Starting and Managing a Nonprofit Organization E-Book

Bruce R. Hopkins

• Herausgeber: John Wiley & Sons
• Kategorie: Fachliteratur
• Serie: Wiley Nonprofit Authority
• Sprache: Englisch
• Veröffentlichungsjahr: 2012

Seitenzahl: 807

Beschreibung

Nuts-and-bolts guidance on the laws, rules, and regulations governing the nonprofit sector--from leading nonprofit law expert, Bruce R. Hopkins Nonprofits must comply with stringent federal and state laws due to their special tax-exempt status; the government's ultimate threat is revocation of a nonprofit's tax-exempt status, which usually means the nonprofit's demise. Written in plain English, not "legalese," Starting and Managing a Nonprofit Organization: A Legal Guide, Sixth Edition, provides essential guidance for those interested in starting nonprofits, as well as valuable advice for leaders of established organizations. * Revised and expanded to include updated information on changes in laws, rules, and regulations governing the nonprofit sector * Covers federal tax law, nonprofit, governance, the annual information return (Form 990), charitable giving rules, and current IRS ruling policy * Presents essential, practical legal information in easy-to-understand English * Explains the applications and implications of corporate, tax, and fundraising laws for nonprofits This easy-to-read resource contains essential information on virtually every legal aspect of starting and operating a nonprofit organization from receiving and maintaining tax-exempt status to tips for successful management practices.

Leseprobe

Contents

Cover

Title Page

Copyright

Dedication

Preface

Acknowledgments

Part One: Starting a Nonprofit Organization

Chapter One: What is a Nonprofit Organization?

A Bit of Philosophy

Nonprofit Organizations and Law

Legal Form

The Four Is

The Corporation

The Trust

The Unincorporated Association

Location

Chapter Two: Starting a Nonprofit Organization

An Illustration: A New Organization

An Initial Checklist

Board of Directors

Officers

Organizational Minutes

Identification Number

Chapter Three: Debunking Some Myths and Misperceptions

Myth 1: Nonprofit and Not-for-Profit are the Same

Myth 2: Nonprofit Organizations cannot Earn a Profit

Myth 3: An Organization must be Incorporated to be Tax-Exempt

Myth 4: Every Nonprofit Organization Qualifies as a Tax-Exempt Organization

Myth 5: Being Tax-Exempt Means that the Organization does not have to Pay any Taxes

Myth 6: All Tax-Exempt Organizations are Eligible to Receive Contributions that are Deductible for Federal Income Tax Purposes

Myth 7: A Tax-Exempt Organization must have a Ruling from the IRS Stating that it is Tax-Exempt

Myth 8: There is Something Called a Tax-Exempt Number

Myth 9: Only Charitable Organizations are Eligible to Receive Contributions that are Deductible for Federal Income Tax Purposes

Myth 10: A Charitable Organization cannot Engage in Legislative Activities

Myth 11: A Charitable Organization cannot Engage in Political Activities

Myth 12: Only the States Regulate the Process of Fundraising by Charitable Organizations

Myth 13: State Regulation of Fundraising for Charitable Purposes has Declined

Myth 14: Nonprofit Organizations have Fewer Reporting Obligations than For-Profit Organizations

Myth 15: A Nonprofit Organization must be Represented by a Professional (Lawyer or Accountant) to Secure Recognition of Tax-Exempt Status from the IRS

Myth 16: All Lawyers and Accountants are Competent to Represent a Nonprofit Organization

Myth 17: It is Easy to Find a Lawyer or Accountant who is Competent to Represent Nonprofit, Tax-Exempt Organizations

Myth 18: All Fundraisers are Equal in Competence

Myth 19: The IRS is Always Right

Myth 20: There is no Humor in the Federal Tax Law Bearing on Tax-Exempt Organizations

Myth 21: To be Charitable, an Organization cannot Charge Fees

Myth 22: To be Charitable, an Organization must Give Something Away

Myth 23: Everyone Loves Nonprofit Organizations

Myth 24: The IRS is the only Part of the Federal Government Involved in the Regulation of Nonprofit Organizations

Myth 25: Only Technical Personnel (such as Lawyers and Accountants) Need to Know the Information in this Book

Part Two: Being Nonprofit, Legally

Chapter Four: Nonprofit Organizations: Much More than Charity

Charitable Organizations

Educational Organizations

Religious Organizations

Scientific Organizations

Other Charitable Organizations

Ongoing Controversies

Social Welfare Organizations

Business Leagues

Chambers of Commerce

Social Clubs

Labor Organizations

Agricultural Organizations

Horticultural Organizations

U.S. Instrumentalities

Single-Parent Title-Holding Corporations

Multiparent Title-Holding Organizations

Local Employees' Associations

Fraternal Beneficiary Societies

Domestic Fraternal Societies

Voluntary Employees' Beneficiary Associations

Supplemental Unemployment Benefit Trusts

Black Lung Benefits Trusts

Multiemployer Pension Plan Trusts

Benevolent or Mutual Organizations

Cemetery Companies

Credit Unions

Mutual Insurance Companies

Crop Operations Finance Corporations

Veterans' Organizations

Farmers' Cooperatives

Shipowners' Protection and Indemnity Associations

Political Organizations

Homeowners' Associations

Prepaid Tuition Programs

Qualified Health Insurance Issuers

Other Tax-Exempt Organizations

Chapter Five: Nonprofits and Private Benefit

Private Inurement

Private Benefit

Joint Ventures

Intermediate Sanctions

Inurement and Intermediate Sanctions

Appearances

Chapter Six: From Nonprofit to Tax-Exempt

Recognition of Tax-Exempt Status

Recognition of Public Charity, Foundation Status

Application Procedure

Application Form

Bizarre IRS Positions

Group Exemption

Exemptions from Filing

Chapter Seven: Charities: Public or Private?

What is a Private Foundation?

Avoiding Private Foundation Status

Additional Options

Facing the Inevitable

Onerous Rules

Taxes

Conclusion

Chapter Eight: Governance: Board Duties and Liabilities

Basics of Governance Principles

Emerging Concepts

Nonprofit Governance Principles

Redesigned Annual Information Return

IRS Guidance

Board Member Responsibilities

Lawsuits against Nonprofit Organizations

Defending against Lawsuits

Individuals as Defendants

Chapter Nine: Braving Annual Reporting

Information Return Basics

IRS Guiding Principles

Summary of Annual Information Return

Sequencing Guidelines

Filing Exceptions

Electronic Filing Rules

Filing Requirements and Tax-Exempt Status

Chapter Ten: Tax Exemption: Not a Paperwork Exemption

Penalties

Disclosure Requirements

Political Organizations

Unrelated Income Tax Returns

Material Changes

Donee Returns

State Annual Reports

Charitable Solicitation Acts

Other Reporting

Chapter Eleven: Charitable Giving Rules

Types of Charitable Giving

Actual Practice

When is a Gift a Gift?

