to protect the nonprofit corporation or its mission.
Creating a nonprofit corporation is neither simple nor straightforward; while it is easy enough to create a corporate shell, creating a nonprofit corporation that operates effectively and appropriately for your organization can be pretty complex.
You should always involve a lawyer in the creation of a nonprofit corporation; if you seek charitable corporation status, you will probably also want to involve a certified public accountant familiar with nonprofit tax laws.
For these and the reasons described below, creation of a nonprofit corporation tends to be issue-specific. Please treat this chapter as setting out only broad guidelines. If you aren't interested in creating a nonprofit corporation yourself, it's probably okay to skip this chapter.
Section 1: Determining Whether to Incorporate
Not every nonprofit organization needs to or should incorporate. Incorporation adds to the expenses of operation, imposes additional duties and risks on the managers of the nonprofit organization, and exposes the nonprofit organization to additional regulation. But in many cases incorporation is the only reasonable option. Some of the factors to consider include, but are not limited to:
Fund-Raising Requirements. There is no question but that being a charitable corporation for tax purposes gives an organization a tremendous advantage in fund-raising efforts. Depending upon the income tax bracket of a private donor, being a charitable corporation can save the donor 28-38% of his money by permitting payment with "pretax" dollars. And to be a charitable corporation, you have to first be a nonprofit corporation.
Requirements Imposed by Third Parties. Many foundations, governments and other entities, either by law or policy, will only deal with nonprofit corporations. If you want a grant from the Alaska Division of Family & Youth Services, or the National Science Foundation or whoever, you may very well have to be a nonprofit corporation.
Continuity of Existence. A nonprofit corporation gives an organization continuity of existence; that is, the organization may out-live its organizers. A partnership or association may cease to exist as a matter of law when its organizers cease to exist or to be involved.
Management of Large Numbers of Members. A membership nonprofit corporation provides an organizational structure that is well-documented, legally well-understood and well known to most persons, since it derives from the for-profit corporate model. That can be a big advantage in dealing with larger numbers of persons.
Risk Management. This is not usually a very good reason to incorporate. While a nonprofit corporation operates as a kind of "poor man's insurance," it is not a substitute for insurance or risk management. Generally, insurance premiums tend to be smaller than the true cost of creating and maintaining a nonprofit corporation. In addition, the corporate veil that makes a nonprofit corporation moderately useful as a risk management device has a distressing tendency to fail just when you need it the most.
Eventual Dissolution. If you can see a time when the nonprofit corporation will no longer be needed, then you need to consider the costs of dissolving or otherwise terminating the nonprofit corporation.
While a nonprofit corporation is by far the most common means of organization, and is the focus of these materials, it is not the only vehicle available. In appropriate circumstances, a trust might be more appropriate, or even a limited liability company organized under AS 10.50.010 et seq. Note: a limited liability company may be organized for "any lawful purpose," AS 10.50.010, without any specific requirement that it be a for profit purpose. However, the creation of one of these alternate forms of structure is beyond the scope of these materials.
Section 2: Selecting the Nonprofit Corporate Structure
There are two broad sorts of nonprofit corporation structures: membership nonprofit corporations and non-membership nonprofit corporations.
Membership Nonprofit. To understand the considerations in deciding whether to create a membership nonprofit corporation, we need to digress again into the law of corporations, with all of the cautions and caveats discussed earlier. A shareholder in a for-profit corporation enjoys three general sorts of rights as a consequence of being a shareholder: the right to elect directors and to vote on certain other issues, the right to share in the profits, if any, of the corporation, and the right to share in the assets of the corporation, if any, on dissolution of the for-profit corporation. By contrast, a member of a nonprofit corporation only has the right to vote. By definition and law, there are no profits to be distributed, and on dissolution the assets must be distributed to another charity. In fact, there can be serious tax consequences for a nonprofit corporation that confers anything but the most minimal benefits on its members.
So while members are roughly analogous to shareholders in a for-profit corporation, it is an extremely loose analogy. Members may have other rights if those rights are described in the Articles of Incorporation or in the Bylaws, as described below. However, generally Alaska law and the IRC prohibit members from receiving special benefits because of their status as members, especially in the case of charitable corporations.
