Nonprofit organizations play a crucial role in addressing social, cultural, and environmental issues. They operate with the aim of serving a public or mutual benefit, rather than generating profit for their owners or shareholders. While the mission of a nonprofit organization is often altruistic, the legal framework that governs these organizations is complex and requires careful attention. From registration to tax compliance, nonprofit leaders must understand the legal obligations that come with running a nonprofit. In this blog post, we will explore key legal considerations for nonprofit organizations and how to ensure compliance with the law while fulfilling your organization’s mission.

1. Legal Structure and Formation

The first step in establishing a nonprofit organization is deciding on its legal structure. Nonprofits can take many forms, but the most common is a charitable organization, which is typically incorporated as a 501(c)(3) organization under U.S. tax law. Incorporating your nonprofit provides several advantages, including limited liability protection for the board members and access to grants and other funding opportunities.

The formation process generally involves the following steps:

• Choosing a Name: The name should be unique and not infringe on any existing trademarks. It must clearly reflect the nonprofit’s mission.
• Filing Articles of Incorporation: These documents must be filed with the appropriate state agency. Articles of incorporation outline the nonprofit’s name, purpose, and structure.
• Bylaws: Nonprofit organizations are required to adopt bylaws, which are internal rules governing how the organization operates, including how board members are elected, how meetings are conducted, and how decisions are made.

It’s essential to consult with a legal expert when forming a nonprofit to ensure that the organization is compliant with all state and federal laws.

2. Tax-Exempt Status

One of the key features of a nonprofit organization is its eligibility for tax-exempt status. Most nonprofit organizations seek to obtain 501(c)(3) status from the Internal Revenue Service (IRS) in the U.S. This designation exempts the nonprofit from federal income tax and allows donations to be tax-deductible for the donors. To achieve tax-exempt status, a nonprofit must meet specific criteria, including:

• Exclusively Charitable Purpose: The nonprofit must be organized and operated exclusively for charitable, educational, religious, or scientific purposes.
• No Private Inurement: The organization must ensure that no part of its income benefits private individuals or shareholders. Any profits must be reinvested into the organization’s mission.
• Public Benefit: The organization must serve the public interest, rather than benefiting private interests.

Applying for tax-exempt status requires submitting a comprehensive application to the IRS, including Form 1023 (for 501(c)(3) organizations) or Form 1024 (for other nonprofit types). The IRS will review the application and determine if the organization qualifies for tax exemption.

3. Governance and Board of Directors

Effective governance is critical to the success of any nonprofit organization. The board of directors plays a central role in overseeing the nonprofit’s operations, ensuring that it adheres to its mission, and maintaining legal compliance.

Nonprofits are required to have a board of directors, and the number of directors varies depending on the state. Board members are typically volunteers, and their duties include:

• Fiduciary Responsibility: Board members must act in the best interest of the organization, ensuring that its resources are used wisely.
• Duty of Care: Board members are expected to stay informed about the organization’s activities and financial status and to make decisions based on sound judgment.
• Duty of Loyalty: Board members must prioritize the nonprofit’s interests over personal or professional conflicts of interest.
• Duty of Obedience: Board members must ensure that the organization follows its mission and complies with all legal requirements.

To maintain transparency and accountability, many nonprofits hold regular board meetings and keep detailed minutes of those meetings. Nonprofit boards should also establish committees to oversee specific aspects of operations, such as fundraising, audit, and governance.

4. Compliance with Employment Laws

Nonprofits are subject to the same employment laws as for-profit organizations, including labor laws, wage and hour laws, and anti-discrimination laws. While nonprofit organizations may have fewer resources and different priorities than for-profit entities, they are still obligated to comply with these laws.

Nonprofits must:

• Classify Employees Properly: Ensuring that workers are classified correctly as employees or independent contractors is critical. Misclassification can lead to fines and penalties.
• Provide Benefits: Nonprofits must adhere to regulations regarding employee benefits, such as health insurance, retirement plans, and paid leave, depending on the size and structure of the organization.
• Follow Anti-Discrimination Laws: Nonprofits must comply with federal and state laws prohibiting discrimination based on race, gender, age, disability, and other protected characteristics.
• Pay Fair Wages: Nonprofits must meet minimum wage and overtime requirements set by the Fair Labor Standards Act (FLSA) and other relevant regulations.

Nonprofits must also ensure that they maintain proper documentation for all employees, including tax forms, employment contracts, and any employee handbooks.

5. Fundraising and Charitable Giving

Fundraising is often a major part of a nonprofit’s operations, and it comes with its own set of legal requirements. To raise funds legally, nonprofits must adhere to both federal and state laws governing charitable solicitation. These laws vary by state, but in general, nonprofit organizations must:

• Register with the State: Many states require nonprofits to register before soliciting donations. This registration process often involves submitting information about the nonprofit’s mission, financial status, and governing structure.
• Follow Truth-in-Advertising Laws: Nonprofits must ensure that their fundraising efforts are truthful and not misleading. This includes disclosing how funds will be used and ensuring that donors understand where their money is going.
• Maintain Accurate Financial Records: Nonprofits are required to keep detailed financial records and submit regular reports to the IRS, state authorities, and donors. Transparency is key to maintaining trust and ensuring legal compliance.

If the nonprofit organization plans to use paid fundraisers or telemarketers, they may need to comply with additional state-specific rules governing these activities. Moreover, organizations operating in certain industries, such as those involved in shipping or transportation, should ensure that their operations are compliant with the Jones Act coverage, which may affect their eligibility for certain contracts or fundraising activities related to maritime operations. Understanding and adhering to the Jones Act can help the nonprofit avoid legal pitfalls and ensure smooth fundraising efforts.

6. Financial Reporting and Accountability

Nonprofits are subject to rigorous financial reporting requirements to ensure transparency and accountability. Even though they are not subject to income tax, they must file annual returns with the IRS. The form filed depends on the organization’s income level:

• Form 990: Most nonprofits with gross receipts over $200,000 or total assets over $500,000 must file this detailed return, which provides a comprehensive overview of the organization’s finances, governance, and activities.
• Form 990-EZ: Smaller nonprofits with less than $200,000 in gross receipts or total assets under $500,000 may be able to file this simpler version of Form 990.
• Form 990-N (e-Postcard): Nonprofits with gross receipts of $50,000 or less are generally eligible to file this shorter online form.

Nonprofits must also comply with state-level financial reporting requirements, which may include additional filings and disclosures. Financial transparency helps protect the nonprofit’s reputation and assures stakeholders that the organization is using its resources responsibly.

7. Risk Management and Liability Protection

Nonprofits, like any other organizations, face risks related to their operations. It is essential to have risk management strategies in place to mitigate legal and financial exposure. Some steps to reduce risk include:

• Insurance: Nonprofits should consider purchasing general liability insurance, directors and officers (D&O) insurance, and other relevant coverage to protect themselves against lawsuits and claims.
• Volunteer Protection: Many states offer protections for volunteers working with nonprofit organizations. These laws can shield volunteers from personal liability if they act within the scope of their duties and follow the organization’s policies.
• Contracts and Agreements: Nonprofits should use clear contracts for employees, contractors, and vendors to define the terms of their relationships and responsibilities.

Conclusion

Legal considerations are vital for nonprofit organizations to ensure their operations run smoothly, their missions are met, and they comply with relevant laws. By understanding and adhering to legal requirements such as tax-exempt status, governance, employment laws, fundraising regulations, and financial reporting, nonprofit leaders can protect their organization from legal risks while making a positive impact on their communities. With careful planning and diligent compliance, nonprofits can focus on their charitable goals and continue to thrive in serving the public good.