Qualified Donees

Gift Properties

Percentage Limitations

Deduction Reduction Rules

Twice Basis Deductions

Other Gift Properties

Partial Interest Gifts

Gifts of or Using Insurance

Appraisal Rules

Recordkeeping Rules

Gift Substantiation Rules

Quid Pro Quo Contributions

Reporting Rules

Chapter Twelve: Government Regulation of Fundraising

Fundraising Regulation at State Level

Constitutional Law Considerations

States' Police Power

Federal Regulation of Fundraising

Corporate Sponsorships

Fundraising by Means of Internet

Part Three: Tax-Exempt Organizations Can Be Taxable, and So Can Their Managers

Chapter Thirteen: Related or Unrelated?

Taxes

Unrelated Income Rules

Internet Activities

Charitable Remainder Trusts

Conclusion

Chapter Fourteen: Lobbying Constraints—And Taxes

Lobbying Restrictions on Charitable Organizations

Lobbying Restrictions on Other Nonprofit Organizations

Nontax Rules

Chapter Fifteen: Political Campaign Activities—And More Taxes

Political Activities by Charitable Organizations

Political Action Committees

Political Activities by Other Nonprofit Organizations

Advocacy Communications

Chapter Sixteen: Donor-Advised Funds, Tax Shelters, Insurance Schemes—And Still More Taxes

Donor-Advised Funds

Tax Shelters

Insurance Schemes

Part Four: Helpful Hints and Successful Techniques

Chapter Seventeen: Subsidiaries: For-Profit and Nonprofit

Establishing a For-Profit Subsidiary

Structural Considerations

Financial Considerations

Treatment of Revenue from Subsidiary

Subsidiaries in Partnerships

Title-Holding Corporations

Supporting Organizations

Other Nonprofit Subsidiaries

Chapter Eighteen: Joint Venturing and Other Partnering

Real Estate Acquisitions

Law Basics about Partnerships

Tax Exemption Issue

Law Basics About Limited Liability Companies

Multi-Member LLCs

Whole-Entity Joint Ventures

Ancillary Joint Ventures

Accountable Care Organizations

Single-Member LLCs

Aggregate Principle

Other Forms of “Partnering”

Chapter Nineteen: Wonderful World of Planned Giving

Appreciated Property Gifts—A Reprise

Planned Gifts—An Introduction

Charitable Remainder Trusts

Pooled Income Funds

Charitable Lead Trusts

Charitable Gift Annuities

Life Insurance

Charitable Split-Dollar Plans

Starting a Program

Chapter Twenty: Putting Ideas into Action

Joint Ventures

Partnerships

Planned Giving

Finding the Best Blend

Part Five: Sidestepping Traps

Chapter Twenty-One: Watchdogs on the Prowl

Watchdog Groups: An Overview

Issues Addressed by Watchdogs

Watchdog Standards and Charities' Rights

Watchdogs: A Closing Perspective

Chapter Twenty-Two: Potpourri of Policies and Procedures

Federal Tax Law and Governance

Current View of IRS

Sources of Policies

Policies Overview

Policies for Typical Nonprofit

Chapter Twenty-Three: Commerciality, Competition, Commensurateness

Commerciality Doctrine

Competition

Commensurate Test

Chapter Twenty-Four: IRS Audits of Nonprofit Organizations

Organization of IRS

Reasons for IRS Audits

IRS Audit Issues

Types of IRS Examinations

Compliance Checks

Hardening the Target

Winning the Audit Lottery

Coping with Examiners

Tours

IRS Audit Process

Closing Agreements

Appeals Process

Retroactive Revocations

Church Audit Rules

Litigation

Chapter Twenty-Five: Avoiding Personal Liability

Avoiding Personal Liability

Protect against Personal Liability

Part Six: Constitutional Law Perspective

Chapter Twenty-Six: Nonprofit Organizations and the Constitution

Constitutional Law Background

Definition of Nonprofit Organization

Eligibility for Tax Exemption

Rationale for Tax Exemption

Public Policy Doctrine

Freedom of Association Principle

Religion Clauses

State Action Doctrine

Corporate Independent Political Expenditures

Tax Exemption as Government Subsidy

Health Care Law Reform

Other Pronouncements

Judicial Deference and Tax Regulations

Glossary

Index

Cover Design: John Wiley & Sons, Inc.

Cover Image: © Kenneth Rivenes/Getty Images

Copyright © 2013 by Bruce R. Hopkins. All rights reserved.

Published by John Wiley & Sons, Inc., Hoboken, New Jersey.

Fifth edition of Starting and Managing a Nonprofit Organization: A Legal Guide published in 2009 by John Wiley & Sons, Inc.

Published simultaneously in Canada.

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Library of Congress Cataloging-in-Publication Data:

Hopkins, Bruce R.

Starting and managing a nonprofit organization : a legal guide / Bruce R. Hopkins. — Sixth Edition.

pages cm. — (Wiley nonprofit authority series)

Includes index.

ISBN 978-1-118-41345-6 (pbk.) ISBN 978-1-118-52062-8 (ebk); ISBN 978-1-118-52752-8 (ebk); ISBN 978-1-118-52048-2 (ebk)

1. Nonprofit organizations—Law and legislation—United States. 2. Nonprofit organizations—Taxation—Law and legislation—United States. I. Title.

KF1388.H66 2013

346.73′064—dc23

2012041955

To my parents, Frederick and Jane, who, as teachers, professional and otherwise, encouraged me, in their own way and in ways they may not realize, to write this book, with love.

Preface

This book was conceived about 25 years ago; the conception remains a vividly memorable experience. Its genesis occurred during a speech before managers of relatively small nonprofit organizations. I had been assigned some esoteric topic on the law of tax-exempt organizations and was about five minutes into my presentation when suddenly—to my chagrin—I realized, from the glazed-over looks, that few people in the audience had even the faintest idea what I was talking about. The remainder of them did not seem to care. Preservation instincts took over. The assignment was hopeless, so I abandoned my intended remarks. (I literally threw my notes on the floor, at least generating—to my relief—a little laughter.) Instead, we talked about what my audience really wanted to hear: some of the basics of the laws affecting nonprofit organizations.