Non-Membership Nonprofit. Alaska nonprofit corporations are not required to have members. AS 10.20.051. If there are no members, then existing directors on the board of directors select their successors. There can be many reasons to have members: they afford a volunteer base, a fund-raising base, a lobbying base and can lend credibility. They can also help your organization with a class of potential tax problems. But they are not required. In designing the nonprofit corporate structure for your goals, try to consider the costs and benefits of membership.
Chapter 2. Obtaining a Certificate of Incorporation
A Certificate of Incorporation is a piece of paper. It is not a lawful, operating nonprofit corporation. Rather, think of it as proof that the persons who are named as the initial board of director have the permission of the State of Alaska to create a corporation. It is a crucial step to creating a nonprofit corporation, but it is by no means the last step. It is your "charter," as it were. It is an important document and should be stored in a safe and secure place.
First, you obtain a Certificate of Incorporation by filing Articles of Incorporation with the appropriate filing fee at the State of Alaska. The form of Articles of Incorporation was altered somewhat recently, and the requirement of verification eliminated. However, consider verifying them anyway if there is any chance your nonprofit corporation will need to register as a foreign corporation in another state. Send them to:
Department of Community & Economic Development
PO Box 110807
Juneau, Alaska 99811-0807
There are provisions that must be in the Articles and, in addition, you can add other provisions, subject to the limits of the law. The following mandatory provisions must be in the Articles of Incorporation for your nonprofit corporation:
Name of the Nonprofit Corporation. The name must not contain any phrase or part that suggests the nonprofit corporation was created for any purpose except those set out in the Articles of Incorporation. The name should not be deceptively similar to that of another corporation or registered business name. You can check available names at Corporations Section, 907-465-2530, or at its World Wide Web site on-line at:
Duration of the Nonprofit Corporation. Ordinarily, the duration of a nonprofit corporation is perpetual. But sometimes a nonprofit corporation might only need to have a limited existence. For example, the nonprofit corporation that coordinated the 50th anniversary of the construction and completion of the Alaska Highway had a limited duration.
Purpose. The Articles of Incorporation must describe with some specificity the purpose or purposes for which the nonprofit corporation is created. Note that to qualify as a tax exempt or charitable corporation the Internal Revenue Code severely limits the permitted purposes. When you identify the purpose of your nonprofit corporation, keep in mind that the purpose will have to be coordinated with the information you provide if you apply for charitable corporation status on IRS Form 1023.
Control of the Nonprofit Corporation. The Articles of Incorporation must address provisions for internal control of the nonprofit corporation. For example, the Articles might be drafted to provide for management by a board of directors selected by the members according to terms set out in the Bylaws, and for Bylaws to be adopted or amended by the board of directors, subject to approval by the members. While the internal management must be addressed, you have considerable flexibility in deciding how to do so.
Distribution of Assets on Dissolution. As a matter of both Alaska law and the Internal Revenue Code, you must describe what happens to the assets of the nonprofit corporation in the event the nonprofit corporation is dissolved. It is imperative that the Articles provide that no part of the assets go to members or directors for the nonprofit corporation simply because of their status. Ideally, the assets should be distributed to another nonprofit corporation with a similar purpose.
Initial Board of Directors. An initial board of directors must be named in the Articles of Incorporation. These are the persons who conduct the first of the series of organizational meetings. Usually, but not always, these are the incorporators, the persons who sign the Articles of Incorporation. You must set out both the name and the mailing address of each initial director. Usually, you must have three initial directors.
Registered Agent and Registered Address. The nonprofit corporation must name a person who is authorized by the nonprofit corporation to receive notices, lawsuits, orders and other official documents affecting the nonprofit corporation. That person must also provide an address. The nonprofit corporation should give careful thought as to who is named as registered agent; they must be responsible enough to always forward the notices to a current officer who can act upon them.
For example, if the nonprofit corporation is sued, the summons and complaint may be mailed or personally served on the registered agent. The nonprofit corporation has a limited time - typically 20 -23 days - to answer the summons and complaint, If the nonprofit corporation fails to timely answer, the nonprofit corporation will lose the lawsuit by default. If the registered agent isn't being conscientious, the nonprofit corporation could lose a lawsuit it didn't even know had been filed.
There are any number of additional issues you may want to set out in your Articles of Incorporation. Just a few examples are provided here. There is no statute which sets out what is prohibited to be set out in the Articles. But state and federal law severely limit some things that would be permissible in the for profit sector. Some nonprofit corporations also use the Articles of Incorporation to set out provisions which are already in the statutes, but are so important that they want the members and directors to always be aware of them. For example, a nonprofit corporation cannot make loans to directors. By setting it out in the Articles of Incorporation, it's harder for the directors to "lose sight" of the provision.
