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Understanding How A Nonprofit Is Founded And Governed

Who Governs Nonprofit Organizations?

It’s common for people to use the terms charitable organization and nonprofit organization interchangeably. In addition to charities, the nonprofit world also includes other types of corporations like churches, public schools, public charities, public hospitals, political organizations, legal aid societies, labor unions, museums, governmental agencies and a few other categories of business.

Because nonprofit organizations form to fulfill the charitable, educational or civic needs of a community, federal and state governments grant them tax-exempt status, so they can use more of their profits to serve the greater good.

Board Directors of Nonprofit Organizations Must Know and Obey Laws

Nonprofit organizations, which fall under the 501(c)(3) IRS code for the federal government, have rules for starting up, administering their operations and shutting down. Trust is a crucial component of the relationship between nonprofit organizations and donors. State and federal regulations exist to prevent fraud and the breakdown of trust between nonprofits, their donors and the communities they serve.

Governments created laws to protect donors and to prevent nonprofit organizations from using donations for a purpose other than their stated one.

Nonprofit organizations that unintentionally break laws or that knowingly engage in fraudulent activities risk fines, lawsuits or loss of their tax-exempt status.

Trust Is the Foundation of the Nonprofit’s Relationship With Donors and the Community

The government puts forth the laws and regulations for nonprofit organizations. However, nonprofit organizations have to develop trust with their donors and the community in order to be successful. Nonprofit organizations that fail to obey laws, rules and best practices will surely fall out of favor with their donors and benefactors. Government regulations are designed to benefit the public as well as the nonprofit organization.

Among the primary activities of nonprofit organizations are fundraising and requesting grants. Failing to obey regulations of any kind violates the public’s trust.  A breach of trust casts a negative shadow on a nonprofit’s reputation that will be difficult, and maybe impossible, to overcome.

 Who Governs Nonprofit Organizations?

The state governments take primary responsibility for regulating nonprofit organizations. In at least 39 U.S. states, nonprofits must register with the state by filling out an application and filing a charter. Part of this process includes designating the organization as a nonprofit, stating its purpose and drawing up articles of incorporation. In most states, the founding members will file these documents with the Secretary of State. Some states also require nonprofits to submit the organization’s objectives and business goals.

Regulation Lacks Consistency Across State Governments

Advocates for nonprofits have expressed some degree of dissatisfaction with the inconsistency of regulation for nonprofit organizations. State governments may have a little more faith in nonprofits than in publicly listed corporations because most nonprofits start with small clusters of people who are dedicated to a particular cause. Churches, schools and other non-charitable organizations are often accountable not only to donors, but also to governments or affiliated organizations.

Many states don’t have an adequate budget or the personnel to pursue unethical nonprofits that partake in fraudulent activities. On the flip side, nonprofits sometimes have to pay excessive amounts of their funds to follow through on compliance obligations. For these reasons, some advocates promote the idea of moving all regulatory responsibility for nonprofits to the federal government, which has the financial means and other resources to crack down on unscrupulous nonprofits.

Nonprofit Rules Apply to Nonprofits and Donors

The 501(c)(3) regulation includes rules for nonprofit organizations and donors. Nonprofits aren’t allowed to use their funds to benefit individuals or shareholders.

Donors must offer their grants or donations with no strings attached.  They aren’t allowed to receive any goods or services in return, even if the nonprofit offers them. In addition, nonprofit organizations may not offer money in the way of contributions to potential donors. Either of these infractions would cause a nonprofit organization to lose its tax-exempt status.

Nonprofit organizations must be sure to learn about any state laws pertaining to fundraising and solicitation. Some states require nonprofits to register their fundraising activities with the state. Most states have some form of charitable solicitation laws to protect the public and charitable donors from deception. Nonprofit charitable organizations may only use their donations to serve the stated purpose for the organization according to the founding charter.

Nonprofits Have Rules for Dissolution 

The process of dissolving a corporation is a bit easier for for-profit corporations than for nonprofit organizations. Typically, for-profit companies distribute funds and assets equally among the shareholders.

The rules for dissolution of a nonprofit are different for a couple of reasons. There usually are no shareholders. Since the nonprofit didn’t pay any taxes into the state or federal government, it would be highly unethical for a nonprofit to distribute remaining funds and assets to the board, employees, volunteers or others. For anyone involved with a nonprofit, to dissolve the entity and keep the funds would be a disservice to the donors.

Rules for nonprofit organizations state that remaining assets and funds must be donated to another nonprofit organization.

While the state governments regulate and monitor most matters related to nonprofits, the federal government does have some jurisdiction to govern nonprofit interstate commerce. Charitable nonprofits that solicit donations from people or organizations in multiple states must check and obey the laws of the state where donations originate. Some states require out-of-state nonprofits to register in their state if they are soliciting donations in that state.

Best Practices for Nonprofit Organizations

While nonprofit organizations aren’t as heavily regulated as for-profit companies, reputable nonprofits abide by ethical standards and best practices as a means of practicing good governance. Best practices for nonprofits include paying attention to such issues as potential conflicts of interest, financial transparency, nonpartisan activities, reasonable compensation for employees, efficiency and cost-effectiveness.

The National Council of Nonprofits provides a link of state-by-state resources for best practice resources for nonprofits.

Concluding Thoughts on Governing Nonprofits

State governments take primary responsibility for regulating the start-up, operation and dissolution processes for nonprofit organizations. The strength of nonprofit monitoring varies and is often limited by state budgeting concerns. To some degree, nonprofits must govern and regulate themselves in order to remain sustainable. Any hint of fraud and poor reputation will sacrifice donation dollars for nonprofits. With the large number of nonprofits competing for grant monies and donations, nonprofits that fail to meet regulations and to follow best practices won’t likely be able to sustain themselves financially.

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