The experience was not a measure of the level of intelligence of that particular audience; rather, it reflects the fact that those who manage nonprofit organizations—particularly the smaller ones—often lack understanding of the basics of the laws that regulate their operations and the legal problems that may be awaiting them in their blissful ignorance. A massive gap exists between the program planning and the legal expertise of many of those responsible for the fate of nonprofit organizations. The law can either help them achieve their goals or prevent them from succeeding.

I was struck by the thought that there was a need for a book providing a basic summary of the laws that affect the operation of nonprofit organizations. The book I envisioned would have no citations or footnotes—just readable text.

I had no shortage of questions from my practice, speeches over the years, and 21 years of teaching a law school course on tax-exempt organizations. I began recalling and noting these questions and was surprised to realize how the same ones are asked again and again. Even though I have practiced law in excess of 40 years, I still find myself asked many of the same basic questions. This book has been written to provide answers to those questions.

The questions are fundamental and important, but they reveal tremendous confusion. The confusion is understandable: The law in this field is confusing—even overwhelming. The ultimate purposes of this book are to decipher the Internal Revenue Code as it affects nonprofit organizations; to translate the intricacies of the law in these areas and try to make them understandable to nonlawyer managers of “nonprofits”; and otherwise to help to close the gap between goals and knowledge in nonprofit organizations.

The law affecting nonprofit organizations is volatile. Ongoing change in this field of law is a constant, and many regulatory changes lie ahead. I have tried to make the book sufficiently general to withstand most of this change. Yet, once the basics in this field are grasped, some readers may want more detail and more current information. My monthly newsletter, Bruce R. Hopkins' Nonprofit Counsel (Wiley), is a useful resource for keeping up with legal developments that affect nonprofit organizations.

For some readers, there may be more in the book than they need at this time, particularly if they are just beginning to establish a nonprofit organization or they are thinking about doing so. Let me offer this perspective for the newcomer to the world, and the law, of nonprofit organizations. There are many types of nonprofit organizations. Nearly always, those who start a nonprofit organization want it to be tax-exempt. At a minimum, they want it to be eligible to receive tax-deductible contributions. They equate nonprofit organizations with tax-exempt organizations and perhaps with charitable organizations.

For those who already know that they want a charitable entity, Chapter 4 can be skimmed as a review. For others, Chapter 4's inventory of the various types of tax-exempt organizations is the place to begin.

A fictional “Campaign to Clean Up America” is used throughout as an illustration of how to organize and qualify a tax-exempt charitable organization. Most individuals, when planning to establish a nonprofit organization, are thinking in terms of a charity, even if that thinking is only subconscious. Rarely have they selected between a public versus a private charity. Usually, they are thinking about the establishment of a foundation.

The first question for an individual interested in establishing a nonprofit organization should be: What is the nonprofit organization going to do? Just like starting a for-profit business, the first step is to determine the organization's functions, then match the category of tax-exempt status (if any) to the organization's purposes and functions. Too often, individuals start with a round-peg nonprofit organization (usually, a charitable one) and try to force it into the square-hole requirements of the law imposed on that type of organization.

A charity will not fit the requirements of all. Here are some of the other choices:

Advocacy organizations. These groups attempt to influence the legislative process or the political process, or otherwise champion particular positions. They may call themselves social welfare organizations or political action committees. Not all advocacy is lobbying. and not all political activity is political campaign activity. Some of this program can be accomplished through a charitable organization, but that outcome is rare where advocacy is the organization's primary undertaking. In some instances, two nonprofit organizations are used, to have it both ways—a blend of charitable and advocacy activities.Membership groups. Some nonprofit organizations—associations, veterans' groups, and fraternal organizations—are structured as membership organizations. This is not to say that a charitable organization may not be structured as a membership entity; it can, but there are other categories of membership groups. Frequently, these are business leagues.Social or recreational organizations. Nonprofit organizations may be organized as formal social clubs (like country clubs, and tennis and golf clubs), or hobby, garden, or sports tournament organizations. The key factor is their primary purpose; some social activity can be tolerated in charitable groups. There is some overlap with other categories—for example, a social organization can be structured as a membership entity.Satellite organizations. Some nonprofit organizations are deliberately organized as auxiliaries or subsidiaries of other organizations. Examples of these organizations include title-holding companies, the various types of cooperatives, and retirement and other employee benefit funds. The parent organization may be a for-profit entity, such as a business corporation with a related foundation.Employee benefit funds. The world of compensation is intricate, regardless of whether the employer is a for-profit or nonprofit organization. Various current and deferred benefits for employees are provided, including retirement and profit-sharing programs. These programs—or “plans”—are often financially supported by benefit funds. When properly organized and operated, these funds are tax-exempt entities.

Once the category of tax-exempt organization has been decided, the reader can turn to Chapter 5, which discusses the concepts of private inurement and private benefit. Among other things, it offers an explanation of the basic distinctions between nonprofit and for-profit organizations. An understanding of the private inurement doctrine is necessary because it applies to most tax-exempt organizations. The private benefit doctrine, by contrast, applies only to charitable organizations (although the IRS is trying to apply it in other contexts). Also in this chapter is a summary of the intermediate sanctions rules—a significant package of statutory law that affects charitable and social welfare organizations, and certain nonprofit health insurance issuers.

If the organization will engage in attempts to influence legislation, a jump ahead, for a reading of Chapter 14, is essential. If the organization is to engage in efforts to intervene or participate in political campaign activities, a perusing of Chapter 15 is necessary.

For charitable organizations, another jump ahead in the book may be in order. Because all charitable organizations are presumed to be private foundations and because there is little advantage in being so classified, most charitable entities strive to avoid private foundation status if they can. A review of the basic differences between public and private charities, included in Chapter 7, is important at the outset.

In addition to being tax-exempt, an organization may have charitable donee status. Not every tax-exempt organization can receive tax-deductible gifts, but many can. Chapter 4 identifies those that are charitable donees; Chapter 11 provides the basic charitable giving rules. An organization's charitable giving program ideally will include at least the rudiments of a planned giving program; this type of giving is described in Chapter 19. If a charitable gift solicitation program is planned, the organization must keep in mind the state and federal laws pertaining to fundraising. These laws are summarized in Chapter 12.

Nearly all charitable organizations must obtain a ruling from the Internal Revenue Service (IRS) that they are tax-exempt and eligible to receive deductible gifts. Most other categories of tax-exempt organizations may wish to obtain IRS rulings but are not required to do so. The process of obtaining such a ruling is the subject of Chapter 6, obviously a necessary chapter for new organizations. Readers will find it helpful to have a copy of IRS Form 1023 at hand when they reach this chapter. (The current form is dated June 2006.)