Officer and Director Immunity. By statute, a nonprofit corporation may limit the liability of directors and officers by adopting specific language in the Articles of Incorporation. Unless the limitations of liability are in the articles, the protection granted by statute is not available. There are two broad drawbacks to adopting those limitations on liability. First, it's a little awkward for officers and directors to immunize themselves from the consequences of their own conduct. Second, the immunity is limited in scope. Officers and directors remain liable for their actions and inactions in the areas described below. See generally the discussion of nonprofit corporations above, addressing this issue in the context of amendments to existing Articles of Incorporation.
Whether to Have Members. You can state in your articles whether or not the nonprofit corporation will have members. You can do this in your bylaws instead, but it's generally better to make this important a decision in the articles.
Procedures for Selection of Directors. You may choose to provide in your Articles of Incorporation for the manner in which directors are elected, whether or not you have members.
Classes of Membership. If you have members, you can provide for different classes of members. For example, your nonprofit corporation might want to have voting members and non-voting members.
Adoption and Amendment of Bylaws. The Bylaws, discussed below, are the operating rules for the nonprofit corporation. Sometimes control of a nonprofit corporation is an important issue; one means of limiting the power to change the balance of power is to provide that the Bylaws of the nonprofit corporation can only be amended with the approval of the members, or by a supermajority of the members.
Chapter 3. Implementing the Nonprofit Corporation
Obtaining a Certificate of Incorporation is only the first step in the process of creating a nonprofit corporation. It creates a skeleton of a nonprofit corporation. Implementing the nonprofit corporation puts some meat on the skeleton and creates an operational entity.
Record Keeping. It's difficult to overstate the importance of complete and accurate record keeping for nonprofit corporations. Record keeping serves three very important purposes.
First, in the eyes of the law, a nonprofit corporation is a person, almost like you or me, except that you cannot tap it on the shoulder. In order for the "person" to be able to prove it did something, there is going to have to be a writing. The testimony of a witness about what happened is not particularly persuasive and, in any event, it may be impossible to find the person who actually has the knowledge to testify long after the fact. For example, the minutes of a meeting of members or the minutes of a meeting of the board of directors needs to be sufficiently specific and detailed to allow each person in attendance to be able to establish with reasonable certainty what occurred at the meeting.
Second, the memory of a nonprofit corporation is only as good as its senior-most officer, director or member. By writing things down, you help maintain the collective memory of the nonprofit corporation, its "institutional memory." A few years after the fact the current board of directors should be able to find out why a former board of directors took the action that it did.
Third, some kinds of things, for example compliance with the safe harbor against excess benefits transactions, can only be established through written, contemporaneous minutes of the corporation.
Organizational Meetings. The organizational meetings of a nonprofit corporation are a series of meetings in which the nonprofit corporation "bootstraps" itself into existence. These meetings may seem a series of silly formalities, but they establish that the nonprofit corporation was properly created. It is critical that the meetings be documented in order to establish that the nonprofit corporation was duly, lawfully and properly created.
The Articles of Incorporation establish the members of the initial board of directors. These are the persons charged with the initial creation of the nonprofit corporation: the first of the steps involved in implementing the nonprofit corporation. Typically, the initial board of directors takes the following actions at the meeting:
If the nonprofit corporation has members, the next organizational meeting is that of the members. If the members have the right to select the board of directors, they elect the directors of the nonprofit corporation. The members might also ratify the actions taken by the incorporators and the initial board of directors. If there are no members, the Initial Board should select the directors.
After the meeting of the Initial Board and the meeting of the members (if there are members), there will be persons who have been selected as directors. Some of the issues that the board of directors might consider are described below. (Note that the board of directors is a long-term, ongoing body, while the Initial Board of Directors meets only one time.)
Adoption of Bylaws. The board of directors adopts permanent Bylaws, usually the same as those adopted provisionally by the initial board of directors, as described above.
Ratification of Prior Actions. The board of directors should review the actions taken by the incorporators and the initial board of directors. If the actions were all appropriate, the board of directors should ratify ñ adopt and approve ñ those earlier actions.
