Legal Basics Every Nonprofit Should Know

Understanding the legal basics is crucial for any nonprofit organization. It ensures compliance with laws and regulations, protects the organization's assets, and helps maintain its tax-exempt status. This article will cover the essential legal aspects every nonprofit should know, from incorporation to volunteer management.

Incorporation and Legal Structure

One of the first steps in establishing a nonprofit is to incorporate it as a legal entity. Incorporation provides several benefits, including limited liability protection for the organization's directors and officers. It also helps establish credibility with donors and grantmakers.

There are different legal structures available for nonprofits, such as charitable trusts, unincorporated associations, and nonprofit corporations. The most common structure is the nonprofit corporation, which is governed by state laws.

For example, in the United States, nonprofits typically incorporate under the laws of the state in which they operate. Each state has its own requirements for incorporation, so it's essential to research and comply with the specific regulations.

Tax-Exempt Status

Once incorporated, a nonprofit can apply for tax-exempt status with the Internal Revenue Service (IRS). The most common tax-exempt status is 501(c)(3), which allows organizations to receive tax-deductible donations and be exempt from federal income tax.

To obtain 501(c)(3) status, a nonprofit must meet specific criteria, including having a charitable purpose, not distributing profits to individuals, and adhering to certain operational restrictions. The application process involves submitting Form 1023 or Form 1023-EZ, depending on the organization's size and complexity.

Maintaining tax-exempt status requires ongoing compliance with IRS regulations, such as filing annual information returns (Form 990), avoiding prohibited activities like political campaigning, and ensuring that no part of the organization's net earnings benefits private individuals.

Governance and Board Responsibilities

Effective governance is essential for the success and sustainability of a nonprofit. The board of directors plays a critical role in overseeing the organization's activities, ensuring compliance with laws and regulations, and making strategic decisions.

Board members have legal responsibilities, including the duty of care, duty of loyalty, and duty of obedience. They must act in the best interest of the organization, avoid conflicts of interest, and ensure that the organization operates in accordance with its mission and legal requirements.

For instance, board members should regularly review financial statements, approve budgets, and ensure that the organization has adequate insurance coverage. They should also establish policies and procedures to guide the organization's operations and ensure compliance with applicable laws.

Financial Management and Reporting

Proper financial management is crucial for nonprofits to maintain their tax-exempt status and demonstrate accountability to donors and stakeholders. This includes budgeting, accounting, and financial reporting.

Nonprofits should develop an annual budget that aligns with their mission and strategic goals. They should also implement sound accounting practices, such as maintaining accurate records, segregating duties, and conducting regular audits or reviews.

Financial reporting is another important aspect. Nonprofits are required to file annual information returns with the IRS (Form 990), which provides information about the organization's finances, governance, and activities. Some states may also have additional reporting requirements.

For example, a nonprofit might use accounting software to track income and expenses, generate financial statements, and prepare for audits. Regular financial reviews can help identify potential issues early and ensure that the organization remains financially healthy.

Volunteer Management

Volunteers are a valuable resource for many nonprofits, but managing them involves legal considerations. Nonprofits should have policies in place to protect both the organization and its volunteers.

One key consideration is liability. Nonprofits should ensure that they have adequate insurance coverage, such as general liability insurance and directors and officers (D&O) insurance, to protect against potential lawsuits.

Additionally, nonprofits should provide clear guidelines and training for volunteers to ensure they understand their roles and responsibilities. This can help prevent misunderstandings and reduce the risk of legal issues.

For instance, a nonprofit might develop a volunteer handbook that outlines expectations, safety procedures, and confidentiality agreements. Regular training sessions can also help volunteers stay informed about best practices and legal requirements.

In summary, understanding the legal basics is essential for every nonprofit organization. From incorporation and tax-exempt status to governance, financial management, and volunteer management, these aspects are crucial for ensuring compliance and sustainability.