Another key chapter is Chapter 9, which outlines the various returns and reports that a tax-exempt organization must file, under both federal and state law. The principal form in this regard is Form 990. This return recently was significantly redesigned. Readers should have the most current form at hand when reading this chapter.

These days, the matter of governance is the hottest law issue for nonprofit organizations. Thus, Chapters 8 and 22 are essential reading.

Chapter 25 may be the most riveting chapter for those who are serving (or are thinking of serving) on boards of directors and/or as officers in nonprofit organizations. The chapter deals with personal liability (as does Chapter 8) and how to avoid it.

The balance of the book can be read when the topics are relevant for particular situations. For example, Chapter 11 focuses on the charitable giving rules, Chapter 12 concerns fundraising regulation, Chapter 13 pertains to the unrelated business rules, and Chapter 17 deals with the use of subsidiaries. Chapter 18 details involvements in partnerships.

Other chapters (16, 21, and 23) pertain to somewhat more esoteric topics—principally, donor-advised funds, tax shelters, insurance schemes, commerciality, and competition with for-profit organizations. Chapter 24 addresses a subject nonprofit entities dread the most: an IRS audit. Chapter 26 summarizes the principles of constitutional law applicable in the context of nonprofit organizations.

No book is a substitute for good legal or other professional advice. Some managers of nonprofit organizations are afraid to seek advice—out of embarrassment for asking “dumb questions” or fear of the costs involved. An operator of a nonprofit organization may not even realize the presence of a legal problem. This book is intended to ease those fears and close those gaps.

Bruce R. HopkinsKansas City, MissouriDecember 2012

Acknowledgments

This book is possible because of the contributions of many people: clients, participants at conferences and seminars, students, colleagues, and my wife. As to the latter, Bonnie J. Buchele, Ph.D., has been and is a director and/or officer of several nonprofit organizations; herewith, many questions and much free legal advice.

Many at John Wiley & Sons, have played significant roles in the development and production of this book. The process started with Jeffrey W. Brown, who provided leadership and much other helpful assistance with this and other projects over several years. He guided the preparation of the first edition. Then, Marla J. Bobowick stepped in, continuing the Wiley tradition of encouragement and support. It was during her years of service that Wiley undertook publication of my newsletter, Bruce R. Hopkins' Nonprofit Counsel. She guided preparation of the second edition of this book. Thereafter, the task of guiding me through the third edition fell to Martha Cooley, who did a terrific job (after recovering from the shock of receiving the manuscript unsolicited). Today, the individual who directs the majority of my writing time is Susan McDermott, who also is always there with support and assistance. Susan has overseen the fourth, fifth, and sixth of these editions. I acknowledge the contributions of all four of these wonderful individuals with thanks.

I further acknowledge a considerable debt to the copyeditor for the first and second editions of this book: Maryan Malone, then of Publications Development Company of Texas. Practicing law and writing legal documents over many years has not aided my book-writing style. To compensate, Maryan worked tirelessly to rid the text of nearly all of its “lawyerese.” Thanks again, Maryan; I never envied you your job. I hope the subsequent editions have not undone your work too much.

Still others at Wiley who have contributed considerably to this project are Robin Goldstein (third edition), Louise Jacob (fourth edition), Natasha A. S. Wolfe (fifth edition), and Jennifer MacDonald and Claire New (this edition).

B.R.H.

Part One

Starting a Nonprofit Organization

Chapter One

What is a Nonprofit Organization?

One of the most striking features of life as we settle into the third millennium is the awesome sweep of societal reform around the globe. Freedom of thought and action is now permitted in societies that previously knew only totalitarianism and suppression. Frequently, a country earns the label emerging democracy by introducing startling economic and political changes. Sometimes, this is accomplished by elections; sometimes, a revolution is necessary. Struggles for individual freedom are today commonplace throughout the world, whether in Eastern Europe, on the African continent, or in the roiling Middle East.

Countries that are planning transitions to a democratic state are discovering a fact that some Western countries learned a long time ago: In order to create and maintain economic and political freedom, which is the essence of a true democracy, the power to influence and cause changes cannot be concentrated in one sector of that state or society. There must be a pluralization of institutions in society, which is a fancy way of saying that the ability to bring about changes and the accumulation of power cannot belong to just one sector—namely, the government. A society that has achieved this type of pluralization is sometimes known as a civil society.

A strong democratic state has three sectors: a government sector, a private business sector, and a nonprofit sector. Each sector must function effectively and must cooperate with the others, to some degree, if the democracy is to persist for the good of the individuals in the society. A democratic society must be able to make and implement policy decisions with the participation of all three sectors. Ideally, a democratic society can solve some of its problems with minimal involvement of government if there is a well-developed and active nonprofit sector—charitable, educational, scientific, and religious organizations; associations and other membership organizations; advocacy groups; and similar private agencies.

Of all countries, the United States has the most highly developed sector of nonprofit organizations. The reach of the U.S. government is often curbed by the activities of nonprofit organizations, but that is a prime mark of a free and otherwise democratic society. The federal, state, and local governments acknowledge this fact (sometimes grudgingly) by exempting most nonprofit organizations from income and other taxes and, in some instances, allowing tax-deductible gifts to them. These tax enhancements are crucial for the survival of many nonprofit organizations.

When an individual in the United States perceives either a personal problem or one involving society, he or she does not always have to turn to a government for the problem's resolution. The individual, acting individually or with a group, can attempt to remedy the problem by turning to a nongovernmental body. There are obvious exceptions to this sweeping statement: Governments provide a wide range of services that individuals cannot, such as national defense and foreign policy implementations. Still, in U.S. culture, more so than in any other, an individual is often likely to use nongovernmental means to remedy, or at least address, personal and social problems.

A Bit of Philosophy

For most Americans, this mind-set stems from the very essence of our political history—distrust of government. We really do not like governmental controls; we prefer to act freely, as individuals, to the extent it is realistic and practical to do so. As the perceptive political philosopher Alexis de Tocqueville wrote in 1835, “Americans of all ages, all conditions, and all dispositions constantly form associations” (meaning nonprofit organizations) and “[w]henever at the head of some new undertaking you see the government in France, or a man of rank in England, in the United States you will be sure to find an association.” About 150 years later, John W. Gardner, founder of Common Cause, observed: “In the realm of good works this nation boasts a unique blending of private and governmental effort. There is almost no area of educational, scientific, charitable, or religious activity in which we have not built an effective network of private institutions.”