Election of Officers. Now that there are Bylaws and assets, the nonprofit corporation can elect officers for the nonprofit corporation. Sometimes the Bylaws provide for the members to elect officers, although it's not clear that Alaska law permits members of a nonprofit corporation to elect the officers. You should consult your lawyer about those issues. But if, as is typical, the Bylaws provide for election of the officers by the board of directors, then that action should be taken at the first meeting of the board of directors.
Under Alaska law, a nonprofit corporation, at a minimum, must have a president and a secretary, and they may not be the same person. A nonprofit corporation may have as many additional officers as it chooses.
Commence Nonprofit Activities. Once the nonprofit corporation has Bylaws setting out the rules under which it will operate, a board of directors to set policy and exercise overall control, and officers to implement that policy, it is ready to conduct its activities. Remember that those activities are closely limited and scrutinized as described in these materials, by the Internal Revenue Code and by the State of Alaska. Also remember that at this point you may have a nonprofit corporation, but you do not yet have a charitable corporation.
Chapter 4. Nonprofit Corporate Bylaws
The Bylaws of a nonprofit corporation tend to be fairly specific to the organization. It’s difficult to develop "generic" Bylaws. There has been a recent effort by a group of nonprofit corporation advisors to develop “model” bylaws for Alaska. They may serve as a useful starting point for you. They are available at the website.
But whether you start with the model bylaws or not, here are some issues to consider for the Bylaws for your nonprofit corporation. Note that your nonprofit corporation must have Bylaws of some kind.
The following are some of the more important issues to consider addressing in your Bylaws. As to all of these examples, you will want to consult with a lawyer familiar with nonprofit corporate law for assistance in keeping your Bylaws consistent with Alaska law.
Membership and Annual Meetings. If the nonprofit corporation is to have members, the Bylaws should provide for the terms under which persons may become and remain members of the nonprofit corporation. The terms under which an annual meeting or special meeting of the members will be held should also be addressed.
Directors and Meetings. The Bylaws should address the procedures for the qualification, selection, and term of members of the board of directors of the nonprofit corporation. The Bylaws should also describe the manner in which notice of a regular or special meeting of the board of directors will be held, and what will constitute a quorum at such a meeting.
Officers and Duties. The kinds of officers and their duties should be set out. The procedures for the qualification, selection and term of each officer should be set out.
Standing Committees. If the board of directors or members want standing or permanent committees created, describe them in the Bylaws. Example might be a finance committee, a risk management committee, or an executive committee.
Amendment of the Bylaws. Describe the procedures under which the Bylaws may be amended. Will you allow the board of directors to amend them? By what vote? Or will membership approval of amendments be required.
Conduct of Meetings. It's prudent to provide something to the effect that, where not inconsistent with the Bylaws and Articles, Roberts Rules of Order will govern meetings of members and directors.
Other Bylaws Provisions
Here are some other matters you also might want to address in nonprofit corporation Bylaws:
Conflicts of Interest. Conflicts of interest, as described throughout these materials, are a real problem and can create liability under many circumstances. You might want to set out a conflict of interest policy. The legal minimum policy is above. Best practices strongly support having a conflict of interest policy in place.
Nepotism. "Nepotism" occurs when family members work under the supervision of another family member. It's not illegal but it does present a variety of risks. You might want to consider adopting nepotism guidelines or rules. Because of the excess benefits rules and, in particular, the new rules on "disqualified persons," there is an additional incentive to consider the risks of nepotism.
Books and Records. You might want to address where records will be stored, how long they will be preserved before being destroyed, and who may have access to them and under what terms. You might also want to address whose signatures are required on a check, letter or other document to create corporate action.
Remember that certain exempt organization records are public records under the IRC, and must be timely produced if requested. See the discussion above.
Chapter 5. Tax Exempt and Charitable Organization Status
Obtaining Tax Exempt Status
A nonprofit corporation is not automatically exempt from payment of income taxes on its income. The nonprofit corporation must comply with Federal law - specifically, the Internal Revenue Code and regulations - to obtain tax exempt status.
You should involve an accountant or other professional familiar with nonprofit corporations from the outset as you seek to obtain your tax exempt status. But you can help yourself by obtaining from the IRS a copy of its Publication No. 557 (Rev. Jan 92) titled "Tax-Exempt Status for Your Organization."