This “effective network of private institutions” (the nation's nonprofit organizations) is called the independent sector, the voluntary sector, or the third sector of U.S. society. For-profit organizations are the business sector; the governmental sector is made up of the branches, departments, agencies, and bureaus of the federal, state, and local governments.

Nonprofit organizations, particularly charitable ones, foster pluralization of institutions and encourage voluntarism. Society benefits not only from the application of private wealth to specific public purposes but also from the variety of programs that individual philanthropists, making gifts of all sizes, make available for support. Program choice–making is decentralized, efficient, and more responsive to public needs than the cumbersome and less flexible government allocation process. As John Stuart Mill observed, “Government operations tend to be everywhere alike. With individuals and voluntary associations, on the contrary, there are varied experiments, and endless diversity of experience.”

Contemporary writing is replete with statements of these fundamental principles. Here are some examples:

... the associative impulse is strong in American life; no other civilization can show as many secret fraternal orders, businessmen's “service clubs,” trade and occupational associations, social clubs, garden clubs, women's clubs, church clubs, theater groups, political and reform associations, veterans' groups, ethnic societies, and other clusterings of trivial or substantial importance.—Max Lerner

... in America, even in modern times, communities existed before governments were here to care for public needs.—Daniel J. Boorstein

... voluntary association with others in common causes has been thought to be strikingly characteristic of American life.—Merle Curti

We have been unique because another sector, clearly distinct from the other two [business and government], has, in the past, borne a heavy load of public responsibility.—Richard C. Cornuelle

The third sector is ... the seedbed for organized efforts to deal with social problems.—John D. Rockefeller

... the ultimate contribution of the Third Sector to our national life—namely, what it does to ensure the continuing responsiveness, creativity and self-renewal of our democratic society.—Waldemar A. Neilsen

... an array of its [the independent sector's] virtues that is by now fairly familiar: its contributions to pluralism and diversity, its tendency to enable individuals to participate in civic life in ways that make sense to them and help to combat that corrosive feeling of powerlessness that is among the dread social diseases of our era, its encouragement of innovation and its capacity to act as a check on the inadequacies of government.—Richard W. Lyman

The problems of contemporary society are more complex, the solutions more involved and the satisfactions more obscure, but the basic ingredients are still the caring and the resolve to make things better.—Brian O'Connell

Nonprofit Organizations and Law

The English language does not serve us well in this context, in that the term nonprofit organization is often misunderstood. This term does not refer to an organization that is prohibited by law from earning a profit (that is, an excess of gross earnings over expenses); nonprofit does not mean no profit. In fact, it is quite common for nonprofit organizations to generate profits. (These make the better clients.) Rather, the definition of nonprofit organization essentially relates to requirements as to what must be done with the profit earned or otherwise received. This fundamental element of the law is found in the doctrine of private inurement (see Chapter 5).

The word nonprofit, by the way, should not be confused with the term not-for-profit (although it often is). (For inexplicable reasons, the accounting profession prefers the phrase not-for-profit.) The former describes a type of organization; the latter describes a type of activity. For example, in the federal income tax setting, expenses associated with a not-for-profit activity (namely, one conducted without the requisite profit motive, as in the nature of a hobby) are not deductible as business expenses.

The concept in law of a nonprofit organization is best understood through a comparison with the concept of a for-profit organization. A fundamental distinction between the two types of entities is that the for-profit organization has owners that hold the equity in the enterprise, such as stockholders of a corporation. The for-profit organization is operated for the economic benefit of its owners; the profits of the business undertaking are passed through to them, such as by the payment of dividends on shares of stock. That is what is meant by the term for-profit organization: It is an entity that is designed to generate a profit for its owners. The transfer of the profits from the organization to its owners is pure private inurement—the inurement of net earnings to them in their private (personal) capacity. For-profit organizations are supposed to engage in private inurement.

By contrast, a nonprofit organization is not permitted to distribute its profits (net earnings) to those who control it, such as directors and officers. Normally, a nonprofit entity does not have owners; a few states allow nonprofit corporations to issue non–dividend paying stock. The U.S. Supreme Court has contemplated this point only once, writing that a “nonprofit entity is ordinarily understood to differ from a for-profit corporation principally because it is barred from distributing its net earnings, if any, to individuals who exercise control over it, such as members, officers, directors, or trustees.”

Simply stated, a nonprofit organization is an entity that is not permitted to engage in forms of private inurement. This is why the private inurement doctrine is the substantive defining characteristic that distinguishes nonprofit organizations from for-profit organizations for purposes of the law. To reiterate: Both nonprofit and for-profit organizations are legally able to generate a profit. Yet, as the comparison between the two types of organizations indicates, there are two categories of profit: one is at the entity level and one is at the ownership level. Both categories of entities can yield entity-level profit; the distinction between the two types of entities pivots on the latter category of profit.

Why, then, the confusion as to the meaning in law of the term nonprofit organization? The answer: For-profit and nonprofit organizations often look alike. (This fact is behind, for example, today's raging debates about the difference between tax-exempt and for-profit hospitals and exempt credit unions and commercial banks.) The characteristics of the two categories of organizations are often identical, in that both mandate a legal form (see discussion following), have directors (or trustees) and officers, have employees (and thus pay compensation and other employee benefits), face essentially the same expenses (such as for occupancy, supplies, travel, and, yes, legal and other professional fees), make investments, enter into contracts, can sue or be sued, produce goods and/or services, and (as noted) generate profits.

Legal Form

What form should a prospective nonprofit organization take? A lawyer may say, “It must be a separate legal entity.” What does that mean?

A nonprofit organization generally must be one of three types: a corporation, a trust, or an “other” (usually an unincorporated association). In recent years the limited liability company has emerged as a possible form. (Occasionally, a nonprofit organization is created by a legislature.) A common element in each is that there should be a creating document (articles of organization) and a document containing operational rules (bylaws).

Keep in mind that before an organization can be tax-exempt, it must be a nonprofit organization. Nonprofit organizations are basically creatures of state law; tax-exempt organizations are basically subjects of federal tax law. State tax exemption tends to follow the contours of the federal tax law (although the state real estate tax exemption rules are likely to be more stringent).

Once the decision has been made to form a nonprofit organization, the legal form of the organization must be considered. This is basically a matter of state law; the laws of the state in which the headquarters is based will govern this decision.

Assuming that the nonprofit organization is expected to qualify as a tax-exempt organization under both federal and state law, it is essential to see whether a particular form of organization is dictated by federal tax law. In most cases, federal law is neutral on the point. In a few instances, however, a specific form of organization is required to qualify as a tax-exempt organization. For example, a federal government instrumentality and a title-holding organization must, under federal tax law, be formed as corporations, while entities such as supplemental unemployment benefit organizations, Black Lung benefit organizations, and multiemployer plan funds must be formed as trusts. A multibeneficiary title-holding organization can be formed as either a corporation or a trust.

These are relatively technical types of nonprofit organizations; the vast majority need not be created by a mandated form. Thus, in the absence of a federal (or state) law requiring a particular form for the organization, the choice is made by those who are establishing the entity.

There are several factors to take into account in selecting the form of a nonprofit organization. Given the reality of our litigious society, personal liability looms as a major element in the decision. Personal liability means that one or more managers of a nonprofit organization (its trustees, directors, officers, and/or key employees) may be found personally liable for something done or not done while acting on behalf of the organization. (See Chapter 25.)

The Four Is

Some of this exposure to personal liability can be limited by one or all of the following: indemnification, insurance, immunity, and incorporation.

Indemnification occurs (assuming indemnification is legal under applicable state law) when the organization agrees (usually by provision in its bylaws) to pay the judgments and related expenses (including legal fees) incurred by those who are covered by the indemnity, when those expenses are the result of a misdeed (commission or omission) by those persons while acting in the service of the organization. The indemnification cannot extend to criminal acts and may not cover certain willful acts that violate civil law. Because an indemnification involves the resources of the organization, the real value of an indemnification depends on the economic viability of the organization. In times of financial difficulties for a nonprofit organization, an indemnification of its directors and officers can be a classic “hollow promise.”

Insurance is similar to indemnification. Instead of shifting the risk of liability from the individuals involved to the nonprofit organization, however, the risk of liability is shifted to an independent third party—an insurance company. Certain risks, such as criminal law liability, cannot be shifted via insurance. The insurance contract will likely exclude from coverage certain forms of civil law liability, such as libel and slander, employment discrimination, and antitrust matters. Even where adequate coverage is available, insurance can be costly; premiums can easily amount to thousands of dollars annually, even with a sizeable deductible.

Immunity is available when state law provides that a class of individuals, under certain circumstances, is not liable for a particular act or set of acts or for failure to undertake a particular act or set of acts. Several states have enacted laws for officers and directors of nonprofit organizations, protecting them in case of asserted civil law violations, particularly where these individuals are functioning as volunteers.

Incorporation is the last of the four Is. This additional form of protection against personal liability is discussed next, as part of the summary of the type of legal entity known as the corporation.

The Corporation

A corporation is a separate legal entity. Liability is generally confined to the organization and does not normally extend to those who manage it. For this reason alone, a nonprofit organization should probably be incorporated.

Incorporation has another advantage. The state nonprofit corporation law may provide answers to many of the questions that inevitably arise when forming and operating a nonprofit organization. Here are some examples:

How many directors must the organization have? What are their voting rights? How is a quorum ascertained? How is notice properly given? What is the length and number of their terms of office?What officers must the organization have? What are their duties? What is the length and number of their terms of office? Can more than one office be held by the same individual?How frequently must the governing board meet? Must the board members always meet in person, or can the meetings be by telephone conference call or video teleconferencing? Can the board members vote by mail or unanimous consent? Can they use proxies?If there are members, what are their rights? When must they meet? What notice of the meetings must be given? How can they vote?What issues must be decided by members (if any)? By directors?May there be an executive committee of the governing board? If so, what are its duties? What limitations are there on its functions?What about other committees, including an advisory committee? Which are standing committees?How are the organization's governing instruments amended?How must a merger of the organization occur?What is the process for dissolving the organization? For distributing its assets and net income on dissolution?

Nearly every state has a nonprofit corporation act. The answers to these and many other questions may be found in that law. If the organization is not a corporation, these and other questions are usually unanswered under state law. The organization must then add to its rules the answers to all the pertinent questions (assuming they can be anticipated) or live with the uncertainties.

There is a third reason for the corporate form: More people will know what the entity is. People are familiar with corporations. The IRS knows corporations. Private foundations understand corporations as potential grantees. In general, the work in which the nonprofit organization will be functioning is compatible with the concept of a corporation.

In contrast to the three advantages of incorporation—limitation against personal liability, availability of information concerning operations, and the comfort factor—what are the disadvantages of incorporation? Generally, the advantages far outweigh the disadvantages. The disadvantages stem from the fact that incorporation entails an affirmative act on the part of the state government: It “charters” the entity. In exchange for the grant of corporate status, the state usually expects certain forms of compliance by the organization, such as adherence to rules of operation, an initial filing fee, annual reports (which are public documents), and annual fees. These costs are frequently nominal, however, and the reporting and disclosure requirements are usually not extensive.

A nonprofit organization that is a corporation is formed by preparing and filing articles of incorporation, with its operating rules embodied in bylaws. The contents of the articles of incorporation, dictated in part by state law, will usually include

The name of the organizationA general statement of its purposesThe name(s) and address(es) of its initial director(s)The name and address of its registered agentThe name(s) and address(es) of its incorporator(s)Language referencing the applicable federal tax law requirements

The bylaws of an incorporated nonprofit organization will usually include provisions with respect to

Its purposes (it is a good idea to restate them in the bylaws)The election and duties of its directorsThe election and duties of its officersThe role of its members (if any)Meetings of members and directors, including dates, notice, quorum, and votingThe role of executive and other committeesThe role of its chapters (if any)The function of affiliated organizations (if any)The organization's fiscal yearLanguage referencing the applicable federal tax law requirements (again, a good idea to repeat this in the bylaws)

Some organizations adopt operational rules and policies stated in a document that is neither articles of incorporation nor bylaws. These rules may be more freely amended than articles or bylaws. They should not, however, be inconsistent with the articles or bylaws.

The Trust

A nonprofit organization may be formed as a trust. This is rarely an appropriate form for a nonprofit organization other than a charitable entity or some of the funds associated with employee plans. Many private foundations, for example, are trusts. Those created by a will are known as testamentary trusts.

Most nonprofit organizations, however, particularly those that will have a membership, are ill-suited to be structured as trusts.

The principal problem with structuring a nonprofit organization as a trust is that most state laws concerning trusts are written for the regulation of charitable trusts. These rules are rarely as flexible as contemporary nonprofit corporation acts, and frequently impose fiduciary standards and practices that are more stringent than those for nonprofit corporations.

A nonprofit organization that is to be a trust is formed by the execution of a trust agreement or a declaration of trust. Frequently, only one trustee is necessary—another reflection of the usual narrow use of trusts.