Unless your nonprofit corporation is a foundation or a charitable corporation under Section 501(c)(3) of the Internal Revenue Code, you will likely need to use Form 1024 to apply for tax exempt status. There is a table at the back of Publication 557 which describes which specific IRS Form to use.
Obtaining Charitable Organization Status
Just because a nonprofit corporation has tax exempt status, as described in the preceding section, it does not follow that it is a charitable corporation for purposes of the Internal Revenue Code. To become a charitable corporation you must also obtain status as a charitable corporation under the Internal Revenue Code.
Even more than is the case for exempt organization status, you should involve an accountant or other professional familiar with nonprofit corporations from the outset as you seek to obtain your charitable organization status. The IRS Publication No. 557 (Rev. Jan 92) titled "Tax-Exempt Status for Your Organization" addresses charitable corporations as well as exempt organizations.
Even by IRS standards, IRS Form 1023, the "Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code" is extremely challenging to complete. In particular, you will want to proceed carefully as you show that you are not creating a "private foundation" under Internal Revenue Code Section 509 (unless that is your intent).
It is best to apply as soon as possible. If you submit the application within 15 months of the date on which the nonprofit corporation was "organized" then the effective date of the charitable corporation status is the date of organization. It gets much more complicated if you wait more than 15 months.
Your application for charitable corporation status seeks a "determination letter" from the IRS which is your proof of charitable corporation status. To obtain a determination letter you must also submit Form 8718, which is essentially the transmittal form for a hefty fee. Without a Form 8718 and the required fee, the IRS will not consider your application.
Chapter 6. Maintaining and Ending a Nonprofit Corporation
A nonprofit corporation requires maintenance and ongoing support to function. At one level, there are reports to be filed, and the failure to file those reports can seriously affect the nonprofit corporation. At another level, the failure to keep minutes, or to preserve the distinction between the nonprofit corporation's assets and those of its directors and members, or the failure to comply with tax law requirements, can cause the nonprofit corporation to cease to exist.
If, unwittingly, the nonprofit corporation is permitted to cease to exist, or loses a part of its status as a tax-exempt or charitable organization, the consequences can be very serious, not just for the nonprofit corporation but for the officers and directors who permitted that to happen. Here are some of the things you must do to maintain the existence of the nonprofit corporation:
Biennial Reports. The nonprofit corporation must file a biennial report (once every two years) with the Department of Community and Economic Development. The failure to timely file a biennial report can result in the involuntary dissolution of the nonprofit corporation. The Department of Community and Economic Development will mail a biennial report form to the registered agent described in the Articles of Incorporation (or any amendment). Obviously, it is important to have procedures in place that assure the form of biennial report is timely forwarded to the secretary or other designated officer of the nonprofit corporation, completed and filed.
If your nonprofit corporation fails to file its biennial reports, the Department of Community & Economic Development will involuntarily dissolve your nonprofit corporation. In the wrong circumstances, that can be disastrous.
Annual Meetings. If the nonprofit corporation has members, then the nonprofit corporation is required to hold an annual meeting of those members. It is important to document that such an annual meeting occurred. Be certain that minutes are taken and preserved.
IRS Reports. Depending upon the kind of tax status enjoyed by the nonprofit corporation, the IRS may impose reporting duties and obligations. Just because a nonprofit corporation is tax exempt does not mean it is excused from filing tax returns. The kinds of reports tend to be specific to the tax status of the nonprofit corporation. You should consult with an accountant or other professional familiar with nonprofit corporations about the reporting requirements imposed on your nonprofit corporation. In many cases, the failure to timely file required reports can result in stiff penalties or even loss of tax exempt status.
Dissolution. If a nonprofit corporation is inactive or is no longer needed, or for some other reason is not operating or about to cease operations, you should consider whether and how to formally end the life of the nonprofit corporation. You cannot simply "walk away" from the nonprofit corporation. To do so exposes the officers and directors to liability to the government, creditors, members and others. There are fairly detailed procedures which must be followed, including a "plan of dissolution" and "articles of dissolution," a kind of mirror image of the Articles of Incorporation which created the nonprofit corporation. Remember that assets must be distributed in compliance with Alaska law, state and federal tax law and consistently with the corporate purposes of the nonprofit corporation. You should consult an attorney familiar with nonprofit corporate law to review how to end a nonprofit corporation.
|Volunteer Legal Handbook, 9th Edition
Handbook > Creating a Nonprofit