The trustees of a trust do not have the protection against personal liability that is afforded by the corporate form.

Although a fee to the state is rarely imposed upon the creation of a trust, most states impose on trusts an annual filing requirement for the trust agreement or declaration of trust.

It is unusual—although certainly permissible—for the trustee(s) of a trust to adopt a set of bylaws.

The Unincorporated Association

The final type of the usual nonprofit organization is the unincorporated association.

To the uninitiated, a nonprofit corporation and a nonprofit unincorporated organization look alike. For example, a membership association has the same characteristics, whether or not it is incorporated. The shield against individual liability provided by the corporate form, however, is unavailable in connection with an unincorporated association.

An unincorporated association is formed by the preparation and adoption of a constitution. The contents of a constitution are much the same as the contents of articles of incorporation; the contents of bylaws of an unincorporated association are usually the same as those of a nonprofit corporation.

It is relatively uncommon for an unincorporated association to have to register with and annually report to a state (other than for fundraising regulation purposes; see Chapter 12).

Occasionally, nonprofit organizations will have articles of incorporation, a constitution, and bylaws. This is technically improper. For an incorporated nonprofit organization, the constitution is a redundancy.

Trusts and unincorporated associations are likely to have less contact with the state than nonprofit corporations, but this advantage is usually overshadowed by more substantive disadvantages.

In some states (e.g., California and New York), the nonprofit corporation and trust law is far more refined. Careful examination of these and other relevant laws is essential when an organization is to be formed in, or to operate in, one or more of these states. In addition, some states have far more stringent laws concerning mergers and dissolutions.

In summary, as a general rule a nonprofit organization has clear advantages if it is organized as a corporation. Nonetheless, the facts and circumstances of each situation must be carefully examined to be certain that the most appropriate form is selected.

Location

The starting point for organizing a nonprofit organization is the law of the state. But which state? Although it can operate in more than one jurisdiction, an organization can be created or formed under the law of only one jurisdiction (at a time). In most instances, this means selecting the jurisdiction in which the organization will be headquartered.

Because the process of qualifying an organization to do business in a state is about the same as incorporating it, there usually is no point in forcing the organization to comply with the laws of two states. There are exceptions to this rule: A stock-based nonprofit organization may be appropriate, or perhaps only one director is desired. Another consideration is the degree of regulation imposed by the office of a state's attorney general or comparable agency; this element varies widely from state to state. If an organization is formed in one state but has offices in one or more other states, this duplication of effort is unavoidable.

A caution: If a nonprofit organization is formed in one jurisdiction and the plan is to qualify it in another, be certain that the organization will meet the requirements of the law of the state of qualification. For example, not all states allow a nonprofit organization formed as a corporation with stock to qualify.

Checklist

Chapter Two

Starting a Nonprofit Organization

Being enthusiastic, imaginative, and creative about establishing a nonprofit organization is one thing. Actually forming the entity and making it operational is quite another matter.

For better or worse, this exercise is much like establishing one's own for-profit business. It is a big and important undertaking, and it should be done carefully and properly. The label nonprofit does not mean “no planning.” Forming a nonprofit organization is as serious as starting up a commercial company.

It is important when setting up an organization to remember that in some instances, the same activity or activities may be undertaken in a for-profit or nonprofit organization. Other considerations come into play as well, such as whether the motive for starting the organization is profit (so that money can be taken out as dividends or money can be made when the stock is sold). In a rare instance, the choice of entity may be dictated by the realities of initial financing. (In an example of the latter, some individuals in New York City decided to establish a Museum of Sex. The original plan was that the museum would be nonprofit but the initial funding could not be obtained because prospective donors and private foundations were leery of the concept. So, the founders attracted capital and made it a for-profit museum.)

Many nonprofit organizations are started on a shoestring; the individuals involved undertake tasks they would never do if they were starting a commercial enterprise. One of the reasons is a widespread nonprofit mentality—a belief that because the undertaking is nonprofit, it need not pay for services rendered. Encumbered with this view, the sponsors of the organization will, in abundant good faith and with the best of intentions seek—or even expect—free assistance. Sometimes, this attitude carries over to the acquisition of equipment and supplies.

In some instances, this nonprofit mentality is wonderful. It enables a skilled manager to parlay a horde of earnest volunteers into a magnificent service-providing organization. Truly skilled managers are rare, however, and anyone considering organizing and operating a nonprofit organization is well advised not to skimp on hiring three consultants: a lawyer, an accountant, and a fundraiser. The professional services of these individuals are crucial. The old adage, “You get what you pay for,” is amply applicable here.

An Illustration: A New Organization

Let's reduce the role of nonprofit organizations to a more practical level. What problems in society trouble you? How would you solve these problems if:

Sufficient money were available to fund the programs you feel are needed?

No governmental agency were to become directly involved?

Suppose you decide that something must be done nationwide about littering. You intensely dislike the cluttering of the environment with an assortment of bottles, cans, and other trash, and you resent those who do the littering. You realize that this is not a problem that you can conquer singlehandedly, and you suspect (correctly) that there is not much money in the coffers of your town, county, state, or federal treasuries to be used for more trash control. Yet you suspect (also correctly) that others in your community and around the nation feel the same about the accumulating litter as you do.

In the best tradition of problem solving in the United States, you decide to form an organization to “do something.” In your opinion, the trash problem can be solved in two basic ways: pickup and disposal, and public education. You envision scores of volunteers who will comb the streets, parks, and other areas of their communities, picking up trash and distributing antilitter literature. Your hope is that greater sensitivity to the trash problem will inhibit littering and encourage citizens to be more willing to clean up their communities and keep them clean.

Being not one of the rich and famous, you begin thinking about how you will fund this organization and the specific nature of its programs. As your plans take shape, you mention your ideas to a neighbor, who is a labor-relations lawyer. He has only a vague idea of what to recommend, but he helps you contact one of his law partners who practices in the field of corporate and tax law.

While you are driving to the first appointment, your car radio delivers a fundraising message on behalf of a charitable organization that has a catchy name and some memorable slogans. Suddenly, you realize that your organization-to-be must likewise be a charitable one (to be exempt from taxes and to receive deductible gifts) and that it needs a suitable name. By the time you reach the lawyer's office, you know what the name will be: “Campaign to Clean Up America.”

The lawyer is a specialist in the field of nonprofit, tax-exempt organizations. She takes down from her bookshelf a 1977 report by a body known as the Commission on Private Philanthropy and Public Needs, and reads this passage:

The practice of attending to community needs outside of government has profoundly shaped American society and its institutional framework....This vast and varied array is, and has long been widely recognized as part of the very fabric of American life. It reflects a national belief in the philosophy of pluralism and in the profound importance to society of individual initiative.

Next, she produces a copy of congressional testimony in 1973, when George P. Shultz, then Secretary of the Treasury, said that charitable organizations “are an important influence for diversity and a bulwark against overreliance on big government.”

Then, as befits a lawyer, she reaches into the casebooks. A federal court of appeals, in the context of explaining the rationale for tax-exempt status for nonprofit organizations, had this to say:

[O]ne stated reason for a deduction or exemption of this kind is that the favored entity performs a public service and benefits the public or relieves it of a burden which otherwise belongs to it.

For further backup, the lawyer turns to a U.S. Supreme Court decision:

The State has an affirmative policy that considers these groups as beneficial and stabilizing influences in community life and finds this classification [tax exemption] useful, desirable, and in the public interest.

She then reads from a federal district court opinion concerning the charitable contribution deduction. The court stated that the reason for the deduction has “historically been that by doing so, the Government relieves itself of the burden of meeting public needs which in the absence of charitable activity would fall on the shoulders of the Government.”

By this time, your enthusiasm and vision are nearly boundless. Here you are, thinking and acting in the finest American traditions: approaching and solving a problem, invoking the principles of pluralism and voluntarism, demonstrating your care and “resolve to make things better”—all without government help. You're relieving government of a responsibility that society must assume. You feel that, almost singlehandedly, you are ensuring the “continuing responsiveness, creativity, and self-renewal of our democratic society.”

Twenty minutes later, however, your soaring enthusiasm for ridding the United States of its litter has plummeted into deep confusion. What seemed like such a wonderful concept has been quickly and repeatedly punctured with swirls of advice about state corporate law intricacies, emerging principles of nonprofit governance, warnings of personal liability, gobbledygook about the law of deductible charitable giving, babble about related and unrelated activities, something about state regulation of fundraising, talk of a Form 1023 and Form 990, and—here the lawyer has totally lost you—a discourse on private inurement and private benefit, and something called intermediate sanctions, the distinctions between private foundations and public charities, and rules regarding the disclosure of tax documents.

Discouraged, and rapidly abandoning any more thoughts about saving your country from the onslaught of more rubbish, you dejectedly mumble something about paying a fee for the consultation and prepare to leave. Sensing your dejection and despair, the lawyer assures you that, although the startup may be more complex than you thought, you have a good idea and she can help you (for a reasonable fee) through the maze of laws to your goal. Implicitly trusting her, you agree to proceed. In a few short months, you have a successful, nationwide, multimillion-dollar charitable organization to combat the blight of trash in the American environment. In fact, you have quit your job and are now the full-time, paid president of the Campaign to Clean Up America.

An Initial Checklist

Looking back, you review the questions that you and the lawyer resolved:

What should be the form of the organization? Why? In what jurisdiction should it be formed?Who should be its directors and officers? Why? What about their personal liability? Should there be employees? Consultants? Compensation arrangements?What will be the organization's activities? Will some of them be unrelated businesses?How will the organization achieve its goals at the community level? Will it have chapters? Members? In either case, what will be the criteria?How can the organization be exempt from federal and state taxation?How will the organization be funded? By gifts? By grants? By income from the performance of exempt functions? By endowment income? By unrelated income?Will the organization be public or private?To what extent will gifts to the organization be deductible?What reports must be filed with federal and state governmental agencies?What are the applicable laws on fundraising requirements?Do the doctrines of private inurement or private benefit have any applicability to what the organization will be doing?Are there any aspects of the organization's operations that might trigger application of the intermediate sanctions penalties?Can or should the organization engage in lobbying or political campaign activities?Is there a need for a separate fundraising foundation?Should a for-profit subsidiary be established?Would it be appropriate for the organization to “partner” with one or more other organizations?

You're aware that there are subsidiary questions within each of these categories. Numerous other questions have come up since you became president. Some are on your desk now, and you surmise (all too correctly) that many others lie ahead.

FOCUS: Campaign to Clean Up America

After consideration of all of the relevant factors, the decision is made (in conformance with the lawyer's advice) to form the Campaign to Clean Up America (CCUA) as a nonprofit corporation. The aspect of limited personal liability is of particular interest, and you can see few disadvantages to incorporation of the entity. (Regarding personal liability, the lawyer advises the use of an indemnification provision and points out that in some instances, under Missouri law, directors and officers of nonprofit organizations are immunized from personal liability.) You instruct the lawyer to prepare the articles of incorporation for the CCUA and to incorporate it in your home state of Missouri.

Board of Directors

Every nonprofit organization—irrespective of form—must have at least one director (or trustee). Few nonprofit organizations, however, have just one manager. (In tax-law language, directors, officers, and key employees are managers.)

The directors are those who set policy for and generally administer the organization (see Chapter 8). The word generally is used here because day-to-day management is supposed to be the province of the employees and, sometimes, the officers. The directors are the policymakers of the organization—they develop plans for the organization and oversee its affairs. In reality, it is difficult to set a precise line of demarcation as to where the scope of authority of the board of directors stops and the authority of the officers begins. The authority of directors and officers in relation to the authority of employees is equally hard to separate. All too frequently, authority or “territory” is resolved on an occasion-by-occasion basis—in the political arena, not the legal one—by the sheer force of personalities.

Although many state nonprofit corporation laws require at least three directors, many nonprofit organizations have far larger governing boards. State laws never set a maximum number of nonprofit organization directors. The optimum size of a governing board of a nonprofit organization depends on many factors.

One factor that affects the size of a nonprofit organization's governing board is the manner in which its membership is elected. If there are bona fide members of the nonprofit organization, it is likely that these members will elect some or all of the members of the governing board. This election may be conducted by mail ballot, online, or by voting at an annual meeting. In some instances, the board may include some ex officio positions (such as one or more of the officers, one or more past presidents, or individuals who hold positions in a separate but related organization). It is quite possible, however, for a nonprofit organization with a membership to have a governing board that is not elected by that membership.

In the absence of a membership (or if the membership has no vote on the matter), the governing board of a nonprofit organization may be a self-perpetuating board. In this case, the initial board may continue with those whom it elects and with subsequent boards. Again, there may be one or more ex officio positions.

In many nonprofit organizations, the source of the membership of the governing board is preordained. Some examples include the typical membership organization that elects the board (for example, a trade association, a country club, or a veterans' organization); a hospital, college, or museum that has a governing board generally reflective of the community; and a private foundation that has one or more trustees who represent a particular family or a corporation.